From left: Michelle De Oliveira and Greg Vanden-Eykel
On Jan. 5, 2023, the Federal Trade Commission (FTC) proposed a rule to ban noncompetition clauses. If promulgated, this new rule will also require employers to rescind all existing noncompetition agreements and clauses, in writing. The proposed rule is based on, among other things, the FTC’s preliminary findings that noncompetition clauses constitute an unfair method of competition and that the current regulatory environment concerning noncompetition clauses allows for serious and unchecked anti-competitive conduct that harms the labor and service markets.
To issue the rule, the FTC relied on purported authority under the Federal Trade Commission Act. Specifically, the FTC cited Section 6(g), which authorizes it to make rules and regulations to carry out the act’s provisions. According to the FTC, Section 6(g) allows it to make rules prohibiting unfair methods of competition — including noncompetition clauses.
Public comment concerning the rule was open until March 10, 2023. On Jan. 31, 2023, 100 business organizations submitted a letter to the FTC requesting a 60-day extension of the public comment period, through May 10, 2023. Business organizations supporting the extension request include organizations in, among other things, commerce, retail, insurance, health care, technology, financial services and construction.
Although the FTC’s proposed rule and noncompete ban is months away from implementation (if at all), the mere fact that such a significant change is being contemplated is sending shockwaves throughout the business and legal communities.
A. Noncompetition Clauses And The Reach Of The Proposed Rule
The FTC’s proposed rule defines a noncompete clause as a contractual provision between an employer and a worker that prevents the worker from “seeking or accepting employment with a person, or operating a business” after the employment relationship ends. The proposed rule does not stop there, however.
Noncompetition clauses also include “de facto” noncompete clauses — or clauses that have the “effect of” prohibiting a worker from “seeking or accepting employment with a person or operating a business” after the employment relationship ends. The proposed rule includes two examples of a de facto noncompete clause:
(a) a broad nondisclosure agreement that does not allow a worker to work in the same field after an employment relationship ends. Although not further detailed in the proposed rule, it is not difficult to see how this language may also apply to confidentiality agreements, nonsolicitation agreements or intellectual property agreements that employers often employ to protect their trade secrets and goodwill.
(b) a contractual provision that requires a worker to pay training costs to the employer or to a third-party entity if the worker’s employment ends within a specified time period in circumstances in which the required payment “is not reasonably related to the costs the employer incurred for training the worker.” The proposed rule contains no additional language explaining this de facto clause. However, employers who provide education assistance programs that require a certain time commitment from employees after completion of the program may be directly impacted by this provision.
These are merely examples — and there could be other contractual terms that have the “effect of” prohibiting a worker from “seeking or accepting employment with a person or operating a business” after the employment relationship ends. The FTC has proposed a “functional test” to determine if a clause in an employment agreement, regardless of how it is labeled, constitutes a noncompetition clause.
However, the proposed rule does not include any factors or criteria for employers to consider when drafting employment agreements. The breadth of any restrictive covenant will likely be considered a determinative factor in evaluating the enforceability of any such agreement, and judicial decisions will inevitably turn on the specific facts of a given dispute.
B. To Whom Does the Proposed Rule Apply?
The proposed rule prohibits “employers” from requiring “workers” to enter into noncompetition clauses. Therefore, practically all individuals, corporations, partnerships, associations and other legal entities are prohibited from entering into noncompete clauses.
Under the proposed rule, the FTC defines the term “worker” as “a natural person who works, whether paid or unpaid, for an employer.” It includes employees, independent contractors, externs, interns, volunteers, apprentices, a sole proprietor who provides a service to a client or customer, and a natural person who works for a franchisee or franchisor. However, franchisees in the context of a franchisee-franchisor relationship are excluded from the FTC’s “worker” definition and, therefore, would not be subject to the noncompete ban. Absent further revision of the rule after public comment, franchisees appear to be the only exception in the context of the “employer / employee” relationship.
With this said, the proposed rule includes a significant exception related to the sale of a business. Specifically, noncompete clauses are still enforceable under the proposed rule if a person is:
(a) selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity; or
(b) selling all or substantially all of a business entity’s operating assets, when the person restricted by the noncompete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the noncompete clause.
For the second exception to apply, the person who is subject to the noncompete clause must hold at least a 25% ownership interest in the business entity. The 25% threshold leaves open the possibility that individuals with a significant ownership interest in a business (up to 24.9%) who have access to substantial confidential and propriety information and trade secrets could compete with their former employers with little to no limitation. This threshold greatly impacts small businesses with fewer owners. As such, this portion of the proposed rule may be subject to extensive public comment and is prime for revision in any final rule.
C. Existing Noncompete Clauses
Not only does the proposed rule prohibit employers from entering or attempting to enter into noncompete clauses with workers after the enactment of the rule, but it also renders unenforceable those noncompete clauses that were in place before the final rule.
Employers that entered into a noncompete clause with a worker before the implementation of the new rule will be required to:
(a) rescind the noncompete; and
(b) provide written notice to the worker that the noncompete clause is no longer in effect and cannot be enforced. Notice must be provided to each affected employee on an individualized basis and within 45 days of rescinding the noncompete clause.
Current and former workers must receive written notice. As to former workers, notice need only be provided if the employer has the worker’s contact information readily available. As drafted, the proposed rule applies to all former workers for whom the employer has contact information readily available, an apparent broad and onerous obligation. The rule does not define the meaning of “readily available” or whether the employer has any duty to obtain contact information. If the rule is promulgated, employers will need to consider implementing best practices regarding notice and documentation of the same.
D. Immediate and Long-Term Impact of the Proposed Rule
If enacted, the proposed rule will become effective 180 days
after the final rule’s publication. Accordingly, the proposed rule has no immediate impact on noncompete clauses.
If the proposed rule becomes final, it will supersede and trump inconsistent state laws and regulations. In Massachusetts, this will almost certainly lead to the repeal or substantial amendment of M.G.L. c. 149, § 24L, which permits noncompetition agreements under specific circumstances. Further, it is quite possible that a final rule will eliminate many of the exceptions to the definition of noncompetition agreements under current Massachusetts law (e.g., nondisclosure or confidentiality agreements, noncompetition agreements made outside of the employment relationship, and noncompetition agreements made in connection with the cessation of or separation from employment). Accordingly, in the long term, the enactment of this rule will significantly change the nature of employer/worker relationships in Massachusetts.
Further, if the final rule is enacted, employers who attempt to enter into noncompete clauses or who fail to rescind existing noncompete clauses (including a failure to comply with the notice requirements) may violate M.G.L. c. 93A and become subject to multiple damages and attorneys’ fees related to such violations. Specifically, M.G.L. c. 93A, § 2 requires courts to be guided by the FTC’s interpretations of unfair or deceptive practices, as amended from time to time. Although courts do not typically find violations of M.G.L. c. 93A in the employer/employee context, the proposed rule may alter this precedent given the FTC’s clear statement that noncompete agreements constitute unfair competition.
With all of this said, litigation appears inevitable, as business advocacy groups have pledged to sue the FTC if the proposed rule is implemented. Legal questions remain open as to whether the FTC has the authority to issue substantive rules such as imposing a nationwide noncompete ban — an issue that has been largely left to the states. Further, a recent U.S. Supreme Court case,
West Virginia v. EPA, could apply to limit the FTC’s rulemaking authority if this proposed rule triggers the “major question doctrine,” which requires specific congressional authority or a “clear statement” of congressional authority for an agency or commission such as the FTC to enact a rule with “political and economic significance.” These are only a couple of examples of the legal challenges facing the proposed rule. Undoubtedly, the proposed rule will be scrutinized closely and is likely to undergo several revisions before any final rule is enacted, if at all.
Businesses and employment attorneys across the nation will be keeping a close eye on further developments given the significant consequences that the FTC’s proposed rule may have.
Michelle De Oliveira is a director at Kenney & Sams in Boston. She focuses her practice on litigation and counseling aspects of employment-related matters, including without limitation, wage and hour, restrictive covenants, leaves of absence, retaliation, discrimination and sexual harassment. She counsels employers and HR professionals on issues relating to disciplinary actions, internal investigations, and the drafting of employment policies, handbooks and contracts. De Oliveira conducts trainings relating to discrimination, sexual harassment, and management practices. In addition to her employment practice, De Oliveira maintains a general litigation practice, representing clients in general commercial litigation matters. She is currently serving as the chair of the Massachusetts Bar Association’s Labor & Employment Section Council. De Oliveira is a graduate of Northeastern University and Northeastern University School of Law, and is a member of the Northeastern University School of Law’s Alumni/Ae Association’s Board of Directors.
Greg Vanden-Eykel is a partner with Kenney & Sams and an employment lawyer who counsels companies and individuals on all aspects of the employer-employee relationship. Often serving as outside general employment counsel, Vanden-Eykel guides management in all employment-related needs, including contracts, employee handbooks, personnel policies, noncompetition agreements, workplace safety, employee discipline, and hiring and terminations. Vanden-Eykel also handles administrative matters, restrictive covenants, wage and hour, regulatory issues, and employee and independent contractor classification matters. Vanden-Eykel also represents employers in litigation matters in state and federal courts, as well as before the Massachusetts Commission Against Discrimination and the Rhode Island Commission for Human Rights.