After centuries of use as a staple of employment law, the non-compete clause may soon become a relic of the past. On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a new rule to ban employers in the United States from including non-compete clauses in employment agreements with workers.[i] The aptly-named “Non-Compete Clause Rule” would “among other things, provide that it is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; or to maintain a worker with a non-compete clause; or, under certain circumstances, to represent to a worker that the worker is subject to a non-compete clause.”[ii] With this rule, the FTC will fundamentally reshape the employment law landscape in the United States.
A non-compete clause, also known as a restrictive covenant, is a contractual agreement often included in employment contracts, business contracts, or agreements related to the sale of a business.[iii] This contractual provision restricts one party, usually an employee or a business owner, from engaging in competitive activities or working for a competing business within a specified time period and geographic area after the termination of the contract or employment relationship. Non-compete clauses serve a dual purpose: On the one hand, they protect employers’ interests by safeguarding trade secrets, proprietary information, and client relationships, while on the other hand, they often hinder employees’ job mobility and entrepreneurial aspirations.
Balancing employers’ and employees’ interests is a longstanding point of contention in labor law. The origins of non-compete clauses can be traced back centuries: As far back as Dyer’s Case in 1414, English common law refrained from enforcing non-compete agreements due to their nature as a restraint on trade.[iv] This ban remained unaltered until Broad v. Jollyffe in 1621, which recognized a limited geographic restriction as an enforceable exception to the previous absolute rule.[v] Nearly a century later, in 1711, the exception became the rule in the pivotal case of Mitchel v. Reynolds, which established the principle that limited restraints on trade could be considered valid and enforceable.[vi] It is this principle that led to the modern framework for evaluating the enforceability of restrictive covenants based on reasonableness of time and location.
The current status of non-compete clauses in the United States is far from uniform. Non-compete agreements have primarily been subject to state regulation, and each state has made individual policy decisions regarding these agreements to protect their respective citizens and economies. While 46 states permit the use of restrictive covenants to varying extents, four states—California, Minnesota, North Dakota, and Oklahoma—have opted to ban employee non-compete agreements outright.[vii] Of those that permit restrictive covenants, some states enforce them vigorously, while others have adopted more employee-friendly policies. For example, ten states have imposed bans on non-compete clauses for low-wage workers,[viii] while seven states and the District of Columbia have imposed notice requirements.[ix] Courts apply independent judicial standards and evaluate the enforceability of non-compete clauses based on factors such as the reasonableness and duration of the restrictions, the geographic scope, and the legitimate business interests protected by the non-compete.
The wild variation in enforceability has generated debates over whether non-compete agreements unduly limit workers’ rights and hinder economic mobility.[x] For example, when news outlets revealed in 2014 that sandwich chain Jimmy John’s forced employees of its franchises to sign two-year, 10-mile non-competition agreements to prevent them from working for rival sandwich shops, several states, including New York and Illinois, launched investigations into whether the use of non-compete agreements for low-wage workers was unconscionable.[xi] The New York Attorney General concluded that the non-compete agreements limited mobility and opportunity for vulnerable workers and bullied them into staying in low-paying jobs under the threat of being sued. While Jimmy Johns ultimately agreed to stop including noncompete clauses in its hiring documents in 2016 and voided past agreements, under the new FTC rule, they would never have been able to restrict employees’ abilities to earn a livelihood.
In proposing an outright ban on non-compete agreements, the FTC rule aims to take a blunt hammer to the patchwork of state laws in an attempt to uniformly strengthen workers’ rights. The proposed rule would add a functional test for whether a contractual term is a non-compete clause: Under the test, any terms that have the effect of prohibiting a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with his current employer are considered de facto non-compete clauses and are prohibited as unfair methods of competition under antitrust law.[xii] The proposed rule only applies to non-compete clauses between employees and employers and exempts non-compete clauses entered by parties pursuant to the sale of a business—however, those transactions are subject to Federal antitrust law.
The proposed rule may offer significant advantages to employees: The agency estimates that the rule could increase wages by nearly $300 billion per year and expand career opportunities for about 30 million Americans. Indeed, the FTC asserts that employers’ use of non-compete agreements to restrict workers’ mobility significantly suppresses workers’ wages—even for those not subject to non-competes or subject to non-competes that are unenforceable under state law. The rule has also spurred other agencies to act: The National Labor Relations Board endorsed the FTC rule, announcing its intent to prosecute employers that use overbroad noncompete agreements as violating workers’ Section 7 rights under the National Labor Relations Act, which protects employees’ rights to take collective action to improve their working conditions.[xiii]
Of course, the FTC rule may significantly hinder employers’ ability to protect their intellectual property and competitive advantages, and they will likely face increased competition in hiring employees from competitors. However, the ultimate purpose of the non-compete ban is to protect free trade and safeguard employees’ rights by promoting job mobility without fear of legal repercussions. While non-compete clauses have been the law of the land for centuries, the FTC has now taken the dramatic step that the balance should tip in favor of workers. If the proposed rule becomes final, employers should prepare to renegotiate or revise existing contracts to align with the new rule.
[i] See Press Release, Peter Kalpan, Office of Public Affairs, FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition (Jan. 5, 2023), https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt-workers-harm-competition.
[ii] Non-Compete Clause Rule, 88 Fed. Reg. 3482 (Jan. 19, 2023) (notice of proposed rulemaking).
[iii] See 5 things you need to know about non-compete agreements, Thomson Reuters (Mar. 11, 2022), https://legal.thomsonreuters.com/en/insights/articles/the-basics-of-non-compete-agreements.
[iv] See Harlan Blake, Employee Contracts Not To Compete, Harv. L. Rev. 73 (4): 625–91 (1961).
[v] See Alger v. Thacher, 36 Mass. 51, 53 (1837) (citing Broad v. Jollyffe, Cro. Jac. 596).
[vi] See Mitchel v. Reynolds, 24 Eng. Rep. 347 (Q.B. 1711).
[vii] See Leah Shepherd, States Outlaw Noncompete Agreements, SHRM (July 10, 2023), https://www.shrm.org/resourcesandtools/legal-and-compliance/employment-law/pages/states-restrict-noncompetes.aspx.
[viii] See Ivy Waisbord, Prohibitions on Non-Compete Agreements for Low-Wage Workers, American Bar Association (Feb. 4, 2022), https://www.americanbar.org/groups/litigation/committees/business-torts-unfair-competition/practice/2022/prohibitions-on-non-compete-agreements-low-wage-workers/.
[ix] See Advanced Notice: Continuing Trends in State Restrictive Covenant Legislation, Proskauer Rose LLP (Feb. 28, 2023), https://www.proskauer.com/pub/advanced-notice-continuing-trends-in-state-restrictive-covenant-legislation.
[x] See Najah A. Farley, How Non-Competes Stifle Worker Power and Disproportionately Impede Women and Workers of Color, National Employment Law Project (May 18, 2022), https://www.nelp.org/publication/faq-on-non-compete-agreements/.
[xi] See Neil Irwin, When the Guy Making your Sandwich Has a Noncompete Clause, New York Times (Oct. 14, 2014), https://www.nytimes.com/2014/10/15/upshot/when-the-guy-making-your-sandwich-has-a-noncompete-clause.html; see also Sarah Whitten, Jimmy John’s drops noncompete clauses following settlement, CNBC (Jun. 22, 2016), https://www.cnbc.com/2016/06/22/jimmy-johns-drops-non-compete-clauses-following-settlement.html.
[xii] See Non-Compete Clause Rulemaking, Fed. Trade Comm’n (Jan. 5, 2023), https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.
[xiii] See Office of Public Affairs, NLRB General Counsel Issues Memo on Non-competes Violating the National Labor Relations Act, NLBR (May 30, 2023), https://www.nlrb.gov/news-outreach/news-story/nlrb-general-counsel-issues-memo-on-non-competes-violating-the-national.
