FTC Proposes New Rule to Bar Non-compete Agreements in Employment Contracts

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On January 5, 2023, the Federal Trade Commission (“FTC”) announced that it was proposing a new rule that has far-sweeping implications for the economy and labor market.  The proposed rule would ban non-compete clauses in employment contracts.  The proposed rule defines a “non-compete clause” as a “contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” 

In Vermont, non-compete clauses are generally disfavored and will only be enforced if necessary to protect the legitimate business interests of the employer and is reasonable in scope and duration.  However, if the FTC rule is enacted as drafted, employers will need to rescind existing non-compete clauses.

According to the FTC, non-compete clauses suppress wages, hamper innovation, and block entrepreneurs from starting new businesses.  The proposed rule is based on the FTC’s preliminary finding that non-compete clauses “constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act.”  Lina M. Khan, the Chair of the FTC, stated that “[t]he freedom to change jobs is core to economic liberty and to a competitive, thriving economy.”  She added that non-compete clauses “block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand  By ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.” 

To address these issues, the proposed rule would make it illegal for an employer to:

(1)   Enter into or attempt to enter into an agreement with a worker that has a non-compete clause;

(2)   Maintain any agreement with a worker that contains a non-compete clause; and

(3)   Represent to a worker, under certain circumstances, that the worker is subject to a non-compete clause.

The proposed rule would also require employers to give specific notice to workers whose non-compete clauses are being rescinded.

Between 20% to 45% of all private sector employees are subject to non-compete clauses and the FTC estimates that the proposed rule will increase American workers’ earnings between $250 and $296 billion per year. 

 Although non-compete clauses are generally legal and enforceable in most states,  California has long prohibited them since 1872, when it enacted Section 16600 of the California Business and Professions Code.  Section 16600, subject to some limited exceptions, makes unlawful contracts in which “anyone is restrained from engaging in a lawful profession, trade or business of any kind.”  California courts have explained that Section 16600 promotes “open competition and employee mobility.”  Some scholars have argued that Section 16600 was instrumental in the growth of Silicon Valley because the ban on non-compete clauses increased employee mobility, promoting knowledge spillovers between firms.  This is in contrast to the Route 128 industrial district in Massachusetts during the same time period, where non-compete clauses were regularly enforced.  See generally, Ronald J. Gilson, The Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U. L. Rev. 575 (1999).

The FTC is seeking public comment on the proposed rule, which is available here.  The FTC will review comments and may make changes in the final rule based on the public comments.  If you would like to submit a comment, the FTC must receive it on or before 60 days after the date the proposed rule is published in the federal register, and the FTC encourages the public to submit comments online at the following link.  According to the FTC, the rule will take effect 180 days after the final version is published, although a legal challenge, which is likely, may delay that plan.