A non-compete clause prevents an employee from working for a competitor, typically for anywhere from six months to two years, after their employment ends. Historically, with the exceptions of California, North Dakota, and Oklahoma, courts have enforced such clauses if they are reasonably drafted to protect a legitimate business interest. But non-compete clauses are still disfavored. A majority of the forty-seven states that permit enforcement of non-compete clauses have laws banning or limiting the enforcement in certain occupations. And eleven of those states, including Maryland, have a statute making non-compete clauses void or unenforceable based on other factors, such as a worker being a low wage earner.
On January 5, 2023, the Federal Trade Commission (FTC) went further by proposing a rule that would prohibit employers nationwide from using non-compete clauses. The proposed rule, which would apply to employees as well as contractors, would provide that it is an unfair method of competition, and therefore unlawful under Section 5 of the Federal Trade Commission Act, for an employer to enter into or attempt to enter into a non-compete clause with a worker. Additionally, the proposed rule would require employers to rescind all existing non-compete clauses.
The proposed rule contains a limited exception allowing non-compete clauses between the buyers and sellers of businesses. A non-compete clause would be lawful if the restricted party is an owner, member, or partner holding at least a 25% ownership interest in a business entity, presumably the selling business entity.
The proposed rule does not apply to non-solicitation, confidentiality, and non-disclosure agreements, because these types of agreements “generally do not prevent a worker from seeking or accepting work with a person or operating a business after the conclusions of the worker’s employment with the employer.” According to FTC, these other type of agreements “may affect the way a worker competes with their former employer … [but] they do not generally prevent a worker from competing with their former employer altogether; and they do not generally prevent other employers from competing for that worker’s labor.” However, tailoring these permissible agreements will be important. Any covenant can be considered a non-compete, regardless of what it is called, if it restricts such a broad range of activity that it is the functional equivalent of a non-compete.
According to the FTC, it proposed the rule against non-compete clauses because research has demonstrated the use of non-compete clauses is interfering with competitive conditions in labor markets, which in turn is reducing worker earnings, job creation, and new business formation, stifling innovation and access to talent, and interfering with product and service markets, including by increasing consumer prices in certain sectors.
The FTC is seeking comment on many different aspects of the proposed rule. You can find the proposed rule here. The notice of proposed rulemaking contains additional details about the FTC’s findings and requests for comments.