Many employment contracts contain non-competition clauses. There has long been a body of case law limiting the enforceability of these restrictive covenants in New York. For example, under the so-called BDO Seidman test, a non-compete provision is only enforceable if it is no greater than required to protect the legitimate business interests of the employer, does not impose undue hardship on the employee, and is not injurious to the public. See generally BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999).
The BDO Seidman test and other judicially created rules governing non-competition clauses may soon fall by the wayside. On January 5, 2023, the Federal Trade Commission (FTC) issued a proposed rule (PR) that would largely ban non-competition provisions throughout the United States. The PR follows an executive order issued by President Biden on July 9, 2021, which urged the FTC to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
The FTC just announced that it will host a public forum via webcast on February 16, 2023, from 12:00 p.m. to 3:00 p.m. EDT. The webcast is intended to supplement the public comment period, during which businesses and individuals can can submit comments to the PR through March 10, 2023. A final rule will be issued thereafter and become effective 180 days after issuance (the Compliance Date).
This blog explores the contours of the PR and what employers can expect if it is finalized.
What does the PR prohibit?
The PR prohibits both contract terms that explicitly prevent workers from seeking or accepting employment after the conclusion of their current employment and other contract terms that have the same practical effect. The PR refers to the latter type of contact term as a “de facto non-compete clause,” and identifies the following examples of such provisions:
i. A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.
ii. A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
The PR’s supplementary materials indicate that non-disclosure agreements and non-solicitation clauses generally will not constitute de facto non-compete clauses. Importantly, however, these sorts of provisions will constitute de facto non-compete clauses “where they are so unusually broad in scope that they function as such” by preventing a worker from seeking or accepting new employment. A non-solicitation provision might meet this standard where, for example, it effectively prevents an employee from doing business with a substantial portion of the available customer base.
Employers are not only banned from imposing non-competition clauses on employees, but also on independent contractors, interns, externs, volunteers, and apprentices. Additionally, these clauses are impermissible in contracts between sole proprietors and clients or customers.
The PR purports to supersede any inconsistent state or local laws, regulations or orders that provide workers with lesser protections.
What does the PR say about existing non-compete clauses?
The PR does not just ban non-compete clauses prospectively but prohibits employers from maintaining existing non-compete provisions or leading workers to believe, without a good faith basis, that such provisions are enforceable.
The PR provides that, in order to comply with the rule, employers must rescind existing non-compete provisions prior to the Compliance Date. The employer must provide individualized written or electronic notices of the rescission to each affected employee within forty-five days thereof. This includes current employees and former employees whose contact information is readily available to the employer.
The PR includes model rescission language, which further states that all other provisions of the employee’s contract will remain intact.
Are there any exceptions?
The PR does not prohibit non-compete clauses agreed to by a person who: (1) held an interest of at least twenty-five percent in a business at the time of the agreement; or (2) sold all of their interest in the business or substantially all of the business’s operating assets. Such provisions are nonetheless subject to Federal antitrust laws and other applicable state or local laws.
Employers with concerns about the impact of the PR on their businesses should take advantage of the public comment period. Comments can be submitted online through the FTC’s website.
Meantime, employers should identify all current and former employees who are subject to explicit non-competition clauses and be prepared to rescind them if the PR, or some modified version of it, becomes final.
Employers should also examine their employment contracts–both existing agreements and any forms that employers intend to use in the future–to determine whether any of their terms might amount to de facto non-competition provisions. We recommend consulting with counsel to determine the likelihood that such provisions might run afoul of the anticipated final rule. If you have questions about the FTC’s proposed rule, please contact Jessica M. Baquet at email@example.com or (516) 663-6506.