On January 5, 2023, the Federal Trade Commission issued a proposed rule that would effectively ban most non-competition agreements in the United States. The proposed rule would, with one limited exception discussed below, prohibit non-competition agreements going forward, and would require rescission by the employer of existing ones. The proposed rule would apply to independent contractors, as well as employees.  The proposed rule would preempt state law, so that contradictory state law would be ineffective. As the rule proposal is based on the concept of unfair competition, it is implemented by making it unlawful for employers to enter into, enforce or maintain a non-competition agreement. The proposed rule can be accessed here:

Non-Compete Clause Rulemaking | Federal Trade Commission (ftc.gov)

Under the proposed rule, the phrase “non-competition agreements” is broadly drafted and could be deemed to include any agreement that functions, in effect, as a non-competition agreement, such as certain broadly drafted non-disclosure agreements.  The FTC release notes that any other agreement – such as a non-solicitation agreement – that functions as a non-compete, would also be banned, but, aside from a non-competition agreement, the FTC focused most closely on overbroad nondisclosure agreements having the effect of a non-competition agreement. 

One exception to the ban would be for 25% or greater owners of businesses being sold. Buyers and such persons would be permitted to enter into non-competition agreements in connection with the sale of such persons’ business.

There are likely to be serious challenges to the FTC’s legal authority to adopt this rule, as well as reconsideration of certain aspects of the rule based on public comment. However, certain potential issues seem apparent in the M&A context and with respect to executive employment agreements.

Suppose a key employee does not own 25% or more of the business being sold? That person would not be permitted to become bound to a non-competition agreement. How would a buyer protect its investment from potential competition by the key person? A narrowly drafted non-solicitation agreement may still work (see rule proposal at page 109), but that raises issues, as the FTC proposal specifically calls out agreements having the effect of non-competition agreements, and a definitive test to determine whether an agreement would be so regarded has not yet been established.

If, until the rule proposal takes effect and its scope becomes clear, the buyer chooses to risk contracting for a non-competition covenant, with the understanding it might be rescinded by the effectiveness of the rule, could there be an enforceable clawback of previously paid consideration or a release of consideration remaining to be paid?

For those agreements which already exist, what would be the practical consequence on acquired companies of the mandatory rescission of the agreement required by the rule proposal? If non-competition contractually bargained for is suddenly eliminated, it would seem to create leverage for employees to renegotiate their compensation. How would it affect earn-outs if key people left to compete?

In the executive employment context, non-competes are frequently supported by severance payment provisions that extend for the duration of the non-compete. The ban would prohibit the non-compete, but then, would the reaction of employers be to eliminate or cut back on such severance commitments?

What happens if an existing non-compete is rescinded by the rule becoming effective but additional payments for severance are still due and owing? Would the rescission of the non-competition undertaking require that the severance payment also be stopped? Suppose the tie between the two is not express but simply exist in the same agreement?

It is likely that many of the issues discussed above will be raised during the comment period. This may result in refinements of the proposed rule. Indeed, the FTC has raised the possibility that different standards apply in executive employment agreements negotiated between sophisticated parties (see the proposed rule at pp. 150-152). Rescission of existing agreements, as the proposed rule provides, is likely to face stiff resistance.

The FTC spent a great deal of ink justifying the proposed rule from a variety of vantage points. It remains to be seen how these justifications will play when the comment period and lobbying begin and when judicial challenges are posed.