The proposed FTC rule to ban non-compete clauses: What California employers need to know

As if California statutory and case law limiting non-competition clauses was not complicated enough, the Federal Trade Commission (FTC) now has entered the fray.  Based on the current proposed FTC rules, the law in California on restrictions of non-competes may expand to include “non-employees” as well as to limit the current “sale of a business” exception and to require notice of rescission of any such clauses.  And, of course, understanding the FTC’s proposed rule is important for California entities with employees and contractors in the many states which, unlike California, do not have restrictions on non-compete clauses. 

On January 5, 2023, the FTC proposed an all-encompassing new rule to bar employers from imposing non-compete agreements with their employees, purportedly as “unfair competition”. The proposed rule, which applies to all employers, regardless of size, provides that it is “an unfair method of competition for an employer to [1] enter into or attempt to enter into a non-compete clause with a worker; [2] maintain with a worker a non-compete clause; or [3] represent to a worker that the worker is subject to a non-compete clause….”  

The proposed rule defines “non-compete clause” as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting an employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.”  It does not specifically apply to non-disclosure or non-solicitation agreements.  

Moreover,  the proposal defines “worker” broadly to include not just employees, but also to include independent contractors, externs, interns, volunteers or sole proprietors who provides services to the employer.  This definition, combined with how the FTC also defined “non-compete clause,” could have the effect of prohibiting the application of non-solicitation, non-compete and non-disclosure agreements with both contractors and employees if those agreements are drafted broadly enough to fall within what the FTC believes is within the scope of the proposed rule. Stated differently, routine non-disclosure and non-solicitation agreements may need to be modified if the FTC rules are adopted.

The proposed rule also significantly limits the “sale of business” exception that currently exists under California law.  Specifically, although the proposal does not apply to non-compete clauses that are entered into by a seller of a business “or otherwise disposing of all of the person’s ownership interest in the business entity”, this exception, unlike California law, only applies to individuals who are 25% owners or more.

In addition, this far-reaching proposal is retroactive. As drafted, the rule would require the rescission of any applicable non-compete clauses entered into prior to the issuance of the proposed rule, and those rescissions must be done within 180 days after publication of the final rule. Moreover, the proposal also contains a requirement which doesn’t exist in California or most states’ laws: an employer rescinding a non-compete clause must provide an individualized written or digital notice informing both former and current workers that the non-compete clause is no longer effective.  

The proposed rule is open to comment until March 10, 2023, and could go into effect in 2023.  We can expect to see litigation over the new rule with respect to whatever form in which it is eventually implemented.

John Viola is a partner in Thompson Coburn’s Labor and Employment practice group.