The FTC’s Proposed Blanket Ban on Non-Compete Provisions will Likely Take Effect in 2023

By Jonathan H. Spadt & Christopher H. Blaszkowski

The FTC’s proposed blanket ban on non-compete provisions will likely take effect in 2023.  There is still time to plan for the profound implications of this rule and to ensure that your company’s patentable inventions, trade secrets, and other proprietary information remain as secure as possible.

1. What the Proposed Rule Says (And What It Leaves Unsaid).

On January 5, 2023, the FTC proposed a sweeping rule which would prohibit an employer from entering into or maintaining a “non-compete clause” with an employee (“the Proposed Rule”). The Proposed Rule ostensibly applies to any employer/employee relationship, as well as agreements with independent contractors.  It specifically requires rescission of existing non-compete agreements, and notice of the rescission to the affected employee, within 180 days of the Proposed Rule becoming final. The Proposed Rule contains only one limited exception—for scenarios where a “substantial owner” of the business sells the business, it would allow a non-compete that would prevent the owner from competing against the sold business.

The Proposed Rule is less clear regarding what other contractual arrangements are covered/prohibited beyond any provision that holds itself out to be a non-compete.  To this end, the Proposed Rule provides a “functional test” for determining whether a contractual provision has “the effect of prohibiting the worker from seeking or accepting employment” and amounts to a de facto non-compete clause.

The exemplary de facto non-compete clauses identified in the “functional test” makes the expansive scope of the Proposed Rule evident. For the purposes of intellectual property protection, the most important exemplary de facto non-compete clause is a non-disclosure agreement “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.”  The FTC explains that non-disclosure agreements

may affect the way a worker competes with their former employer after the worker leaves their job. However, 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. For example, if a worker leaves their job with their employer and goes to work for a competitor, an NDA the worker signed with their employer may prevent the worker from disclosing certain information to the competitor. However, a standard NDA would not prevent the worker from seeking or accepting work with the competitor.

Although a “standard” NDA may survive FTC scrutiny, the business community is not left with a clear definition of what is “standard” and what “effectively precludes” competition in the same field post-employment.

The Proposed Rule provides scant additional guidance regarding its examples of de facto non-competes.  Thus, the scope of the functional test, and how it will be applied by the FTC, remains largely unexplained.

2. What Your Business Can Do Now to Prepare For and Mitigate Risks to Intellectual Property Resulting From the Proposed Rule.

It is likely that some sort of non-compete ban—whether in the form of the Proposed Rule or something similar—will become final at some point during 2023.  And although it is certain to be challenged in the courts, probably on several fronts,  there is no way to reliably predict the timing or outcome of that challenge. Regardless, there are certain steps that a business can take now to reduce the risk that its intellectual property, i.e., patents, trade secrets, and other proprietary information, will be misappropriated by competitors.

a. Review and Audit of Non-Disclosure Agreements and Other Restrictive Covenants

While the Proposed Rule applies to any agreement which includes a non-compete provision (whether explicit or amounting to such under the functional test), businesses should pay particular attention to non-disclosure agreements.  Non-disclosure agreements are commonly used by businesses to limit an employee’s use or disclosure of confidential information, including trade secrets.

NDAs are almost as common between businesses (e.g., joint ventures, strategic partnerships, etc.) as they are within a business. It is unclear to what extent the Proposed Rule implicates non-disclosure agreements between businesses. For example, the definition of “worker” (the Proposed Rule prohibits “a non-compete clause with a worker”) includes a “sole proprietor who provides a service to a client or customer”.  Thus, potentially, the Proposed Rule is expected to cover independent contractors, and could be read to cover NDAs between an employer and other service providers.

Even without the Proposed Rule, overreaching in NDAs (e.g., to cover non-confidential information or information that an employee may have gained prior to employment with the employer) is risky and can result in a court striking the obligation or otherwise modifying it. But until there is more guidance regarding the Proposed Rule (or jurisprudence interpreting it), the takeaway for now is that NDAs must be carefully tailored to protect confidential and proprietary information, without hampering an employee (or sole proprietorship) from competing in the same field after separating from the employer.  RatnerPrestia’s attorneys can assist with this balancing act.

Businesses should also consider whether any legitimate interests can be protected through other restrictive covenants such as non-solicitation clauses.  Non-solicitation clauses do not per se fall under the Proposed Rule; instead they would likely be evaluated under the functional test described above.

b. Review and Audit Trade Secret Policies

The importance and value of trade secret protection has been on the rise for well over a decade due to favorable legal conditions which include, e.g., the comparatively broad scope of protection (as compared to patent rights), the enactment of the Defend Trade Secrets Act in 2016, and the substantial damages available as shown by numerous recent jury verdicts (including several awards of hundreds of millions of dollars).

NDAs, of course, are critical to protecting the valuable trade secrets of your enterprise.  However, trade secret protection requires more than an NDA which passes FTC scrutiny.  With workforce mobility on the rise, and technology making it easier than ever for employees or business partners to access and leave with sensitive information, the Proposed Rule is just one more reason among many to ensure that your trade secret policies sufficiently observe the legal requirements for protection.

Under the Proposed Rule, it is expected that trade secret litigation will increase as businesses look to means other than non-compete provisions to protect against misappropriation by a competitor. As a result, trade secret policies that quickly and clearly identify potential trade secret candidates and which impose reasonable efforts to maintain the secrecy of those trade secrets are imperative. Moreover, workforces should be educated regarding these trade secret policies so that intellectual property can be efficiently secured and protected from competitors. Given the potential that all or part of an NDA could be struck down under the Proposed Rule, the other measures taken by a business (limiting access to computer networks, device policies, visitor controls) may be the deciding factor in a court’s determination that “reasonable measures” were taken so as to warrant trade secret protection.

RatnerPrestia has assisted many clients in devising and implementing robust trade secret policies, and in creating training programs to message these policies to employees.

c. Review and Audit Patent Policies

For the same reasons, it is just as important to quickly identify innovations for the purposes of securing an organization’s patent rights.  Prompt identification of and application for patent protection, including cooperation from inventors and developers, will be critical in a landscape lacking non-competes to discourage employees involved with research and development from becoming competition.

3. What Happens Next.

The Proposed Rule is not final and could end up with substantial changes before a final rule comes into effect. Comments and/or objections regarding the Proposed Rule may be submitted to the FTC up until March 10, 2023. Such comments are public, and may be submitted in the name of a business or individual, or may be submitted anonymously through a trade group.

If the final rule is the same or substantially the same as the Proposed Rule, there will undoubtedly be litigation challenging the rule.  These challenges would likely assert that the FTC exceeded its authority in promulgating a non-compete ban.  FTC Commissioner Christine Wilson identified 3 bases of potential challenge in her dissenting statement concerning the Proposed Rule:

1. The Proposed Rule exceeds the FTC’s authority under the FTC Act because the FTC lacks substantive competition rulemaking authority.
2. The Proposed Rule exceeds the FTCs authority under the major questions doctrine.
3. The Proposed Rule violates the nondelegation doctrine.

Stay tuned—RatnerPrestia attorneys are continuing to monitor the FTC’s rulemaking process and will provide updates as warranted.

About RatnerPrestia

RatnerPrestia is a law firm expert in all things IP. The Firm handles procurement, enforcement, licensing, commercialization, global strategic IP planning, and all related business aspects of IP. The Firm has attorneys experienced and successful in all relevant U.S. jurisdictions, including the U.S. Patent and Trademark Office, The U.S. International Trade Commission and Federal Courts, both trial and appellate. This expertise extends to all areas of IP protection, including patent, design, copyright, software, trademark, and trade secret protection.