The proposed FTC rule would broadly ban employers from imposing non-competes on their workers. The rule, once it becomes final, would supersede California state law, which allows non-competes in limited situations, including when necessary to protect the employer’s trade secrets.
On January 5, 2023, the Federal Trade Commission (FTC) announced a notice of “Non-Compete Clause Rulemaking” that would broadly ban employers from imposing non-competes on their workers. The FTC proposed to add a new Subchapter J, consisting of Part 910, to Chapter I in Title 16 of the Code of Federal Regulations. The rationale behind this proposed rule lies in that, as § 910.2(a) states:
It is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.
A non-compete clause, as defined under § 910.1(b)(1), means “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.”
The rule would apply retroactively such that an employer that entered into a non-compete clause with a worker prior to the compliance date (i.e., 180 days after date of publication of the final rule) must rescind the non-compete clause no later than the compliance date. See § 910.2(b)(2).
The requirement would apply to all but one situation: when the non-compete clause is entered into by a person who is selling all or substantially all of that person’s ownership interest of a business entity or the business entity’s operating assets, and the person restricted by the non-compete clause is a substantial owner of, or substantial member or partner in, the business entity at the time of the non-compete clause. See § 910.3.
This proposed Part 910 would “supersede any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with this Part 910.” § 910.4.
Currently, the proposed rule is subject to a 60-day public comments period. The FTC will then review the comments and make changes, in a final rule, based on the comments and the FTC’s further analysis of this issue.
Non-Competes Under Current California Law
In California, cases discussing non-competes can be generally classified into three categories:
(1) Non-compete clauses (post-term employment) in employment contracts. These are generally per se invalid in California as an unlawful restraint on trade, with a few statutory exceptions. Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 945 (2008); StrikePoint Trading, LLC v. Sabolyk, 2008 WL 11334084, at *4 (C.D. Cal., Dec. 22, 2008) (“[C]ovenants not to compete may be enforceable if ‘necessary to protect the employer’s trade secrets’ or other protected confidential proprietary information.”).
(2) Non-competition clauses outside the employment arena. Courts have deemed these clauses to be valid. See, e.g., Quidel Corp. v. Superior Ct. of San Diego Cnty., 57 Cal. App. 5th 155, 166 (2020). For example, covenants not to compete entered into in connection with the sale of the goodwill of a business are protected under California Business and Professions Code section 16601. Fillpoint, LLC v. Maas, 208 Cal. App. 4th 1170, 1182 (2012). Notably, this exception under California Business and Professions Code section 16601 is mostly consistent with the exception under proposed § 910.3 of the FTC rule.
(3) In-term non-competition clauses. These clauses, unlike post-term non-competition clauses, impose the restriction only during the term of the contract. These have also been held valid. Quidel Corp. v. Superior Ct. of San Diego Cnty., 57 Cal. App. 5th 155, 168 (2020). Particularly, in-term covenants not to compete in exclusive dealing clauses are not per se invalid. Id. at 169.
Practice Tips
If the proposed Part 910 becomes final, non-compete clauses governing post-term employment in employment contracts will be deemed per se invalid subject to only one exception: where a person selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person selling all or substantially all of a business entity’s operating assets, assuming the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.
Even though the FTC’s broad ban would supersede California state law, the ban is limited to non-competes in employment contracts that restrict post-term employment. Non-competition clauses may still be deemed valid by California courts under certain circumstances, such as in-term non-competition clauses and contracts in connection with the sale of the goodwill of a business.
The KF&C team is monitoring the proposed rule and will post updates on the KF&C California Law Blog.
For further questions or comments on the content of this post, please email Matt Cave at [email protected] or Sara Borjigin at [email protected].
