FTC proposes rule to ban non-compete agreements

In detail

The proposed rule, if finalized, would bar an employer from imposing limits on a worker’s right to seek or accept employment with another employer. The rule would apply to both traditional non-compete agreements as well as any “de facto non-compete clause” that has the same functional impact as a non-compete. Seller non-competes also would be prohibited, but an exception is provided where the selling shareholder owns at least 25% of the entity at the time they entered into the non-compete.

The rule applies broadly to paid and unpaid employees, independent contractors (including gig workers), and volunteers. Franchisees and businesses that are not subject to the Federal Trade Commission Act — including certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and certain tax-exempt entities — would not be subject to this rule.

If finalized, the rule would require employers to rescind existing non-compete agreements and provide individual notice to employees that a non-compete provision no longer is in effect. Employers must tell employees who have left employment and are subject to a non-compete as of the effective date of the final rule that the non-compete no longer is in force. Employers also must give notice to each affected employee within 45 days of rescinding the non-compete.

Observations:

• The rule, if finalized, would have a significant impact on the calculation of amounts subject to the golden parachute rules of Section 280G, which imposes a 20% employee-paid excise tax and disallows a corporate tax deduction for certain compensation payments made in connection with a change in control event. Currently, the value of payments associated with an enforceable non-compete are excluded from Section 280G. In many cases, this exclusion can be a key factor in mitigating or eliminating exposure under Section 280G in public company transactions.
  
  Understanding the impact of Section 280G on both a target company and its executives generally is a key consideration in public company transactions. Accordingly, public companies may want to understand the impact that the proposed rule would have on its and its executives’ Section 280G exposure in a sale event, and consider alternative mitigation measures that may be available if a transaction may be on its horizon.
• Currently, certain employers treat non-competition provisions as a “substantial risk of forfeiture” under Section 83 in order to delay the imposition of income and/or FICA taxes on certain compensation awards. This position would be unavailable if the rule were finalized, resulting in accelerated taxation of outstanding awards.

Non-competes currently are an important retention tool for employers. If the prohibition becomes effective, employers may need to consider whether remaining incentive and retention arrangements are adequate to retain key talent.