On January 5, the Federal Trade Commission (“FTC”) published a notice of proposed rulemaking (the “Proposed Rule”) that would effectively prohibit noncompete clauses in contracts between employers and workers. The FTC’s authority to issue regulations prohibiting noncompete clauses in employment contracts is purported to come from Section 5 of the Federal Trade Commission Act (the “FTC Act”). Section 5 of the FTC Act provides that unfair methods of competition are unlawful, and the FTC is empowered to prevent persons from using unfair methods of competition in or affecting commerce.

Currently, the enforceability of noncompete clauses in employment contracts is governed by state law. Three states – California, North Dakota, and Oklahoma – have prohibited noncompete clauses for nearly all workers. South Dakota, however, falls in with the majority of the other 47 states, which impose limitations on noncompete clauses, but do not invalidate them entirely except in employment contracts with workers in certain occupations such as health care. As drafted, the Proposed Rule would supersede any conflicting state laws and impose a federal ban on noncompete clauses in employment contracts.

But is the Proposed Rule applicable to banks?  

The Proposed Rule defines an “employer” as any natural person, partnership, corporation, association or other legal entity that hires or contracts with a worker to work. On its face, this definition would appear to encompass banks. However, Section 5 of the FTC Act empowers the FTC to prevent unfair methods of competition for all persons EXCEPT banks and certain other financial institutions. The term “bank” is defined under the FTC Act as (1) national banks; (2) member banks of the Federal Reserve System; and (3) banks insured by the Federal Deposit Insurance Corporation. Thus, the Proposed Rule may not be applicable to banks since the FTC lacks authority under the FTC Act to prevent banks from engaging in activity the FTC deems to be an unfair method of competition. In fact, the Proposed Rule expressly states that “some entities that would otherwise be employers may not be subject to the Rule to the extent they are exempted from coverage under the FTC Act. … Where an employer is exempt from coverage under the FTC Act, the employer would not be subject to the Rule.”

However, it is important to note that Section 8 of the Federal Deposit Insurance Act permits federal banking agencies to enforce violations of “a law, rule, or regulation” against insured depository institutions. It is this authority under Section 8 that allows federal banking agencies such as the FDIC to enforce the FTC Act’s Section 5 prohibition on “unfair and deceptive acts or practices” against regulated financial institutions. Consequently, while the FTC Act and Proposed Rule may not be directly applicable to banks, bankers should still review any clarifying information provided after the Proposed Rule’s March 10, 2023 comment deadline to assess whether the Proposed Rule may be enforced against banks by a federal banking agency.

In addition, banks should be aware that the Proposed Rule may apply to their affiliated entities. For example, does the bank have an affiliated holding company, mortgage brokerage, or insurance agency that employs workers but does not qualify as a “bank” under the FTC Act definition above? If so, noncompete clauses in contracts between workers and those affiliated entities would likely be prohibited under the Proposed Rule.

What is the impact if the Proposed Rule does apply?

The Proposed Rule generally prohibits an employer from: (1) entering into a noncompete clause with workers; (2) maintaining noncompete clauses with workers; and (3) representing to workers that they are subject to a noncompete clause when the employer has no good faith basis to believe the clause is enforceable. Employers that rescind noncompete clauses must provide notice to all impacted workers that the noncompete clause is no longer in effect. This includes sending notice to current and former workers, if the former workers’ contact information is readily available to the employer. Any notice to rescind a noncompete clause should be consistent with the model notice language provided in the Proposed Rule and narrowly tailored to avoid terminating any other provisions of the contract.

Employers subject to the Proposed Rule should also review any employment policies or procedures that may contain noncompete clauses. While the Proposed Rule defines a noncompete clause as a “contractual term,” it also prohibits falsely representing to workers that they are subject to an enforceable noncompete clause. Thus, employer policies and procedures with noncompete provisions may also be problematic under the Proposed Rule.

The Proposed Rule contains some exceptions for those employers subject to its prohibitions. For example, the Proposed Rule expressly exempts noncompete clauses entered into in connection with certain sales of businesses. It also does not apply to other types of restrictive employment covenants, such as non-disclosure agreements and client or customer non-solicitation agreements. As these types of covenants do not typically prevent a worker from seeking or accepting other employment, they do not meet the definition of a noncompete clause under the Proposed Rule.

Finally, while it’s important for banks to be aware of the FTC’s effort to prohibit noncompete clauses, the Proposed Rule appears to not be directly applicable to banks, and there will likely be protracted litigation if the Proposed Rule eventually makes it into final form. One FTC Commissioner who dissented to the Proposed Rule pointed out that the Rule is vulnerable to challenge in court as (1) exceeding the FTC’s authority; (2) lacking Congressional authorization; and (3) impermissibly delegating legislative authority to the FTC in violation of the non-delegation doctrine. Thus, a reasonable bank response to the Proposed Rule might be to provide comments, review any additional guidance provided, and then sit back, grab your popcorn, and watch the litigation begin.

This article appeared in the Volume 1 of The Bottom Line, a publication of The Independent Community Bankers of South Dakota.

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Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the State’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.