FTC Issues Rule Banning Non-Competes

As we reported in an alert last week, on April 23, 2024, the United States Federal Trade Commission (“FTC”) voted in favor of a Final Rule banning nearly all non-compete agreements, with limited exceptions related to the sale of a business and certain pre-existing agreements with senior executives.  The Final Rule provides that it is an unfair method of competition, and therefore a violation of the Federal Trade Commission Act (the “Act”) to enter into, attempt to enter into, enforce, or attempt to enforce non-compete clauses with a worker or represent that the worker is subject to a non-compete clause. “Worker” is defined broadly under the Final Rule to include current or former employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a person.  

The Final Rule defines a non-compete clause as a “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

In its commentary to the Final Rule, the FTC notes that many of those who submitted comments to the proposed rule requested that the FTC expressly state whether other forms of restrictive covenants satisfy the definition of a non-compete. While the FTC declined to do so, it did note that other restrictive clauses in employment agreements (e.g., non-disclosure agreements, non-solicitation agreements, and training repayment agreement provisions (“TRAPS”), etc.), “do not by their terms or necessarily in their effect prevent a worker from seeking or accepting work with a person or operating a business after the worker leaves their job.” The FTC did note, however, that these agreements can function to prevent workers from seeking or accepting other work or starting a business after leaving a job, such that they might violate the Rule under the “functions to prevent” definitional prong. In declining to clarify the circumstances under which the definition of a non-compete would apply to other types of restrictive employment agreements, the FTC noted that “a restrictive covenant may be a non-compete under [the Final Rule] if it expressly prohibits a worker from, or penalizes a worker for, seeking or accepting other work or starting a business, or if it does not do so expressly but is so broad or onerous in scope that it functionally has the same effect of preventing a worker from doing the same.” Employment agreements containing any such restrictive clauses will likely now require close scrutiny to avoid inadvertently violating the Rule, even if they do not contain a non-competition clause. 

As mentioned above, the Final Rule adopts a different approach for non-competes with senior executives entered into before the effective date of the Final Rule. Whereas non-competes entered into with non-senior executives will no longer be enforceable after the effective date, pre-existing agreements with senior executives remain effective after the effective date. The Final Rule defines senior executives as workers earning at least $151,164 in a “policy-making position.” The Final Rule clarifies that “policy making position” means the individual must have final policy-making authority (e.g., the president, CEO or equivalent, or any other officer who has final authority to make policy decisions that control significant aspects of a business entity).  Simply advising or influencing policy decisions is insufficient under the Final Rule, as is having final authority only over a subsidiary or affiliate of a common enterprise.  The commentary to the Final Rule also clarifies that having decision-making authority over a division (e.g., marketing, finance, or human resources departments) would not be sufficient to establish that individual as a senior executive. This narrow definition likely means that very few non-competes will remain enforceable after the Rule becomes effective. Indeed, the fact sheet published by the FTC in conjunction with the Final Rule indicates that “less than 1% of workers are estimated to be senior executives under the final rule.”

The Final Rule also exempts non-competes that are entered into pursuant to a bona fide sale of a business entity, of a person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.  Importantly, while the proposed rule initially required the seller have at least a 25% ownership interest, the Final Rule does not contain an ownership threshold to trigger this exception.  

Notably, the Final Rule also requires employers to notify all workers subject to what will be unenforceable non-competes under the Final Rule that the non-compete will not be, and cannot legally be, enforced against the worker. This notice would be required to be provided to both current and former workers subject to unenforceable non-competes. The Final Rule provides a model form of notice that employers can use to satisfy the notice requirements.  While the Final Rule does not mandate that the employer provide the model notice, the Final Rule also contains a safe harbor provision which clarifies that employers will be deemed to have complied with the notice requirements of the Final Rule if it utilizes the model notice.  Notice must either be delivered by hand, mail, email, or text message.

Importantly, the Final Rule does not apply to any causes of action relating to a non-compete violation which accrues before the effective date, so employers may continue to enforce their existing non-competes at this time.  That said, it also does not preempt any state legislation or case law which are more restrictive than the Final Rule, so long as the state legislation or law is not in conflict with the Final Rule. Less restrictive state non-compete laws would be preempted by the Final Rule.  

The Final Rule will become effective 120 days after it’s published in the Federal Register. However, at least two cases have already been brought challenging the Final Rule, and we anticipate there will be more to come, which we will continue to monitor. While the outcome of any litigation cannot be determined at this time, should litigation result in a stay of the Final Rule, the effective date may be delayed for some time. As the likely litigation around this Final Rule unfolds, employers should take stock of their existing non-compete agreements and other restrictive covenants and consult with counsel to consider what other steps to take to ensure their proprietary information and good will is as protected as possible.  Employers with questions about the Final Rule or their non-compete agreements should contact Kate Townley at ktownley@fglawllc.com or any other attorney at the Firm.

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