News & Events
The FTC Bans Non-Compete Agreements – What You Need to Know
In a vote held at a special open commission meeting on April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 in favor of issuing the final Non-Complete Clause Rule (the Final Rule) banning post-employment non-compete agreements for workers, with very limited exceptions. The FTC published the Final Rule on May 7, 2024, and it is currently set to go into effect on September 4, 2024 (the Effective Date), pending the outcome of various ongoing legal challenges to the validity of the Final Rule. It took over a year for the Final Rule to be published following the publication of the Proposed Rule (the Proposed Rule) on January 19, 2023, during which time the FTC received and considered over 26,000 comments to the Proposed Rule.
The FTC’s rationale for banning post-employment non-compete agreements is to remove what the FTC views as an unfair method of competition that limits the freedom of Americans to pursue new jobs and start new businesses, ultimately stifling economic innovation and productivity. The FTC estimates that about 30 million people are currently bound by non-compete agreements and believes the Final Rule will lead to increased wages totaling nearly $300 billion per year. There is, of course, considerable disagreement among impacted parties on whether this rule will have its intended effect of protecting employees and promoting innovation, or whether it will have the opposite effect as businesses find new ways to protect their trade secrets.
Overview of the Final Rule
The Final Rule provides that it is a violation of Section 5 of the Federal Trade Commission Act (the FTC Act) for an entity under the FTC’s authority (i) to enter into or attempt to enter into a new non-compete clause following the Effective Date; or (ii) to enforce or attempt to enforce existing non-compete clause for workers, other than non-competes with “senior executives” entered into prior to the Effective Date. This rule applies both proactively and retroactively, prohibiting employers both from entering into non-compete agreements with any of their workers following the Effective Date and from enforcing non-compete agreements that were entered into prior to the Effective Date, unless one of the limited exceptions apply.
FTC Jurisdiction
The Final Rule applies to all employers that are within the FTC’s jurisdiction, which, the FTC argues, generally includes all for-profit entities across the United States. Employers that are not subject to the FTC’s jurisdiction, and therefore, not subject to the Final Rule, include certain banks, savings and loan associations, federal credit unions, common carriers, air carriers, persons covered by the Packers and Stockyards Act of 1921, and non-profit organizations.
Ban on Non-Compete Clauses
Non-compete clauses are defined in the Final Rule 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 employment that includes the term or condition.” This includes terms or conditions of employment stated in a contract or workplace policy, that are either written or verbal. On its face, the Final Rule does not ban non-solicitation clauses, non-disclosure clauses, or other similar clauses, but the Final Rule makes clear that any clause that effectively functions to prevent a worker from seeking or accepting employment or starting a business post-employment violates the FTC Act (a non-solicitation of business clause would likely be subject to heightened scrutiny under the Final Rule). The Final Rule’s broad definition of a “worker” includes employees, independent contractors, externs, interns, volunteers, apprentices, sole proprietors, or any other natural person who works or worked with or without pay, regardless of the worker’s title or status under law.
Existing Non-Compete Clauses with Senior Executives
The Final Rule distinguishes between both (i) new and existing non-compete clauses; and (ii) workers and senior executives. All new non-compete clauses entered into after the Effective Date are ineffective, and only non-compete clauses with senior executives entered into prior to the Effective Date will remain valid after the Effective Date. A “senior executive” is limited to an employee in a “policy-making position” who earned the equivalent of $151,164 or more in annual compensation for the prior year (or the year prior to the senior executive’s departure if the senior executive departed from employment prior to the preceding year). The FTC’s reason for providing this limited exception (again, only for pre-existing non-competes with senior executives as of the Effective Date), is that these agreements are more likely to have been negotiated between the parties.
Worker Notice Requirement
For existing non-compete clauses with workers who are not senior executives, employers must provide clear notice by the Effective Date to each worker who is a party to a non-compete clause, indicating that such non-compete cannot and will not be enforced. The Final Rule provides that the notice must identify the person who entered into the non-compete clause with the worker, and be in writing, delivered by hand, mail, email, or text message to the worker. The Final Rule provides model language to be used in the notice that will be a safe harbor for compliance for any employer that uses it.
Exceptions to the Final Rule
The requirements of the Final Rule do not apply to: (i) non-compete clauses that are entered into pursuant to the bona fide sale of (a) an entity, (b) a person’s ownership interest in an entity, or (c) all or substantially all of an entity’s assets; (ii) causes of action related to non-compete clauses that accrued prior to the effective date; and (iii) situations in which a person has a good-faith basis to believe that the Final Rule does not apply to their non-compete clause.
Challenges to the Final Rule
Lawsuits
The viability of the Final Rule was subject to question even before its publication as the two dissenting commissioners expressed their view that the rulemaking exceeds congressional authorization. Shortly after the publication of the Final Rule, multiple lawsuits were filed, challenging the FTC’s authority to adopt and enforce this rule. The first lawsuit, brought by Ryan, LLC alleges the Final Rule contravenes the FTC Act, violates the Constitution, and is arbitrary and capricious. The second lawsuit, brought by the US Chamber of Commerce and other business associations alleges that the Final Rule exceeds the FTC’s authority under Section 5 of the FTC Act, that Section 5 of the FTC Act violates the Constitution, and that the FTC lacks the authority to make retroactive regulations, among other claims. Additional legal challenges to the Final Rule have been, and will likely continue to be, brought against the FTC. At a minimum, these legal challenges, if successful, may affect the effective date of the Final Rule, and have the potential to completely overturn the Final Rule.
Political Changes
The outcome of the 2024 presidential election will likely impact the Final Rule and its enforcement. A new President would have the power to appoint a new FTC Chair and will eventually be able to nominate new FTC Commissioners to replace other Commissioners as their terms expire (no more than three Commissioners may be from the same political party), with the next Commissioner’s term expiring in 2025. The Final Rule is also currently eligible for repeal by Congress under an expedited procedure provided through the Congressional Review Act (CRA). Due to time constraints imposed by the CRA, however, the current Congress would likely have to be the legislative body to overturn this Final Rule and would have to act fast.
Interplay with State Law
Prior to the publication of the Final Rule, non-compete clauses were historically governed by state law. Most states still allow non-compete clauses subject to limitations, including restrictions on their scope, geography, and duration. However, some states, including California, North Dakota, Oklahoma, and Minnesota recently banned non-compete agreements prior to the enactment of the Final Rule. In the publication of the Proposed Rule, the FTC cited the existing state law bans on non-compete agreements as “natural experiments” of the impact that this law will have on the economy. The recent trend among state legislatures has been to increasingly restrict non-competes (27 states have revised their non-compete statutes in the last five years – including Colorado).
The passage of the Final Rule does not limit the enforcement of state laws that restrict non-compete covenants, provided that they do not conflict with the Final Rule. In instances where state law does conflict with the Final Rule, the Final Rule will apply. Further, where state law provides stricter limitations on non-compete clauses that do not directly conflict with the Final Rule, the state law will apply.
Conclusion
While the Final Rule has potential to bring extensive change to the non-compete landscape, the true outcome will be unclear pending the ongoing legal challenges and possible political changes. We will continue to monitor the Final Rule and the relevant challenges as they continue to play out. In the meantime, employers are encouraged to be prepared for the Final Rule to take effect, take stock of their existing non-compete agreements, review and potentially refine their processes for departing employees, and otherwise revisit ways to increase employee loyalty and retention.
