BACKGROUND: The FTC Act was enacted in 1914. Section 5 of the Act “declared” that “unfair methods of competition in commerce” are “unlawful,” and it “empowered and directed” the Federal Trade Commission (FTC)  “to prevent” entities subject to its jurisdiction from “using” such methods.

On January 19, 2023 the FTC proposed the so-called “Non-Compete Clause Rule” pursuant to sections 5 and 6(g) of the FTC Act.  The proposed rule categorically banned employers from using non-competes with all workers and required rescission of all existing non-competes.

On April 23, 2024 the FTC voted 3-2 to approve a final version of the rule. To read a copy of the final rule follow this link: https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf

The FTC asserts that non-competes “harm competitive conditions in labor, product, and service markets … suppressing earnings for workers across the labor force … [suppresses] new business formation and innovation.”

WHAT IT SAYS: The final rule provides that it is an unfair method of competition—and therefore a violation of FTC Act section 5—for employers to, among other things, enter into “non-compete clauses” with workers on or after the final rule’s effective date.

The final rule defines “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.”

The final rule further provides that, for purposes of the final rule, “term or condition of employment” includes, but is not limited to, a contractual term or workplace policy, whether written or oral

The final rule further defines “employment” as “work for a person.”

The final rule defines “worker” as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” The definition further states that the term “worker” includes a natural person who works for a franchisee or franchisor but does not include a franchisee in the context of a franchisee-franchisor relationship.

Unlike the proposed rule, formal rescission of existing noncompete agreements is no longer required under the final rule. Instead, employers will be required to issue a notice to all non-senior executive workers who have existing noncompete agreements explaining that those agreements will no longer be in effect and will not be enforced upon the effective date of the rule. To assist employers, the FTC published a model notice on its website. Notably, the model notice contains language stating that the employer will not enforce any noncompete clause against the employee, the employee may seek or accept a job with any company or any person (even if competitive), the employee may run their own business (even if competitive), and the employee may compete with the employer following their employment.  See the following link for a copy of the model notice in English:  English.docx (live.com)

Other forms of notice and employer resources are available at https://www.ftc.gov/legal-library/browse/rules/noncompete-rule  See also Noncompete Clause Rule: A Guide for Businesses and Small Entity Compliance Guide (ftc.gov)

EXCEPTIONS: The core exception is for companies’ existing agreements with a small subset of workers considered “senior executives,” defined as those earning more than $151,164 annually who are in “policy-making” positions. A “policy-making position” is defined as “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.”  The rule further defines an individual with policy-making authority as one who has “final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.” Employers should note that this class of workers should be very narrowly construed, as the FTC states that it expects less than 1% of workers to qualify as “senior executives” under this definition.

The final rule also does not apply to:

  • non-solicitation agreements and nondisclosure agreements. However, employers should note that restrictive covenants that effectively prevent a worker from working in the same field would (according to the FTC) violate the rule, because they “functionally operate” as a noncompete clause.
  • non-competes entered into by a person pursuant to a bona fide sale of a business entity (note that, unlike the proposed rule, the final rule adopts the exception permitting non-competes for the “bona fide sale of a business,” without requiring that the seller have at least a 25% ownership interest in the business entity, as originally proposed);
  • where a cause of action related to a non-compete accrued prior to the effective date;
  • noncompete agreements prohibiting competing against an employer during employment;
  • the enforcement or attempt to enforce a non-compete or to make representations about a non-compete where a person has a good-faith basis to believe that the final rule is inapplicable; or
  • a franchisee in the context of a franchisee-franchisor relationship (see definition of “worker” above.

EFFECTIVE DATE: The rule takes effect 120 days from publication, at which point employers will be required to notify workers (other than “senior executives”) that existing non-compete agreements will not be enforced. The FTC noted that trade secret laws and non-disclosure agreements are effective alternatives for companies to protect proprietary information without inhibiting competitive conditions in labor markets.

IMPACT: The FTC estimates that 30 million workers (or about 18% of the workforce) are covered by non-compete agreements. The FTC cites a mix of survey and anecdotal evidence to suggest that use of non-compete agreements is “widespread” across the economy. Several studies cited by the FTC support the notion that non-competes are more prevalent in professional services, finance, information technology, and other scientific and technical fields. These sectors could see outsized effects once the rule eventually takes effect.

VIOLATIONS: Violations of the rule will be deemed a violation of Section 5 of the FTC Act, which prohibits “unfair or deceptive acts or practices in or affecting commerce.” The FTC, however, cannot obtain civil penalties or other monetary relief against parties for using an unfair method of competition. The agency can instead pursue adjudication under Section 5(b) of the FTC Act or seek an injunction in federal court against a party that has engaged in an unfair method of competition. The agency can obtain civil penalties in court if a party is ordered to cease and desist from a violation and fails to do so.

LEGAL CHALLENGE: Less than 24 hours after the FTC approved the final rule, the new regulation has already faced a legal challenge from the Chamber of Commerce and other business groups such as Ryan LLC) in a federal court in Texas. See the following link for a copy of the complaint in the Texas case:

https://files.lbr.cloud/public/2024-04/Ryan.pdf?VersionId=0yu9qPkQFUOJ5XXAaZvtgXK4EzWprx7N

The key legal issue in the case is whether the FTC has exceeded its authority under the FTC Act. In Ryan’s complaint, the plaintiff challenges the FTC’s rulemaking authority under the Administrative Procedure Act – and alleges that the rule constitutes “an unauthorized, unconstitutional attempt to eliminate a long-established private economic arrangement.”

Chamber of Commerce officials stated that their concern lies principally with what this decision would mean for the FTC’s power to regulate unfair methods of competition.

Objections to the agency’s rulemaking authority were also raised by the two FTC commissioners voting against the rule on April 23, 2024. In particular, Commissioners Melissa Holyoak and Andrew Ferguson both expressed that the noncompete rule exceeds congressional authorization, and that the agency does not have the authority to undo millions of existing contracts and existing noncompete laws in many states.

We expect a lengthy legal battle stemming from the Chamber of Commerce’s lawsuit and others that are likely to emerge across the country. As more lawsuits crop up in various jurisdictions, odds increase that the Supreme Court may eventually need to weigh in and it is unlikely to look favorably upon this rule. It’s also likely that implementation  of the final rule will be paused while the legal arguments are heard.

In the meantime, employers should take proactive steps now to carefully evaluate their use of noncompete agreements – including the business justifications and goals for imposing such restrictions and the range of employees for whom such covenants are imposed.