April 24, 2024Client Alert

FTC Bans Non-Compete Agreements

What Happened?

On April 23, 2024, The U.S. Federal Trade Commission (“FTC”), in a vote of 3-2, approved a rule banning most worker non-competition restrictions (“Final Rule”).

The Final Rule was adopted following FTC’s release of the Notice of Proposed Rulemaking on January 5, 2023, and changes made to the proposed rule following the receipt of over 26,000 comments from the public. 

What is the Effective Date of the Rule?

Barring any legal challenge (which is likely), the new rule will take effect 120 days from the Final Rule’s publication in the federal register (the “Effective Date”), with the final publication expected to occur soon. As detailed below, the possibility of litigation challenging the Final Rule could delay the Effective Date.

What is Now Banned?

New non-compete clauses on and after the Effective Date.

The Final Rule bans new non-competes with all “workers,” including “senior executives,” that are entered into on or after the Effective Date. Specifically, it will be an unfair method of competition for a person:

  • to enter into or attempt to enter into a non-compete clause;
  • to enforce or attempt to enforce a non-compete clause; or
  • to represent to a worker or a senior executive that they are subject to a non-compete clause.

Enforcement of existing non-compete clauses on and after the Effective Date.

For non-competes that are already in existence before the Effective Date, the Final Rule adopts different approaches for workers versus senior executives.  For workers, employers must provide them with written notice by the Effective Date that the non-compete is no longer enforceable. With respect to senior executives, however, existing non-compete clauses can remain in place.

Worker” and “Senior Executive” Defined

The Final Rule uses the term “worker” instead of “employee” because the term worker is broadly defined to include paid and unpaid employees, independent contractors, interns, externs, volunteers, apprentices, or a sole proprietor who provides a service to a person. The term worker does not include a franchisee in the context of a franchisee-franchisor relationship.

The Final Rule defines “senior executive” as a worker who was in a policy making position and earned at least $151,164.00 in total compensation: (i) in the preceding year, or (ii) when annualized if the worker was only employed part of the year, or (iii) in the preceding year prior to departure.  Total compensation includes salary, commissions, non-discretionary bonuses and any other non-discretionary compensation earned during that one-year period.

What is Not Affected by this Final Rule?

The restriction is purportedly only limited to non-compete clauses, which the Final Rule defines 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 FTC’s press releases are quick to note that the Final Rule does not affect trade secret laws and non-disclosure agreements established to protect a company’s proprietary or other sensitive business information.  However, the press releases are notably silent as to how the Final Rule would affect customer or employee non-solicit provisions. 

On its face, this Final Rule should not affect the enforceability of customer and employee non-solicit restrictions in most cases, but the proof may be in the application of this Final Rule to a particular set of circumstances and/or industries.  This will be one of the areas that we expect to be contested in litigation.  For example, if an offer of employment made by a competitor to a worker is conditioned upon them being able to work with certain customers, then the FTC (or counsel for an employee) could argue that a customer non-solicit provision would operate to “penalize a worker for, or functions to prevent a worker from. . .  seeking or accepting work” with the competitor, rendering the restriction void under the new Final Rule.

The introductory comments to the Final Rule purport to explain this section of the rule.  The following are important take-aways regarding the FTC’s intent:

  • “prohibits” applies to terms and conditions that expressly prohibit a worker from seeking or accepting employment (e.g. working for a competing sandwich shop).
  • “penalizes” covers any clause requiring that an employee pay a penalty for seeking or accepting work or starting employment after employment ends (e.g., liquidated damage of 50K; or extinguishing a company’s obligation to provide promised compensation; tying severance to compliance)
  • “functions to prevent” – this phrase functions as a catch-all, and the FTC explains in broad brushes what it means by this catch-all.
    • Does not categorically prohibit other types of restrictive employment agreements – e.g. nondisclosure of confidential information or trade secrets, non-solicitation agreements.  However, “if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.”
    • “[w]hether a given restrictive covenant rises to the level of being a functional non-compete will turn on the facts and circumstances of particular covenants and the surrounding market context does not render this aspect of the final rule overinclusive or vague.”
    • “An NDA would not be a non-compete under § 910.1 where the NDA’s prohibitions on disclosure do not apply to information that (1) arises from the worker’s general training, knowledge, skill or experience, gained on the job or otherwise; or (2) is readily ascertainable to other employers or the general public.”
    • “Clauses requiring repayment of a bonus when a worker leaves their job would not be non-competes under § 910.1 where they do not penalize or function to prevent a worker from seeking or accepting work with a person or operating a business after the worker leaves their job.”
    • Garden Leave: “With respect to garden leave agreements, as noted previously, commenters used the term “garden leave” to refer to a wide variety of agreements. The Commission declines to opine on how the definition of non-compete clause in § 910.1 would apply in every potential factual scenario. Instead, the worker continues to be employed, even though the worker’s job duties or access to colleagues or the workplace may be significantly or entirely curtailed. Furthermore, where a worker does not meet a condition to earn a particular aspect of their expected compensation, like a prerequisite for a bonus, the Commission would still consider the arrangement “garden leave” that is not a non-compete clause under this final rule even if the employer did not pay the bonus or other expected compensation.”
    • Businesses not covered by FTC rules.  While almost all businesses are covered by FTC rules, not all are.   In its comments, FTC suggests that those businesses may be affected in the same way by the Sherman Act.  

Worker Notification Requirement

The Final Rule requires that, by the Effective Date, employers actively notify current and former workers who are subject to non-compete clauses that the banned restrictions are no longer in effect and will not be enforced. The FTC also provides a sample notification for employers to use as a safe harbor.

Exception to Non-Competes Incident to a Sale of Business

The Final Rule creates a limited exception to allow non-compete clauses that are part of a sale of business agreement. Specifically, the law exempts non-compete clauses that are entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of the business entity’s operating assets.   Notably, this is narrower than earlier versions of the Rule, which would have limited “sale of business” agreements to sellers of 25% or more of the equity of the business.

Litigation Expected

Whether FTC has the required authority to ban non-compete agreements will soon be challenged in the courts, and the issue ultimately may be decided by the U.S. Supreme Court.  Legal challenges will likely delay the implementation of the Final Rule, but employers should continue to monitor such challenges so that they can be prepared to timely comply should the challenges prove unsuccessful.

What To Do Now

Currently, the ban does not become effective until the actual Effective Date, so businesses should consider whether they want to continue requiring new employees to sign non-compete provisions as part of their onboarding process.  Given the potential legal hurdles the FTC faces, it may be appropriate for employers to continue following their current onboarding processes pending litigation over the Final Rule.

Inventory all potentially covered agreements

It is likely that litigation will at least delay implementation of the Final Rule. Businesses should begin gathering all potentially covered agreements (including sale/purchase of business agreements, NDAs, IP ownership agreements, non-competition, and non-solicitation agreements) to determine which are covered by the Final Rule.

            Prepare notices

Businesses should prepare required notices now so that they are ready to send before the deadline (which may be delayed by the courts).

            Modify agreements

Most non-competition agreements are not standalone documents. They are typically clauses included in broader agreements. Businesses should prepare now to have functioning versions of agreements ready in case the Final Rule survives legal challenge.

If you have any questions, please contact your Michael Best attorney.

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