In a novel and sweeping act of substantive rulemaking, the U.S. Federal Trade Commission (FTC) determined that non-compete agreements between employers and workers constitute an “unfair method of competition” prohibited under the FTC Act. The FTC issued a final rule that:

• Bans virtually all new non-compete agreements after the effective date.
• Renders unenforceable all existing non-compete agreements with employees who do not meet the criteria for a “senior executive.”
• Requires employers to notify affected employees of the change before the effective date.

The controversial rule, passed by a 3-2 vote, invited immediate legal challenge. The U.S. Chamber of Commerce and others argue that the rule violates the Administrative Procedure Act because the FTC lacks statutory authority to engage in such substantive rulemaking. They also say any such delegation of authority from Congress violates the U.S. Constitution and that the rule as finalized is arbitrary and capricious.

Unless stayed by a court, the rule will take effect 120 days after its publication in the Federal Register, which has not occurred. Here is what companies need to know:

Q: What is a “non-compete clause?”

The rule defines a prohibited “non-compete clause” to include any contract term, workplace policy or term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking work, accepting work or operating a business after the conclusion of the employment that included the term or condition.

Q:  What type of “workers” does the rule cover?

The rule covers “employees, individuals classified as independent contractors, externs, interns, volunteers, apprentices or sole proprietors who provide a service to a client or a customer.”

Q:  What type of employers are covered?

The rule applies to all employers other than certain banks, savings and loan institutions, nonprofits and common carriers that are exempt from FTC jurisdiction. The FTC, however, cautioned that nonprofit tax status does not necessarily place a nonprofit beyond FTC jurisdiction. The FTC expressed interest in scrutinizing nonprofits in healthcare, citing enforcement actions against a nonprofit hospital affiliated with for-profit physician practices.

Q:  Are garden leave provisions prohibited?

The FTC stated that traditional garden leave provisions, where the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis, would not constitute non-compete clauses because they do not impose post-employment restrictions.

Q:  What about forfeiture-for-competition provisions?

The FTC stated that forfeiture-for-competition and other provisions that require a worker to pay a penalty for engaging in post-employment competition are prohibited non-compete clauses.

Q:  Are non-solicitation provisions or NDAs prohibited non-compete clauses?

The FTC’s comments to the rule clarify that the rule does not cover non-solicitation provisions or non-disclosure provisions that do not prevent a worker from seeking or accepting work or operating a business.

However, the rule prohibits any clause that has the effect of prohibiting a worker from seeking or accepting employment or operating a business.

The FTC comments indicate that non-solicitation provisions, non-disclosure provisions and other post-employment restrictive covenants could function to prevent workers from competing if they are too broad in scope or onerous in practice; they therefore could be considered prohibited non-compete clauses.

Q:  Is there an exception for existing non-compete clauses?

The rule exempts non-compete clauses that senior executives entered into prior to the effective date. A “senior executive” is a worker who earned at least $151,164 in total compensation in the preceding year (or annualized if employed for only a partial year) and who holds a “policy making position” with their former employer. The rule defines a policy making position 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.”

Q:  Is there a sale-of-the business exception?

Yes. The rule does not apply to non-compete clauses entered into “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 a business entity’s operating assets.” Unlike the original proposed rule, this exception is not limited to only substantial 25% or greater owners. A “bona fide” sale is one made in good faith and not for the sole purpose of evading the rule.

Q:  Does the rule impact existing disputes?

The rule provides an exception for causes of actions related to a non-compete clause that accrued prior to the effective date. Therefore, workers who were in breach of a non-compete clause before the effective date can still be sued for breaches of the non-compete clause.

Q:  Who must receive notice and when?

On or before the effective date, employers must provide workers with impacted non-compete clauses with clear and conspicuous notice that the clauses will not, and cannot be, enforced. The notice must be provided in writing and delivered by hand, mail, email or text message.

Q:  What form should the notice take?

The rule provides a sample form notice and provides that employers will comply with the notice requirement if they use the sample form.

Q:  Does the rule supersede state law?

Yes. It supersedes any conflicting state law.

Q:  What are the penalties for violating the rule?

Issuing a non-compete or otherwise failing to comply with the rule would be a violation of Section 5 of the FTC Act, which may result in penalties or injunctive relief.

Q:  When will the rule take effect – and what is the status of legal challenges?

The rule states that it will go into effect 120 days after its publication in the Federal Register. The rule has not been published in the Federal Register yet, and there is no mandated timeline for that. The U.S. Chamber of Commerce has filed a motion for a preliminary injunction staying the effective date of the rule. We expect the court to rule on this motion well in advance of the effective date.

Q:  What steps should employers take?

Monitor Legal Challenges.

Plan for Notices. Employers should plan to provide the notices that will be needed if the rule goes into effect. Determining which employees should receive a notice could take time for larger employers.

Update existing agreements. If the rule become effective, employers should review and update form employment agreements to ensure the agreements do not contain post-employment restrictions, such as non-solicitation or non-disclosure provisions, that are so overbroad and onerous they run the risk of being deemed a non-compete clause.

Consider adopting employee retention tools. If the rule becomes effective, employers should consider adopting retention tools such as bonuses, deferred compensation plans that require continued employment to receive payouts and equity awards that vest over long periods of time.

Trade Secret Protection. Employers should audit of systems, policies and practices designed to protect confidential and proprietary information and trade secrets. Employers should determine how to improve trade secret protection practices, including by training employees, developing clear and comprehensive onboarding and off-boarding policies and practices, adopting technical solutions and updating employment agreements and policies designed to protect trade secrets.

Q:  Why is the FTC, as an antitrust agency, addressing employment practices?

In recent years, the FTC and the Antitrust Division of the U.S. Department of Justice (DOJ) have increasingly applied antitrust law to protect stakeholders other than consumers, including workers.

The FTC and DOJ have brought enforcement actions, including criminal charges, under antitrust laws to challenge agreements between companies not to hire each other’s employes (“no poach” agreements) and agreements to fix employee wages. The FTC has also scrutinized exchanges of information across competing employers about wages and compensation. The FTC’s release explains, however, that it believes the rule will benefit consumers as well by enabling former employees to launch new competing businesses and enabling rivals to recruit talent to compete.

Q:  What do the rulemaking and pending legal challenges indicate for future FTC enforcement based on “unfair methods of competition?”

The FTC said in November 2022 that it intends to challenge conduct and agreements that otherwise would be lawful under antitrust laws if the FTC believes they constitute an “unfair method of competition” (“UMC”) under Section 5 of the FTC Act. As explained in the FTC’s release for the non-compete rule, the FTC believes it can ban such unfair methods of competition by rule.

Because rulemaking takes time and resources, and because the FTC’s authority to engage in substantive UMC rulemaking will be tested in court, the FTC is unlikely to propose any new UMC rules prior to the conclusion of that litigation or at least before the next presidential election.

The FTC, however, is likely to continue to focus on individual UMC enforcement actions. The FTC will primarily target conduct or agreements that “violate the spirit of the antitrust laws” while not violating the letter of the law, or that would not violate antitrust law when viewed in isolation yet could harm competition if prevalent in the industry or if repeated in serial fashion. Examples from the FTC include:

• Invitations to collude.
• Practices that facilitate tacit coordination among competitors.
• Fraudulent practices in the standard-setting process or in advertising and marketing.
• Leveraging lawful market power in one market to dominate another, including through using technological incompatibilities to adversely impact competition in adjacent markets.
• Inducing suppliers to disadvantage a company’s rivals in ways that do not violate the Sherman or Robinson Patman Acts.
• Certain interlocking directorates (overlapping officers and directors with competitors) that fall outside of the prohibition in Clayton Act Section 8.
• Use of common commercial terms like loyalty rebates, exclusive dealing, tying, bundling or resale price maintenance that do not individually violate the Sherman Act, but can harm competition if prevalent in an industry.
• Engaging in a series of small acquisitions to grow market power or consolidate industries over time (“roll-up” or “platform” strategies).

Companies can manage risks of incremental UMC scrutiny by periodically evaluating their business practices and seeking advice from experienced antitrust counsel.