May 2, 2024

Potential Exceptions Under FTC’s Non-Compete Ban

Megan Gerking, Alexander Paul Okuliar, Lisa Phelan, David Shaw, Cooper Spinelli, Eric Akira Tate

+ Follow Contact

Send

Embed

Morrison & Foerster LLP

On April 24, 2024, the U.S. Federal Trade Commission (FTC) promulgated its final rule prohibiting non-competes for most workers in the United States (the “Final Rule”).

The Final Rule raises several issues, including enforceability, legal challenges, policy implications, how it interacts with other laws, and what may be some of its potential exceptions. This article focuses on the potential exceptions.

As we reported, the Final Rule defines prohibited non-competes as a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

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
operating a business in the United States after the conclusion of the employment that includes the term or condition.

16 C.F.R. § 910.1 (as published in the prospective Federal Register notice).

But this does not mean all restrictive covenants that may have the effect of deterring employee competition are prohibited under the Final Rule. Several restrictive covenants may remain in the employer’s toolbox depending on the particular facts and language at issue and the state jurisdiction in which they purport to apply. The Final Rule clarifies, for instance, that it does not categorically prohibit non-solicits, NDAs, garden leave, and training repayment agreements. Nor does it prohibit fixed-term agreements. Other covenants and situations, however, such as forfeiture for competition provisions (prohibited) or non-competes on the dissociation of a partner from a partnership (unaddressed) appear to be prohibited or unaddressed under the Final Rule.

The chart below details these and other potential exceptions.[1] To be clear, just because the covenants or circumstances listed below may not be prohibited or categorically prohibited under the Final Rule does not make them per se lawful and enforceable. Determining whether the Final Rule applies is only one step when analyzing the enforceability of a particular covenant. Employers must also consider any restrictions under state or other applicable laws, as well as the circumstances of the particular case.[2]

Potential Exceptions	Status Under Final Rule	FTC Comments/Rules
Sale of Business	Not prohibited	Codified in § 910.3 – The exception “shall not apply to a noncompete clause that is entered into by a person pursuant to a bona fide sale of a business entity,[3] of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets” Note that the Final Rule does not contain the 25% ownership threshold that the FTC included in its proposed rule This exception would not include, however, “[s]o-called ‘springing’ non-competes and non-competes arising out of repurchase rights or mandatory stock redemption programs.” According to the FTC’s notice, these “are not entered into pursuant to a bona fide sale because, in each case, the worker has no good will that they are exchanging for the non-compete or knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting”
Non-Solicits (customer and employee)	Not categorically prohibited But could run afoul of the Final Rule where they “function to prevent a worker from seeking or accepting other work or starting a business.” (And see 2016 Joint DOJ/FTC Guidance for HR Professionals stating that certain non-solicit agreements between companies (“no poach” agreements) can be criminally illegal).	“Non-solicitation agreements are generally not non-compete clauses under the final rule because, while they restrict who a worker may contact after they leave their job, they do not by their terms or necessarily in their effect prevent a worker from seeking or accepting other work or starting a business”
NDAs	Not categorically prohibited Examples of broad NDAs that might be prohibited: NDAs prohibiting workers from “disclosing, a future job, any information that is ‘usable in’ or ‘relates to’ the industry in which they work”, i.e., any information that is usable in the industry regardless of whether it was ever used by the company and regardless of whether it was ever owned by the company; and NDAs prohibiting workers from disclosing any information or knowledge the worker may obtain during their employment whatsoever.	“[A]n 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” NDAs “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”
Garden Leave	Not categorically prohibited	“[T]he Commission notes that an agreement whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis would not be a non-compete clause under the definition, because such an agreement is not a post-employment restriction. 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”
Forfeiture for Competition	Prohibited	“Another example of a term that ‘penalizes’ a worker, under § 910.1, is an agreement that extinguishes a person’s obligation to provide promised compensation or to pay benefits as a result of a worker seeking or accepting other work or starting a business after they leave their job. One example of such an agreement is a forfeiture-for-competition clause, which, similar to the agreement with liquidated damages described previously, imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee seeking or accepting other work or starting a business”
Training Repayment Agreement (TRAP)	Not categorically prohibited	A TRAP might be prohibited if it “requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred to train the worker.”
Fixed-Term Agreements	Not prohibited	“The Commission relatedly clarifies that fixed-duration employment contracts, i.e., contracts between employers and workers whereby a worker agrees to remain employed with an employer for a fixed term and the employer agrees to employ the worker for that period, are not non-compete clauses under the final rule because they do not restrain post-employment conduct”
B2B Non-Competes	Not categorically prohibited	“[T]he Commission notes as a general matter that the definition would not apply to non-competes between businesses, but the Commission declines to opine on specific factual circumstances”
Non-Competes between Franchisors and Franchisees	Not prohibited	“[T]he final rule does not cover franchisor/franchisee non-competes” [b]ut, per the FTC, they remain “subject to the State common law and Federal and State antitrust laws, including section 5 of the FTC Act.”
Foreign Non-Competes	Not categorically prohibited	The “final rule would not invalidate non-competes entered into by foreign companies with foreign workers unless they restrict a worker’s ability to work or start a business inside the U.S.”
Dissolution of Partnership; Dissociation of Partner from Partnership; Termination of Member’s Interest in an LLC (similar to exceptions codified in CA BP §§ 16602, 16602.5)	Not addressed
Non-Competes in ERISA-covered employee benefit plan	Not addressed

[1] These exceptions are in addition to the senior-executive and cause-of-action exceptions already addressed in our client alert.

[2] The FTC also made it clear in its Final Rule that it believes it has the authority to regulate (whether through enforcement action or future rulemaking) many of these covenants even if they are not covered under the Final Rule. And at least one commissioner expressed a desire for the FTC to find ways to restrict, if not prohibit, non-competes in the franchisee-franchisor context.

[3] A “business entity” is defined as a “partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.”

[View source.]

Send Print Report

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Attorney Advertising.