Our Labor & Employment and Antitrust teams unpack the new Federal Trade Commission rule banning most employer noncompete clauses.

• Most U.S. workers under the FTC’s jurisdiction are covered by the ban
• Employers may still be subject to stricter state laws
• The rule goes into effect in late August, pending court challenges

On April 23, 2024, the U.S. Federal Trade Commission (FTC) voted to finalize a rule prohibiting employers from entering or enforcing noncompete clauses with U.S. workers, with only limited exceptions. This unprecedented vote marks a significant change in the law and for the first time establishes federal regulation of protective covenants in employment agreements.

In general, a noncompete clause is a contractual term between an employer and a worker that forbids the worker from working for a competing employer or starting a rival business. Until now, regulation of noncompete clauses had been left to the states. With its new rule, the FTC asserts that noncompete clauses are “an unfair method of competition” and argues that because noncompetes prevent workers from leaving jobs, they decrease competition for workers and allegedly lower wages. Additionally, the FTC asserts that noncompete provisions prevent new businesses from forming and stifle entrepreneurship, as well as any innovation that would otherwise occur when workers can broadly share their ideas in the market. With those stated justifications, the FTC voted 3–2, along party lines, to adopt a rule that bars almost all worker noncompete agreements in the United States.

Quick Summary

The rule bans noncompetes for the vast majority of U.S. workers by prohibiting companies from entering into new noncompete agreements with employees, independent contractors, or other workers. The rule also invalidates most existing noncompete agreements and requires companies to provide notice to current and former employees that such agreements are invalid.

Compliance with the new rule is required when it takes effect 120 days after publication in the Federal Register, meaning it will not be effective until late August. However, legal challenges may significantly alter, delay, or eliminate the impact of the FTC’s new rule.

Employers should carefully monitor developments and consult with their legal advisors to ensure compliance.

Definition of “Noncompete”

The rule only applies to post-employment noncompete provisions, and thus will not invalidate noncompete provisions that apply during the period of employment. In addition, the rule does not address business-to-business noncompetes—it is only concerned with the relationship between companies and their workers. Those agreements remain subject to existing antitrust laws.

The rule does not expressly prohibit customer/client nonsolicitation covenants, employee nonsolicitation covenants, confidentiality/nondisclosure covenants, or training expense reimbursement provisions. The FTC’s explanation of the rule, however, leaves open the possibility that certain nonsolicitation covenants, nondisclosure covenants, or training expense reimbursement provisions could be considered noncompetes if they “function to prevent” a worker from seeking or accepting other employment or starting a business. If the rule ultimately goes into effect, we anticipate a considerable amount of litigation surrounding this fact-specific gray area of the rule.

Notice Requirement

The rule requires employers to provide notice to current and former workers that the workers’ noncompete clauses are no longer in effect and may not be enforced against the worker. The deadline for providing this notice is 120 days after the rule is published in the Federal Register. An earlier proposed version of the rule would have also required formal recission of these agreements. Although the recission language was removed from the final version, the notice requirement remains.

The rule includes model “safe harbor” language employers may use to give the required notice to persons covered by noncompete agreements that will be rendered invalid by its terms. FTC guidance also states that an “all-staff email using the model language” fulfills an employer’s notice obligations.

Important Exceptions

Senior executive exception

The rule includes a limited exception for “senior executives.” It allows companies to enforce existing noncompete agreements with senior executives but bars new noncompete agreements with them once the rule takes effect. This effectively establishes a 120-day period to enter into new noncompete agreements with those senior executives. Employers should consult with counsel before doing so because those agreements may be subject to challenge under existing antitrust laws or other state labor regulations.

The term “senior executive” is defined narrowly and only covers officers at the highest levels of a company, such as the chief executive officer, president, or “any other officer of a business entity who has [final] policy-making authority,” provided they earn annual compensation of at least $151,164. The term also excludes executives of “a subsidiary or affiliate of a business entity that is part of a common enterprise” if they only have final policy-making authority for a subsidiary or affiliate, but not for a common enterprise.

Sale-of-business exception

The rule also includes a sale-of-business exception. The rule allows companies to enter into noncompetes with a person who sells an ownership interest in a business. This exclusion covers any seller of an ownership interest in a “bona fide sale of a business.” It broadens the exception in the proposed draft rule, which would have applied only to “substantial” owners, defined as sellers holding at least 25% ownership interest in the acquired business.

Other Exceptions Based on the Limits of FTC Jurisdiction

Given that the rule is promulgated under Section 5 of the FTC Act, it is limited to entities that can be regulated by the FTC Act. This excludes bona fide nonprofits, as well as certain entities defined in other federal laws referenced by the FTC Act, including banks (though generally not their affiliates), air and common carriers, and certain entities in the meat processing industry.

Penalties

Under the rule, the use of a noncompete is an “unfair method of competition” that violates Section 5 of the FTC Act, and the FTC may pursue injunctive relief. The FTC acknowledges it is not authorized to obtain civil penalties or other monetary relief for violations of unfair competition but that it may recover civil penalties in court when a party ignores an order to cease and desist from such a violation. While there is no private right of action under Section 5 of the FTC Act, the FTC is encouraging reporting violations of the rule via email.

Litigation Challenging the New Rule Is Imminent

The rule was approved by a 3–2 vote, with the commission split along party lines. During the open hearing at which the rule was adopted, newly appointed Commissioner Melissa Holyoak dissented from the adoption of the rule, characterizing the noncompete rule as a “broad rule making that exceeds Congressional authorization and will likely not survive legal challenge.” On April 24, the U.S. Chamber of Commerce filed a lawsuit in federal court in Texas challenging the FTC’s legal authority to issue the rule, which seeks to vacate the rule and permanently enjoin the FTC from enforcing it. Judge J. Campbell Barker, who last month vacated the National Labor Relations Board’s new joint-employer rule, was assigned. Other legal challenges are expected in the coming days and weeks.

It is unclear when or whether the rule will go into effect, and we are closely monitoring the legal challenges.

If the rule is struck down as an overreach of its rulemaking authority, the FTC may still be able to pursue individual enforcement actions against companies for employee noncompete agreements as a violation of Section 5 of the FTC Act, as it did against a number of companies in 2023.

Summary of Key Points

• The FTC rule bans noncompetes for U.S. employees, with only narrow exceptions:
  • It allows companies to enforce existing noncompete agreements with senior executives (a narrowly-defined term), but does not allow companies to enter into new noncompete agreements with them once the rule takes effect in late August.
  • It allows companies to enter into noncompetes with a person who sells an ownership interest in a business.
  • Some banks and nonprofits (and a few other types of employers) are not within the FTC’s jurisdiction and are not covered.
• This rule operates as a floor rather than a ceiling, and employers may still be subject to even stricter laws in effect in certain states.
• The FTC rule does not prohibit customer nonsolicitation agreements, employee nonsolicitation agreements, or nondisclosure agreements, though care should be taken to ensure that those agreements are not so broad that they “function to prevent” a worker from seeking or accepting other employment or starting a business.
• The FTC rule does not go into effect for four months.
• The FTC rule is being challenged in court, and so may be enjoined from taking effect.

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