On April 23, 2024, in a 3 to 2 vote, the Federal Trade Commission (FTC) voted to implement its final rule prohibiting non-compete agreements in the workplace.
What the Final Rule Prohibits
Scheduled to take effect 120 days after its publication in the Federal Register, the rule makes it an unfair method of competition to enter into or enforce, or attempt to enter into or enforce, non-compete clauses with “employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person.” The rule even prohibits representing that a worker is subject to a non-compete clause. Pre-existing non-competes with senior executives remain enforceable following the rule’s effective date.
The definition of “non-compete clause” includes agreements that penalize or “function to prevent” a worker from seeking or accepting work or operating a business. The rule then would prohibit agreements that include financial penalties for competing. The rule could also prohibit a non-solicitation of customers provision if it is too restrictive but would likely not prohibit most non-solicitation of employees or contractors clauses. Given the rule’s notice requirement discussed below, employers will likely need expert legal advice in making these determinations.
Effect on State Law
The final rule supersedes any and all conflicting state laws. In other words, it voids even those agreements that comply with state non-compete laws. For example, agreements that comply with the Texas Covenants Not to Compete Act will be unenforceable unless excepted from the final rule.
Narrow and Limited Exceptions
1. Senior Executive Exception
As mentioned, the rule carves out non-compete agreements executed by senior executives but only if those agreements pre-date the effective date. The regulations define “senior executives” as workers in a policy-making position with annual compensation of at least $151,164.00.
Policy-making positions include presidents, chief executive officers, or any other officer with policy-making authority, and a person with policy-making authority is defined as anyone who can make final decisions related to significant aspects of a business or common enterprise. Notably, the rule specifically states that a person with policy-making authority over only a subsidiary or affiliate of a common enterprise does not qualify for the senior executive carve out.
2. Bona Fide Sale of a Business Exception
Under the rule originally proposed by the FTC in January 2023, the sale of a business exception only allowed a purchaser to utilize non-competes with workers who are also owners, members, or partners of entities with 25% or more ownership interest in the purchased entity. The final rule did away with the ownership percentage requirement, permitting non-competes pursuant to the sale of a business or substantially all of its assets.
3. Franchising Exception
The rule excludes from the definition of “worker” a franchisee in the context of a franchisee-franchisor relationship. Non-compete agreements remain viable tools for franchisors.
4. Pending Litigation
The rule does not apply where a cause of action arising under non-compete clause accrued prior to the effective date of the rule. That should exempt most pending non-compete litigation from application of the rule, as well as unfiled lawsuits where the breach of the non-compete clause has already occurred.
Notice Requirement
The rule requires notice be sent to any worker subject to an existing non-compete clause not subject to an exception identified above. The notice must include a clear and conspicuous statement that the worker’s non-compete clause will not and cannot be legally enforced against the worker.
The notice requirement may necessitate evaluating every non-compete an employer has used to determine the length of time restrictions. Once the time period has been identified, employers must identify every worker subject to the relevant agreement and send notice to them. In other words, the notice must be sent to both current and former workers.
Next Steps
Employers seeking safe harbor in the senior executive exception should begin taking steps toward drafting and executing enforceable non-compete agreements before the effective date of the rule. Such steps may include ensuring the senior executive’s salary and job duties meet the requirements of the rule.
Employers should also begin the process of identifying workers subject to non-compete agreements, keeping in mind the broad definition of “worker” provided by the final rule. However, before sending out notice, employers should wait and see if, before the effective date, a court stays enforcement of the rule. Otherwise, an employer may waive enforcement of a non-compete clause based on an FTC rule that is ultimately found unconstitutional.
What is Next?
Within hours of the FTC’s issuance of its final rule, lawsuits were filed in federal courts in Texas challenging the FTC’s authority to implement a regulation with such sweeping effect on commerce absent an act of Congress. The Supreme Court recently struck down an Environmental Protection Agency regulation as an unconstitutional overstep by an administrative agency into the legislative process. See West Virginia v. EPA, 142 S. Ct. 2587 (2022). The West Virginia opinion reined in administrative power under the so-called “major questions doctrine,” by limiting the agency’s ability to address “major questions” with “vast economic or political significance” absent clear statutory authority from Congress.
