Restrictive covenants have traversed a tumultuous road since the Federal Trade Commission (FTC) issued a Notice of Proposed Rulemaking (NPRM) on January 5, 2023, purporting to ban noncompetition agreements throughout the United States. As described in Eversheds Sutherland’s January 6, 2023, Legal Alert, the FTC’s move built upon the Biden Administrations July 9, 2021, Executive Order on Promoting Competition in the American Economy, encouraging the FTC to tackle the issue by limiting or banning noncompetition agreements. The FTC was not the only agency to take steps to further this Executive Order. On June 1, 2023, Eversheds Sutherland published a separate Legal Alert summarizing the National Labor Relations Board (NLRB) General Counsel’s May 30, 2023 Memorandum to Regional Directors indicating that the “proffer, maintenance, and enforcement of [employee noncompete] agreements violate Section 8(a)(1) of the National Labor Relations Act (NLRA)” in most circumstances.

The FTC’s NPRM proposed sweeping restrictions as to “Unfair Methods of Competition” stating that “[i]t is an unfair method of competition for an employer to enter into or attempt to enter into a noncompete clause with a worker; maintain with a worker a noncompete clause; or represent to a worker that the worker is subject to a noncompete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable noncompete clause.” See Proposed Rule at 910.2(a). The FTC’s Proposed Rule would apply not only to noncompete covenants, but also includes a “functional test” to determine whether a particular contractual term operates as a de facto noncompete clause. See Proposed Rule at 910.1(b)(2). Specifically, the Proposed Rule defines the term “noncompete clause” as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” The FTC pointed to broad non-disclosure agreements and contractual terms requiring departing employees to repay training costs unrelated to actual costs the employer incurred as “de facto” noncompete clauses.

Over the last 16 months, the FTC received more than 26,000 comments regarding the NPRM. On April 23, 2024, the FTC approved its Final Rule banning noncompetes in employment agreements by a margin of 3-2. The FTC indicated during its presentation that over 25,000 of the comments received supported a comprehensive ban of noncompetes in employment agreements. The FTC indicated that, according to its research, the Final Rule will increase earnings by $400b-$488b over the next ten years (approximately $524 per worker/per year). Additionally, the FTC indicated that the Final Rule will result in increase in new businesses (roughly 8,500/year) and frequency of patent applications (from 17,000-29,000/year over the next ten years).

The Final Rule differs from the NPRM in some ways. First, existing noncompetes may remain in effect for “senior executives.” However, the Final Rule bans new noncompetes with senior executives, stating that noncompetes prevent senior executives from starting new businesses, which ultimately harms competition and the labor market in general. Two commissioners opposed implementation of the Final Rule, stating that it exceeded their authority under Section 6(g), lacked the clear direction to legislate under the major questions doctrine, and usurped powers traditionally left to the states. The highlights of the proposed Final Rule are as follows:

• The Final rule bans new noncompetes with all workers, including senior executives after the effective date.
  • Specifically, the final rule provides that it is an unfair method of competition—and therefore a violation of Section 5 of the FTC Act—for employers to enter into noncompetes with workers after the effective date.
• For existing noncompetes, the final rule adopts a different approach for senior executives than for other workers. For senior executives, existing noncompetes can remain in force. Existing noncompetes with workers other than senior executives are not enforceable after the effective date of the final rule.
  • “senior executive” refers to workers earning more than $151,164 annually who are in a “policy-making position.”
• The Effective Date of the Final Rule is 120 days after the date the rule is published in the Federal Register.

Typically, restrictive covenants between an employer and employee have been governed by state law. Here, the Proposed Rule did not reference “employee” but used the term “worker” which it defined broadly to include employee, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a client or customer. The FTC acknowledged application of state law in its NPRM, and expressly included a preemption provision indicating that its Final Rule “shall supersede any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent” with the rule.

However, parties opposed to the FTC’s ban committed to challenging any Final Rule in the courts. For example, the US Chamber of Commerce, likely the most outspoken critic of the FTC’s NPRM, laid the groundwork for a potential multi-pronged legal challenge in its April 17, 2023 Comment including that: (1) the FTC’s reliance on Section 6(g) authority is misplaced, especially when balanced against the major-questions doctrine; (2) noncompete agreements have never been considered per se violations of anti-trust laws; and (3) the FTC’s arbitrary and capricious decision-making violates the Administrative Procedures Act. Therefore, legal challenges to the Final Rule are likely imminent.

From a practical standpoint, assuming the FTC’s Final Rule (or some variation of it) survives the legal challenges, employers can look for alternative ways to protect their investment in research and development, employee training, and customer/client development including: (1) review and update policies and agreements with “workers” regarding protection of confidential and proprietary information; (2) implement protection strategies to limit workers’ access to confidential and proprietary information (and ensure proper marking of confidential information); (3) customize non-solicitation of customers provisions in agreements; (4) narrowly tailor non-disclosure agreements; (5) provide training to workers so that they can identify confidential and proprietary information of their employer as well as any customers or others; (6) bolster exit protocols for departing employees; and (7) modernize company electronic systems. There are obvious second and third order effects that accompany any such decisions.

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