The Federal Trade Commission, voting 3-2 along party lines, adopted a Final Rule banning non-compete agreements. The Final Rule allows some narrow exceptions (based both on time and circumstances) but prospectively prohibits employment-related non-competes to the full extent of the FTC's jurisdiction when it takes effect in 120 days. As the FTC noted in adopting the Final Rule, mounting abuses and distortions of the labor market led to this action. But there remains a key question to be litigated before the Final Rule takes effect -- whether the FTC has the power to ban non-compete agreements and, if so, to what extent.
The Final Rule sets up a simple regime for non-compete agreements that would be entered into after the Effective Date: employers cannot do it, except as part of a sale of a business (whether the bound person is selling the business as a whole, in part, or substantially all of the assets). That is, employers can no longer enter into non-competes with employees or independent contractors after the effective date, cannot represent to a worker that they are subject to a non-compete clause, and cannot seek to enforce or attempt to enforce a non-compete entered into prior to the effective date (unless the cause of action accrued before the effective date).
With regard to non-compete agreements entered into by employees before the effective date, the Final Rule voids the vast majority of them. It establishes an exception, however, for "senior executives" -- company officers who have policy making authority to make decisions that control significant aspects of the business, such as company presidents, CEOs, secretaries, treasurers, or CFOs. Such officers also must make over the oddly specific sum of $151,164 in total annual compensation.[1] The Final Rule allows those senior executives to be bound to non-compete agreements entered into before the effective date, at least to the extent permissible under state law.[2]
Importantly, the scope of what could be construed as a non-compete agreement is quite broad. It includes any written or oral contractual employment term or workplace policy
that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:
(i) 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
(ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
The intent of the broad definition is to capture not only express non-compete agreements, but also overly broad non-disclosure agreements ("NDAs"), non-solicitation agreements, and training repayment agreements ("TRAPs"), as well as other de facto non-competition provisions. But there is no clear safe harbor for what type of agreements or terms would be excluded from the definition of a non-compete provision; it is not intended to include prohibitions on trade secret misappropriation or properly-scoped NDAs, but there are situations where a worker practically could not accept employment with a competitor without a substantial risk of trade secret misappropriation. So employers are left in the dark, not knowing if they can enforce a prohibition or not and potentially subject to FTC enforcement if they are believed to have acted in less than good faith.
In addition to prohibiting new non-compete agreements, the Final Rule requires employers to provide notice to employees who are currently subject to non-competes that they will be freed from those obligations. The Final Rule has the text of a "safe harbor" notice, which must be delivered by hand, mail, email, or text to the last known address or number of an employee or former employee. That is, even if an employer has not sought to enforce a non-compete agreement against a former employee, it must go back to its files and dispel any perception that it would enforce the agreement against a former employee in the future.
The Democratic members of the FTC (but not the Republicans) reached the conclusion that the Final Rule was appropriate based on over 26,000 comments, 570 pages of reasoning, and numerous studies of the prevalence of non-compete provisions. Approximately 20% of American workers are subject to non-compete agreements.[3] Most notoriously, Jimmy John's made its sandwich makers subject to onerous non-compete provisions, prohibiting them from moving to greener pastures at Subway or Potbelly's. But such provisions are also quite common in the medical field. While they bring stability to hospitals and doctor's groups, they impede unhappy doctors and nurses from switching practices while continuing to serve their existing patients (instead requiring them to move geographically to continue practicing or wait out the non-compete provision). The problems created are especially acute in rural areas, where there may already be limited options for patients, even without the limitations imposed on doctors' movement.
The FTC Final Rule shifts substantial power from employers to employees. It provides no way for employers to recoup investment in employee training and other capital development, and requires them to fall back on trade secret law and NDAs to protect their confidential information. It therefore will place a greater enforcement burden on employers, which will place a premium on putting strong IP protection policies in place and having competent trade secret litigators at the ready. But it also will encourage innovation and fluidity in the labor market, potentially freeing employees to use public information and job skills to develop their own businesses or help grow more hospitable companies.
All of this relies, however, on the courts not striking the Final Rule down as exceeding the bounds of the FTC's power under the Federal Trade Commission Act. The report on the Final Rule provides extensive argument justifying why the three Democratic Commissioners believe the Final Rule to be in the FTCs mandate. But it is a question of what paradigm the courts adopt: is the Final Rule a means of regulating conduct between businesses (albeit through the mechanism of employer-worker relations) at the outer edge of the FTC's power or is it interference in the labor market only incidentally related to interstate commerce? Decisions on the legality of prior rules provides no clear answer, and the outcome may depend on the record presented to the deciding judge (as well as the identity of the deciding judge). If the question comes before the current Supreme Court, there will be a substantial likelihood that the Court will not defer to the FTC's expertise on construing its own powers.
In the meantime, employers should prepare for the possibility that they will have to comply with the Final Rule. That means reviewing what non-compete provisions they have outstanding (including NDAs, non-solicitation agreements, TRAPs, employee handbooks and other agreements). Employers then must figure out which may still be enforceable and which will be negated by the Final Rule and prepare to provide notice to employees and former employees who will no longer be bound by non-competes. But just as importantly, they must sit down and rethink their IP protection strategy and determine how they can ensure employees will not be walking out the door and taking trade secrets to competitors. In short, the disappearance of the clear (but blunt) tool of non-competes may force employers to adopt completely different policies for protecting their IP.
[1] The FTC chose this amount because it represents the compensation for 85th percentile of full-time salaried employees nationally in 2023. But the choice of the 85th percentile was arbitrary -- it was proposed to be raised from the 80th percentile as the metric for "highly-compensated employees" in September 2023. Furthermore, it is not pegged to the earnings of officers, but employees as a whole.
[2] In California, non-compete agreements that are not incident to the sale of a business are already not enforceable. The Final Rule does not allow such agreements, it just does not prohibit them.
[3] Notably, lawyers cannot be subject to traditional non-compete agreements under existing ethical rules. The reasoning for the prohibition on non-competes in the legal field is that it would impact clients' choice of counsel.
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