As reported earlier, the FTC voted last week to approve its Final Non-Compete Clause Rule (the “Rule” or “Final Rule”), which outlaws almost all non-compete agreements between employees and employers throughout the country.
While the move made significant headlines, its actual impact—for the moment—remains slim.
Litigation efforts from business groups to block the rule came quickly. On Wednesday, the U.S. Chamber of Commerce filed a much-anticipated lawsuit seeking to invalidate the rule. The Chamber’s complaint, filed in the U.S. District Court for the Eastern District of Texas, alleges the FTC operated outside of its authority in promulgating and approving the final rule.
While onlookers wait for the court challenges to play out, an overview of the Rule and expected next steps will help businesses prepare and consider their next steps.
What Exactly Is The FTC’s Non-Compete Rule?
The FTC, as a federal agency, has authority to issue regulations (i.e., “rules”) that relate to the laws the agency enforces. The FTC enforces the Federal Trade Commission Act (the “FTC Act”). More specifically, the FTC primarily enforces Section 5 of the FTC Act, which is aimed at prohibiting “unfair methods of competition, and unfair or deceptive acts or practices affecting commerce.”
The FTC itself is governed by a panel of 5 commissioners, currently led by Chair Lina Khan.
Before a federal agency may authorize a rule, it generally needs to solicit and review comments from the general public. The FTC did that last year, by issuing its “Proposed” Rule to prohibit non-compete agreements. The FTC then solicited public comment on the Proposed Rule last year.
Now, with the review of public comment complete, the FTC’s Final Rule is an agency-made regulation to prohibit non-competes in almost all private-sector employment throughout the country. In general, the FTC justified the rule by asserting non-compete clauses are an “unfair method of competition” in the labor market, and “inhibit[] new business formation and innovation.”
Legal challengers will contend that the Rule is unlawful on several grounds, but most will revolve around two basic arguments: (1) that the FTC has no authority to regulate what amounts to employment contracts, and (2) that the FTC did not properly consider public comment in formulating the Final Rule.
What is a “Non-Compete Clause” Under the Rule?
As defined by the Rule, a “non-compete clause” is any term or condition that prohibits a worker from seeking or accepting work with a different employer after they leave their current employer. That definition will capture virtually all traditional non-compete agreements between employers and employees.
Is the Rule Already In Effect?
No. Setting aside the court challenges, the Rule can only go into effect 120 days after it is published in the Federal Register, where most Federal agencies’ rules-and-regulations are initially published. At earliest, this means the Rule will not be effective until at least August 2024—and again, only if it survives court challenges to its viability.
Does the Rule Invalidate Non-Compete Clauses In Every Industry?
By its terms, Section 5 of the FTC Act does not cover most non-profit organizations. This means that many large non-profit institutions, such as hospitals and others in the health care industry, will likely still have the ability to utilize and enforce non-compete agreements.
Other entities similarly fall outside of the FTC’s jurisdiction under Section 5 of the FTC Act, including many banks, savings and loan institutions, federal credit unions, common carriers (including air carriers), and certain agricultural-and-farming entities covered by the Packers & Stockyards Act of 1921. Employers in these industries would also likely be left untouched by this non-compete Rule.
But if the Rule holds up against legal challenge, the issue of “covered employer” is sure to become a testing ground for FTC enforcement—especially in the health care arena.
Are There Exceptions For Some Types of Non-Compete Agreements?
There are two noteworthy exceptions.
First, the Rule carries an exception for any non-compete clause that was part of a “bona fide sale of a business” or “ownership interest in a business.” Unlike the Proposed Rule, the Final Rule loosens the eligibility for non-competes that are part of a business sale. In other words, non-compete agreements that are part of a business sale will be—at least theoretically—left untouched by this Rule.
Second, and in another change from the Proposed Rule, the Final Rule adds a carve-out for existing non-competes between businesses and “senior executives.” These non-compete agreements will essentially be grandfathered in. To qualify for the “senior executive” exception:
- The senior executive must have signed their non-compete agreement before the Final Rule becomes effective;
- The senior executive must make more than $151,164 annually;
- The senior executive must be in a “policy-making position,” such that they have “final authority” on decisions “that control significant aspects of a business entity”;
- The senior executive must be an “officer” of the company, such as a president, chief executive officer, vice president, or other principal officer.
Importantly, this carve-out applies only to existing non-competes with senior executives. If the Rule survives legal challenges and goes into effect, even senior executives will not be permitted to enter into non-compete agreements.
Does The Rule Invalidate Existing Non-Compete Agreements?
Yes, except for those pre-existing non-compete agreements with “senior executives” as discussed above.
Will Businesses Have to Notify Employees That Their Non-Competes Are Invalidated?
Yes. Businesses will be required to “provide clear and conspicuous notice” to those under existing non-compete agreements that their non-compete clause is legally unenforceable. The Final Rule sets out “model” notice language for businesses to use, and businesses that use the model language will be considered in compliance with their notification obligations.
The Rule also specifies that businesses must provide this notice no later than the “effective date” of the Rule. But with litigation against the Rule pending, businesses may elect to weigh their options before notifying any employees (or ex-employees) that are currently subject to a non-compete agreement.
What about Non-Solicitation Agreements and Non-Disclosure Agreements?
By its terms, the Rule does not prohibit non-solicitation agreements and non-disclosure agreements. In general, a non-solicitation agreement allows a worker to join another company after their departure, but, limits their ability to contact their former employer’s customers, clients, or employees. Non-disclosure agreements (“NDAs”) by contrast are used to safeguard an employer’s proprietary or other confidential information.
But the “title” of an agreement (or contractual clause) will not be a perfect shield against the Rule. In its commentary accompanying the Rule, the FTC noted that some overbroad NDAs and non-solicit agreements may serve as “functional non-competes.” Going forward, the FTC would analyze such clauses on a case-by-case basis to determine whether they functionally bar the worker from taking up employment with another company.
What About “Garden Leave” Agreements?
“Garden leave” agreements typically refer to arrangements where a business continues paying a worker for a set period of time, while simultaneously directing them to not perform any work and to not join any other companies.
In its response to public comments on garden leave, the FTC stated they could not comment on “every potential factual scenario” concerning garden leave. That said, the FTC added that certain garden leave arrangements would not constitute a prohibited non-compete agreement. In one portion of the FTC’s response, it stated that an agreement where a “worker [on garden leave] 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 Rule.
Regardless of the Rule’s survival against legal challenges, businesses should work with their employment counsel to consider alternatives in their employment contracts, such as garden leave provisions in lieu of traditional non-compete arrangements.
As stated above: litigation to block the rule is already underway. While court cases will be closely observed, businesses and executives alike are well-served to prepare for multiple eventualities.
First: looking strictly at the Final Rule, businesses with any interest in securing a non-compete agreement with key leaders should act fast, and, consider any compensation adjustments needed to come within the Rule’s exception for “senior executives.”
Second: businesses may consider modifying their existing employment agreements to bring them into best-as-possible compliance with regard to non-solicitation, confidentiality, and trade secret matters.
Third: businesses should review all of their restrictive covenant agreements and prepare for a potential “sea-change” in the world of non-competes, irrespective of whatever happens with the FTC’s Rule. State and local governments, including New York State, continue to draft their own non-compete prohibitions. Regardless of the final disposition of the FTC’s Rule, the regulatory and legislative oversight of non-compete agreements may have finally reached a tipping point. Consulting with employment counsel is critical to protect core interests.
