Non-Compete Clauses Banned By The FTC

In January 2023, the Federal Trade Commission (FTC) issued a notice of proposed rulemaking for a comprehensive ban on employee non-compete clauses. The FTC received over 26,000 comments from employees, businesses of all sizes, and other stakeholders in the months that followed. Today, April 23, 2024, the FTC approved a draft final rule (the “Rule”) to ban non-compete agreements by a 3 to 2 vote. A copy of the Rule can be found here.

The Rule’s impact on non-compete clauses will depend on two factors: (i) when the parties entered into the non-compete, and (ii) whether the affected employee qualifies as a “senior executive.”

1. For senior executives, non-competes will remain enforceable provided that they were entered into prior to the Rule’s effective date, which will be 120 days after the upcoming publication of the Rule in the Federal Register.
2. For employees who are not senior executives, employers will be prohibited from enforcing non-competes entered into prior to the Rule’s effective date, and employers must issue a notice stating that they will not attempt to enforce such non-competes.
3. For all employees (including senior executives), employers are prohibited from entering into new non-competes following the effective date.

What Is a “Non-Compete Clause”?

As discussed above, the Rule prohibits non-compete clauses in a variety of different contexts. As defined by the Rule, a non-compete clause means:

“[a] term or condition of employment 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.”

Clearly, the Rule covers the vast majority of true non-competition provisions – i.e., those that restrict where an employee can work post-employment.  The Rule would prevent employers from requiring employees to enter into such provisions moving forward and from enforcing existing non-competes, except against “senior executives.”

However, the definition does not expressly cover other commonly utilized restrictive covenants, such as confidentiality agreements, non-disclosure agreements (NDAs) and non-solicitation provisions. Notwithstanding, commentary to the Rule indicates that if any of these restrictions are sufficiently broad to have the “functional equivalent” of a non-compete, they may fall under the Rule and thereby be prohibited.

Additionally, commentary to the Rule suggests that forfeiture-for-competition provisions, where an employee sacrifices money or equity benefits if they compete against their former employer, are covered by the Rule and would thus be prohibited moving forward.

If the Rule goes into effect following likely imminent legal challenges, we expect there to be significant litigation over the Rule’s definition of what constitutes a non-compete clause, and the battleground between employers and employees will likely come down to whether an allowable restriction such as a non-solicitation provision acts as a de facto unlawful non-compete.

Who Is a “Senior Executive”?

The Rule differentiates “senior executives” with respect to enforcing existing non-competes, and this definition will also likely come under exacting scrutiny as courts grapple with the Rule if and when it comes into final effect.

The definition of “senior executive” requires the employee to meet two conditions: (1) they must be in a “policy-making position”; and (2) they must have an annualized compensation of at least $151,164.

What constitutes a “policy-making position” is not exact. While the Rule’s definition unambiguously captures chief executives and other decision-making officers, for example, it leaves open questions on how to treat officers of affiliated and subsidiary companies. Specifically, the Rule suggests that an individual who is an officer of an affiliated or subsidiary company who only has policy-making authority with respect to the subsidiary or affiliate, but not the overall common enterprises, would not qualify as a “senior executive” for purposes of the Rule.

Again, the Rule requires that both conditions be met for an individual to be considered a senior executive. Absent clarification from the courts, it is likely that many highly compensated individuals who are not directly involved in actually running their organization would not qualify as senior executives, and thereby the Rule would prevent their employer from even enforcing existing non-competes.

What Is the Notice Requirement for Employers Who Have Been Using Non-Competes?

Recognizing that the Rule will have the effect of invalidating hundreds of thousands of non-compete clauses across the United States in a single swoop, the FTC embedded a notice obligation for employers. On or before the effective date, employers must provide notice to each employee affected by a now-unlawful non-compete providing that the clause will not be, and cannot be, enforced against them. The FTC published a model notice as part of the Rule, which can be found at Section 910.2(b)(4) (page 566) of the Rule.

Are There Any Exceptions to the Rule’s Prohibition of Non-Competes?

The Rule contains certain exceptions to its general prohibition of non-compete clauses. One relates to the sale of a business. The Rule expressly provides that it does not apply to non-compete clauses entered into “pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.” The Rule also provides that its prohibition on non-competes does not apply to existing causes of action related to non-compete clauses that accrued prior to the Rule’s effective date. Finally, the Rule provides that it is not an unfair method of competition to attempt to enforce a non-compete clause when a person has a good faith basis to believe that the Rule’s prohibition on non-competes clauses is inapplicable. With regard to these exceptions, too, the exact nature and scope of the Rule will likely be the subject of significant litigation if and when the Rule becomes enforceable.

What Do I Do Now to Protect My Business?

Take a breath and wait! The Rule will undoubtedly be challenged imminently and, given the importance of the issue, will likely reach the United States Supreme Court. When and how those legal challenges will play out in court is impossible to predict. Even if those challenges are unsuccessful, the Rule’s effective date should provide ample opportunity for employers to get prepared. While not certain, to the extent any legal challenges are partially successful, it is possible the FTC will even push the effective date back depending on the litigation. Moreover, how this Rule will be impacted (if at all) by the 2024 election cycle is nearly impossible to predict.

Employers who want to get ahead of the game can focus on reviewing their existing practices with respect to other restrictive covenants that may provide suitable protection for their confidential information, goodwill and other business interests. For example, employers may find that an appropriately tailored non-solicitation provision provides the same (or even greater) protection to their goodwill and client relationships, while also avoiding various legal challenges under the Rule, existing case law and statutes governing the use of restrictive covenants. Employers may also want to begin taking stock of which non-senior executive employees have non-compete clauses for the purpose of determining to whom notice should be sent if and when the Rule becomes enforceable.

We are staying up to date on these issues and will provide updates as information is released.