Federal Trade Commission Bans Non-Compete Agreements
May 2, 2024
By: Meagan Cooper Borgerson and Stephen B. Stern
The Federal Trade Commission (“FTC”) announced on April 23, 2024 that it issued a final rule that bans most non-compete agreements between employers and employees. The final rule goes into effect 120 days after the date of publication in the Federal Register. It is scheduled to be published in the Federal Register on May 7, 2024.
The FTC’s final rule bars employers from entering into non-compete agreements with its workers. The final rule defines a “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” The term “penalizes” applies to a restrictive covenant that requires a worker to pay a penalty for seeking or accepting other work. The phrase “functions to prevent” was included in the final rule to cover clauses that are not labeled as non-competes but are so restrictive that their effect is to prevent a worker from working elsewhere. One example identified by the FTC of an agreement that “functions to prevent” an employee from seeking employment is an overbroad non-disclosure agreement that can be construed to effectively preclude a former employee from working in the same field after the employee’ employment terminates. Determinations regarding the “functions to prevent” prong of the definition are likely to result in litigation and will be analyzed on a case-by-case basis.
The new rule applies to all workers, except “senior executives” who entered into a non-compete agreement prior to the effective date of the final rule. The final rule defines “worker” as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” This includes full-time, part-time, and temporary workers. A “senior executive” is a worker who earns more than $151,164 (calculated either based on the preceding year, or annualized if the worker was employed during only part of the preceding year) and is in a “policy-making position.” A “policy-making position” is a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. There are nuances to this definition related to those workers that have policy-making authority for subsidiaries, affiliates, or other common enterprises. The final rule defines “officer” as a president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any natural person routinely performing corresponding functions with respect to any business entity whether incorporated or unincorporated. “Policy-making authority” is defined as final authority to make policy decisions that control significant aspects of a business entity or a common enterprise, which ensures that the term “senior executive” is broad enough to cover more than just a president or chief executive officer, especially for larger companies, as others may have final policy-making authority over significant aspects of a business entity. Although the final rule does not apply to “senior executives” who are under an existing non-compete agreement, the final rule prohibits employers from entering into non-compete agreements with “senior executives” after the effective date of the rule.
Prior to the effective date of the final rule, notice must be provided to all affected employees. The FTC has published a model notice in English and other languages, which is available on the FTC website. Notice should be delivered by whatever method each business typically transmits notices of policy changes to employees, whether by email, text message, paper notice by hand, or mail. Whatever form of notification is used should be documented and preserved.
Although non-compete agreements going forward will be void, the FTC recommends that businesses delete all non-compete clauses from future employment contracts, future versions of employee handbooks or other workplace policies, and from company websites.
The FTC’s final rule applies to nearly all for-profit businesses in nearly all industries. There are some limited instances in which employers fall outside the FTC’s jurisdiction and, therefore, are not subject to the FTC’s final rule. Examples of industries not covered by the FTC include banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and certain non-profits.
While many businesses likely will find the new FTC rule substantially limits their ability to protect legitimate business interests, the rule does not eliminate all non-compete agreements and it does not eliminate other agreements that can help businesses protect their intellectual property, business relationships, and other business interests. For example, the final rule does not ban non-solicitation clauses, confidentiality or other non-disclosure agreements, and it does not affect trade secret protections, unless these agreements or protections “function[] to prevent” a worker from finding employment elsewhere (e.g., a non-compete clause in the form of an overbroad nondisclosure agreement). The final rule also does not apply to non-compete agreements entered into by a person in connection with a bona fide sale of a business entity. In addition, the final rule does not apply where a cause of action related to a non-compete accrued prior to the effective date.
Although businesses should start planning how they plan to operate in a world that will mostly operate without non-compete agreements, in consultation with their counsel, it is still not a certainty that the FTC’s final rule ultimately will take effect. The US Chamber of Commerce and the Business Roundtable already filed litigation in the United States District Court for the Eastern District of Texas, seeking to block the implementation of the final rule. Another lawsuit also was filed in the United States District Court for the Northern District of Texas, and other lawsuits likely will follow. Businesses that utilize non-compete agreements will want to monitor these lawsuits to see whether the final rule takes effect or whether courts halt its implementation. Regardless of what happens at the trial court level, the validity of this FTC rule likely will be decided by the United States Supreme Court.