On April 23, 2024, the Federal Trade Commission (“FTC”
or the “Commission”) voted to finalize a rule abolishing
the vast majority of employee noncompetes across the United States
(the “Noncompete Rule” or “Rule”). The FTC
first announced its proposal to ban noncompetes in 2023, prompting over 26,000 public comments
in response. The FTC has been reviewing these comments ever since,
culminating in this week’s vote during an open meeting of the
five-member Commission. The vote to adopt the rule was 3-2, with
the Commission’s three Democratic members voting in favor of
the rule and its two Republican members dissenting.
The Noncompete Rule bans noncompete agreements with employees of
all ranks and seniorities in virtually all industries across the
United States. The core of the rule is the FTC’s finding that
noncompetes are an “unfair method of competition” under
Section 5 of the FTC Act, both to the extent
that noncompetes can be exploitative and insofar as they can
prevent the formation and growth of new competitors.
The FTC’s vote to finalize the Noncompete Rule is not
necessarily the final word on worker noncompetes. The U.S. Chamber
of Commerce, among other groups, has already filed a lawsuit
challenging the Noncompete Rule, seeking injunctive relief to delay
the effective date as well as a ruling to vacate the Noncompete
Rule in its entirety. In fact, two of the FTC’s five
Commissioners appear to be persuaded by the challengers’
arguments, with one Commissioner expressing during the open meeting
that she believes the Noncompete Rule “likely will not survive
legal challenge.”
Overview of the FTC’s Noncompete Rule
The FTC’s Noncompete Rule has three main components:
- For the great majority of workers, the Noncompete Rule declares
it an “unfair method of competition” to enter into or
enforce a noncompete agreement. “Workers” are defined
broadly to include employees, independent contractors, externs,
interns, volunteers, apprentices, and sole proprietors.
- Before the effective date of the Rule, employers that have
noncompetes subject to the Noncompete Rule must notify affected
employees that their noncompete will not and cannot be enforced.
The Noncompete Rule includes model language to this effect that can
be shared with employees.
- To the extent that a noncompete agreement may be permitted
under state law, the Noncompete Rule states that it preempts such
state law.
In terms of timing, the Noncompete Rule is scheduled to go into
effect 120 days after its publication in the Federal
Register. Although the Rule has not yet been published, the
effective date is likely to fall in late August or early September
of 2024.
What Does the FTC Consider To Be a Noncompete?
The Noncompete Rule applies to “traditional”
noncompete clauses, i.e., prohibitions on work after
employment ends. But the Noncompete Rule also applies to provisions
that “penalize” a worker (e.g., forfeiture of
severance or equity, buyout clauses) for seeking or accepting work
after the conclusion of the person’s employment.
Finally, the Noncompete Rule includes a catchall provision to
capture other types of agreements that “function[ ] to
prevent” a worker from accepting different work after the
conclusion of their employment. This catchall language may
potentially encompass other forms of restrictive covenants,
including non-solicitation agreements. While the FTC’s
rulemaking notice refers to non-solicitation clauses, customer- or
client-based “no business agreement[s],” and non-hire
agreements as “generally not non-compete clauses,” the
FTC notes that such restrictions could potentially rise to the
level of a prohibited noncompete based on a fact-specific inquiry.
It remains an area of uncertainty where the FTC or courts would
draw the line.
Does the Rule Apply to Already-Executed Noncompetes?
Yes, with one exception. The Noncompete Rule does not disturb
noncompete agreements made before the Rule’s effective date for
those workers whom the FTC defines as “senior
executives.” Instead, the Rule only declares it an
“unfair method of competition” to enter into or enforce a
noncompete agreement with a senior executive when that agreement is
made after the Rule’s effective date. A “senior
executive” is defined as a worker who earns at least $151,164
per year (the 2025 salary threshold for a “highly compensated
employee” under the Fair Labor Standards Act) and serves in a
“policy-making position” with the organization. For
workers who are not “senior executives,” however,
pre-existing noncompetes will no longer be enforceable after the
Rule’s effective date.
To be clear, while pre-existing agreements with senior
executives will remain enforceable after the Noncompete Rule’s
effective date, employers will not be able to
enter into new noncompetes with “senior executives” after
said date.
Are There Any Exceptions?
Yes, there are a few.
For one, by statute the FTC does not have authority to prevent
“unfair methods of competition” when done by certain
banks, certain nonprofits (including certain nonprofit health care
providers), certain common carriers, or persons subject to the
Packers and Stockyards Act of 1921. These sorts of organizations
will therefore be exempt from the Noncompete Rule. That said, there
are ambiguities in the scope of some of these exemptions that will
need to be carefully considered.
For instance, even though nonprofits generally fall outside the
scope of the FTC Act, the scope of this exemption is unsettled and
can be hazy. Some nonprofits use management or administrative
corporations that may, themselves, be for-profit entities. Some
health care organizations use for-profit medical groups or
professional corporations to employ physicians and other
professionals that are otherwise subject to a “corporate
practice of medicine” prohibition. Additionally, nonprofit
hospitals sometimes contract with for-profit staffing company to
provide employee coverage. Any of these sorts of for-profit
entities may well be subject to the Noncompete Rule. Therefore,
nonprofit organizations such as universities, health systems, and
other charitable entities should be careful to identify those
members of their corporate family that may be subject to the
Noncompete Rule — and those that are not. These organizations
therefore should take care not to send the
required notice to those employees who are not subject to the
Noncompete Rule.
Second, the Noncompete Rule only applies to agreements that
restrict workers from taking work with another employer “after
the conclusion” of their employment. Therefore, subject to
state law, an employer would still remain able to prohibit
current employees from working for a
competitor.
Finally, the Noncompete Rule includes three explicit
exemptions:
- Sale of a Business. The Noncompete Rule does
not apply to noncompetes “entered into by a person 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.” Therefore,
noncompetes entered into in connection with the sale of a business
will remain enforceable under the Noncompete Rule.
- Prior Breaches. The Noncompete Rule does not
apply “where a cause of action related to a non-compete clause
accrued prior to the [Noncompete Rule’s] effective date.”
In other words, the Noncompete Rule is only prospective in effect.
If a worker violated an otherwise valid noncompete before the
Rule’s effective date, the worker may still be subject to legal
action for that violation.
- Good-Faith Belief the Rule is Inapplicable.
Finally, the Noncompete Rule does not apply “where a person
has a good-faith basis to believe that [the Noncompete Rule] is
inapplicable.” For example, if a nonprofit hospital believes
in good faith that it is exempt from the FTC’s jurisdiction,
then that good-faith belief provides it with a defense in any
enforcement proceeding — even if a court ultimately
determines that the FTC’s authority applies to that
nonprofit.
Does the FTC Have the Power To Do This?
It is unclear. The FTC has never attempted anything of this
scope before, and litigation over the Noncompete Rule will raise a
host of interesting constitutional, statutory, and administrative
issues. One of the leading grounds for a challenge will be the
so-called “major questions doctrine,” which requires
clear Congressional authorization before an administrative agency
will be found to have the power to decide major policy questions.
The FTC, however, will point to a 1973 decision by the D.C. Circuit Court of
Appeals, which held that the FTC has the authority to promulgate
“substantive” rules about what constitutes unfair methods
of competition. These precedents are difficult to reconcile, and it
is possible that different courts may decide these cases in
seemingly inconsistent ways. There is even a potential for
different results to apply in different parts of the country.
What Should I Do Now?
In the immediate term, we will be closely watching the lawsuits
filed by the U.S. Chamber of Commerce and others. One or more
courts might issue a nationwide injunction barring the Noncompete
Rule from taking effect pending a full trial on the merits, in
which case the Rule would not go into effect for the foreseeable
future.
If, however, the Noncompete Rule survives the initial round of
court challenges, then businesses should be prepared to move
quickly in anticipation of a country without noncompetes. At a
minimum, before the effective date of the Noncompete Rule,
businesses should be prepared for the following:
- Prepare to distribute the required notices informing employees
that their noncompetes will no longer be enforced. However, to the
extent that existing noncompetes are in place with senior
executives above the earning threshold and who have the requisite
policy-making authority, such senior executives should be excluded
from the distribution of that notice.
- Businesses should explore whether they might have other ways
— such as nondisclosure agreements or fixed-duration
employment contracts — to accomplish some of the same goals
as noncompetes.
- Businesses should review their other restrictive covenants,
including non-solicitation and no-hire clauses, to ensure those
clauses are narrowly tailored to protect their legitimate
interests, thereby reducing the risk that they will be challenged
as being within the Noncompete Rule’s catchall provision
prohibiting terms that “function[ ] to prevent” a worker
from working for a different company after employment.
- Businesses should have confidentiality agreements in place with
employees and should prepare for a potential wave of trade secret
litigation, as employees are increasingly enticed to leave their
employment to work for competitors. This means businesses will need
to be prepared for increased costs of data and forensic work that
are generally prevalent in trade secret and confidentiality
litigation matters.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
#FTC #Finalizes #Rule #Employee #Noncompetes #Contract #Employment
