FTC Votes in Favor of Issuing Final Rule.
On April 23, 2024, the Federal Trade Commission
(“FTC”) voted in favor of issuing its final rule which
essentially bans all noncompetes going forward and invalidates most
pre-existing noncompetes. The final version of the FTC’s
non-compete ban largely tracks its initial proposed rule despite
receiving over 26,000 comments, many of which demonstrated that
damage to businesses and innovation will result from forbidding
noncompetes. The final rule will be effective on August 31, 2024,
so businesses should take steps now to protect their confidential
and trade secret information.
The Final Rule Keeps Most of the Proposed Rule’s
Restrictions on Noncompetes.
Despite wide-spread criticism of the FTC’s initial proposed
rule that it promulgated in January 2023,1 the final
version of the non-compete rule will largely have the same
restrictive impact on noncompetes. As first announced, the proposed
rule deemed all noncompetes to be prohibitively unfair and
retroactively rendered them in violation of section 5 of the
Federal Trade Commission Act (“FTCA”).2 It
broadly defined such clauses as any “contractual term between
an employer and a worker that prevents the worker from seeking or
accepting employment with a person, or operating a business, after
the conclusion of the worker’s employment with the
employer.”3
The initial proposed rule also included a “functional
test” that would invalidate agreements that function similarly
to a noncompete, including certain non-disclosure and
non-solicitation agreements, as “de facto” non-compete
clauses.4 While the proposed rule did contain a minimal
carve out for the sale of a business, this required that the
transaction involve those who own more than 25% of the business
entity, leaving the majority of sales within the rule’s
prohibitive purview.5 Notably, the proposed rule did not
contain any exceptions or limitations accounting for an
employee’s job responsibilities, seniority, or access to
confidential information.
As with the proposed rule, the final rule bans virtually all
future and existing noncompetes. While it does exempt from the ban
pre-existing noncompetes for senior executives making over $151,164
annually, the final rule prohibits all new noncompetes going
forward, including for senior executives.6
In its final rule, the FTC made a few other important changes.
With respect to the functional test for determining whether an
agreement is a noncompete, the FTC tweaked its definition of
“non-compete clause” to clarify what is considered a
noncompete, “de facto” or otherwise. Non-compete clauses
are now defined as terms or conditions of employment—whether
written or oral—that “prohibit . . . penalize . . . or
function to prevent” workers from seeking or accepting work
with a new employer after the conclusion of their current
employment.7 It is important to note that the FTC did
not view this change as narrowing the types of agreements that the
FTC will deem to be noncompetes and thus covered by the ban.
One positive change is that the final rule discarded the 25%
ownership threshold for business sales, instead exempting all
noncompetes connected to the “bona fide sale” of a
business.8 This change should help alleviate one concern
of the business community that purchasers of a business would be
unable to keep the sellers from competing even after having been
paid substantial sums for the business.
Legal Challenges to Final Rule are
Expected.
The US Chamber of Commerce and other business groups have
already filed several different suits challenging the FTC’s
authority to ban noncompetes even before the FTC issued its final
rule.9 These suits challenge the FTC’s legal
authority to pass it in the first place, including on the basis of
the major questions doctrine. This doctrine limits administrative
agencies from enacting rules that amount to “major policy
decisions” or “decisions of vast economic and political
significance” without “clear congressional
authorization” to do so.10 Additional legal
challenges are to be expected, including in individual lawsuits
seeking to enforce existing noncompetes against departing
employees.
In enacting this rule, the FTC invoked section 5 of the FTCA,
which “prevent persons, partnerships, or corporations . . .
from using unfair methods of competition in or affecting commerce
and unfair or deceptive acts or practices in or affecting
commerce.”11 The FTC undoubtedly will argue that
noncompetes are the quintessential unfair method affecting
competition.
We expect to see the issue of the FTC’s authority play out
in individual noncompete cases where the employee will argue that
their noncompete no longer is legally enforceable. Employers will
echo the current lawsuit and likely will argue that a rule banning
noncompetes almost in their entirety is a major policy decision
with vast economic significance. They also may argue that the
FTCA’s language lacks the “clear” authorization from
Congress that the FTC needs to enact this historic, wide-sweeping
ban.12 Challengers can point to the statements of the
two dissenting commissioners who stated that they believed that the
FTC lacked the authority to enact a non-compete ban. Moreover, the
current Supreme Court likely would be receptive to such arguments
given its recent statements concerning the major questions
doctrine.13 It is important to note that challengers
likely will ask the Court to stay enforcement of the rule while its
legality is being litigated.
In addition to potential litigation, the FTC’s rule is
subject to challenge under the Congressional Review Act
(“CRA”). Under the CRA, within sixty Congressional
session days of an agency rule’s publication, Congress may pass
a joint resolution of disapproval of the rule.14 If the
resolution is signed by the President—or if Congress
overrides a presidential veto—the rule would be
ineffective.15 Given the required time to act, any
resolution would need to be passed by this Congress. Because this
non-compete ban has been a centerpiece of President Biden’s
agenda, it is unlikely, however, that the Democratic Senate would
pass such a resolution.
Employers Should Prepare for Impact of Rule as
Enacted.
Even if there is a good chance that the rule ultimately will be
invalidated, it is risky for employers to wait and see. As we
already have seen, the FTC has been aggressive in seeking consent
orders with companies that use noncompetes on a broad scale even
before it issued its final rule.16 We expect that the
FTC may try to secure additional orders quickly while the legality
of the rule is being litigated. Even if the FTC’s ban is
ultimately invalidated, the trend against noncompetes at the
federal, state, and local levels will likely continue, and could
result in legislation with a similar impact as the FTC’s
ban.
As a result, employers should consider alternatives to
noncompetes, such as non-disclosure agreements and deferred
compensation plans, that can protect the company’s legitimate
business interests and confidential information while avoiding
being covered by the new rule. These agreements should not be part
of any employment agreement, but separate agreements with the
employees where specific consideration is paid and referenced in
the agreements .
Also, because of the FTC’s functional test, employers should
use narrowly tailored agreements only for those senior executives
and other employees who are likely to have access to the
employer’s most important confidential and trade secret
information. Otherwise, employers risk having those agreements
deemed unlawful non-competes as well.
Further, while existing noncompetes with senior executives will
remain lawful, employers should audit these noncompetes to ensure
they are narrowly tailored to a legitimate business interest and
connected with material consideration, as the executives may still
challenge the enforceability of these provisions in court as not
reasonable to protect any purported legitimate business interests.
Employers will also need to evaluate other options for any new
executives that they plan on hiring and for current executives who
are not already subject to a noncompete.
Footnotes
1 See, e.g., Stakeholders Speak Out During
Webinar on FTC’s Proposed Rule Banning Noncompetes (Mar. 6,
2023), https://www.jenner.com/en/news-insights/publications/client-alert-stakeholders-speak-out-during-webinar-on-ftcs-proposed-rule-banning-noncompetes.
2 Non-Compete Clause Rulemaking, Federal Trade Commission
(Jan. 5, 2023), https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.
3 Non-Compete Clause Rule, Federal Register (Jan. 19,
2023), https://www.federalregister.gov/documents/2023/01/19/2023-00414/non-compete-clause-rule.
4 Id.
5 Id.
6 FTC Announces Rule Banning Noncompetes, Federal Trade
Commission (Apr. 23, 2024), https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes.
7 Non-Compete Clause Rule, Federal Trade Commission, https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf.
8 Non-Compete Clause Rule, Federal Trade Commission, https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf.
9 Chamber of Commerce, et al. v. FTC, No.
6:24-cv-00148, ECF No. 1 (E.D. Tex. Apr. 24, 2024); Ryan, LLC
v. FTC, No. 3:24-cv-00986, ECF No. 1 (N.D. Tex. Apr. 23,
2024).
10 West Virginia v. EPA, 142 S. Ct. 2587
(2022).
11 15 U.S.C.A. § 45.
12 See The FTC Proposes Ban on Non-Competes
(Jan. 6, 2023), https://www.jenner.com/en/news-insights/publications/client-alert-the-ftc-proposes-ban-on-non-competes.
13 See West Virginia v. EPA, 142 S. Ct.
2587, 2605 (2022).
14 The Congressional Review Act (CRA): A Brief Overview,
Congressional Research Service (Feb. 27, 2023).
15 Id.
16 See DOJ Continues Push Against Non-Competes,
Non-Solicitations, and Other Post-Employment Restrictions (Mar. 1,
2022), https://www.jenner.com/en/news-insights/publications/client-alert-doj-continues-push-against-non-competes-non-solicitations-and-other-post-employment-restrictions;
Latest Decisions in Criminal No-Poach and Civil Non-Compete Cases
Indicate Continuing Scrutiny of Restrictive Covenants (July 12,
2022), https://www.jenner.com/en/news-insights/publications/client-alert-latest-decisions-in-criminal-no-poach-and-civil-non-compete-cases-indicate-continuing-scrutiny-of-restrictive-covenants.
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