The FTC Issues Final Rule Banning Non-Compete Agreements

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Non-compete agreements have been a staple in many industries often used by employers to restrict employees from working or starting a business with a competitor or within a competing industry upon termination of employment and have faced surmountable scrutiny in recent years. In a landmark move, on April 23, 2024, the Federal Trade Commission (the “FTC”) issued a final rule that seeks to prohibit most employers and workers from entering into non-compete agreements. The effective date of the rule will be September 4, 2024. The issuance of the final rule signals the Biden Administration’s intention to significantly change the landscape of non-compete agreements.

Background

Non-compete agreements have been a contentious issue for a while with some arguing that they stifle competition and limit employee mobility while others are of the opinion that such agreements are necessary to preserve client relationships and protect trade secrets. With the issuance of the final rule, the tide seems to be turning against the widespread use of non-compete agreements—at least for the time-being. The FTC’s approach marks a departure from its previous policy of largely deferring to a century-old body of state law on the matter.

The Final Rule

If and when the final rule becomes effective, it will make non-compete agreements unenforceable, which, in turn, will require employers to provide notice to both current and former workers that the non-compete agreements they may have previously signed are no longer enforceable. The notice must be provided on or before the final rule’s effective date and may be delivered by hand, mail, e-mail, or text message. While no specific language is required, the FTC has provided a sample notice.

A prohibited non-compete clause need not be found in a formal contract—such restrictions also may not be imposed in a less formal manner, such as in offer letters, employee handbooks, and stock awards or deferred compensation plans. Note that other restrictive clauses, such as non-disclosure, non-solicitation, or confidentiality clauses, generally remain enforceable so long as they are not overly broad and do not function in a similar manner as a non-competition agreement, i.e. to restrict subsequent employment.

It is important to note that a grandfathering provision for senior executives will make certain non-compete agreements entered into prior to the final rule’s effective date nevertheless enforceable whereas new non-compete agreements are not permitted. A senior executive is such an employee who has earned annual compensation in the preceding year exceeding $151,164 and holds a policy-making position with final authority to make policy decisions that control significant aspects of the business, which is defined as a form of control that runs across all of the businesses within a common controlled group of businesses. Mere power to advise or exert influence over policy decisions or the decisions that affect one company within a controlled group of companies is insufficient. Generally, employers can expect C-suite executives and corporate officers to qualify as senior executives. Notably, certain non-compete agreements entered into pursuant to a bona fide sale of a business entity, ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets are exempt from the final rule. Additionally, an FTC rule generally is not applicable to non-profit entities that are not engaged in interstate commerce, but could still be applicable to those entities where they are “organized to carry on business for their own profit or the profit of their members.”

Legal Challenges

Numerous lawsuits have already been filed to challenge the FTC’s authority to issue the final rule and ban non-compete agreements. Some have requested the courts to stay the enforcement of the ban until the courts address the merits. Most notably, the United States Chamber of Commerce (the “Chamber”) has commenced an action in the U.S. District Court for the Eastern District of Texas that seeks a declaration that the final rule is arbitrary, capricious, or otherwise contrary to law within the meaning of the Administrative Procedure Act as well as a permanent injunction against enforcement of the final rule against its members. Based on an initial ruling in that case, it appears that the Chamber will have to merge its claims with another lawsuit filed earlier in the same court system by Ryan, LLC, a tax service company. Still, multiple business groups challenging the FTC rule, including the Chamber and Ryan, LLC, allege that the FTC has overstepped its designated authority to develop internal rules, and raised issue with the retroactive effect of the final rule on the existing non-compete agreements. Another case was filed by ATS Tree Services, LLC in the U.S. District Court for the Eastern District of Pennsylvania. More legal challenges as to the FTC’s rulemaking authority are expected. As is predictable with judicial review, it may be a while until any final decisions are made.

Employer Impact

The FTC’s decisive stand against the use of non-compete agreements makes it clear that the agency views such agreements as anticompetitive and harmful to certain stakeholders. Among other things, the FTC contends that non-compete agreements suppress wages in affected industries by reducing the bargaining power of workers. In addition, such restrictions may also impact economic growth and hinder innovation by way of restricting the free movement of talent between employers. The FTC’s recognition of the concerns surrounding non-compete agreements has invoked a broader national conversation regarding the need to reform certain labor practices with economic fairness and employment mobility at the forefront of concerns. Several states have followed the FTC’s lead and have similarly restricted the use of non-compete agreements. However, the final rule supersedes state laws to the extent that such laws conflict with the final rule, although employers must comply with state laws that have stricter bans than the final rule.  It seems likely that even if the FTC rule were be restricted by judicial decision, state legislatures are may take their cue from the FTC, resulting in a growing wave of state-level efforts to curtail the use of non-compete agreements.

Naturally, the critics of non-compete agreements have welcomed the FTC’s intervention with open arms. In their opinion, curbing the abuse of non-compete agreements will promote a more dynamic economy and competition based on merit and innovation rather than fictitious restrictions. On the other hand, the proponents of such agreements are wary of the overreach of the final rule. In particular, their concerns are housed within the desire to protect legitimate business interest and safeguard proprietary information and unique business relationships.

Conclusion

The debate over non-compete agreements is far from settled. Employers and employees alike should stay informed about the ever-evolving regulatory landscape with regard to non-compete agreements and carefully consider the implications.