FTC Approves Final Rule To Ban Many Non-Competes; Opponents Quickly Sue

With the Federal Trade Commission's (FTC) April 23, 2024, approval of its Final Rule banning most non-competes, businesses subject to the FTC Act face an important change in rights that until now have been exclusively governed by state law. 

Litigation challenging the FTC’s authority to issue the Final Rule was launched almost immediately after the FTC voted to approve it. This means it is uncertain whether or when the ban will take effect.  Nonetheless, covered business should prepare to comply with the Final Rule, and consider alternative ways to protect their trade secrets, confidential information, and other business interests.

If it is not stayed by the courts, the Final Rule will take effect on September 4, 2024--120 days after its publication in the Federal Register on May 7, 2024. 

What Does The Final Rule Say?

The Final Rule prohibits a covered business from:

  • Entering into or attempting to enter into a non-compete clause with a covered worker;
  • Enforcing or attempting or enforce a non-compete clause with a covered worker; or
  • Representing that a covered worker is subject to a non-compete clause.

These restrictions have the effect of nullifying current non-compete clauses and prohibiting future non-compete clauses with covered workers.  However, the Final Rule will not apply to nullify a non-compete where a cause of action related to the non-compete accrues prior to the effective date.

The Final Rule requires covered business to notify all workers who are subject to prohibited non-competes that their non-competes will not be enforced after termination of employment.  Notice must be given no later than the effective date of the Final Rule.  The Final Rule includes model language covered businesses can use to communicate with workers and satisfy this requirement.

What is a Non-Compete Clause?

The Final Rule defines "non-compete clause" as any “term or condition of employment” that “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” seeking or accepting work in the United States with another business, or owning their own business United States, after their current work ends. 

A "term or condition of employment" includes, but is not limited to, a contractual term or workplace policy, whether written or oral, affecting post-termination activities.  Although workplace policies are typically not contractually enforceable, the FTC included any such policies prohibiting post-termination conduct in the definition because they may discourage the worker from seeking or accepting other work or from owning their own business.

Even though the Final Rule does not prohibit non-disclosure or non-solicitation agreements, they may be construed as prohibited non-compete clauses if they effectively "prohibit," "penalize," or "function to prevent a worker from" seeking or accepting work, or owning their own business, after their current work ends.  

Who Is a Worker?

The Final Rule applies to “workers,” which includes employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person, whether the person is working in a paid or unpaid status, and regardless of the worker’s title or status under other state or federal laws. Therefore, the Final Rule is not limited to parties in a classic employer/employee relationship. The Final Rule also applies to a person working for a franchisee or a franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.   

There are three important exceptions to the non-compete ban:

  • The Final Rule does not invalidate non-competes with “senior executives” entered into before the effective date. A “senior executive” is defined as someone in a “policy making position” earning total annual compensation (prorated for partial years of employment) of no less than $151,164. A “policy making position” includes an entity’s president, chief executive officer, or the equivalent, and any other officer or worker with policy-making authority for the business. Although existing non-competes with senior executives remain valid, the Final Rule prohibits covered businesses from entering into or enforcing new non-competes with senior executives after the Final Rule takes effect. 
  • The Final Rule only applies to workers who work in, or own a business in, the United States.  Non-compete provisions that would prevent a worker from seeking or accepting work or owning a business solely outside the United States are not covered.
  • The Final Rule permits non-compete agreements executed in connection with the bona fide sale of a business. Such provisions are valid under the Final Rule so long as the sale consists of the disposition of the person's ownership interest in the business entity or all, or substantially all, of the entity's operating assets. 

What Businesses Are Covered?

The Final Rule prohibits unfair competition through non-competes by “persons,” defined as “any natural person, partnership, corporation, association, or other legal entity within the FTC’s jurisdiction, including any person acting under color or authority of state law.”

Under the FTC Act, the FTC’s authority to prevent unfair competition does not extend to some banks, savings and loans, federal credit unions, common carriers, air carriers, foreign air carriers, businesses subject to the Packers and Stockyards Act of 1921, and businesses "not organized to carry on business for their own profit or profit of their members.” Businesses in these categories should seek legal advice to determine whether they are subject to the Final Rule.

Affect On State Laws

The Final Rule supersedes state laws that would permit non-competes prohibited by the Final Rule.  However, state laws that are more protective of worker rights would still be valid. This means, for example, that employers in states where non-competes already have been banned cannot rely on the “senior executive” exception to protect otherwise unlawful non-competes.  Similarly, businesses that are not covered by the FTC Act must still comply with applicable restrictions on non-competes in their states. 

What Businesses Should Do Next

As noted, litigation has already commenced challenging the Final Rule, with the U.S. Chamber of Commerce suing the FTC in federal court in Texas just hours after it voted to approve the Final Rule.

Although the Final Rule’s ultimate fate in the courtroom is unknown, businesses should nevertheless work with counsel to review coverage under the Final Rule, identify existing non-compete clauses or policies that may be affected by the Final Rule, consider other options for protecting their interests, and prepare to give notice to covered workers by the effective date of the Final Rule.

If you have questions about these developments or would like assistance reviewing and modifying your company's non-competition agreements or workplace policies, please contact Melissa Jones at Tydings.