Background
On April 23, 2024, the Federal Trade Commission (FTC) issued its final rule banning virtually all non-compete agreements for employees with only limited exceptions. This final rule follows its January 2023 proposed rule and its review of over 26,000 public comments in support of the FTC’s proposed ban on non-compete agreements. The FTC voted 3-2 in favor of the final rule, but it is not yet effective. The final rule is effective 120 days after Federal Register publication – not after the FTC’s public announcement.
A non-compete agreement is not just a contractual term but can also include any workplace policy. Section 910.1 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” either seeking or accepting work after the conclusion of employment, or operating a business after the conclusion of employment.
Rule Summary
The final rule adopts a comprehensive ban on new non-compete agreements with all employees, including senior executives. The final rule provides that it is an unfair method of competition — and therefore a violation of section 5 of the FTC Act — for employers to enter into non-compete agreements with employees.
Further, employers will be required to provide notice to employees other than senior executives who are bound by an existing non-compete agreement that they will not be enforcing any non compete agreement against them in the future. In sum, the notice must identify the person who entered into the non-compete with the employee. The notice must “be on paper”, delivered by hand, by mail, by email or by text message. To aid employers’ compliance with this provision, the FTC has included model language in the final rule that employers can use to communicate to employees.
Existing Non-Compete Agreements
For existing non-competes, the final rule adopts a different approach for senior executives than for other employees. For senior executives (in section 910.2(a)(2), senior executives are defined as those earning more than $151,164 annually who are in a “policy-making position”), existing non-compete agreements can remain in force. Existing non-competes with employees other than senior executives are not enforceable after the effective date.
Exceptions to the Final Rule
The final rule contains two (2) limited exceptions where is does not apply. Under section 910.3(a), the final rule does not apply to a non-compete clause in connection with the “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”. Section 910.3(b) added a new exception, stating that the final rule does not apply “where a cause of action related to the non compete clause accrued prior to the effective date.”
Rationale for Ban on Non-Compete Agreements
The FTC estimates that banning non-compete agreements will result in protection of the fundamental freedom of employees to change jobs, reduced health care costs, an increase in new businesses created each year, a rise in innovation with more patents each year, and higher employee wages. In sum, the FTC Chair Lina M. Khan indicated “the FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business or bring a new idea to market.”
Alternatives to Non-Compete Agreements
The FTC found that employers have several alternatives to non-compete agreements that still enable companies to protect their investments without having to enforce a non-compete clause. Trade secret laws and non-disclosure agreements (NDA) both provide employers with well-established means to protect proprietary and other sensitive information. Please note that in the 560 pages of “Supplementary Information” accompanying the final rule, it is possible that NDA’s that are overbroad and “function to prevent” a worker from seeking or accepting other work or starting a new business after employment ends could be barred by the final rule, depending on the precise language of the agreements, and the surrounding facts and circumstances. Generally, generic non-solicitation clauses are not covered by the final rule.
The FTC also found that instead of using non-compete agreements to lock in workers, employers that wish to retain employees can compete on the merits for the employee’s labor services by improving wages and working conditions.
Employer Action Needed
Since the final rule is not yet effective and legal challenges abound, all future restrictive covenants should be narrowly drafted to protect legitimate business interests of the employer like trade secrets, confidential information, or customer good will. The restrictions should not be overly broad, and they must contain reasonable provisions in terms of duration, geography,
and scope of activities prohibited. And agreements should contain severability provisions in case any provisions are found to be unlawful (which will leave other provisions intact). It is also not recommended that restrictive covenants not be used with lower-level employees unless there is a legitimate reason to do so.
Next Steps
The final rule will become effective 120 days after publication in the Federal Register. If the final rule is deemed “significant” due to its economic impact or important policy implications, the president will review it before being published in the Federal Register. Further, Congress and the Government Accountability Office will have an opportunity to review it before it takes effect. If both the House and Senate pass a resolution of disapproval and the president signs it, or it both houses override a presidential veto, the rule is void and cannot be reinstated in the same form without Congressional approval. It is anticipated that legal challenges to the final rule will occur as some have already started.
Turke & Steil is available to discuss the final rule and provide guidance on existing non competes or other restrictive covenants.