FTC Issues Final Rule to Ban Non-Competes
On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule that would generally prohibit companies from utilizing non-compete clauses with employees, independent contractors, consultants, and similar workers.[i] The final rule will become effective 120 days following its publication in the Federal Register. As discussed in more detail below, the U.S. Chamber of Commerce and other business groups have challenged the final rule in a lawsuit filed on April 24, 2024.
Key Points
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The final rule is scheduled to go into effect on August 21, 2024.
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The final rule broadly bans non-compete clauses entered into with workers, but generally does not apply to customer and employee non-solicitation clauses or non-disclosure agreements (to the extent such clauses do not have the effect of functioning as a non-compete).
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The final rule retroactively bans non-compete clauses entered into prior to the effective date of the final rule, with the exception of non-compete clauses entered into with “senior executive” workers before the effective date of the final rule.
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Companies may enter into non-compete clauses with workers until the final rule becomes effective, with the understanding that the non-compete clauses may be rendered invalid upon the final rule becoming effective.
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Upon the final rule taking effect, companies must provide written notice to workers (except for senior executives) informing them that the worker’s non-compete clause “will not, and cannot legally be, enforced against the worker.”[ii]
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The U.S. Chamber of Commerce and other business groups have filed a lawsuit challenging the final rule that may delay or block the final rule from taking effect.
Potential Next Steps for Employers
The final rule represents a considerable expansion in the FTC’s regulatory activity and as such there is possibility that the federal district court hearing the Chamber of Commerce’s lawsuit may issue a temporary restraining order or a preliminary injunction, which would likely delay the final rule from becoming effective during the course of the litigation. Given this uncertainty, companies have a number of options in assessing how to proceed now and in the near future.
- Companies may wish to simply wait and see what happens with the challenge to the final rule. As noted above, the final rule becomes effective in late August 2024 (120 days after April 23, 2024) at the earliest. If companies take this approach, they can continue to operate business as usual, but they may have to act quickly in revising their agreements and preparing notices to come into compliance if / when the final rule is set to become effective.
- On the other hand, companies may choose to proceed as if the final rule will become effective on the 120 day timeline set forth in the final rule, including removing non-compete clauses from any agreements signed with workers prior to the effective date, limiting any non-solicitation and non-disclosure clauses to avoid such clauses being found to “function” as a non-compete clause, and preparing notices to be sent to non-senior executives upon the final rule becoming effective.
- Lastly, companies may elect to take an approach somewhere between the two options described above. For example, companies may choose to review their agreements to identify any restrictive covenants that may need to be removed or revised if / when the final rule is effective, but continue to utilize non-compete clauses in agreements that are signed with workers prior to the final rule becoming effective.
Although every company will have to make its own decision, Koley Jessen suggests that the third option will best serve businesses by balancing the need to prepare for the implementation of the final rule with the uncertainty of if, and how, legal challenges will affect the rule.
Categorical Ban on Non-Compete Clauses
As noted above, the final rule bans the use of non-compete clauses with respect to a company’s workers, which include any employee, independent contractor, consultant, or any other person who works for such company. The final rule prohibits the use of a non-compete clause signed after the effective date of the final rule with any worker. The final rule further invalidates non-compete clauses signed with workers prior to the effective date of the final rule, with the exception of non-compete clauses entered into with “senior executive” workers prior to the date the final rule becomes effective. Non-compete clauses entered into with “senior executives” prior to the effective date of the final rule will remain enforceable. It is necessary to note, however, that any non-compete clause entered into with a senior executive after the effective date of the final rule will be unenforceable under the final rule.
The term “non-compete clause” is broadly defined as any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) seeking or accepting work in the United States with a different person” after the conclusion of the workers’ service with the company; or “(ii) operating a business in the United States” after the conclusion of the workers’ service with the company.[iii] A “senior executive” means a worker who “[w]as in a policy-making position” and received total annualized “compensation of at least $151,164 in the preceding year.”[iv]
The final rule does not directly address the use of non-disclosure agreements or non-solicitation agreements and the comments provided with the final rule explain that the definition of “non-compete” would include any contract term that is sufficiently broad so as to “function” as a non-compete as determined pursuant to a “fact-specific inquiry.” In other words, there is a possibility that a broad customer-based restriction might be deemed to “function” as a non-compete and, as such, be prohibited under the final rule.
Notice Requirement
In addition to banning the use of non-compete clauses, the final rule requires companies to notify each worker, in writing, that such worker’s non-compete clause is not enforceable, with the exception of non-compete clauses with senior executives. The final rule contains a model notice for use in notifying workers; however, companies should carefully review the model notice and potentially revise certain portions of the notice before sending to workers. Koley Jessen will be preparing a sample notice that will address the points of concern in the FTC’s model notice.
As noted above, companies do not have to send notice to any worker until the final rule becomes effective, which will be in late August 2024 at the earliest.
Non-Compete Clauses in the Sale of Business Context
The final rule contains an exception for the use of non-compete clauses “entered into by a person pursuant to a bona fide sale of a business entity, of a person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.”[v] The final rule does not contain any ownership threshold for the application of the sale of business exception; however, the comments provided with the final rule explain that the exception only applies to “bona fide sales,” meaning sales “made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule.”[vi]
Organizations Not Subject to the FTC
The FTC’s authority is limited to for-profit organizations and certain industries are statutorily excepted from the Federal Trade Commission Act (and thus the FTC’s regulatory authority). As such, the final rule will not apply to non-profit organizations or banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and businesses that are regulated pursuant to the Packers and Stockyards Act.
Impact on State Laws
The final rule states that it will supersede any state law, including, but not limited to, any statute or judicial decision, that is inconsistent with the final rule. As mentioned above, the broad definition of “non-compete clause” could be used to ban customer-based restrictions, such as those currently enforceable under Nebraska law. Specifically, under current Nebraska case law, a customer-based restriction that prohibits an employee from working for, accepting business from, or being employed by customers is enforceable as long as it is limited to those customers with whom the employee did business and had personal contact. It is unclear whether a court would determine that these restrictions “prevent[ ] the worker from seeking or accepting employment with a person . . . .”[vii]
The Koley Jessen Employment, Labor, and Benefits Department will continue to monitor the developments on the final rule and the legal challenges to the final rule and will provide additional guidance as needed. Employers with questions about the final rule, including how the rule may impact their current and future agreements and practices, should contact a member of our Employment and Labor team with any questions they may have about the final rule.
[i] Non-Compete Clause Rule, Federal Trade Commission (Apr. 23, 2024), https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf
[ii] Final Rule at 564-565.
[iii] Final Rule at 561-562.
[iv] Final Rule at 563.
[v] Final Rule at 567.
[vi] Final Rule at 342.
[vii] Final Rule at 561-562.
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