FTC Approves Final Rule Banning Most Non-Competes
On Tuesday, April 24, 2024, the Federal Trade Commission (FTC) voted to approve a Final Rule banning and voiding most employee non-compete agreements.
The Final Rule, if it takes effect, will void all existing non-compete provisions in employment agreements, except for those involving “Senior Executives” (as this term is discussed below), and makes all future non-compete provisions unenforceable (whether for Senior Executives or any other worker).
The FTC first announced its proposed non-compete rule in January 2023. The underlying rationale for the ban, as outlined in both the proposed and final versions, is that it is an “unfair method of competition” and, therefore, violates Section 5 of the FTC Act for a person other than a senior executive to enter into or attempt to enter into a non-compete clause, enforce or attempt to enforce a non-compete clause, or represent that the worker is subject to a non-compete clause.
Given its implications, the proposed rule prompted the submission of over 26,000 public comments. While the broad contours of the proposed rule made their way into the final version, it does include a couple of significant changes from the initial draft.
Here are the key elements of the Final Rule that employers need to know:
Non-Compete Defined
The Final Rule defines “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:
- Seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or
- Operating a business in the United States after the conclusion of the employment that includes the term or condition.”
For purposes of the Final Rule, “term or condition of employment” includes, but is not limited to, a contractual term or workplace policy, whether written or oral. The Final Rule does define “non-compete agreements” slightly more strictly than the original proposed rule: the proposed rule expressly included “De Facto” Non-compete Agreements–other arrangements that might have the effect of a non-competition agreement. However, the specific language of “De Facto” Non-compete Agreements has been removed from the Final Rule.
Nevertheless, the Final Rule will still bar many agreements which are not, strictly speaking, non-competition agreements. For example, the FTC’s commentary to the Final Rule expressly includes so-called “forfeiture-for-competition” clauses, in which a worker may be required to forego, or repay, a particular benefit or severance pay in exchange for the right to work for a competitor. While not technically a “non-compete agreement,” these types of agreements would still be banned.
In addition, the FTC’s commentary on the Final Rule indicates that the removal of “De Facto” from the definition of “Non-compete Agreement” is not intended to be a substantive change. The FTC notes that, by including agreements that “function to prevent” a worker from competition, it sought to clarify, but not remove, the originally proposed ban on De Facto Non-compete Agreements. At the end of the day, the FTC notes, whether a particular agreement “functions” as a non-compete will be a question of fact, which would require “case-by-case adjudication for whether they constitute an unfair method of competition.”
Employees Covered by the Non-Compete Ban
Quite simply, the rule bans all non-competes for employees, independent contractors, externs, interns, volunteers, apprentices, sole proprietors who provide a service to a person, and a person who works for a franchisee or franchisor but does not include a franchisee in the context of a franchisee-franchisor relationship. Except for limited instances (discussed below), all existing non-compete agreements will become unenforceable, and no employer may require a non-compete in any future employment agreement.
Ban Does Not Apply to Existing Agreements With “Senior Executives,” Agreements Connected to the Sale of a Business, or Restrictions on Working for Competitors Located Outside the United States.
One significant change between the proposed and final rules is that the final version does not void existing non-competes involving “senior executives.” However, it prohibits employers from entering into or enforcing new non-competes with senior executives after the Final Rule’s effective date.
A “senior executive” is defined as a worker in a “policy-making position” who earns an actual or annualized sum of $151,164 (through salary, bonuses, and/or commissions, but excluding fringe benefits, retirement contributions, and medical/life insurance premium payments). A “policy-making position” means a business entity’s president, chief executive officer, or the equivalent, any other officer with policy-making authority, or any other person with policy-making authority for the business, similar to an officer with policy-making authority. Again, just as with the definition of “functions to prevent” discussed above, the FTC intended the “Policy-Making Position” aspect to be decided by courts on a case-by-case basis.
The Final Rule also does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity, so long as the sale involves the disposition of the person’s ownership interest in the business entity, or all or substantially all of the entity’s operating assets.
Finally, the Final Rule does not apply to non-compete agreements which only restrict work outside the United States. Here, the FTC expressly acknowledged business owners’ legitimate concerns about certain foreign countries’ lack of respect for American intellectual property rights.
Notice Requirements Regarding Existing Non-Competes
The proposed rule would have required employers to legally modify existing non-competes by formally rescinding them in writing. The Final Rule streamlines these obligations, and employers must simply provide written notice to workers (including workers who are no longer employed by the employer but still subject to a non-compete agreement) advising them that the non-compete agreement will not be enforced against them in the future. To aid employers’ compliance with this requirement, the Commission has included model language in the final rule that employers can use to communicate with workers.
The Effective Date of the Final Rule
The Final Rule becomes effective 120 days after its publication in the Federal Register, but legal challenges to the rule have already begun. The United States Chamber of Commerce filed a lawsuit contesting the Final Rule almost immediately after the rule was approved. Several other groups and businesses have announced that they will be following suit.
Regardless of the rule’s ultimate fate, the impetus for the rule is the increasingly abusive non-competition provisions that employers have used to protect dubious “interests.” For the most part, because there is no penalty for an overbroad non-compete (other than a court refusing to enforce it), employers have had an incentive to draft these agreements to be as broad as possible. Because of this, even aside from the FTC action, numerous states and other government agencies have expressed concern—or even outright opposition—to the increasing use of non-compete agreements. Even if the rule ultimately is withdrawn or defeated in the courts, business owners seeking to protect their business interests should engage counsel to review non-competition language in employment agreements and consider other options for protecting trade secrets, confidential information, and other vital proprietary interests. In other words, with regard to non-competes, business owners beware: misuse them, and you may well lose them!
In a recent Breakfast Bites webinar, issues surrounding non-competes were discussed. To watch the video or view the materials, click here.
If you have questions or concerns about the final FTC rule and your company’s use of non-competes, please contact Jordan Segal at Maddin Hauser.