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FTC Ban on Most Non-Compete Agreements

On April 23, 2024, the U.S. Federal Trade Commission (“FTC”) released its final rule banning most non-compete agreements between workers and employers (the “Final Rule”). The effective date of the Final Rule is 120 days after its publication in the Federal Register, unless stayed by pending litigation.

Under the Final Rule, non-compete clauses are generally determined to be an unfair method of competition resulting in a violation of Section 5 of the Federal Trade Commission Act. The Final Rule adopts a comprehensive ban on new non-compete agreements with all workers and invalidates any existing non-compete agreements with workers (other than a very narrow exception for non-competes with senior executives that exist before the effective date of the Final Rule).

Under the Final Rule, a non-compete clause is broadly defined as an employment term or condition that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (1) seeking or accepting work in the United States with a different employer or (2) operating a business in the United States, in each case, after the conclusion of the worker’s employment. Prohibited terms or conditions include workplace policies, as well as contractual terms, whether written or oral.

The Final Rule defines a worker as a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws. A worker includes an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service.

 

Exceptions:

  • Senior Executive. The continued enforceability of non-compete clauses that were entered into with the senior executives before the effective date of the Final Rule. However, no new non-competes can be entered into with any workers, including senior executives, after the effective date of the Final Rule.

A senior executive is defined as a worker who (1) is in a policy-making position; and (2) earned at least $151,164 in annual compensation in the preceding year.

  • Bona fide sales of business. The Final Rule does not prohibit a non-compete clause that is entered into by a person pursuant to a 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. There is no specified minimum ownership requirement for this exception (unlike the Proposed Rule which required the worker to have at least 25% ownership for this exception to apply).

  • Existing causes of action. The Final Rule creates an exception allowing the enforcement of a non-compete clause where the cause of action for its breach accrued prior to the effective date of the Final Rule.

  • Entities outside of the FTC’s jurisdiction. such as non-profit entities, certain common carriers, certain domestic and foreign air carriers, and businesses subject to the Packers and Stockyards Act of 1921. 

Are other restrictive agreements, such as non-disclosure agreements or non-solicitation agreements, prohibited?

While the Final Rule does not categorically prohibit other types of restrictive agreements, like non-disclosure agreements, training-repayment agreements or non-solicitation agreements, employers should be aware that provisions that function to prevent competition are prohibited. The FTC notes that if the term or condition is so broad and onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a restrictive agreement would be subject to the prohibition on non-competes.

Notification Requirement

By the effective date of the Final Rule, employers are required to provide a clear and conspicuous notice to workers subject to an invalidated non-compete clause that the non-compete will not be, and cannot legally be, enforced against the worker. The notice must specify who entered into the non-compete clause with the worker, and the notice must be provided by hand-delivery, mail to the worker’s last known personal address, email or text message. The Final Rule provides safe harbor model language to satisfy the notice requirement.

Ongoing Legal Challenges

Since the publication of the Final Rule, three lawsuits have been filed in federal courts challenging the FTC’s authority to ban non-compete agreements. The first lawsuit came within hours of the Final Rule’s publication, a tax services firm filed a lawsuit (Ryan, LLC v. Federal Trade Commission, Case No. 3:24-cv-986) in the United States District Court for the Northern District of Texas. Shortly thereafter, the Chamber of Commerce filed a lawsuit (Chamber of Commerce v. Federal Trade Commission, No. 6:24-cv-148) in the United States District Court for the Eastern District of Texas. Finally, a tree services company filed an action (ATS Tree Services, LLC v. Federal Trade Commission, No. 2:24-cv-1743) in the United States District Court for the Eastern District of Pennsylvania.

These lawsuits allege, among other things, that the FTC lacked constitutional and statutory authority to promulgate the Final Rule, and seek orders vacating it and setting it aside. 

In a recent development, the court in Ryan, LLC v. Federal Trade Commission set a fast-track schedule for legal arguments and intends to decide by July 3rd, 2024 on whether to temporarily block the Final Rule. This decision is well ahead of the Final Rule's official effective date. The lawsuit filed by the Chamber of Commerce (Chamber of Commerce v. Federal Trade Commission) was put on hold until the Ryan case is resolved. However, the Chamber successfully joined the Ryan lawsuit as a plaintiff.

Several organizations, including industry giants like the National Retail Federation and the National Association of Manufacturers, submitted legal documents (amici briefs) supporting the request to pause the Final Rule. Finally, the court in ATS Tree Services, LLC v. Federal Trade Commission plans to rule on the company's request for a preliminary injunction by July 23rd, 2024.

Given the speed with which these actions have been filed, we expect more actions may be forthcoming.  

Next Steps

Given the current and anticipated litigation related to the Final Rule, employers should carefully monitor whether the Final Rule is enjoined or the deadline for compliance remains.

Notwithstanding these legal challenges, the 120-day countdown to implementation will continue to run unless a Federal court moves to enjoin the implementation of the rule pending judicial review.  In light of the potentially tight timeframes, employers may want to consider taking the following steps in preparation for any effective date of Final Rule:

  • Review all employment, compensation, and severance arrangements, including employee handbooks, policies, severance plans, separation agreements, equity and incentive plans, award agreements, employment agreements and severance agreements, to identify any non-compete clauses that would be prohibited under the Final Rule.

-          A review should also include assessing the scope of non-solicitation and non-disclosure agreements to ensure that they do not constitute a “functional” non-compete and whether any modification is required.

  • Identify non-compete agreements for which worker notification will be required if the Final Rule becomes effective. Prepare to develop a process to identify impacted current and former employees with relevant contact information.

  • Identify “senior executives” described above. Evaluate whether there are any senior executives (as defined above) with whom employers may want to enter into non-competes prior to the Final Rule’s effective date.

  • Consider alternatives to post-employment non-compete clauses, such as notice and garden leave periods.

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