The rule represents an unprecedented effort by the FTC to assert broad rulemaking authority, and has already been challenged in court. Thus, employers may wish to adopt a “wait-and-see” approach for the time being rather than rushing to make changes in response to this rule.
How we got here and effective date of FTC’s rule
The publication of the final non-compete rule concludes an eighteen month deliberation stemming from the Commission’s issuance of a Notice of Proposed Rulemaking (NPRM) in January 2023. In its April 23, 2024 press release, the FTC said that it received over 25,000 comments received in response to the NPRM.
New rule will ban future non-competes for all workers
The final rule prohibits all non-compete clauses entered into after the rule’s effective date. A non-compete clause is broadly defined by the FTC 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.”
The rule defines a non-compete clause to include not only a clause in a written contract, but also a “workplace policy,” and includes both “written” and “oral” contracts or workplace policies. The FTC states that whether a given prohibition constitutes a “non-compete clause” is a “fact-specific inquiry.” For example, a non-solicitation of customers clause could, if sufficiently broad, be seen by the FTC as a prohibited non-compete clause.
Significantly, the FTC’s definition of a non-compete clause not only includes clauses prohibiting competition, but also clauses that “penalize” competition, which may include agreements that require an employee to forfeit a benefit (e.g., equity forfeiture or repurchase) due to competition. However, the FTC clarified that in its view, a “garden leave” provision – where an employee is still receiving the same total annual compensation while continuing to be employed by the employer – is not a non-compete.
Notably, the FTC’s prohibition applies not only to employees but to all “workers,” which it defines as including employees, independent contractors, interns, and volunteers. The prohibition does not, however, apply to a “franchisee in the context of a franchisee-franchisor relationship.”
The rule will permit pre-existing non-competes to remain in place only for “senior executives”; employers must notify all other workers with non-competes that they will no longer be enforced.
Non-compete agreements entered into prior to the effective date are considered unlawful for all workers except for those classified as “senior executives".
The definition of “senior executive” is narrow and limited to those who (1) earn $151,164 annually and (2) are in a “policy-making position.” The rule identifies a company’s president, or chief executive officer, or an individual in a similar position as being in a “policy-making position.” However, other officers such as vice-presidents must hold job responsibilities where they have the final authority to make policy decisions that control significant aspects of the business. The rule carves out of the definition of “senior executive” individuals that only have final authority to make policy decisions over a subsidiary of the business, and not the business as a whole.
For workers who have pre-existing non-competes and do not qualify as “senior executives,” the rule requires that employers provide them with notice stating that the employer will not enforce the non-compete. This notice must be provided to current and former workers, by the effective date of the final rule. The FTC has posted model language for such notices.
Sale of business transactions are exempt
Importantly, the rule does not ban non-compete agreements entered into between buyer and seller in the context of a “bona fide” sale of business. In general, according to the FTC, a “bona fide” sale of business means “one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.” Given this statement, the FTC may not consider a non-compete entered into between an individual selling a small equity stake or who otherwise lacks sufficient individual bargaining power to be covered by this exception. Notably, the FTC explains that non-competes entered into in connection with a sale that “aris[e] out of repurchase rights or mandatory stock redemption programs are not entered into pursuant to a bona fide sale because, in each case, the worker has no good will that they are exchanging for the noncompete or knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting.”
The new rule will not cover entities that fall outside of the FTC’s jurisdiction, such as non-profits
The final rule acknowledges that “the FTC Act defines the limits of the Commission’s jurisdiction and those limits govern [the final rule].” While the rule notes specifically that “the [FTC] Act exempts ‘banks’ and ‘persons, partnerships, or corporations insofar as they are subject to the Packers and Stockyards Act,’ ” it also explains that the FTC opted not to include “all potential interpretations of the laws governing exclusions from the FTC Act,” citing the potential confusion that such an effort would engender. Instead, the rule states that “whether an entity falls under the Commission’s jurisdiction can be a fact-specific determination.”
As we have previously reported, the FTC lacks jurisdiction over non-profit organizations. Therefore, such organizations—which often include employers in the health care and higher education sectors—are not covered by the rule. However, the rule articulates the view of the majority that “not all entities claiming tax-exempt status as nonprofits fall outside the Commission’s jurisdiction.” Commissioner Slaughter emphasized this point in her remarks during the April 23 public hearing, explaining that if an organization claims non-profit tax status but is really “organized for the profit of its members,” it is covered by the rule.
Also, the final rule does not purport to apply to non-competes if “they restrict only work outside the U.S. or starting a business outside the U.S.”
New non-compete rule is an example of the FTC majority’s expansive view of its Section 5 authority
The new non-compete rule is grounded in the FTC majority’s broad understanding of its authority to target “unfair methods of competition” under Section 5 of the FTC Act. This view was outlined in a November 2022 Policy Statement released by the agency stating that “Section 5 reaches beyond the Sherman and Clayton Acts to encompass various types of unfair conduct that tend to negatively affect competitive conditions.”
One day after the final rule was published, the U.S. Chamber of Commerce, Business Roundtable, Texas Association of Business and Longview Chamber of Commerce filed a lawsuit against the FTC in Texas federal court, seeking, among other things,1 to permanently enjoin the FTC from enforcing the non-compete rule against plaintiffs’ members. The complaint alleges that the FTC’s “radical” Section 5 policy statement “ultimately clear[ed] the path for its nationwide regulation of noncompete agreements,” which plaintiffs contend is unsupported by decades of bipartisan enforcement policy that “had interpreted Section 5 to prohibit only practices that cause actual harm to competition and are not outweighed by procompetitive justifications.” The complaint also challenges the FTC’s claim that it has “the power to issue substantive, binding regulations prohibiting ‘unfair methods of competition’ under Section 6(g) of the FTC Act,” arguing that “the Commission has never enforced a binding regulation to broadly proscribe ‘unfair methods of competition’ standing alone [] and has often taken the position that it lacks authority to issue substantive rules at all.”
Practical implications
The FTC’s new rule calls for a drastic and unprecedented legal change. But, significantly, it does not provide a private right for employees to pursue legal action against employers that fail to comply. Nor does the FTC generally have the authority to seek civil penalties or other monetary relief for violations of Section 5. Instead, the FTC can either seek an injunction in federal court or bring an administrative action to establish a cease and desist order. Only in the event a party is subject to a cease and desist order and violates that order can the FTC obtain civil penalties in court.
In light of the current legal challenges, it is unclear when—or if—the rule will ever take effect. Employers at this time may wish to review their non-compete and other restrictive covenant practices to understand the impact of the rule. However, we expect that most employers will not dispense with all non-competes until there is further clarity on the status of legal challenges. And even if the FTC’s new rule survives legal challenge, the scope of the rule will undoubtedly be subject to substantial litigation. Specifically, there will certainly be litigation testing the contours of the rule, particularly with respect to what is necessary to satisfy the “policy making position” prong for senior executives or what constitutes a “bona fide” sale of business.
Even though the FTC’s rule could be struck down, the FTC has clearly signaled that it is actively seeking to bring cases challenging employee non-competes as violations of Section 5 of the FTC Act. Certain state attorneys general have also been active in challenging employee non-competes.
Employers should also remember that non-competes are currently primarily regulated by state laws, which impose various restrictions on them. Some states—such as California, North Dakota, and Oklahoma—outright ban non-competes. States that do enforce non-competes scrutinize them and will only enforce them if found to be reasonable under the circumstances. Increasingly, certain states have imposed specific additional limitations on non-competes such as: prohibitions on non-competes for employees earning less than a certain amount of compensation, capping the length that a non-compete may run after employment, or requiring employers to adhere to technical notice requirements that, if violated, will invalidate the non-compete. In fact, even in a state such as California that has historically prohibited non-competes, the California Legislature recently passed new laws which significantly increase the risk of using of non-competes in California and broadened its already restrictive prohibition against non-competes. Employers that fail to comply with these limitations with employees in certain states can sometimes face exposure for penalties, civil, and even criminal liability.
Ultimately, although the legal landscape related to non-competes continues to shift, the final rule is a good reminder for employers to consider whether their non-competes and other restrictive covenants are reasonable in terms of scope and duration, meet technical state labor and employment law requirements, and are applied to an appropriate subset of the employer’s workforce.
Authored by Lauren Battaglia, Justin Bernick, Logan Breed, Benjamin Holt, Chuck Loughlin, Muhammad Burney, Michael DeLarco, George Ingham, Tao Leung, and Jill Ottenberg.
References
1 Plaintiffs have also asked the court to issue an order to delay the effective date and implementation of the new rule pending the conclusion of the case. See Complaint for Declaratory and Injunctive Relief, Chamber of Commerce of the United States of America et al. v. FTC, No. 24-cv-00148 (E.D. Tex.).
