Client Alert: The Federal Trade Commission’s Rule Banning Non-Compete Agreements
On April 23, 2024, following on its proposal from last year, the Federal Trade Commission (“FTC”) issued a Final Rule implementing a comprehensive ban on non-compete agreements with workers finding that non-competes are an unfair method of competition under the Unfair or Deceptive Acts or Practices Section of the FTC Act.
Given the scope of the FTC’s Rule, there are substantial concerns that the FTC has exceeded its legal authority, but companies would be well advised to take stock of their agreements with employees that contain non-competition clauses as well as other restrictions that may be implicated by the Rule (such as non-disclosure or non-solicitation provisions).
What agreements are covered by the Rule?
The FTC’s Rule applies to any agreement with a worker containing a non-compete clause. The Final Rule 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:”
(1) 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
(2) operating a business in the United States after the conclusion of the employment that includes the term or condition.
“Employment” is defined as “work for a person.” A “person” means any natural person, partnership, corporation, association, or other legal entity within the FTC’s jurisdiction, including any person acting under color or authority of state law. This broad language includes a worker who provides services as an “employee, independent contractor, extern, intern, volunteer, apprentice, or sole proprietor and further includes a person who works for a franchisee or franchisor.” However, the definition of “worker” does not include a franchisee in the context of a franchisee-franchisor relationship.
Does the Rule apply to other agreements with employees, such as non-disclosure, non-solicitation, or retention bonus agreements?
Possibly. The FTC’s responses in the Final Rule to public comments on the original proposal shed light on how it will interpret the Rule’s coverage. Where a non-disclosure or confidentiality agreement is narrowly tailored to confidential information of the business, the Rule will likely not affect those agreements. Conversely, where an agreement restricts the use of information (i) derived from the worker’s general training, knowledge, or experience gained on the job or otherwise or (ii) that is readily ascertainable by other companies or the general public, it may amount to a non-compete under the Rule.
The FTC also did not expressly exclude non-solicitation provisions from the Rule, stating that whether a non-solicitation clause qualifies as a non-compete under the Rule is fact specific. Courts have historically considered non-solicitation provisions that are drafted broadly, meaning the provisions are not limited to contacts with whom the employee worked, as overbroad restraints on trade. It is conceivable that broadly-worded non-solicitation clauses may fall under the Rule’s definition.
As to retention bonus or incentive agreements, the FTC did explain that merely requiring repayment or forfeiture of a bonus if an employee leaves a job will not be treated as a “non-compete” under the Rule. Any provision requiring forfeiture for competition would likely be covered by the Rule, however.
When does the Rule go into effect?
The final Rule is effective 120 days after the date of the publication in the federal register. At this time, the Rule has not been published. However, the Rule could be published within the next few days.
What does the Rule mean for existing non-compete agreements?
If the Final Rule goes into effect, non-compete agreements for all workers except “senior executives” cannot be enforced against the worker. This means that a worker cannot be required to enter into a non-compete agreement after the effective date, and if a worker previously agreed to a non-compete clause prior to the Rule’s effective date, the company is unable to enforce the agreement. In effect, after the effective date, an employer will have no recourse against an employee for breach of a non-compete provision previously entered into.
The company who entered into an existing non-compete agreement with the worker is also required to provide clear and conspicuous written notice to the worker for each existing non-compete clause that such a clause will not be, and cannot legally be, enforced against the worker.
What is the exception for “Senior Executives?”
Under the Rule, a “senior executive” is a worker who is in a policy-making position with an annual or total compensation of at least $151,164. Policy-making positions include presidents, chief executive officers, and workers who have “final policy-making authority over significant aspects of a business entity.”
Under the Final Rule, only new non-compete agreements entered into with senior executives after the Rule’s effective date are invalid, meaning that any pre-existing non-compete agreements with senior executives are unaffected. A person may not enforce or attempt to enforce a non-compete clause with a senior executive entered into after the effective date or represent that such an agreement is enforceable.
Are there any exceptions to the Rule?
The Final Rule does not apply to bona fide sales of businesses, including a non-compete clause 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.
The Rule also does not apply to existing causes of action that accrued prior to the effective date nor in instances where a person has a good-faith basis to believe that the Rule is inapplicable. The FTC explained that this good-faith exception was included out of an abundance of caution to ensure that the Rule does not run afoul of any First Amendment protections, but the FTC does not believe that the Rule infringes on any First Amendment protections. This indicates that the good-faith exception will likely be narrow in its application.
The Final Rule also does not annul or exempt any person from complying with any State statute, regulation, order, or interpretation applicable to a non-compete clause pertaining to State antitrust, consumer protection, and common laws, indicating that some protections still exist for businesses and employers. The Rule only supersedes such laws to the extent that a law allows a person to engage in unfair competition as defined under the Rule.
Additionally, as noted above, the definition of “worker” does not include a franchisee in the context of a franchisee-franchisor relationship. Such businesses may continue use of non-competes because the Rule is inapplicable to franchisee-franchisor relationships.
Will the Final Rule stand?
The Chamber of Commerce has already filed a coalition lawsuit1 in the Eastern District of Texas against the FTC, claiming the Rule exceeds the FTC’s legal authority, constitutes an unlawful interpretation of the law, constitutes an unconstitutional delegation of authority, and causes unlawful retroactivity. A Dallas-based global tax services firm has also filed a suit in federal court challenging the Final Rule.2
Given the sweeping breadth of the Final Rule, it is unclear that the Rule will withstand legal challenge. Regardless, the Rule demonstrates a growing hostility toward non-competes. As mentioned in KRCL’s previous commentary, some states have already restricted non-compete provisions. Businesses should keep a watchful eye on such trends. Additionally, even if the Rule is invalidated, the proposal may foreshadow additional enforcement efforts by the FTC and other federal agencies to limit the use or effect of non-compete agreements, as Michael Twomey discussed with The Texas Lawbook last year.
What should companies do now to prepare if the Rule survives?
Now is a good time for companies to take stock of their employee agreements and their terms. An inventory of your company’s agreements and those that the Final Rule may implicate will give you a head start should the Rule go into effect and require revisions to agreements.
In the event that the Rule survives the legal challenges, other avenues exist to protect a business’s investment in its employees and goodwill. For instance, as noted above, narrowly tailored non-solicitation agreements and non-disclosure agreements should escape coverage under the Rule. If you have any questions or concerns, KRCL’s labor and employment team is available and ready to help.
1 U.S. Chamber of Commerce v. Fed. Trade Comm’n, No. 6:24-cv-00148-JCB, pending in U.S. District Court for the Eastern District of Texas, Tyler Division.
2 Ryan LLC v. Federal Trade Comm’n, No. 3:24-cv-00986-E, pending in U.S. District Court for the Northern District of Texas, Dallas Division.
