FTC Votes to Ban Noncompete Agreements
On April 23, 2024, the Federal Trade Commission (the “FTC”) voted 3-2 to issue its final rule (“Final Rule”) banning employers from imposing noncompete clauses on their workers, approving the final rule in a special Open Commission Meeting.
The FTC issued the Final Rule more than 15 months after publishing a proposed rule. Since that time, the FTC has received tens of thousands of comments, with the FTC claiming that 25,000 of the 26,000 comments received supported a ban on noncompetes.
According to FTC Chair Lina Khan, “Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned . . . [t]he FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”[1]
The Final Rule defines a “noncompete” as any 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 employment that includes the term or condition.”
Given the proposed rule’s breadth and controversial nature, some expected the Final Rule to be substantially narrower, but the Final Rule largely adopts the proposed rule in its entirety.
At bottom, the Final Rule provides that an employer may not enter into noncompetes with its workers after the rule’s effective date (120 days after publication in the Federal Register). Doing so would violate Section 5 of the FTC Act, and the noncompetes will be unenforceable. Existing noncompetes (i.e., those entered prior to the rule’s effective date) are also unenforceable after the effective date with very limited exception. The Final Rule defines “worker” broadly—meaning any “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, including, but not limited to, whether the worker is an employee [or] independent contractor”. A “worker” is not, however, a “franchisee in the context of a franchisee-franchisor relationship” under the Final Rule.
Specifically, the Final Rule prohibits employers from:
- entering into or attempting to enter into a noncompete with a worker;
- maintaining a noncompete with a worker; or
- representing to a worker, under certain circumstances, that the worker is subject to a noncompete.
There are a few noteworthy changes from the proposed rule. Under the Final Rule, existing noncompetes can remain in force with senior executives (defined as workers earning more than $151,164 annually who are in “policy-making positions”). The Final Rule also carves out noncompetes entered in connection with the bona fide sale of a business or a person’s ownership interest in a business entity, eliminating the 25% ownership threshold from the proposed rule. Further, the Final Rule’s requirements “do not apply where a cause of action related to a noncompete clause accrued prior to the effective date,” shielding ongoing litigation from immediate implications of the Final Rule. In addition, to comply with the Final Rule, employers must provide notice to workers that the employer will not enforce noncompetes in place when the rule takes effect, whereas the proposed rule required employers to legally modify existing noncompetes by formally rescinding them. That change will help to streamline compliance, according to the FTC, and the Final Rule includes model notification language to aid compliance.
According to the Final Rule, non-solicitation covenants are still generally permissible, provided they do not have the practical effect of a noncompete. Specifically, the FTC stated that non-solicitation agreements “are generally not noncompete clauses under the final rule because, while they restrict who a worker may contact after they leave their job, they do not by their terms or necessarily in their effect prevent a worker from seeking or accepting other work or starting a business.” The FTC cautioned, however, that certain non-solicitation agreements “can satisfy the definition of [a] noncompete . . . where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.” Those seeking clarity on when a non-solicit crosses over into a noncompete will likely be disappointed; as the FTC stated that whether a non-solicit has the practical effect of a noncompete is a “fact-specific inquiry.”
Legal challenges have already commenced,[2] with more expected. Daryl Joseffer, chief counsel of the U.S. Chamber of Commerce’s Litigation Center, labeled the ban as an “administrative power grab,” and the Chamber’s President and CEO, Suzanne P. Clark, stated, “[t]he Chamber will sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked.”
We expect more litigation to follow challenging the FTC’s administrative and constitutional authority to promulgate and enforce the rule, perhaps along the lines of the FTC’s dissenting Commissioners. For instance, during the Open Commission Meeting, recently-appointed FTC Commissioner Holyoak argued that the FTC lacks rulemaking authority under Section 6(g) of the FTC Act to promulgate the rule, and Commissioner Ferguson argued that this rulemaking threatens Congress’s lawmaking power.
The Final Rule will take effect 120 days after publication in the Federal Register, which has not yet occurred. Given the legal challenges, we will monitor developments closely. While no action is required immediately, in light of this rulemaking, employers should consider both present and prospective employment contracts with respect to noncompete agreements. Employers also should consider the impact of the final rule on pending mergers and acquisitions, as noncompetes included in transaction agreements closing prior to the rule’s effective date would be unenforceable after the effective date for all but sellers and senior executives. We will have more analysis of the final rule and its implications in the coming days and weeks.
Sheppard Mullin attorneys are ready to help clients navigate the final rule and its implications on existing and prospective noncompete agreements. Additionally, employers should assess the measures in place to protect confidential, proprietary, and trade secret information outside of employment agreements. Non-disclosure provisions, confidentiality policies and proper training remain critical in protecting proprietary information in the wake of the final rule, regardless of the outcome of legal challenges. Sheppard Mullin attorneys can help employers assess the risk associated with their existing noncompetes and implement measures to protect their information going forward.
FOOTNOTES
[1]
[2] A lawsuit has already been filed in the Northern District of Texas.
