The Final Rule would require employers to notify current and past workers subject to existing non-compete agreements that the agreements are now disavowed and will not be enforced. In three key exceptions, the Final Rule will not apply to:
- Existing non-competes for senior executives (those workers earning more than USD151,164 annually who are in policy-making positions).
- Non-competes entered into by a person pursuant to a bona fide sale of a business entity.
- Non-competes involving employees of non-profit entities (which would include, for example, certain healthcare providers), due to these entities falling outside the jurisdiction of the FTC.
The Final Rule is already facing legal challenges in court.
Introduction
On Tuesday, April 23, 2024, the U.S. Federal Trade Commission (FTC) held a special Open Commission Meeting during which it voted to issue a Final Rule banning non-compete clauses, an area that has historically been the subject of state regulation only. The vote, which passed 3-2 along party lines, follows from the notice of proposed rulemaking that the FTC issued in January 2023. The FTC received over 26,000 public comments prior to promulgating the Final Rule. Please see our previous alert for a comprehensive guide on the initial proposed rule.
The Final Rule would apply retroactively and require employers to notify most current and past workers who are subject to existing non-compete restrictions that such restrictions are now disavowed and unenforceable. Such retroactive effect, however, will not extend to “senior executives” (defined as workers earning more than USD151,164 and are in policy-making positions). These existing non-competes would remain in effect under the Final Rule.
The Final Rule departs from the proposed rule in that it no longer requires employers to formally rescind or modify existing non-competes for workers. Rather, employers will simply be prohibited from enforcing non-competes as of the effective date and will be required to provide notice to workers by such date. Further details on the Final Rule are discussed below.
Final rule
The Final Rule bans new non-competes with all workers, regardless of their seniority or status, after its effective date. Further, the Final Rule renders non-competes agreed with workers prior to the effective date unenforceable unless applicable to senior executives (as defined above). The rule does not require formal rescission and employers must only provide notice to workers using model language provided by the FTC.
What qualifies as a “non-compete” and who is covered by the final rule?
Under the Final Rule, a “non-compete clause” includes any written or oral contractual term of employment or engagement that prohibits a worker from, or penalizes a worker for, seeking or accepting work in the United States with a different person or from operating a business in the United States, in each case, after the conclusion of the employment or engagement subject to such term. The Final Rule only applies to non-competes that impose post-employment or post-engagement restrictions and does not restrict non-competes during the service term. Furthermore, all workers, including employees, independent contractors, interns, or volunteers, whether paid or unpaid, are covered by the Final Rule.
What about other agreements with employees that may restrict employee movement?
Under the broad definition, the Final Rule considers other employment restrictions as prohibited non-competes if they have a function of preventing workers from leaving their jobs or starting a business. The Final Rule provides specific examples of what may constitute a non-compete, including an agreement that “penalizes” a worker from seeking a new job or business by requiring a liquidated damage payment to the employer or requiring forfeiture of compensation of benefits. See also What happens to severance benefits, equity and deferred compensation tied to non-competes? below.
Other types of employment agreements or terms may be considered de facto non-competes if they have a functional effect of prohibiting or penalizing a worker from seeking a new job or starting a business. Two examples of de facto non-competes are (1) non-disclosure agreements, if drafted so broadly that they preclude a worker from working in the same field after the current job, and (2) training repayment agreement provisions, which require a worker to repay their employer or a third-party for training costs if the worker’s employment or engagement terminates within a specified time period and the required payment is not reasonably related to the costs that the employer incurred.
Non-solicitation agreements are generally not treated as non-competes under the Final Rule because they do not, by their terms or necessarily in their effect, prevent a worker from seeking or accepting other work or starting a business. However, a non-solicitation agreement can meet the definition of a non-compete if it functionally prevents a worker from seeking or accepting other work or starting a business after their employment or engagement ends.
Are there any exceptions?
The Final Rule contains some exceptions, including non-competes entered into by a person pursuant to a bona fide sale of a business entity, or instances in which a cause of action related to a non-compete occurred prior to the effective date or a person had a good-faith basis to believe that the Final Rule is inapplicable.
Furthermore, the Final Rule’s retroactive effect would not extend to senior executives (workers earning more than USD151,164 and in policy-making positions), therefore, their existing non-competes would remain in effect. The FTC estimates that fewer than 1% of workers will be considered senior executives under the Final Rule.
Businesses operating as non-profits (which would include, for example, certain healthcare providers) are not covered. The FTC recognized that non-profits fall outside of its jurisdiction, but stated that it reserves the right to evaluate an entity’s non-profit status. Similarly, franchisor/franchisee relationships are not covered by the rule and fall outside of its scope.
What happens to severance benefits, equity and deferred compensation tied to non-competes?
A severance agreement or term that is contingent on a worker’s non-competition would be considered a non-compete under the Final Rule because the payment would be conditioned on the worker not competing and thus would have the functional effect of a non-compete.
A contractual term or arrangement that requires a worker to forfeit compensation under an equity plan or a deferred compensation plan for competing would also be considered a non-compete under the Final Rule. The Final Rule, however, will not retroactively impact or require employer compensation of workers who already forfeited compensation for competing under an existing non-compete that was valid at the time.
What about garden leave agreements?
The Final Rule states that a garden leave agreement, whereby the worker is still employed and receiving the same total compensation and benefits, would not be considered a non-compete clause under the Final Rule because such an agreement is not a post-employment restriction.
How will the rule interact with different jurisdictions?
Within the U.S., the Final Rule purports to displace state law. It would create a national standard for the currently varied state rules and expressly supersedes any conflicting state laws. The Final Rule will not affect state laws that already restrict non-competes if such laws do not conflict with the Final Rule.
The Final Rule does not apply to non-competes that restrict work or the starting of a business solely outside the U.S. However, international employers should note that the Final Rule may conflict with practices in non-U.S. jurisdictions in which non-competes are permitted, resulting in a non-compete clause or other similar restrictive provision potentially being enforceable in other countries but not in the U.S.
When does the rule take effect?
The Final Rule will take effect 120 days from its publication in the Federal Register, which is expected imminently. As noted below, the Final Rule faces legal challenges that may delay its implementation. See Outlook on the Final Rule below.
Employers will have 120 days from the date of publication, subject to any delay imposed by the pending court challenges, to comply with the Final Rule and must provide the requisite notice to workers no later than the effective date.
FTC commissioners’ statements
Chair Lina Khan and Commissioners Rebecca Slaughter and Alvaro Bedoya expressed support for the FTC’s Final Rule, praising the increase in worker earnings, innovation, and reduced health care costs that it will bring over the next decade. Indeed, the FTC’s presentation found the Final Rule will lead to over USD400 billion in worker earnings over the next decade, 8,500 new businesses per year, and between 17,000 and 29,000 new patents per year.
The Commissioners further stated that the FTC is empowered by the Federal Trade Commission Act to enact rules when state protections are insufficient, and that it has a rich history of doing so. The Commissioners also noted that while they considered the business justifications of protecting trade secrets and confidential information, there are many less restrictive means to accomplish these ends, such as NDAs, fixed-duration contracts, and trade secret law.
In her specific comments, Chair Khan remarked that upholding economic freedom by banning non-competes helps to uphold other constitutional rights. In their comments, Commissioners Slaughter and Bedoya expressed interest in expanding the scope of the rule to include employees of franchises and franchisees, as well as non-profits.
Republican Commissioners Melissa Holyoak and Andrew Ferguson voted against issuing the Final Rule. Both stressed that although they agree that certain non-compete agreements may be anticompetitive, the FTC lacks the authority to issue such rules under Sections 5 and 6(g) of the Federal Trade Commission Act.
Commissioner Holyoak opined that Article 1 of the Constitution vests all legislative power in Congress, making the FTC’s rulemaking unconstitutional in and of itself. She further provided that, even if Sections 5 and 6(g) are read to provide the FTC with rulemaking authority, the FTC can only promulgate procedural rules. In her dissent, Commissioner Holyoak also lamented that the FTC was using its limited resources to create a rule that “will likely not withstand legal challenge.”
Likewise, Commissioner Ferguson opined that all legislative power must reside in Congress and that “the difficulty of legislating in Congress is a feature of its design, not a fault.” He elaborated that the insulated position of the FTC, along with the fact that Commissioners are unelected, make it an unconstitutional legislative voice for Americans. In particular, Commissioner Ferguson noted that the FTC’s rule will nullify approximately 30 million contracts between employers and workers and preempt the decision-making power of 46 states, costing employers between USD400 and USD488 bn over the next decade in additional wages and benefits.
Outlook on the final rule
The Final Rule is already facing legal challenges in court. A lawsuit was filed on April 23, 2024 in the U.S. District Court for the Northern District of Texas by a tax services firm, claiming that the FTC lacked statutory authority to issue the rule (see Ryan LLC v. Federal Trade Commission, 3:24-cv-986 (N.D. Tex., Apr. 23, 2024)), and the U.S. Chamber of Commerce filed another lawsuit on April 24, 2024, similarly claiming the FTC’s lack of constitutional and statutory authority to write its own competition rules (See Chamber of Commerce v. FTC complaint here).
These lawsuits were anticipated in the FTC Commissioners’ statements above as well as the comprehensive legal authority section of the Final Rule, and we can anticipate additional legal challenges to the rule and the agency’s statutory authority based on ongoing questions regarding the major questions doctrine, the non-delegation doctrine, and the use of the correct statutory rulemaking procedure by the FTC.
In the meantime, non-competes remain a developing area of law at the state level, as well. For example, there have been legislative developments to ban non-competes in New York state and New York City. See above How will the rule interact with different jurisdictions?
Employer considerations
The Final Rule will not take effect until the effective date; however, employers should review and revisit all existing non-competes or similar restrictive arrangements with both current and former workers and seek legal counsel to ensure that their current practices comply with the Final Rule.
International employers with both workers in the U.S. and other countries should consider, when entering into new employment agreements, that a non-compete clause or other similar restrictive provision may be enforceable in other countries but not in the U.S.
If the Final Rule survives legal challenge, employers may need to negotiate related employment terms differently, such as providing workers with a longer notice periods or garden leave as an alternative to imposing non-competes in the U.S., which may help serve a similar purpose.
We note that the Final Rule is very broad in scope; therefore, we recommend that employers seek legal counsel to consider the impact of the Final Rule on their individual circumstances.
