FTC Final Rule Prohibits Employer-Worker Non-Compete Agreements

FTC Final Rule Prohibits Employer-Worker Non-Compete Agreements

The United States Federal Trade Commission (FTC) issued a final rule on April 23, 2024 which purports to ban employer-worker non-compete agreements nationwide as of the effective date of the rule.  The final rule does not have a direct impact on non-solicitation and confidential information agreements.

Employment restrictive covenants, such as non-compete and non-solicitation provisions have been predominantly governed by state laws.  Employee noncompete agreements have grown more and more disfavored in recent years by various states determining they are an unreasonable and unnecessary restraint on the free market and worker mobility.  Prior to this year, four states had banned employee non-compete agreements: California, Minnesota, Oklahoma, and North Dakota.  Twelve other states have previously passed legislation restricting employee non-compete agreements.  A significant majority of other states have developed case law through the years refusing to enforce overbroad employee non-compete agreements.

The final rule from the FTC this past week now attempts to inject a federal rule into the legal landscape governing employee non-compete agreements.  The final rule provides that it is a violation of sections 5 and 6(g) of the FTC Act to, among other things, enter into non-compete agreements with workers.  The FTC justified its reasoning in its press release, including the following explanation:

Noncompetes are a widespread and often exploitative practice imposing contractual conditions that prevent workers from taking a new job or starting a new business.

Noncompetes often force workers to either stay in a job they want to leave or bear other significant harms and costs, such as being forced to switch to a lower-paying field, being forced to relocate, being forced to leave the workforce altogether, or being forced to defend against expensive litigation. An estimated 30 million workers—nearly one in five Americans—are subject to a noncompete.

Effective Date:  The final rule will become effective 120 days after publication in the Federal Register. 

However, it is likely that the effective date may be further delayed.  Federal courts, such as the Fifth Circuit, have in the past intervened to enjoin federal administrative activity providing more expansive employee protections prior to the protections taking effect.[1]  An injunction issued by a federal court may delay the final rule taking effect until the legality of the final rule is addressed by the U.S. Supreme Court.  Additionally, Congress and the President may also weigh in on the final rule prior to it taking effect.  Employers should therefore review and familiarize themselves with the final rule as the effective date approaches, but should hold off on making immediate changes until the dust settles from the anticipated legal challenges to the final rule.

We will continue to monitor the progress of the FTC rule as its effective date nears.  Employers should continue – at minimum – to comply with state laws regarding non-compete agreements and other restrictive covenants such as non-solicitation agreements.  Employers should consult with local counsel regarding the interplay between the final rule and state laws, specifically regarding state laws applicable to non-solicitation and confidential information agreements.

Applicability and Covered Employers:  The final rule itself broadly defines business entities subject to the rule as any “partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.”  Despite its broad description of entities subject to the final rule, the final rule nonetheless remains limited to a relationship between a business and its workers.

A limited number of entities are exempt from coverage under the FTC Act, such as banks and common carriers.  Businesses should examine whether they are in industries exempt from the FTC Act.

A question which remains to be resolved is whether application of the final rule is only limited to businesses engaged in interstate commerce.  The FTC’s comments to the rule evidence an awareness of the FTC’s limitation to regulating business involved in interstate commerce by explaining, “[t]he final rule extends to the full extent of the FTC’s jurisdiction, which in turn extends no further than the Commerce Clause permits.”  However, the FTC’s comments additionally explain the FTC’s general findings that non-compete agreements impact interstate commerce, regardless of whether the employer is engaged in interstate commerce.  The definition of “impacting or relating to interstate commerce” has typically been given broad interpretation by federal courts.

Retroactive Impact:  The final rule has retroactive impact.  Existing non-competes with workers who are not senior executives will no longer be enforceable after the effective date of the final rule regardless of when the non-compete agreements were entered into.  It will be a violation of the FTC Act with respect to non-senior executives to (i) enter into or attempt to enter into a non-compete clause; (ii) to enforce or attempt to enforce a non-compete clause; or (iii) to represent that the worker is subject to a non-compete clause.  However, the final rule expressly provides that it does “not apply where a cause of action related to a non-compete clause accrued prior to the effective date.”

Senior Executives:  The retroactive impact of the final rule does not apply to senior executives (as senior executives are defined under the final rule).  Non-compete agreements with senior executives entered into before the effective date of the final rule remain enforceable.  However, the final rule prohibits employers from entering into non-compete agreements with senior executives after the effective date of the final rule.

Employers’ Notice Obligations:  Importantly, the final rule imposes an obligation on employers to notify workers under non-compete clauses that the worker’s non-compete clause “will not be, and cannot legally be, enforced against the worker.”  The final rule provides information regarding the acceptable methods of providing this notice, and additionally provides a model notice for employer to utilize.  The notice is required by the effective date of the final rule.  Employers should review the notice requirement and discuss any questions regarding their obligations with local counsel prior to the effective date of the final rule.

The Final Rule does not prohibit non-solicitation agreements and confidential information agreements:  Employers continue to have options to protect their customer base, their employees from unfair recruitment, and their confidential information.  The final rule’s definition of prohibited non-compete agreements does not include a prohibition of non-solicitation agreements preventing former employees from soliciting their former employer’s clients and/or employees.  Similarly, the final rule does not speak to a prohibition of agreements designed to protect employer’s confidential business and trade secret information.

Nonetheless, employers are cautioned that a non-solicitation agreement is not so restrictive that it can serve as a disguised non-compete agreement.  Overbroad non-solicitation agreements have been challenged under existing state laws, and are now further susceptible to challenge under the FTC rule.  For instance, in California – where non-competes have been previously prohibited – case law has developed restricting overbroad non-solicitation agreements which serve to function as non-compete agreements.

Employers are encouraged to work with their counsel to review existing agreements and/or draft new non-solicitation and confidential information agreements which will withstand scrutiny if the final rule becomes effective.

Sale of Business Exception:  Non-compete agreements are frequently used as important tools in sales of businesses in order for a buyer to ensure that the seller will not turn around and compete against the entity sold to the buyer.  The final rule provides a sale of business exception allowing the enforceability of non-competes in a sale of business contexts.  Individuals and entities entering into transactions involving the sale of a business – or their interests in a business – should review the final review with counsel to assure compliance.

If you have additional questions regarding the enforceability of non-compete agreements or employment matters, please email Shar Bahmani at Bahmani@SacksTierney.com  or Katya Lancero at Lancero@SacksTierney.com.

[1] For instance, the National Labor Relations Board (NLRB) sought to ban class-action waivers in arbitration agreements in 2016, a rule upheld by several circuit courts.  The Fifth Circuit stopped the NLRB rule from taking effect resulting in the circuit split reaching the U.S. Supreme Court in 2018.  The nation’s high Court ultimately sided with the Fifth Circuit in determining that class-action waivers in arbitration agreements are enforceable.  (See Epic Systems Corp. v. Lewis.)  It is a likely possibility that a federal court may intervene to enjoin the FTC’s ban of non-compete agreements, thereby leaving the FTC rule in doubt until it reaches the U.S. Supreme Court.