The headlines are rampant: “Federal Trade Commission Bans Noncompetes”. But don’t tear up those agreements just yet. Staying informed about the terms of the FTC ban and also when – and whether – they are enforceable will be critical for employers seeking to protect their intellectual property and customer relationships and for employees seeking the benefit of increased mobility.
Background. On April 23, 2024, the FTC commissioners voted along party lines (3 Democrats-2 Republicans) to adopt a Final Rule prohibiting noncompetes throughout the United States (the “Rule”). The FTC’s action – which would be the first such federal ban – is the culmination of a process that began in January 2023 when the FTC first announced its proposed rule on this subject. Importantly, none of the Rule’s requirements become effective until 120 days from its publication in the Federal Register, which should take approximately two weeks, i.e., in or about September 2024. In the meantime, the U.S. Chamber of Commerce and others have already filed lawsuits in federal courts challenging the FTC’s authority to adopt and enforce the Rule. There is also a fair chance that a court will preclude the FTC from enforcing the Rule pending a resolution of these legal challenges. Accordingly, while it is vital for employers and employees to stay informed about further developments, the first important take away is that, for now, whichever laws governed the enforceability of noncompetition agreements before the FTC adopted the Rule remain in effect, as do the existing agreements themselves and the ability to enter into them.
Terms and Scope of the Ban. If the Rule does go into effect, it will drastically change the legal landscape that currently exists for noncompetes and contractual provisions that have the same “functional effect” as noncompetes. This landscape currently consists of a patchwork of statutory and judicially-created rules that often vary from one state to the next. A number of states (such as California) already ban or severely curtail noncompete agreements; others (such as New York) determine the enforceability of noncompetes on a case-by-case basis, which involves a fact-intensive inquiry under what is often referred to as a “rule of reason.”
Regardless of any state law, the FTC’s Rule provides that an employer unlawfully engages in an unfair method of competition under the FTC Act if it: (i) enters or attempts to enter into a non-compete clause; (ii) enforces or attempts to enforce a non-compete clause; or (iii) represents that an employee is subject to a non-compete clause. The Rule defines noncompetes as a “term or condition of employment that prohibits a worker from (i) seeking or accepting work in the United States . . . where such work would begin after the conclusion of the employment . . .; (ii) operating a business in the United States after the conclusion of employment . . . .” The Rule goes further, however, by also including agreements that “function” to prevent a worker from doing either of these things. The Rule also contains specific requirements for employers to “clearly and conspicuously” notify their employees that their pre-existing noncompetes are no longer enforceable.
Exemptions. Subject to noncompetes with “senior executives” that pre-existed the Rule’s enactment, as discussed below, the only exemptions to the ban are for (i) non-compete clauses that are 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 all or substantially all of a business entity’s operating assets, (ii) causes of action concerning noncompetes that accrued before the effective date, and (iii) enforcement or attempts to enforce a non-compete clause – or to make representations about same – where a person has a good-faith basis for believing that the Rule does not apply.
Retroactive Application. The Rule will apply retroactively, with a narrow exception for “senior executives” who entered into a noncompete before the Rule’s effective date. To qualify as a “senior executive,” the individual must earn more than $151,164 annually and be in a “policy-making position”. On a go-forward basis, however, “senior executives” are not exempt from the Rule’s prohibitions.
Open Questions and Administrative Burdens. While it remains uncertain whether the Rule will ever go into effect, one thing is certain if it actually does: the Rule begs many questions that will lead to additional litigation concerning non-compete clauses, such as (i) whether someone qualifies as a “senior executive”, (ii) whether provisions such as forfeiture-for-competition clauses, training repayment agreements, no-hire agreements, and certain severance arrangements in which the worker is paid only if they refrain from competing are “functionally equivalent” to a banned non-compete clause, and (iii) whether an NDA or client non-solicitation agreement is appropriately tailored in such a way as to escape the Rule’s reach. Employers will also need, among other things, to put systems in place to identify any pre-existing non-competes and provide the requisite notice to those who are subject to them as well as ensure that such clauses are removed from employment agreements, equity award agreements, and similar documents that they provide to their workforce in the future.
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