On Tuesday, April 23, the Federal Trade Commission (FTC) issued a final rule, which would effectively ban most post-employment non-compete agreements.
Here are the top line takeaways (full explanation below):
- Lawsuits have already been filed to challenge the new rule and it is likely that a temporary injunction will be issued halting the rule before it goes into effect in late August and that the issue will ultimately be decided by the Supreme Court.
- The rule bans new post-employment non-compete agreements for all workers (including independent contractors) and invalidates existing post-employment non-compete agreements except for those with senior executives. Employers will need to give employees with invalidated non-competes notice that they are no longer enforceable.
- The new rule does not ban non-disclosure and non-solicitation agreements, which employers commonly used as an alternative to non-competes. However, because of the rule’s broad definition of a non-compete, these clauses will have to be carefully drafted to ensure that they do not get caught up in the ban.
- Even if the new rule is struck down, a growing number of states have passed legislation limiting or banning the use of non-competes, and, particularly in industries with labor shortages, businesses should expect to see increased pushback from workers on the use of non-competes. Now is the time for businesses to start thinking about alternative ways to protect their business information and interests.
Background and Challenges to the Non-Competes Rule
The FTC first proposed the new rule in January 2023 and received over 26,000 public comments in response. The final rule has a few tweaks but closely resembles the original proposal, and is scheduled to go into effect 120 days after it is published in the Federal Register, which should occur sometime in the next week or so (meaning a late August effective date).
However, as noted above, almost immediately upon the FTC voting to issue the final rule, lawsuits were filed to challenge it including one filed by the U.S. Chamber of Commerce in the Eastern District of Texas, which has a history of striking down significant agency actions (including the Department of Labor’s overtime rule during the Obama Administration).
While there is a good chance that the rule will be stayed, at least temporarily, before its effective date, this is not a guarantee and an injunction could happen at the last minute so it is important for businesses to begin to familiarize themselves with the new rule.
Key Provisions in the New Non-Competes Rule
Should the new rule go into effect, the key provisions are as follows:
- The new rule prohibits businesses from entering into any new non-compete agreements (or agreements containing non-compete provisions) on or after the effective date of the rule. The restriction applies to agreements with any type of worker, including employees, independent contractors, and interns. The only narrow exceptions to the ban is for contracts between franchisees and franchisors (but not their employees) and contracts associated with the bona fide sale of a business.
- Non-compete agreements entered into before the effective date of the rule may no longer be enforced and employers will be required to provide notice of this to employees with such agreements. The FTC has published a model notice for this purpose. There is a significant exception for existing non-competes with senior executives, which may still be enforced (though no new non-competes may be entered into with senior executives). To meet the definition of a “senior executive” for the purposes of the new rule, the person must earn more than $151,164 annually and be in a “policy-making position”.
- The restrictions in the rule only apply to post-employment non-competes restraining what employees can do after the working relationship ends.
- The new rule broadly defines a non-compete 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.”
This means that, while the rule does not directly prohibit the use of non-disclosure agreements (preventing disclosure of information) or non-solicitation agreements (preventing the solicitation of the business’ customers, clients, employees, business partners, or others), these agreements will need to be carefully drafted to ensure that they aren’t so overbroad as to effectively prevent the employee from going to work for a new employer.
- With certain limited exceptions (for banks, insurance companies, and certain other unique types of businesses) the rule applies to all for-profit businesses. Registered non-profits will only be exempt from coverage by the rule to the extent that they satisfy the FTC’s two-part test to affirm that they are not organized for profit.
- The FTC will be able to pursue injunctive relief against employers who violate the rule but cannot issue or pursue civil penalties or monetary relief for violations. There is no private right of action in the rule, so workers cannot sue for violations of the rule, but the rule will prohibit employers from successfully suing to enforce a non-compete voided by the rules.
As mentioned above, even if the new rule is ultimately struck down, it is reflective of a growing legal and cultural shift disfavoring the use of non-compete agreements.
Now more than ever, employers should be giving careful thought to how they use restrictive covenants – like non-compete, non-solicitation and non-disclosure provisions – to ensure not only that their agreements are legal and enforceable but that they are carefully drafted and strike the appropriate balance so as not to deter employees and applicants.
For more information on the new rule and what it means for employers, contact Jessie at [email protected].
