FTC Final Rule Bans Most Non-Compete Agreements and Judicial Challenges Begin

On April 23, 2024, the Federal Trade Commission issued a final rule effectively concluding that it is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for employers to enter into non-competes with workers and to enforce certain non-competes.

Except for senior executives, the final rule provides that it shall be unlawful to enter or attempt to enter into a non-compete provision, enforce or attempt to enforce a non-compete provision, or represent that a worker is subject to a non-compete provision.

The final rule is set to become effective in September 2024.  The FTC vote to approve the issuance of the final rule was 3-2 with Commissioners Melissa Holyoak and Andrew N. Ferguson voting no.  Commissioners Rebecca Kelly Slaughter, Alvaro Bedoya, Melissa Holyoak and Andrew N. Ferguson each issued separate statements.

How Does the Final Rule Define “Non-Compete?”

The final rule defines a “non-compete” provision as a term or condition of employment that prohibits a worker from, penalizes a worker for, or “functions to prevent” a worker from: (i) seeking or accepting work in the United States with a different person after the conclusion of their employment; or (ii) operating a business in the United States after the conclusion of their employment.

What is the Purpose of the FTC Non-Compete Rule?

The final rule is intended to promote competition by banning non-competes nationwide, protecting the freedom of workers to change jobs, increasing innovation, and foster new business formation.

“Non-compete 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 non-competes are banned,” said FTC counsel and Chair Lina M. Khan.  “The FTC’s final rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

According to the FTC, non-competes are “a widespread and often exploitative practice imposing contractual conditions that prevent workers from taking a new job or starting a new business.”  “Non-competes 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.”

What Impact will the FTC Non-Compete Rule Have on Existing Non-Competes?

Under the FTC’s new rule, existing non-competes for the majority of workers, including, not limited to, employees, independent contractors, interns and sole proprietors, will no longer be enforceable after the effective date.

Importantly, existing non-competes for senior executives may remain in force under the FTC’s final rule.  However, employers are banned from entering into or attempting to enforce any new non-competes – even those involving senior executives.  The final rule defines “senior executives” as workers earning more than $151,164 annually and who are in policy-making positions.

Existing non-competes with workers other than senior executives are not enforceable after the effective date.  The new rule provides that employers are required to provide clear and conspicuous notice (prior to the effective date) to workers other than senior executives that are bound by an existing non-compete that they will not and cannot lawfully enforce any non-competes against current and former workers.  To aid employers’ compliance with this requirement, the FTC has included model language and instructions in the final rule that employers can use to communicate to workers.

Are There Alternatives to Non-Competes?

FTC commentary illustrates that agency’s position that “employers have several alternatives to non-competes that still enable firms to protect their investments without having to enforce a non-compete.”

For example, trade secret laws and non-disclosure agreements provide means to safeguard proprietary and other sensitive information.

What Other Circumstances Will Non-Compete Provisions be Permitted?

The final rule will permit non-compete agreements in the context of a bona fide sale of a business.  It shall also not apply in the context of a cause of action related to to a non-compete agreement that accrued prior to the effective date.

Note that it shall not be considered an unfair method of competition to enforce or attempt to enforce, or make representations about, a non-compete provision where there exists a good faith belief that the final rule does not apply.

Have There Been Challenges to the Final Rule Banning Non-Compete Agreements?

Following announcement of the final rule, a Dallas, Texas-based global tax consulting firm filed a lawsuit in a Texas federal court challenging the FTC’s authority to issue the final rule, including that the FTC has no authority to issue retroactive rules.  The U.S. Chamber of Commerce is expected to join the challenge.

A ruling on the challenge is anticipated sometime in July 2024.

Employes are advised to consult with experienced FTC defense practice counsel to identify workers that may require notice, implement all necessary measures to comply with the final rule, and consider whether various alternatives may be practicable to protect corporate interests.

Richard B. Newman is an FTC CID lawyer at Hinch Newman LLP.  Follow FTC defense lawyer on National Law Review and FTC CID attorney on JD Supra.

Informational purposes only. Not legal advice. May be considered attorney advertising.