FTC Issues Nationwide Ban on Employment Non-competes

April 24, 2024

On April 23, 2024, the US Federal Trade Commission voted to approve a set of regulations (the "Final Rule") that will largely prohibit new employment-context non-compete agreements, and will render most existing non-competes unenforceable. Litigation over the FTC's authority to issue such a rule is virtually certain, and could delay or stop the new regulation in its tracks. Nevertheless, the Final Rule is currently scheduled to go into effect around the end of August 2024, so employers need to understand and begin preparing for this significant change in the law.

In the employment context, a non-competition covenant is essentially an agreement by a worker not to engage in competition with the employer for a period of time after the worker's employment ends. Historically, the enforcement of non-competition agreements has been a subject of state law, and there has been wide variation in how states view such agreements. In a few states, including California, North Dakota and Oklahoma, non-competes are entirely (or nearly-entirely) prohibited in the employment context. In most states, non-compete covenants are subject to judicial scrutiny but are potentially enforceable as long as they contain some reasonable limits on their scope, geography and time, and as long as the employer can show a legitimate business interest that is being protected.

Because non-competition covenants are essentially restraints on free trade, they have long sat in an uneasy co-existence with antitrust law, although non-competes have generally been viewed as not constituting an antitrust violation as long as the covenant is narrow and reasonably supported by pro-competitive justifications, such as protection of confidential information, specialized training or customer goodwill. While the U.S. Department of Justice has pursued antitrust claims against companies that entered into wage-fixing agreements or "no poach" agreements, under which the companies agree not to hire away each other's employees, the DOJ and the Federal Trade Commission (both of which have a hand in antitrust enforcement) historically had not directly attempted to bring antitrust law into the realm of non-compete agreements between employers and employees. This has shifted considerably under the Biden Administration, which is keen to use antitrust laws to protect labor competition. In an Executive Order on Competition issued in July 2021, President Biden explicitly encouraged the FTC to exercise its rulemaking authority to "curtail the use of non-compete clauses or other clauses or agreements that may unfairly limit worker mobility."

The Path to the Final Rule

A proposed regulation was issued in January 2023, largely prohibiting employers from imposing non-compete agreements on workers, with few exceptions. The FTC had a public comment period, and 26,000 comments were received. After considering the comments, the FTC held a public hearing on April 23, 2024, to disclose the contents of the final regulation and then to vote on it. In a closely divided vote, the Final Rule was adopted, with three (Democratic-aligned) commissioners voting in favor, and two (Republican-aligned) commissioners dissenting. The dissenting commissioners asserted that the Final Rule exceeds the FTC's powers, and that a rule this sweeping should be determined by Congress rather than by an administrative agency.

When does the Final Rule become effective?

The Final Rule will become effective 120 days after the publication of the Final Rule in the Federal Register. This means that its effective date will likely fall around the end of August 2024.

What does the Final Rule Say?

The Final Rule imposes the following key requirements:

• After the effective date of the rule, employers are prohibited from entering into new non-competes with allcategories of workers.
• For non-competes that are in existence as of the effective date:
  • Existing non-competes with "senior executives" can remain in place
  • For all other workers, existing non-competes are immediately unenforceable. Employers do not have an obligation to formally rescind such agreements, but must provide notices to employees informing them that the covenants are unenforceable.

What kinds of non-competes are covered and not covered by the Final Rule?

• The Final Rule defines a "non-compete clause" 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 where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition."
• The Final Rule does not expressly prohibit customer non-solicitation covenants, employee non-solicitation covenants, or confidentiality covenants. However, because the definition of "non-compete clause" encompasses a provision that "penalizes a worker for" or "functions to prevent a worker from" pursuing other employment, there will likely be disputes about whether other kinds of restrictions can be swept into the scope of the Final Rule.
• The Final Rule is focused on non-competes with "workers," which includes independent contractors, interns, externs and volunteers, in addition to employees.
• The Final Rule does notaddress non-competes in the context of agreements between franchisors and franchisees. (During the public hearing, one of the Commissioners specifically noted that the FTC is continuing to review non-competes in the franchisee context, but that this Final Rule does not address that topic.)
• The Final Rule also does not prohibit non-competes that are executed by the seller of a business (or of the assets of a business). Non-competes are common in this context and have generally been accepted as justifiable if they have a reasonable duration.
• Because of the nature of the FTC's jurisdiction, which is limited to regulating for-profit businesses, the Final Rule does not reach non-competes that a nonprofit entity may impose on its employees.

How is "senior executive" defined?

A "senior executive" is a worker who (a) was in a "policy-making position" and (b) earned total annual compensation of at least $151,164.

"Total annual compensation" includes salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation, and does not include board, lodging, medical insurance, life insurance, retirement plan contributions or other fringe benefits. The definition does not explain whether discretionary bonuses count towards total annual compensation.

The Final Rule includes lengthy definitions of "policy-making position" and "policy-making authority," which attempt to constrain "senior executive" to the very highest levels of a company - equivalent to president, CEO or similar senior officer. A "senior executive" must have "final authority to make policy decisions that control significant aspects" of the company, and does not include someone whose authority is limited to "advising or exerting influence over such policy decisions" or who exerts policy-making authority only over a division or subsidiary of a common enterprise rather than the whole enterprise.

Assuming the Final Rule goes fully into effect, there are likely to be many disputes regarding the scope of the "senior executive" exception.

A Biden Administration Competition Policy Priority

Protecting labor competition has been a fundamental pillar of the Biden Administration's competition policy. Indeed, the Executive Order on Competition (July 2021) focuses first on workers before businesses and consumers, explaining that "a competitive marketplace creates more high-quality jobs and the economic freedom to switch jobs or negotiate a higher wage." The FTC explained that its rule is justified by the negative impacts of non-competes on workers and on free trade, competition and innovation. The FTC staff explained that non-competes are often imposed in a coercive manner with no opportunity for negotiation. They also asserted that non-competes discourage labor mobility and discourage starting new businesses and innovating. Even for senior executives, who generally have the ability to negotiate over non-competes and are typically compensated for them, non-competes still hinder innovation and interfere with competition and mobility. The FTC staff looked at the experience of California, North Dakota and Oklahoma to conclude that the banning of non-competes does not cause negative consequences for economic progress and innovation.

What steps must employers take to comply with the Final Rule?

As noted above, for any existing non-compete agreements (whether with current or former employees, other than senior executives), employers must issue notices to tell the employees that the non-compete covenants are unenforceable. The Final Rule includes model language that an employer can use, and utilizing the model language will constitute a "safe harbor" for compliance with the rule. The notices must be sent (by mail, email, text message, or hand delivery) beforethe effective date of the rule (i.e., by late August 2024). There is no express penalty for failing to provide the required notice, but the FTC may try to utilize Section 5 of the FTC Act, which prohibits unfair or deceptive acts or practices, to enforce compliance.

Employers must also cease entering into any new non-competes after the effective date of the Final Rule, even with senior executives.

Will the Final Rule actually go into effect?

It is virtually certain that the Final Rule will be challenged in court as being beyond the scope of the FTC's statutory authority, harkening back to the challenges to the FTC's ambitious rulemaking agenda in the late 1970s. The FTC had abandoned most of its rulemaking initiatives after Congress restricted its funding and passed legislation to curb its rulemaking authority in the FTC Improvements Act of 1980. But, one of the first moves Lina Khan made when she assumed the role of FTC Chair was to revise the FTC's Section 18 Rulemaking Procedures to better enable FTC rulemaking to "set out clear conduct rules for industry."

The outcome of such litigation is difficult to predict, but given the number of anticipated challenges, there appears to be a reasonable likelihood that the Final Rule will be put on hold by a court before its formal effective date, so the timeline of when (or if) the Final Rule actually goes into effect is quite uncertain.