Federal Trade Commission Issues Rule Banning Most Non-Competes

Making good on President Biden's July 2021 Executive Order commanding it to exercise its rulemaking authority to curtail the use of non-compete clauses and other agreements that limit worker mobility, on April 23, 2024, the Federal Trade Commission (FTC) issued its long-awaited final rule on Non-Compete Clauses, 16 CFR Part 910 (the "Rule"). The Rule was previously released as a Notice of Proposed Rulemaking (NPRM) in January 2023, followed by a lengthy period of public comment. In a 3-2 vote along partisan lines, the full Commission voted to finalize the Rule. The effective date of the Rule is 120 days after the Rule is published in the Federal Register (the official compendium of all federal regulations). In a companion Guide for Businesses issued on April 23, the FTC suggests that the effective date will likely be in early September 2024.

The Rule makes it an "unfair method of competition" for an employer to enter into or maintain with a worker a non-compete clause. 16 CFR §910.2(a). Being deemed an unfair method of competition opens the door to the FTC's jurisdiction under Section 5 of the Federal Trade Commission Act, a 1914 law that gives the FTC broad powers to regulate fair competition and bring enforcement actions against businesses engaged in unfair methods of competition.

By federal agency standards, the Rule is short and straightforward. The rule begins with several key definitions:

• Non-compete clause: 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 current employment ends; or (ii) operating a business in the United States after the conclusion of the current employment. Importantly, in its Supplementary Information published with the Rule, the Commission devoted extensive commentary to the definition of the non-compete clause. In that commentary, the Commission examined other types of contractual provisions that it labeled as de facto or functional non-competes, including overly broad non-disclosure agreements, client or customer non-solicitation agreements, and liquidated damages provisions that require the worker to pay the employer a sum of money if the worker competes. The Commission found those types of agreements, which penalize a worker for or prevent a worker from accepting other employment, are included in the Final Rule's prohibition of non-compete clauses.
• Senior Executive: a worker who has policy-making authority and who receives a total annual compensation of at least $151,164. "Policy-making authority" generally means the final authority to make policy decisions that control significant aspects of a business entity.
• Worker: a person who works or who previously worked for a business entity; the term includes persons occupying the status of employee, independent contractor, extern, intern, volunteer, apprentice, or sole proprietor.

The Rule's prohibition of non-competes turns on the effective date and a worker's status:

• No New Non-competes: after the effective date of the Rule, it is an unfair method of competition for an employer to enter into or attempt to enter into, enforce or attempt to enforce, or represent that a worker is subject to a non-compete clause with any worker. That means that on a going-forward basis, all new non-competes are banned for all workers, including senior executives.
• Existing non-competes: for senior executives, the rule prohibits new non-competes, but existing non-competes with senior executives will remain in force, unaffected by the Rule. For workers who are not senior executives, existing non-competes will not be enforceable as of the effective date.
• Notice required: prior to the effective date, any employer who entered into a non-compete with any worker other than senior executives must provide a written notice to the worker that the non-compete clause will not be, and cannot legally be, enforced against them. A form of that notice is included in the Rule; the language of that notice not only informs the worker that the non-compete clause will not be enforced by the employer, but goes on to inform the worker that they may accept a job with a competitor and that they may compete with the employer.

Finally, the Rule contains three exceptions, situations to which the requirements of the Rule shall not apply:

• Bona fide sales of business: a non-compete entered into by a person pursuant to a bona fide sale of a business entity, or sale of the person's ownership interest in a business entity, or sale of all or substantially all of a business entity's operating assets.
• Existing causes of action: the Rule does not apply to a cause of action related to a non-compete that accrued prior to the effective date.
• Good faith: it is not an unfair method of competition to enforce or attempt to enforce a non-compete clause where a person has a good faith basis to believe that the Rule does not apply.

What Employers Should Do Now

Although the FTC is requiring employers to notify certain employees with existing non-competes that they are invalid prior to the effective date of the Rule, no timeline has been given as to when such notices must be issued. As such, no immediate action is required of employers who maintain non-compete covenants with existing and prior employees. Remember, the effective date of the Rule will likely be in September 2024, or later.

Just hours after the FTC issued the Rule, Plaintiff Ryan, LLC, a global tax services firm, filed the first lawsuit against the FTC in the United States District Court for the Northern District of Texas. Ryan has asked for a judicial declaration that the rule violates the Administrative Procedures Act and Article II of the U.S. Constitution. The next day, the U.S. Chamber of Commerce filed a lawsuit seeking declaratory and injunctive relief in the United States District Court for the Eastern District of Texas, making similar allegations contesting the validity of the Rule. The Chamber's lawsuit includes a request for a permanent injunction on the enforcement of the Rule and delay of the effective date of the Rule pending the conclusion of the litigation. More lawsuits are likely to be filed challenging the Rule. If any reviewing court issues a stay or injunctive relief, the implementation of the Rule likely would be delayed while the challenge to its validity is litigated.

While employers should be mindful of the need to comply by the effective date, they should keep an eye on the news as to the legal challenges to the Rule for any important new developments that could delay or avoid implementation.

Employers who wish to plan on the Rule taking effect as planned would be well-served to use this time to take an "inventory" of their existing non-competes and de facto non-competes. That review should identify all personnel (current and past) with whom the employer has these agreements, and then ascertain which agreements are in place with senior executives (which agreements will survive the Rule), and those agreements with workers who are not senior executives (and who therefore will be entitled to the notice mandated by the Rule).

The Labor & Employment lawyers at Calfee will continue to monitor ongoing developments with the Rule and report significant items in future First Alerts. In the meantime, should you have any questions about the Rule and its impact on your business, please contact any of the lawyers listed below or your regular Calfee contact.