FTC Issues Final Rule Purporting to Ban Non-Compete Clauses with U.S. Workers

FTC Issues Final Rule Purporting to Ban Non-Compete Clauses with U.S. Workers

April 23, 2024, Covington Alert

On Tuesday, April 23, during a special Open Commission Meeting, the Federal Trade Commission voted 3-2 to issue a final rule adopting what the FTC referred to as a "comprehensive ban on new non-competes with all workers."[1] The rule leaves intact non-competes entered into with "senior executives" before the rule's effective date and carves out certain non-competes entered into pursuant to the sale of a business entity, ownership interest, or all or substantially all of a business entity's assets. Once the final rule is published in the Federal Register, employers will have 120 days to comply, including by affirmatively rescinding any existing non-competes covered by the rule.

Publication of the final rule in the Federal Register will be the latest step in a process that began publicly on January 5, 2023, when the FTC voted 3-1 to issue a Notice of Proposed Rulemaking. The FTC received more than 26,000 comments from members of the public and hosted a forum to discuss its proposed rule.

The FTC commissioners who voted in favor of the rule contend that the rule was properly promulgated pursuant to the FTC's authority under Sections 5 and 6(g) of the FTC Act. Meanwhile, the dissenting FTC commissioners provided a roadmap of the expected court challenges on a variety of grounds, including with respect to whether the FTC has the statutory authority to issue competition-related rules (which numerous commentators have disputed), the constitutionality of the FTC's non-compete ban (e.g., under the major questions doctrine), and the Administrative Procedure Act. It is an open question whether a court will stay the implementation of the non-compete ban pending the outcome of any such litigation.

The FTC's Rule to Ban Noncompete Clauses

The final rule asserts that it is an unfair method of competition for a person (e.g., employer) to (1) enter into or attempt to enter into a non-compete; (2) enforce or attempt to enforce a non-compete; or (3) represent to a worker that the worker is subject to a non-compete. The rule would apply to all persons subject to the FTC's jurisdiction and to all workers (i.e., any natural person who works, whether paid or unpaid, including independent contractors, interns, volunteers)[2] across the U.S.

The final rule broadly 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" seeking or accepting employment in the U.S. or operating a business in the U.S. after the conclusion of the worker's service. Significantly, the rule does not apply to a non-compete entered into by a person pursuant to a bona fide sale (i) "of a business entity," or (ii) "of the person's ownership interest in a business entity," or (iii) "of all or substantially all of a business entity's operating assets."[3] The preamble to the final rule also notes that the rule does not categorically prohibit other types of restrictive covenants like NDAs and non-solicitation agreements. However, the FTC expressed the view that, if these types of covenants "function to prevent" a worker from seeking or accepting work or starting a business after they leave their job, such covenants could constitute non-competes under the final rule.

Non-competes entered into with "senior executives" before the effective date of the final rule are excluded from the ban. A "senior executive" is a worker who (1) was in a "policy-making position" and (2) received a total annual compensation of at least $151,164 in the preceding year. The final rule defines "policy-making position" narrowly - as a business entity's (a) president, CEO, or equivalent, or (b) any other officer[4] or equivalent who has "policy-making authority." "Policy-making authority" is the final authority to make policy decisions that control significant aspects of a business entity, excluding authority limited to advising or exerting influence.[5] The FTC noted that this definition is a modified version of SEC Rule 3b-7.

The rule mandates that, within 120 days after publication of the rule, employers that have previously entered into non-competes covered by the rule must rescind the non-compete by providing clear and conspicuous notice to the worker that the non-compete is no longer in effect. Notice is not required with respect to eligible non-competes with "senior executives" or non-competes excluded from the rule (e.g., non-competes entered into pursuant to the sale of a business entity). The final rule published by the FTC contains a model notice (see page 566).

The Commission voted 3-2 to promulgate the final rule during an open commission meeting on April 23, 2024. Commission staff presented the empirical research they relied upon in connection with the non-compete ban. Chair Lina Khan and Commissioners Rebecca Kelly Slaughter and Alvaro Bedoya largely echoed the staff's remarks. Commissioners Slaughter and Bedoya also noted that, while the rule would not apply to franchisee-franchisor agreements, such agreements are of particular interest to them.

Commissioners Melissa Holyoak and Andrew Ferguson dissented. Each questioned the FTC's authority to promulgate the rule under Sections 5 and 6(g) of the FTC Act. The Commissioners also noted that National Petroleum Refiners Association v. FTC, on which the rule relies for support, fell out of favor decades ago. Commissioner Ferguson added that he believes that this rule presented a major policy question as it will nullify over 30 million contracts, redistribute half a trillion dollars, and affect nearly the entire economy.

In her final remarks, Chair Khan addressed the arguments of the dissenting Commissioners, contending that the plain language of the FTC Act provides clear authority to promulgate this rule, courts have agreed with such an interpretation, and the Commission has used Section 6(g) authority for decades.

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Takeaways

The rule is likely to be challenged in the near term. In the meantime, employers should take stock of their use of non-competes, including in current employment agreements, severance agreements, consulting agreements, IP assignment agreements, confidentiality agreements, employee handbooks, and equity award agreements, as well as in any past agreements where any such non-compete provisions are still effective. Employers that use or are considering including non-compete clauses in arrangements with workers should consult antitrust and employment and executive compensation counsel. Employers will need to determine which of their workers are subject to non-compete clauses and determine whether they are required to provide notice of non-enforcement to those workers as required by the rule. This may include assessing whether a worker is a "senior executive" within the meaning of the rule.

The FTC has continued to aggressively enforce restrictions on labor mobility. With its vote to adopt the final rule on non-competes, the FTC will likely pursue enforcement actions against companies that it determines have violated the new rule after the 120-day grace period.

For further information on the final rule or questions regarding the use of non-compete provisions, please contact the members of Covington's Antitrust/Competition, Employment, or Employee Benefits and Executive Compensation practices.

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