Ban On Non-Compete Clauses: The Dos And Don'ts

The rule is expected to impact up to 30 mn U.S. workers

 
In April, the Federal Trade Commission (FTC) finalized (3-2) a new rule to prohibit employers from enforcing new non-compete clauses and invalidating the majority of existing noncompetes.

This rule, initially proposed in 2023, will pertain to non-competes in industries governed by the commission. ^[1]

Non-compete clauses have faced scrutiny at both state and federal levels in recent years, with both substantive limits on their use and procedural requirements on their enforcement. Likewise, Congress has considered bills with broad support to limit non-competes. 

However, the FTC’s decision is a nationwide, broad restriction on the use of contract terms that function as non-competes, whether in traditional “non-compete” language or in any other form, such as an overly broad and restrictive non-disclosure agreement.

Recently, in its final rule and its 500-plus page analysis of comments from industry and the public on the rule proposed in January 2023, the FTC determined that non-competes are an unfair method of competition and violate the FTC Act. The FTC’s final rule bans nearly all new non-competes, with very narrow exceptions, regardless of the level of worker, and renders most existing non-competes unenforceable (other than those the claim accrued, e.g., is in litigation, and for executives at certain levels).

The final rule takes effect 120 days from the final rule being posted in the Federal Register. The rule is expected to be legally challenged, which may ultimately delay its implementation. However, if the rule remains in place as of the effective date, it will invalidate most non-competes and is expected to impact up to 30 million workers in the U.S.

Among other things, opponents to the rule assert that it is based on its November 2022 overly broad policy change to the FTC’s interpretation of the scope of the FTC Act and its own authority. 
 

Restrictions and Applicable Definitions

Generally, the rule prohibits employers from (1) entering into “non-competes” with “workers” after the effective date, and (2) enforcing previously executed non-competes with workers other than senior executives. The rule defines key terms throughout.

The rule defines “non-competes” as:

A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: ^[2]
 

• Seeking or accepting work in the U.S. with a different person where such work would begin after the conclusion of employment that includes the term or condition; or
• Operating a business in the U.S. after the conclusion of the employment that includes the term or condition.

The term “workers” includes employees, independent contractors, externs, interns, apprentices, volunteers, and sole proprietors who provide a service.

Exceptions

Whether existing non-competes can remain in place is dependent on whether the non-compete agreement is with a “senior executive.” Senior executives are workers earning more than $151,164 who have “policy-making authority,” such as presidents and officers. The FTC estimates that less than 1% of workers fall into this exemption. 

“Policy-making authority” is defined as “final authority to make policy decisions that control significant aspects of a business entity or a common enterprise.” Policy-making authority does not include “authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or an affiliate of a common enterprise.” 

Importantly, this exception only applies to existing non-competes as of the effective date and does not permit the execution of new non-competes with senior executives.

Two other primary key exceptions exist under the rule. First, non-competes between the seller and buyer of a business are not impacted by the rule and are still permissible. Second, the rule does not apply where a cause of action related to a non-compete accrued prior to the effective date.

Notification Requirement

Importantly, while the rule does not require any formal steps to rescind existing non-competes, the rule does require employers to notify workers that executed non-competes that are no longer enforceable that their agreements are no longer in effect and will not be enforced. 

The FTC provides a proposed model language for this. Large employers may find the notification requirement to be a significant time burden and cost for former employees.

State Law

The FTC rule generally preempts state laws that allow non-compete clauses or that are inconsistent with the rule; however, it does not preclude enforcement of state laws that are consistent with the FTC rule (e.g., the California statute against non-competes).

Next Steps for Employers

• Stay up to date on when the FTC rule will go into effect, including any impacts that potential legal challenges may have on the effective date.
• Take steps to determine and evaluate existing non-compete restrictions, including employees who are subject to noncompete agreements.
• Consider alternative methods to protect business interests. Other types of restrictive covenants, such as non-disclosure and non-solicitation agreements, should be narrowly tailored as they could violate the FTC rule if they “function to prevent” a worker from seeking or accepting employment elsewhere or operating a business after the end of their employment.

Notes
[1] For example, the FTC does not govern certain industries, such as banks, nonprofits, air carriers, etc. Therefore, the FTC rule is inapplicable to the industries not governed by the FTC.
[2] This language is very similar to that used in the California statute banning non-competes. See Ca. Bus. and Prof’l. Code § 16600.

This article first appeared here.

	Bethany Vanhooser is an Associate at Spencer Fane LLP.
	Danielle Healey is a Partner at Spencer Fane LLP.