Employment / 5 min read
On April 23, 2024, the Federal Trade Commission (FTC) issued its Final Rule banning all noncompetes for all workers employed by virtually every private enterprise in the United States, with some limited exceptions. The Rule has been met with applause from workers’ right groups, unions, and even some small businesses, while the larger business world has offered a less favorable reaction. The Final Rule goes into effect September 4, 2024, unless it is enjoined by a federal court before then.
This is considered a landmark rule because of its outright ban on all future non-compete agreements and retroactively affects most existing non-competes. The final rule defines “noncompete clause” as: a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.
The Rule extends to all workers, including employees, contractors, and unpaid staff such as interns. The Rule also arguably bans other restrictive covenants, such as non-solicitation agreements, that “function to prevent” workers from seeking work elsewhere or starting their own business. This “function to prevent” language could extend the rule to non-solicitation agreements and non-disclosure agreements.
The Rule is not without some exemptions and limitations. There are five important exemptions. First, the Rule does not cover “executive employees”, defined as those workers who earn at least $151,164 per year (salary and non-discretionary bonuses only) and have “Policy Making Authority” in their workplace. The Rule’s exclusion of executives is only temporary and is not retroactive, as it relates to existing non-competes. Going forward, under the Rule, businesses will not be allowed to draft new restrictive covenants subjecting executives to a non-compete. Banks are also exempted by The Rule because banks have never been subject to FTC regulation.
The Rule also exempts a “bona fide sale of business” from the non-compete ban. To address commenters’ concerns that employers will use sham transactions, stock-transfer schemes or exemption, a non-compete must be entered into pursuant to a “bona fide” sale. There is no ownership percentage threshold and no dollar amount required to qualify for the sale of a business exemption, only that the sale be “bona fide.” Whether a sale of business qualifies for the exemption from the Final Rule will be a fact specific, case by case analysis. The FTC reminds buyers and sellers that state laws still generally require that non-competes are necessary to protect the value of the business being sold and that state and federal antitrust laws still apply to the sale of businesses.
Non-compete agreements between franchisors and franchisees are not subject to the Final Rule. Of course, the Rule still covers the various workers employed by the franchisor and franchisee.
The FTC does provide some carveouts. Employees for whom a cause of action under existing non-competes has accrued will not be safe from their former employers. The cause of action must have accrued as of the Effective Date – which will be September 4, 2024.
If an employer has a good faith belief that that the Final Rule does not apply to existing noncompetes, the employer may still pursue legal action, whether the cause of action has accrued or not. There are many factors that will determine whether a cause of action has accrued or whether an employer has brought an action in good faith believing the Rule does not apply to the existing non-compete.
It is also important to remember that solicitation of customers/employees in violation of a restrictive covenant is actionable under the Final Rule.
Two lawsuits have already been filed in Texas, and both lawsuits seek injunctive relief and ask the Courts to stay the Rule. The first lawsuit was brought by a software company out of Dallas, and the second lawsuit was brought by the U.S. Chamber of Commerce, in the Eastern District of Texas. The software company will get the first opportunity at an injunction because it filed first. Commentators expect the Chamber of Commerce to intervene in that lawsuit.
Other than the limitation on the executive exemption, which will honor only existing noncompetes for senior executives until September 4, 2024, the Ban is mostly retroactive. Meaning that all existing non-competes will be obsolete as of the Effective Date unless a cause of action has already accrued. Opponents of the Rule argue that this will deprive those who have bargained for such agreements of their consideration and that this would be an impermissible ""taking"" under the Fifth Amendment.
A change of this magnitude is bound to create uncertainty in the marketplace. The biggest uncertainty is obvious: will the Rule succumb to legal challenges, which are mostly constitutional in nature? The Rule does not invalidate non-solicitation, non-recruitment, and nondisclosure agreements, unless they ""function"" as non-competes. This fact specific analysis concerns the scope of activity prohibited and the impact the restriction has on an employee. The FTC has opined, however, that state courts already engage in this type of analysis for overbroad nondisclosure and non-solicitation agreements. Other gray areas include the definition and interpretation of “non-profit,” the interpretation of “bonafide sale” as it pertains to mergers, acquisitions, and sale of business transactions, and what effect an effective ban will have on the economy.
While the gray areas raise big questions, employers can prepare today for what may happen in September. Andrews Myers suggests that employers should:
- Begin to analyze the rule’s application to their practices and work with attorneys to protect their competitive interests when workers leave to join a competitor or found a competing business. Strategies rooted in intellectual property law, antitrust law, enforcement of reasonably tailored non-solicitation agreements and non-disclosure agreements, and breach of contract causes of actions are all still viable options.
- Continue to draft and enforce reasonable, enforceable non-solicitation agreements.
- Consider rolling out new benefit and incentive plans for executives between now and September 4, 2024, that incorporate non-competition covenants for senior executives not previously bound by non-competition agreements before the rule takes effect.
- Audit current non-competes to identify workers who have a non-compete on the books in preparation for the notice provisions in the final rule.
- Monitor these legal developments and consult with attorneys to prepare for a scenario where the Rule survives judicial scrutiny and carefully follow whether the Rule is enjoined and the deadline for compliance should the rule remain intact.