FTC Rule Bans Non-Compete Clauses for Non-Senior Employees
Non-compete clauses have long been a contentious issue in employment agreements, with concerns raised about their potential to stifle competition and limit employee mobility. On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule addressing some of these concerns. The final rule is set to go into effect 120 days after Federal Register publication. In this article, we will address the key provisions of the FTC’s final rule, what it means for employers, executives, and non-executive employees, and potential legal challenges ahead.
Simply stated, the rule provides that future non-compete clauses will be invalid against all employees, and existing non-compete clauses (except those with senior executives who earn at least $151,164) will be invalid.
What the Rule Sets Out
Non-Competes
The FTC’s final rule on non-compete clauses aims to address the potential anticompetitive effects of overly restrictive agreements. The final rule sets out that it is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for persons to enter into non-compete clauses with workers on or after the final rule’s effective date. Some key provisions provide that:
- For existing non-competes entered into before the effective date, the final rule treats senior executives differently from other workers.
- Existing non-competes for senior executives will remain in place.
- Existing non-competes for other workers will no longer be enforceable after the final rule’s effective date.
- The final rule does not apply where a cause of action related to a non-compete accrued prior to the effective date.
- It is not an unfair method of competition to enforce or attempt to enforce a non-compete or to make representations about a non-compete where a person has a good-faith basis to believe the final rule is inapplicable.
- The final rule does not apply to a non-compete clause that is entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.
Definition of Non-Compete
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 (1) seeking or accepting work in the United States with a different person where such work would being 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.” A term or condition of employment can include a contractual term or workplace policy, whether written or oral.
Definition of Senior Executive
A “senior executive” is defined as a worker who: (1) was in a policy-making position; and (2) received from a person for the employment: (i) total annual compensation of at least $151,164 in the preceding year; or (ii) total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or (iii) total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.
Impact on Non-Disclosure and Non-Solicitation Clauses
The final rule did not directly address whether the prohibition of non-compete clauses would also preclude the use of non-solicitation clauses (for example, preventing the worker from soliciting its former employer’s customers or employees) or non-disclosure provisions (for example, barring the disclosure of the former employer’s proprietary of confidential information). Since “non-compete clause” is defined by the rule to include clauses that “function to prevent a worker” from seeking or accepting other work or starting a new business, it is possible that broadly written non-disclosure agreements could be deemed to prevent a worker from seeking or accepting other work. The same result is possible but less likely with respect to a broadly worded non-disclosure provision.
Impact on Clawbacks or Forfeiture Clauses
Because the final rule applies to any term or condition of employment that “penalizes” a worker for seeking or accepting work or operating a business after the conclusion of employment, it appears that forfeiture and clawback clauses will not be permitted following the effective date of the final rule.
Impact on Non-Compete Clauses in Equity Award Agreements
A non-compete clause contained in an equity award agreement will likely be covered by the final rule and therefore will not be permitted following the effective date of the final rule. The final rule covers all terms of employment, whether the term is included in an employment agreement, a restrictive covenants agreement, a handbook, a separation agreement, an equity award agreement, or some other document.
Impact on State Laws
Historically, non-competes have been governed by state law. The final rule does not limit or affect the enforcement of state laws that restrict non-competes where the state laws do not conflict with the final rule. However, the final rule preempts state laws that conflict with the final rule.
What Employers Should Keep in Mind
For employers with non-compete clauses currently in place, it is important to distinguish between non-compete clauses in effect with non-executive workers and with senior executives.
- For non-executive workers, the employer must provide the worker with clear and conspicuous notice by the final rule’s effective date that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. The form of notice must identify the worker, be on paper hand delivered to the worker, or mailed to the worker’s last known address, or emailed to the worker’s email address, or texted to the worker’s cell phone number. If the employer does not have any record of the worker’s street address, email address, or cell phone number, such person is exempt from the notice requirement. The final rule contains a sample notice for employers to use.
- For senior executives who are in a policy-making position and earn at least $151,164 annually, any non-compete clauses currently in place before the effective date will still be valid. However, going forward, non-compete clauses with senior executives will not be permitted following the effective date of the final rule. This applies to any agreement the employer may have with the employee, including employment agreements, equity award agreements, restrictive covenants agreements, or handbooks.
- An employer is permitted to seek to enforce a non-compete clause if the employer has a good faith belief that the final rule is inapplicable.
- Employers that have typically relied on non-compete clauses should speak with an attorney about drafting confidentiality and/or non-solicitation clauses that will effectively protect the employer without being overly broad.
Application of the Final Rule to Senior Executives
For senior executives, once the final rule is effective it is an unfair method of competition for a person to:
- To enter into or attempt to enter into a non-compete clause;
- To enforce or attempt to enforce a non-compete clause entered into after the effective date; or
- To represent that the senior executive is subject to a non-compete clause, where the non-compete clause was entered into after the effective date.
However, it will still be permissible for an employer to enforce any non-compete clause entered into prior to the effective date of the final rule.
Application of the Final Rule to Other Workers
For workers other than senior executives, it is an unfair method of competition for a person:
- To enter into or attempt to enter into a non-compete clause;
- To enforce or attempt to enforce a non-compete clause; or
- To represent that the worker is subject to a non-compete clause.
If a non-senior executive worker is currently subject to a non-compete clause, their noncompete will no longer be enforceable against them once the final rule takes effect.
Possible Legal Challenges Ahead
While the FTC has issued a final rule, the rule will face challenges to its validity. We anticipate litigation alleging that the final rule should not be implemented because the FTC exceeded its authority in issuing the final rule and that the final rule is preempted by state law or conflicts with existing federal regulations.
Employers should consider consulting with an attorney to carefully review any existing noncompete agreements they have with employees and consider the implications of the final rule for future agreements.