The Federal Trade Commission (FTC)'s recent final rule that would ban virtually all noncompete agreements in the United States will take effect Sept. 4, 2024, barring delays from pending legal challenges. While the rule has garnered a significant amount of attention, many California businesses are already accustomed to complying with California's long-standing public policy disfavoring such agreements.
If the FTC's final rule survives its various legal challenges, how exactly does it stack up against existing California law on the subject?
Below is a general overview of what California employers should consider before the final rule goes into effect.
Similarities Between the Final Rule and California Law
1. General Ban on Noncompete Agreements
Both the final rule and California law start from the proposition that noncompete agreements are void, generally. The final rule accomplishes this by declaring it "an unfair method of competition" – and thus unlawful – for one "(i) [t]o enter into or attempt to enter into a non-compete clause; (ii) [t]o enforce or attempt to enforce a non-compete clause; or (iii) [t]o represent that the worker is subject to a non-compete clause." 16 C.F.R. § 910.2(a). In a preceding section of the final rule, the FTC defines a "[n]on-compete clause" as "(1) [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 where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition." 16 C.F.R. § 910.1.
California, meanwhile, sets forth its succinct general rule in Business and Professions Code section 16600: "[E]very contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void." Several courts have interpreted this statute to extend to non-solicitation covenants and overbroad confidentiality restrictions that would operate as a pseudo-noncompete.
2. Exceptions Concerning the Sale of a Business
Both the final rule and California law also include narrow exceptions to their general ban on noncompetes in the context of the sale of a business. For this part, the FTC's final rule is the more concise of the two, providing simply that the final rule "shall 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." The final rule does not expressly include any geographic or temporal limitations on such permitted noncompetes (however, any lawful noncompete must generally be reasonable and somewhat limited in scope to be enforceable).
California's sale of a business exception is a bit narrower and more complex. Noncompetes are permitted where a business owner sells "(a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary[.]" Bus. & Prof. Code § 16601. In such circumstances, the seller "may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein." Id. This Section 16601 exception has been further defined and narrowed by various California judicial decisions.
3. Required Notices
Both the federal and California regulatory schemes require employers to notify affected workers. In the final rule, the FTC requires that, for any worker with a noncompete rendered invalid by the rule, notice must be provided to the worker that the noncompete "will not be, and cannot legally be, enforced against the worker." 16 C.F.R. § 910.2(b)(1). The final rule includes model language for the notice. 16 C.F.R. § 910.2(b)(4). Unless impacted by the legal challenges to the law, employers must notify workers prior to Sept. 4, 2024.
In California, Assembly Bill No. 1076, effective Jan. 1, 2024, added Section 16600.1 to the Business and Professions Code. The new law required, among other things, that employers give individualized notice to both current and former employees (employed for any period after Jan. 1, 2022) who had entered noncompete or other agreements containing noncompete clauses that would be void under California law that the noncompete is void. Such notices were required to be issued by Feb. 14, 2024.
Differences Between the Final Rule and California Law
1. Federal Versus State-Level Application
Of course, one major difference between the two regulatory schemes is in the scope of their application. As a federal regulation, the FTC's final rule will apply to any employer conducting business in the United States. California's statutes, on the other hand, apply to employers conducting business in California (including any employees performing work within the state of California for an out of state employer). California's restrictions also may apply to employees working outside of California as the most recent amendments to California law clarify that any non-compete that is void under California law is unenforceable "regardless of where and when the contract was signed" (including regardless of "whether the contract was signed and the employment was maintained outside of California"). Cal. Bus. & Prof. Code § 16600.5.
2. Distinct Application to 'Senior Executives'
The final rule makes a distinction in its provisions between a worker and a "senior executive," which it defines as a worker who (1) "[w]as in a policy-making position" (i.e., CEO, president, or equivalent officer) and who received total compensation of at least $151,164. 16 C.F.R. § 910.1. Such persons must have "final authority to make policy decisions that control significant aspects of a business entity or common enterprise," but it does not include a person whose role is limited to advising or influencing such decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise. Regarding these senior executives, the final rule does not render existing noncompete agreements unlawful, as it does for noncompetes with workers, but instead works prospectively to prohibit enforcement of or attempts to enforce new noncompetes entered into after the effective date of the final rule. 16 C.F.R. § 910.2(a)(2). California does not make any such distinction in Section 16600.
3. California Exceptions Concerning Partnership and LLC Dissolutions
In addition to the sale of a business exception of Business and Professions Code section 16601, California law also separately includes exceptions to its general ban on noncompetes in the context of (1) a dissolution of or dissociation from a partnership and (2) the dissolution of or termination of a member's interest in a limited liability company. Bus. & Prof. Code §§ 16602, 16602.5. The final rule does not separately designate such exceptions, though, in the context of its sale of a business exception, the FTC defines "business entity" broadly to include "a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof." 16 C.F.R. § 910.1.
Which Set of Laws Would Apply to California Businesses?
Both the final rule and California law apply to California business engaged in interstate commerce. The FTC expressly intended that the final rule would not displace more-restrictive state laws on noncompetes. 16 C.F.R. § 910.4.
Thus, to the extent California's laws are even more restrictive than the final rule – which they generally are – California businesses are subject to both laws.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.