On April 23, 2024, the Federal Trade Commission (the "FTC") issued a final rule that prohibits most employee non-compete agreements in the United States (the "Final Rule"). The FTC concluded that agreements between employers and their workers that restrict such workers' ability to work after terminating their employment are an unfair method of competition and an exploitative practice that adversely affects competitive conditions in labor, product, and service markets. The FTC expects that the implementation of the Final Rule will encourage the creation of new businesses, promote innovation, and increase employee wages.
The Final Rule will become effective 120 days after its publication in the Federal Register (i.e., around September 2024) and will apply retroactively to existing non-competes.
Employers should take this time to understand and begin preparations for compliance with this new prohibition and determine whether alternative protections are available for their businesses. The following is a high-level overview of the key provisions of the Final Rule, along with some important considerations for employers navigating this new regime.
The Final Rule Prohibits Clauses That Prevent a Worker From Leaving or Starting a Business
The Final Rule's definition of a non-compete is broad and includes any term or condition of employment that prohibits, penalizes, or functions to prevent a worker, after the termination of the employment, from:
- seeking or accepting another job in the United States; or
- operating a business in the United States.
Accordingly, the Final Rule requires all U.S. employers to refrain from the following conduct in connection with their current and former workers:
- attempting to execute or actually executing a non-compete agreement;
- attempting to enforce or actually enforcing a non-compete agreement; or
- representing that a worker is subject to a non-compete agreement.
Importantly, the FTC emphasizes that, in addition to any non-compete agreements or clauses, any contractual provisions or workplace policies that "restrain such a large scope of activity that they function to prevent a worker from seeking or accepting other work or starting a new business after their employment ends" are within the scope of the Final Rule.
The FTC has identified common agreements that would be prohibited under the Final Rule, such as:
- forfeiture-for-compensation clauses, which terminates promised compensation or benefits if a worker engages in any of the conduct described above;
- severance agreements in which workers are paid only if they do not compete with their employer; and
- agreements in which workers are required to pay liquidated damages for engaging in competitive activities.
Employers should also note that, within the scope of the Final Rule, a worker is defined not only as a paid employee, but any person who works or previously worked, whether paid or unpaid, and irrespective of any title the worker may have or have had, including independent contractors, interns, externs, volunteers, apprentices, or even sole proprietors providing a service.
However, as noted below, there are certain exemptions to the prohibition on non-competes, such as non-competes already entered with senior executives and non-competes prohibiting workers from competing during the term of employment.
Certain Non-Competes Are Still Allowed Under the Final Rule
The Final Rule prohibits existing and future non-competes, except in the following cases:
- Existing non-competes with senior executives: Non-competes with senior executives entered into before the Final Rule becomes effective are not affected. Under the Final Rule, a "senior executive" is a worker that (1) has annual compensation in excess of $151,164 and (2) is in a "policy-making position", defined as the company's president, CEO or equivalent, or any officer or person with "policy-making authority", i.e., final authority to make decisions that control significant aspects of a business. According to the FTC, this carve-out has limited effect given that "senior executives" represent less than 0.75% of workers in the United States.
- Non-competes in connection with the sale of a business: The Final Rule does not prohibit non-competes entered into in connection with a bona fide sale of a business, i.e., a sale that is not made for the "sole purpose of evading the rule" but is made in good faith.
- Causes of action that accrued prior to the effective date: The Final Rule does not apply to a cause of action relating to a non-compete agreement that arose prior to the Final Rule's effective date, including, according to the FTC, a scenario "where an employer alleges that a worker accepted employment in breach of a noncompete if the alleged breach occurred prior to the effective date [of the Final Rule]".
- Non-competes restricting competition during employment: The Final Rule prohibits non-competes that restrain what a worker can do after employment. Non-compete agreements that restrict the worker's ability to compete with the employer during employment are not prohibited under the Final Rule.
- Good-faith basis for not applying the Final Rule: The Final Rule does not apply to the enforcement or attempted enforcement of a non-compete, or to a representation regarding a non-compete "where a person has a good-faith basis to believe (...)" the Final Rule is inapplicable.
Besides these exceptions, the FTC has clarified that employers that are not subject to the FTC's jurisdiction under the FTC Act are not bound by the Final Rule. Among the employers excluded from the Final Rule are "banks," certain entities claiming tax-exempt status, and insurance companies.
Notice to Workers Is Mandatory for Employers
While employers will not be required to make any changes to existing non-competes, they will be required to provide workers - other than senior executives - with "clear and conspicuous notice (...) that the worker's non-compete will not be, and cannot legally be, enforced against the worker" following the effective date of the Final Rule.
According to the FTC, the notice must identify the worker who entered into the non-compete agreement. Delivery of the notice to the worker may be by hand, physical mail, email, or text message. The Final Rule includes model notice language that employers may use to comply with the notice requirement.
Enforcement of the Final Rule Can Be Triggered by Workers
Workers will be able to report suspected violations of the Final Rule once it goes into effect.
According to the FTC, "whether a given restrictive covenant rises to the level of being a functional non-compete will turn on the facts and circumstances of particular covenants and the surrounding market context".
Employers Should Explore Alternative Safeguards to Protect Their Sensitive and Confidential Business Information and Customer Relationships
The FTC emphasized that non-disclosure agreements and other restrictive employment agreements which are not prohibited non-competes may be used by employers to protect confidential information, provided they do not bar a worker from disclosing information that is readily available to other employers or that relates to a "worker's general training, knowledge, skill or experience, gained on the job or otherwise".
Further, the Final Rule does not prohibit non-solicitation agreements as long as they limit whom a worker may contact after termination of employment and do not prevent the worker from seeking or accepting other employment or from starting a competing business. Likewise, training-repayment agreements or TRAPs generally would not be affected by the Final Rule if the amount an employee is required to pay for training costs as a result of his or her employment ending at a particular time is reasonably related to the employer's costs of training the worker.
The FTC stated that so-called garden leave agreements that maintain the same compensation and benefits for a worker while preventing access to the workplace or to co-workers, or even diminishing job duties, are not prohibited by the Final Rule. Also, a garden leave agreement that sets a condition on a worker's expected compensation, such as a bonus, is not considered a non-compete agreement under the Final Rule because it does not contain a post-employment restriction.
Finally, the FTC also stressed that intellectual property laws, and trade secret laws in particular, already provide significant legal protection for an employer's confidential business information.
Broadly, alternative protections must be tailored adequately to avoid the specific level and type of impact that the FTC has determined non-competes - as defined in the Final Rule - have on competitive conditions.
Stakeholders Are Already Challenging the Final Rule In Court
The Final Rule has faced legal challenges even before its effective date. On April 24, 2024, the U.S. Chamber of Commerce filed a lawsuit seeking to have the ban on non-competes struck down. The Chamber of Commerce alleges that the FTC is engaged in an "unprecedented power grab", overstepping its authority by issuing rules defining new anticompetitive conduct and voiding a vast number of contracts without Congressional approval. The U.S. Chamber of Commerce has also stated that "the FTC is empowered by federal law to enforce existing antitrust laws passed by Congress, but not to enact rules determining what other type of conduct by businesses is anticompetitive".
Additional lawsuits have also been filed against the FTC challenging its rulemaking authority.
The Way Forward
Despite the pending litigation and resulting uncertainty surrounding the Final Rule, it is critical that both employers and affected market participants understand its implications and consider alternative protections. Curtis' dedicated team will continue to monitor developments with respect to the Final Rule. Should you need assistance in preparing for its implications, Curtis is here to help.
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.