On April 23, 2024, the U.S. Federal Trade Commission (“FTC”) released its final rule banning most non-compete agreements between workers and employers (the “Final Rule”). The effective date of the Final Rule is 120 days after its publication in the Federal Register. Legal challenges related to the Final Rule are already underway and could delay the effective date or enjoin the enforcement of the Final Rule.
Background
On April 23, 2024, the FTC voted 3-2 along party lines to approve the issuance of the Final Rule that prohibits most non-compete clauses between workers and employers. This action follows the FTC’s proposal in January 2023 to ban non-competes nationwide (the “Proposed Rule”). The Proposed Rule garnered significant attention and criticism from business and industry groups and resulted in over 26,000 comments. The Final Rule maintains the broad sweep of the Proposed Rule and incorporates only very narrow exceptions for existing non-compete agreements with “senior executives” and non-compete agreements connected to the sale of a business.
Scope and Key Definitions
Under the Final Rule, “non-compete clauses” are generally determined to be “an unfair method of competition” resulting in a violation of Section 5 of the Federal Trade Commission Act. The Final Rule adopts a comprehensive ban on new non-compete agreements with all workers and invalidates any existing non-compete agreements with workers (other than a very narrow exception for non-competes with “senior executives” that exist before the effective date of the Final Rule).
Specifically, the Final Rule prohibits:
- entering, or attempting to enter, into a non-compete clause;
- enforcing, or attempting to enforce, a non-compete clause (except for non-compete clauses entered into with a “senior executive” before the effective date of the Final Rule); and
- representing that a worker is subject to a non-compete clause (except for non-compete clauses entered into with a “senior executive” before the effective date of the Final Rule).
“Workers” broadly defined. The ban broadly covers “non-compete clauses” with “workers.” The Final Rule defines a “worker” as a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws. A worker includes an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service. A worker also includes a natural person who works for a franchisee or franchisor but does not include a franchisee in the context of a franchisee-franchisor relationship.
“Non-Compete Clause” broadly defined. Under the Final Rule, a “non-compete clause” is broadly defined as an employment “term or condition” 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 employer or (2) operating a business in the United States, in each case, after the conclusion of the worker’s employment. Prohibited terms or conditions include workplace policies, as well as contractual terms, whether written or oral.
Narrow Exception for Senior Executives
There is an exception for the continued enforceability of non-compete clauses that were entered into with “senior executives” before the effective date of the Final Rule. However, no new non-competes can be entered into with any workers, including “senior executives,” after the effective date of the Final Rule.
A “senior executive” is defined as a worker who (1) is in a “policy-making position” and (2) earned at least $151,164 in annual compensation in the preceding year.
- A “policy-making position” means (i) a business entity’s president, chief executive officer or the equivalent, (ii) other officers of a business entity with policy-making authority, or (iii) other persons with policy-making authority for the business entity similar to an officer with policy-making authority.
- “Officer” means a president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any natural person routinely performing corresponding functions with respect to any business entity whether incorporated or unincorporated.
Notably, the policy-making position requirement to be a “senior executive” significantly narrows its scope. Under the Final Rule, “policy-making authority” means final authority to make policy decisions that control significant aspects of a business entity or common enterprise and 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 affiliate of a common enterprise. This definition excludes a person who has policy-making authority over a subsidiary or an affiliate of a business entity that is part of the common enterprise, if that person does not have policy-making authority over a common enterprise.
What about forfeiture-for-competition? Garden leave?
In the preamble to the Final Rule, the FTC identifies forfeiture-for-competition clauses as an example of a term that “penalizes” a worker because the term “imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee seeking or accepting other work or starting a business after their employment ends.” The FTC also cites severance arrangements in which the worker is paid only if they refrain from competing as an example of a term that “penalizes” a worker.
However, the FTC notes that “garden leave” arrangements, such as severance agreements without restrictions on post-employment work, or arrangements where the worker remains employed and receives the same compensation and benefits, but with a reduced workload or job responsibilities are not non-compete clauses because they are not post-employment restrictions.
Are other restrictive agreements, such as non-disclosure agreements or non-solicitation agreements, prohibited?
While the Final Rule does “not categorically prohibit” other types of restrictive agreements, like non-disclosure agreements, training-repayment agreements or non-solicitation agreements, employers should be aware that provisions that “function” to prevent competition are prohibited. The FTC notes that if the term or condition is “so broad and onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends,” such a restrictive agreement would be subject to the prohibition on non-competes.
For example, the FTC indicates that non-disclosure agreements may be non-competes where they “span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.” Similarly, non-solicitation agreements can satisfy the definition of non-compete clauses “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”
Other Exceptions; Excluded Entities
In addition to the exception for pre-existing non-compete agreements with “senior executives,” the following exceptions apply:
- Bona fide sales of business. The Final Rule does not prohibit 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. There is no specified minimum ownership requirement for this exception (unlike the Proposed Rule which required the worker to have at least 25% ownership for this exception to apply). To address concerns about sham transactions, the FTC states that a bona fide sale is one that is made between two independent parties at arm’s length, in which the seller has a reasonable opportunity to negotiate the terms of the sale.
- Existing causes of action. The Final Rule creates an exception allowing the enforcement of a non-compete clause where the cause of action for its breach accrued prior to the effective date of the Final Rule.
- Good faith. The Final Rule provides that it is not an unfair method of competition to enforce, attempt to enforce, or make representations about a non-compete clause “where a person has a good-faith basis to believe” that the Final Rule is inapplicable.
Finally, the non-compete ban does not apply to entities outside of the FTC’s jurisdiction, such as non-profit entities, certain common carriers, certain domestic and foreign air carriers, and businesses subject to the Packers and Stockyards Act of 1921. While certain banks and savings and loan institutions, federal credit unions, FDIC insured state chartered banks and other commercial lenders are outside of the FTC’s jurisdiction, the FTC did not exclude bank holding companies, subsidiaries, or other affiliates of federally regulated banks from the Final Rule; as a result, employees of different affiliates within the same organization, like a bank holding company, will be subject to the FTC rules while others may be exempt. The Final Rule does not apply to non-compete clauses if they restrict only work or the operation of a business outside the United States.
Notification Requirement
By the effective date of the Final Rule, employers are required to provide “clear and conspicuous notice” to workers subject to an invalidated non-compete clause that the non-compete “will not be, and cannot legally be, enforced against the worker.” The notice must specify who entered into the non-compete clause with the worker, and the notice must be provided by hand-delivery, mail to the worker’s last known personal address, email or text message. The Final Rule provides safe harbor model language to satisfy the notice requirement.
Challenges to FTC Authority
Shortly after the issuance of the Final Rule, two different lawsuits in Texas federal courts seeking to invalidate the rule were filed. We expect other legal challenges to be presented in the coming weeks.
Since the issuance of the Proposed Rule, a number of commenters have questioned the FTC’s authority to issue the non-compete ban. The FTC includes a discussion of its authority in this area in the preamble, and the Final Rule includes a severability clause that would sever any part of the Final Rule that is held to be invalid or unenforceable, while construing to the maximum effect permitted by law any surviving portions of the rule.
Next Steps
Given the current and anticipated litigation related to the Final Rule, employers should carefully monitor whether the Final Rule is enjoined or the deadline for compliance remains. We believe it is likely that a Federal court hearing a challenge will enjoin the Final Rule’s implementation pending judicial review and that implementation may be delayed.
Notwithstanding these legal challenges, the 120-day countdown to implementation will continue to run unless a Federal court moves to enjoin the implementation of the rule pending judicial review. In light of the potentially tight timeframes, employers may want to consider taking the following steps in preparation for any effective date of Final Rule:
- Review all employment, compensation, and severance arrangements, including employee handbooks, policies, severance plans, separation agreements, equity and incentive plans, award agreements, employment agreements and severance agreements, to identify any non-compete clauses that would be prohibited under the Final Rule.
- A review should also include assessing the scope of non-solicitation and non-disclosure agreements to ensure that they do not constitute a “functional” non-compete and whether any modification is required.
- Identify non-compete agreements for which worker notification will be required if the Final Rule becomes effective. Prepare to develop a process to identify impacted current and former employees with relevant contact information.
- Identify “senior executives” described above. Evaluate whether there are any “senior executives” with whom employers may want to enter into non-competes prior to the Final Rule’s effective date.
- Consider alternatives to post-employment non-compete clauses, such as notice and garden leave periods.
We will continue to monitor the litigation concerning the Final Rule and will provide updates as they become available.
Please reach out to our Executive Compensation and Employee Benefits team if you have any questions or would like to speak with us about the Final Rule.
For further information, please contact:
Andrew Gaines, Partner, Linklaters
andrew.gaines@linklaters.com
