Introduction
On April 23, 2024, the Federal Trade Commission, chaired by Lina Khan, passed a comprehensive ban on non-compete agreements. The FTC has determined that “non-competes are an unfair method of competition” and that a business conducts an unfair method of competition by entering into or enforcing non-competes with workers. “Workers” notably includes a broad swath of individuals, including employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person. According to the FTC, one in five Americans will be directly affected by the new rule.
The FTC’s focus on combating unfair methods of competition is rooted in Section 5 of the FTC Act, which the FTC has made clear gives it expansive powers beyond the reach of the Sherman and Clayton Acts.
Non-Competes Before the New Rule
Historically, state laws have governed whether non-competes were enforceable, and those laws have varied greatly by jurisdiction. “Reasonable” non-competes in most jurisdictions were typically enforceable to some extent, while broad non-competes that were not reasonably necessary to protect a legitimate business interest were not. What was “reasonable” or “reasonably necessary” differed between states. Some states imposed geographic and time limitations for a non-compete to be enforceable or limited the enforceability of non-competes to certain industries or categories of employees (high-level versus low-level). In a limited number of states—California, North Dakota, Oklahoma, and Minnesota—post-employment non-competes were entirely or largely unenforceable.
Although drafting an enforceable non-compete has always entailed careful consideration and care, in states where they were permitted, employers have been able to use non-competes for decades to protect valuable corporate assets, such as intellectual property, confidential resources, and other proprietary information, without fear that those assets would be revealed to competitors when employees switched jobs or started their own businesses. Employers that wanted to hire the best talent and invest significant resources in their development could do so with less fear that the employee would leave shortly thereafter to set up a rival business in the same vicinity.
Beginning in July of 2021, when President Biden signed an Executive Order that dictated in part that the FTC should consider using its rulemaking authority to “curtail the unfair use of non-compete clauses” that “unfairly limit work mobility,” the tide began to change, and a federal ban on non-competes that would preempt less restrictive non-competes permitted under state laws appeared in the offing.
What Does the Rule Require?
The new Rule bans business entities subject to the FTC’s jurisdiction from entering into, enforcing, or representing that a non-compete agreement is in effect with their workers. The Rule defines a non-compete agreement as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” The Rule notes that the determination of whether an agreement falls under the definition of a non-compete agreement will be a “fact-specific inquiry,” which likely means that the definition will be heavily litigated.
Non-compete agreements that were entered into before the effective date of the rule with “senior executives” are exempt from the rule. “Senior executives” are defined as workers in a “policy-making position” making more than $151,164 in total compensation. The Rule defines a “policy-making position” as a president, CEO or equivalent, or any other person with “policy-making authority.” “Policy-making authority” is further defined as the authority to make decisions controlling “significant aspects of a business entity or common enterprise.” Noncompete agreements between a seller and buyer of a business are also exempt from the rule.
Under the rule, business entities that have active non-compete agreements with their workers must notify their workers that the business entity will not enforce the noncompete agreements. The business entity must provide “clear and conspicuous notice” that the non-compete agreement is now unenforceable. The FTC has provided model language, and the Rule includes a “safe-harbor” provision for any entity that uses the model language.
The Rule does not apply to any business entity outside of the FTC’s jurisdiction. This includes banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and certain non-profits. However, the Rule argues that certain business entities believed to be outside of the FTC’s jurisdiction—non-profit corporations, for example—may be within the FTC’s jurisdiction. This is another area likely to spur heavy litigation.
What’s Next?
The new Rule banning non-compete agreements becomes effective 120 days after publication in Federal Register, which the FTC has indicated will occur in early September 2024. There will likely be immediate court challenges to the Rule, which will delay, or possibly preclude, enforcement of the Rule. In fact, on April 24, 2024, the United States Chamber of Commerce promptly filed a Complaint for declaratory and injunctive relief against the FTC for exceeding its substantive rulemaking authority and an unlawful interpretation of “unfair methods of competition.”
If upheld, the Rule will be retroactive and will invalidate non-compete agreements that existed prior to the Rule, except for existing non-compete agreements with senior executives, as discussed above. While the Rule applies retroactively, the Rule does contain an exception for existing causes of action. Specifically, the Rule “does not apply where a cause of action related to a non-compete clause accrued prior to the effective date.” Once the Rule becomes effective, however, there is still a risk that employers in litigation to enforce non-compete agreements will be, in the FTC’s view, committing unfair competition unless they dismiss any claims based on any non-compete agreements.
Although the Rule bans non-compete agreements, there are potential alternatives for employers to protect confidential company information and goodwill, including, among other things, non-solicitation agreements, garden leave provisions, and confidentiality agreements. Employers should proceed with caution when pursuing these alternatives and consult an attorney to ensure compliance with the FTC’s current enforcement posture.
If you have any questions regarding the new rule banning non-compete agreements or employer alternatives to protect company information, please contact your Labor and Employment counsel or your Antitrust and Trade Regulation counsel at Smith, Gambrell & Russell, LLP.