Overview
On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to ban most non-compete agreements as an unfair method of competition. If implemented, the rule will require most businesses to stop using non-compete terms and policies going forward. For now, no affirmative action is needed: there is a 120-day pre-implementation period after publication in the Federal Register, which is scheduled for May 7, 2024, plaintiffs have already sued to stop the rule, and implementation of the rule will likely be enjoined before it goes into effect.
But businesses should take two steps now to prepare for potential implementation: drafting but not issuing a notice of the non-enforceability of non-compete provisions, and identifying how the business uses non-compete provisions so that such provisions can be eliminated from future or renewed contracts and policies if the rule goes into effect.
The Rule's Impact on Employee Contracts. At base, the rule prohibits "non-compete clauses" in contracts with or policies regarding "workers." A "non-compete clause" is a term or condition of employment that functions to prevent or restrict a worker from either taking subsequent employment or starting their own business. Notably, the new ban reaches not only US employers but also any business that prohibits a covered employee from taking a job or operating a business in the United States.
The non-competes ban refers to any contractual term or workplace policy, whether written or oral. A "worker" is a natural person who works or who previously worked, whether paid or unpaid, and includes an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service.
Taken together, the ban broadly covers activities ranging from informal non-competes in employee handbooks to a contractual ban on working for a competitor. The ban includes almost all non-compete provisions between employers and workers.
The ban also extends to provisions in contracts that have the effect of preventing employees from seeking employment from a competitor, such as requiring damages, forfeitures of bonuses or reimbursement of training expenses if an employee works for a competitor. The FTC has also stated that in reviewing alleged violations, it will go beyond the wording in a contract to see how it is actually enforced in practice.
In addition to prohibiting non-compete provisions going forward, employers must provide notice to employees that any existing non-competes are no longer enforceable.
There are a few narrow exclusions. First, the rule does not apply to non-competes ancillary to the sale of a business (in most circumstances), in the sale of a person's ownership in a business, or in the sale of substantially all of a business' operating assets. Second, the rule clarified that the ban does not apply to non-compete provisions for franchisees in franchisor-franchisee agreements. Third, it does not apply to non-profit enterprises, as the Commission does not have authority over non-profits. Non-profits are not fully off the hook, though, as the FTC stated that just because an entity claims tax-exempt status does not mean it actually is a non-profit organization. Finally, the rule allows existing non-compete agreements for senior executives, defined as employees earning more than $151,164 per year and who are in policy-making positions, to remain in force. But employers cannot enter into or enforce new non-competes as to senior executives.
Rule Likely to be Temporarily Blocked. The rule is scheduled to become effective on September 4, 2024. But a court is likely to at least temporarily enjoin the rule before it goes into effect and may block it entirely. One day following the FTC vote, the U.S. Chamber of Commerce filed a lawsuit seeking to block the rule, alleging the FTC lacks the authority to issue the rule and that such a major action fails under the “major questions” doctrine (i.e., the principle of statutory interpretation that presumes that Congress does not delegate to agencies issues of major political or economic importance). Appeals are almost ensured, and the rule will likely be delayed for many months or even years. Note, though, that any judicial opinion on the FTC rule will not affect the state laws already prohibiting non-compete provisions, including in California, Colorado, Minnesota, North Dakota, and Oklahoma, with New York likely joining soon.
Steps Businesses Should Take. Because the rule will likely be temporarily enjoined, generally a wait-and-see approach is appropriate. Nonetheless, caution is warranted – there is no guarantee that the court will enter the preliminary injunction that the Chamber of Commerce requested. Until an injunction is entered, it is prudent for employers to take two preparatory steps. First, businesses should prepare (but not issue) a draft notice to employees, compliant with the rule, stating that existing non-compete provisions are not enforceable. The FTC has released suggested language for the notice but consultation with counsel is advised. Depending on the size of the workforce and the company’s use of non-competes, a blanket notice may be more effective and efficient than identifying specifically-affected workers. Second, businesses should identify the non-compete provisions and policies that they currently use in existing contracts, so that they will be prepared to ensure that non-compete provisions are not included in new or renewed contracts.
Businesses should also think about other ways to protect their proprietary information. The FTC's press release announcing the final rule pointed to trade secret laws and non-disclosure agreements as tools to protect proprietary and other sensitive information. The FTC also suggested that rather than adopting a non-compete to restrain workers, employers could offer better wages and working conditions. Of course, if these other tools were sufficient, businesses might already have been relying on them instead of imposing non-compete provisions. Still, if these are the only shields available, businesses should explore ways to strengthen them so as to achieve the greatest degree of protection.
