The Federal Trade Commission (FTC) conducted an open commission meeting on April 23 where the five FTC Commissioners voted on a final rule that would prevent employers from enforcing noncompetes against nearly all workers. The five Commissioners voted along party lines, with three of five votes in favor of issuing the Final Rule.
In January 2023, the FTC announced a notice of proposed rulemaking (NPRM) that would ban employers from entering into and maintaining noncompete clauses with their workers. Through April 19, 2023, the FTC received over 26,000 public comments about both the proposed noncompete ban and various alternatives to the ban. The FTC considered these comments through April 2024.
The FTC’s Final Rule prohibits employers from entering into or enforcing a “noncompete clause” with “workers” on or after the Final Rule’s effective date, which is 120 days from the Rule’s publication in the Federal Register, thus adopting a comprehensive ban on both new noncompetes and enforcement of current noncompetes after the effective date. The Final Rule adopts a limited exception for noncompetes for “senior executives” in place at the time the Final Rule becomes effective, which the Final Rule allows to remain enforceable to the extent permitted by current law.
Workers
The Final Rule broadly defines “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, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” This definition extends far beyond the low-wage employees on whom proponents of a ban have focused their opposition to noncompete agreements.
Noncompete Clauses
Under the Final Rule, a “noncompete clause” includes “a term or condition of employment 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 person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” (Emphasis added.)
The definition “also applies to terms and conditions that require a worker to pay a penalty for seeking or accepting other work or starting a business after their employment ends.” This may include clauses that impose “liquidated damages” or other “forfeiture-for-competition” clauses that “impose adverse financial consequences on a former employee expressly conditioned on the employee seeking or accepting other work or starting a business” or a “severance arrangement in which the worker is paid only if they refrain from competing.”
Under the “functions to prevent” prong of the Final Rule’s definition of “noncompete clause,” the ban also applies to terms and conditions 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.
The FTC makes clear in its commentary to the Final Rule that such functional noncompetes could include non-disclosure agreements (NDAs) and other restrictive covenants, training repayment agreements (TRAPs), non-solicitation agreements, no-hire agreements, and no-business agreements.
By way of example, confidentiality agreements and NDAs may be noncompetes under the “functions to prevent” prong of the definition where they bar a worker from disclosing, in a future job, any information that is “usable in” or “relates to” the industry in which they work and thereby effectively prevent the worker from working for another employer in that industry, or where they bar a worker from disclosing any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information.
Other Restrictive Covenants
The FTC’s commentary to the Final Rule states that, in contrast to noncompete clauses, other restrictive covenants that generally do not prohibit workers from seeking or accepting employment after the conclusion of their employment may not qualify as prohibited noncompete clauses and thus may still be permissible under the FTC’s Final Rule. However, “such covenants would be subject to case-by-case adjudication for whether they constitute an unfair method of competition” even in the absence of the Final Rule.
Restrictive covenants that may still be permissible under the Final Rule include appropriately tailored confidentiality clauses and NDAs, TRAPs, non-solicitation agreements, no-hire agreements, and no-business agreements. With respect to garden leave agreements, which refer to a wide variety of agreements, the Commission declined to opine on how the definition of “noncompete clause” would apply in every potential scenario.
However, the Commission noted that an agreement whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis would not be a noncompete clause under the definition because such an agreement is not a post-employment restriction.
Limited Exception for ‘Senior Executives’
While the Final Rule broadly bans noncompete clauses entered into with workers, it provides a limited exception for noncompetes entered into with senior executives before the effective date. The Final Rule defines “senior executive” as a worker earning more than $151,164 annually who is in a “policy-making position” with respect to the entire business enterprise.
Exception for Sale of Business
The prohibition against noncompete clauses does not apply to a noncompete clause that is entered into 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.
Notice Requirement
The Final Rule does not require rescission of existing noncompetes, as proffered in the Proposed Rule. However, the Final Rule still requires employers to provide workers who entered into a noncompete clause with “clear and conspicuous notice,” by the effective date, that the noncompete clause will not be enforced against such workers.
The notice must identify the employer who entered into the noncompete and must be delivered on paper by hand to the worker, by mail to the worker’s last known personal street address, by email at an email address belonging to the worker, or by text message at a mobile telephone number that belongs to the worker.
The FTC provides the following model notice:
A new rule enforced by the Federal Trade Commission makes it unlawful for us to enforce a noncompete clause. As of [DATE EMPLOYER CHOOSES BUT NO LATER THAN EFFECTIVE DATE OF THE FINAL RULE], [EMPLOYER NAME] will not enforce any noncompete clause against you. This means that as of [DATE EMPLOYER CHOOSES BUT NO LATER THAN EFFECTIVE DATE OF THE FINAL RULE]:
The FTC’s new rule does not affect any other terms or conditions of your employment. For more information about the rule, visit ftc.gov/noncompetes. Complete and accurate translations of the notice in certain languages other than English, including Spanish, Chinese, Arabic, Vietnamese, Tagalog, and Korean, are available at ftc.gov/noncompetes.
In voting on the Final Rule, the five FTC Commissioners split along party lines in a 3-2 vote to adopt the Final Rule, with the three Democrats on the Commission voting in favor of the Final Rule and the two Republican Commissioners voting against the Final Rule. In voicing their opposition to the Final Rule, Republican Commissioners Andrew Ferguson and Melissa Holyoak highlighted several challenges that the Final Rule will likely face in the coming weeks and months, including that (1) the Commission is not authorized under the Federal Trade Commission Act to promulgate binding legislative regulations concerning unfair methods of competition and that such lawmaking should be reserved to Congress, and (2) the Final Rule represents arbitrary and capricious decision-making in violation of the Administrative Procedure Act.
Their voiced objections lay the groundwork for a challenge to the Final Rule under the major questions doctrine from the US Supreme Court’s decision in West Virginia v. Environmental Protection Agency, 597 US 687, 723 (2022) (“We presume that ‘Congress intends to make major policy decisions itself, not leave those decisions to agencies.’”).
The prospect of a Final Rule banning noncompetes drew criticism well before the FTC’s open meeting. On April 22, 2024, the US Chamber of Commerce stated that it “plans to take the FTC to court if the agency finalizes its proposed rule banning noncompetes.” It is unclear at this time whether and to what extent other trade organizations will join in any challenge to the Final Rule. Within hours of the FTC’s vote to adopt the Final Rule, however, the first challenge to the Final Rule was filed in the US District Court for the Northern District of Texas by a tax services firm, Ryan LLC. (Ryan LLC v. Federal Trade Commission, 3:24-cv-986 (N.D. Tex., Apr. 23, 2024).
Morgan Lewis is closely monitoring these developments. Despite the uncertainty surrounding the Final Rule and the legal challenges it will face, employers and parties to existing or potential transactions should prepare by reviewing existing or proposed noncompete agreements and considering the effect that the Final Rule will have on such agreements.
Employers should also prepare for the Final Rule going into effect by analyzing the breadth of their confidentiality clauses, nondisclosure covenants, forfeiture clauses, and employees and customer nonsolicitation covenants to ensure that such covenants comply with the Final Rule.
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