On April 23, the Federal Trade Commission (FTC) approved by a 3-2 vote a Final Rule that, if it becomes effective, will ban almost all noncompete clauses for nearly all workers. This is the first in a blog series exploring the fallout from the sweeping ban, specifically in terms of executive compensation and employee benefits. In Part 1, we address the first important threshold questions posed by the Final Rule. Future posts in the series will address the wide scope of the Final Rule and the types of executive compensation arrangements it prohibits; the types of arrangements that survive the Final Rule; and specific issues related to equity compensation, corporate transactions, Section 280G of the Internal Revenue Code (Code), and other compensation-related tax issues.
What Happened?
On January 5, 2023, the FTC proposed a rule that purported to ban the adoption or maintenance of noncompete clauses. In response, the FTC received over 26,000 public comments. After consideration of these comments, the FTC adopted a Final Rule on April 23, 2024 that bans nearly all noncompete clauses as well as other clauses or agreements that operate as noncompetes.
For more detail on the process and overview of the rule, see our recent LawFlash and FAQs.
Who Is Covered by the Final Rule?
The Final Rule generally bans noncompetes with “workers”—broadly defined by the Final Rule to include any “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.”
There are two limited exceptions that are potentially applicable in the executive compensation context:
- Existing noncompetes with “senior executives” who are in “policy-making positions” with respect to the entire business enterprise and earn more than $151,164 annually remain enforceable. A noncompete is existing if it is in place at the time that the Final Rule becomes effective (please see below for discussion of timing of effectiveness of the Final Rule).
- The Final Rule does not prohibit enforcement of noncompete clauses that are entered into pursuant to a bona fide sale of a business entity. A later post in this series will address this sale-of-business exception and transaction-related issues of the Final Rule in more detail.
Under the Final Rule, a “senior executive” is the president, CEO (or equivalent), any other officer with policymaking authority, and any other natural person who has policymaking authority similar to that of an officer with policymaking authority. Notably, a senior executive must have policymaking authority for the entire business entity, and not solely a subsidiary, business unit, or division.
The Final Rule’s definition of senior executive is significantly narrower than similar concepts in other legal regimes that govern executive compensation. For example, for the purposes of Section 16 of the Securities Exchange Act of 1934, an “officer” includes any vice president of the issuer in charge of a principal business unit, division, or function (such as sales, administration, or finance) and any other officer who performs a policymaking function. The senior executive definition is also narrower than the definition of officer under Section 280G of the Code, which relies on a facts and circumstances functional test.
Although the Final Rule leaves preexisting noncompetes with senior executives undisturbed, the Final Rule prohibits all noncompetes on a go-forward basis. Any future noncompetes with senior executives are prohibited by the Final Rule.
What Arrangements Are Covered by the Final Rule?
The rule prohibits any noncompete covenant (subject to the exceptions noted above), which is defined as any term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking or accepting work in the United States with a different person following termination of employment or operating a business in the United States following termination of employment.
This will include stand-alone noncompete agreements, but will also pick up many executive agreements, including noncompete covenants in equity grants, employment agreements, and severance agreements. In some cases, broad nonsolicitation covenants could be considered noncompete covenants for purposes of the Final Rule. Garden leave arrangements, stay bonuses, and other retention arrangements that remain in place during employment or other service should in many cases continue to be enforceable as long as they are not tied to postemployment or postservice noncompetition.
What Actions Does the Final Rule Require that Companies Take?
Unlike the proposed rule, the Final Rule does not require rescission of current noncompetes. However, it does require companies to provide a “clear and conspicuous notice” to workers that any violative noncompete will not be enforced. The Final Rule includes a safe harbor example notice. These notices must be delivered prior to the effective date of the Final Rule.
When Is the Final Rule Effective?
The Final Rule will go into effect 120 days following its publication in the Federal Register, assuming that it is not enjoined by a court. On April 30, 2024, the Final Rule was placed on file for public inspection at the Office of the Federal Register and is scheduled to be published in the Federal Register on May 7, 2024. The 120-day period will not commence until publication, and assuming it is published on May 7, 2024, the Final Rule will become effective Wednesday, September 4, 2024. As noted above, the timing of the effectiveness is important, because any noncompete entered into with a senior executive prior to the Final Rule becoming effective will remain enforceable.
To date, the Final Rule has been the subject of multiple legal challenges. It is possible that the Final Rule will become subject to a court order delaying or enjoining its effectiveness or that a court ultimately invalidates it.
What to Do Now?
Although the Final Rule may be delayed, invalidated, or otherwise may not become effective, the state-level legal landscape surrounding noncompete and other restrictive covenants has seen significant upheaval in recent years, making this a pertinent time for companies to review executive and other employee agreements for compliance and best practices. Below are key action points that companies may want to consider in light of the Final Rule and this everchanging landscape.
- Review arrangements currently in place with workers to determine whether and to what extent notices would need to be provided under the Final Rule if it becomes effective. This would be a good time to revisit restrictive covenant agreements that have been assumed from acquired companies and evaluate the scope of their enforceability in light of state legislation and potential noncompliance with the Final Rule.
- Evaluate the design of equity compensation practices for future grants, including whether the scope of individuals subject to noncompetes makes sense from a business perspective and how unenforceability of noncompete restrictions would impact equity award terms.
- Analyze whether compensation packages should be recalibrated if noncompetes lose value on a go-forward basis.
If you have any questions about the information in this post, or otherwise related to the FTC’s Final Rule, please contact the authors or your usual Morgan Lewis contacts.