On May 7, 2024, the Federal Trade Commission (FTC) published the final rule banning non-compete clauses in most employment agreements nationwide, marking a significant shift in the landscape of employment law. The effective date of the ban will be September 4, 2024.
Let’s discuss the events leading up to the FTC’s decision, key provisions of the final rule, and crucial next steps for employers to ensure compliance and protect their business interests.
The Road to the FTC’s Final Rule
In the absence of a comprehensive federal law or agency rule, many states developed different approaches to non-compete agreements over the years, which generally fall into three categories:
- Laws prohibiting all employment non-compete agreements;
- Laws establishing salary-based thresholds, notice, and disclosure obligations for non-compete agreements; and
- Reliance on common law, court-adopted restrictions on non-competes.
This patchwork of state laws has created challenges for employers, especially those operating across multiple jurisdictions, as they must navigate varying legal requirements and restrictions.
The primary rationale behind the push for banning non-compete agreements—at the state and, now, federal level— is the belief that they stifle competition, limit worker mobility, and depress wages. Ban proponents argue that by restricting employees’ ability to work for competitors or start their own businesses, non-compete agreements give employers an unfair advantage and hinder innovation. They also contend that non-compete agreements disproportionately affect low-wage workers who may not have the bargaining power to negotiate better terms.
On the other hand, supporters of non-compete agreements argue that they are necessary to protect businesses’ legitimate interests, such as trade secrets, confidential information, and investments in employee training. Without non-compete agreements, companies may be less inclined to invest in their employees’ development, as they risk losing them to competitors. Additionally, there’s an argument that non-compete agreements can actually encourage innovation by providing a secure environment for businesses to develop new ideas and technologies without fear of immediate competition.
The momentum behind banning non-competes has culminated in the FTC’s final rule establishing a uniform nationwide ban on such agreements, with limited exceptions. Importantly, the rule includes a preemption provision, meaning that conflicting aspects of state laws will be preempted by the federal rule. However, state laws that do not conflict with the FTC’s rule can remain in effect.
Key Provisions of the Final Rule
- Covered Businesses and Employees: The final rule applies to most for-profit entities subject to the FTC Act, with certain exceptions for non-profit organizations and financial institutions which do not fall within the jurisdiction of the FTC Act. The ban covers all new non-compete agreements across all industries and worker types, including senior executives and lower-level employees. The definition of “worker” is broad, encompassing employees, independent contractors, interns, externs, volunteers, and sole proprietors providing services.
- Definition of “Non-Compete Clause”: The rule defines a “non-compete clause” as any term or condition of employment that prevents a worker from seeking or accepting work with a different employer or operating a business after the conclusion of their employment.
- Treatment of Existing Non-Compete Agreements: Existing employment non-compete agreements may continue to be enforced, but only for “senior executives.”
- Definition of Senior Executive: A “senior executive” is generally an employee who holds a policy-making position and earns total compensation (including salary, commissions, and nondiscretionary bonuses, among other forms of compensation) of at least $151,164. “Policy-making position” means a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.
- Providing Notice of Non-Enforcement: Employers must provide clear and conspicuous notice to workers subject to a prohibited non-compete, informing them that their non-compete agreement will not be enforced against them. This notice must be provided by the final rule’s effective date (120 days after the rule is published in the Federal Register) through hand-delivery, mail, email, or text message. The final rule contains model language that employers can use for this notice, which provides a safe harbor for compliance.
- Impact on Other Restrictive Covenants: While the final rule does not explicitly ban non-disclosure agreements, customer non-solicitation agreements, or employee non-solicit agreements, it does prohibit these forms of restrictive covenants when they have the same functional effects as non-compete clauses.
Analysis and Next Steps for Employers
The FTC’s final rule banning non-compete agreements has far-reaching implications for employers across the United States. To ensure compliance and protect their business interests, employers should take proactive steps such as reviewing existing agreements, preparing notices, and exploring alternative protective measures.
Taking Stock of Existing Non-Competes. Employers should review their existing non-compete agreements for current and former workers to determine which agreements will be affected by the final rule. This process should involve identifying senior executives whose non-compete agreements may remain enforceable after the effective date.
Entering into Non-Competes with Senior Executives. Employers may consider entering into non-compete agreements with senior executives before the effective date of the final rule (September 4, 2024), as appropriate. However, it is essential to ensure that these agreements comply with the rule’s requirements and any applicable state laws.
Providing Notice of Non-Enforcement. Employers must provide clear and conspicuous notice to workers subject to a prohibited non-compete, informing them that their non-compete clause will not be enforced against them. This notice must be provided by the final rule’s effective date through hand-delivery, mail, email, or text message. The final rule contains model language that employers can use for this notice, which provides a safe harbor for compliance. Because the FTC’s authority to enforce the final rule is being challenged (as discussed below), the best course of action for employers may be to prepare to issue notices but not send them until closer to the effective date.
Monitoring Legal Developments. Multiple legal challenges to the FTC’s authority to ban restrictive covenants are expected, creating uncertainty surrounding the final rule’s implementation. For example, the day after the final rule was announced, the U.S. Chamber of Commerce filed suit in federal court. Employers should closely monitor these legal developments while still preparing to comply with the rule. We will continue to keep you apprised of the situation.
Exploring Alternative Protective Measures. Although the final rule does not explicitly ban non-disclosure agreements, customer non-solicitation agreements, or employee non-solicit agreements, it does prohibit these restrictive covenants when they have the same functional effects as non-compete clauses. Employers should carefully review and revise these agreements to ensure they do not prevent workers from seeking or accepting other work or starting a business after their employment ends. In addition, instead of or in addition to utilizing restrictive covenants, businesses may consider providing long-term financial incentives, such as retention bonuses, performance bonuses tied to long-term performance metrics, stock options or deferred compensation, in order to encourage key employees to remain loyal and aligned with the company’s interests over an extended period.
Conclusion
The FTC’s final rule banning non-compete agreements represents a significant shift in employment law, requiring employers to reassess their use of restrictive covenants and take proactive steps to ensure compliance. By understanding the key provisions of the rule and exploring alternative protective measures, employers can navigate this new legal landscape while still safeguarding their business interests. However, the rule’s ultimate impact will depend on its ability to withstand judicial scrutiny.
If you have any questions about or require assistance with the final rule, or would like to discuss alternative ways to protect your business’ competitive advantage in an environment in which non-compete agreements can no longer be enforced, please contact Trembly Law Firm.
