FTC Final Rule Banning Non-Competes - What Companies Need to Know
On April 23, 2024, the U.S. Federal Trade Commission (the “FTC”) issued its Final Rule enacting a nationwide ban on non-compete clauses.[1] Declaring non-competes to be an unfair method of competition and unlawful, the FTC characterized the ban as promoting competition by upholding the fundamental freedom of workers to change jobs and launch entrepreneurial businesses. According to FTC Chair Lina M. Khan, non-competes “keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once non-competes are banned.”[2]
This Alert summarizes certain key provisions of the Final Rule, and actions that companies should consider taking in light of its adoption.
Scope of Ban and Exceptions
The Final Rule bans new non-competes altogether for any current or former “worker” (defined to include any natural person who provides services, whether as an employee, independent contractor, volunteer or otherwise)[3] and makes currently existing non-compete agreements unenforceable, other than as follows:
- Senior Executive Existing Non-Competes Exception. The Final Rule exempts non-compete agreements for senior executives (as defined below) existing as of the effective date of the Final Rule, but bans new non-competes even for senior executives.
- A “senior executive” is defined as a worker with total annual compensation[4] exceeding $151,164 and in a “policy-making position” – i.e., a Chief Executive Officer, President or the equivalent, or any other officer who has policy-making authority (as defined below).[5]
- The term “policy-making authority” is defined as “final authority to make policy decisions that control significant aspects of a business entity or common enterprise,” but does not encompass authority which is limited to advising or exerting influence over such decisions.[6]
- Business Sale Exception. The ban does not apply to “a non-compete clause that is entered into by a person 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.” A “bona fide sale” is “one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.”[7]
The seller is not required to have any minimum ownership percentage of the sold entity. Nor is it required that the entire company be sold – e.g., it could apply when an owner leaves the business and sells their ownership interests,[8] provided that it is a bona fide sale.
- Accrued Actions. The ban does not prevent enforcement of a non-compete clause where the cause of action related to the non-compete clause accrued prior to the effective date of the Final Rule.
- Industry Specific Exceptions. Certain entities that would otherwise be subject to the Final Rule may fall outside the FTC’s jurisdiction under the FTC Act. These include banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act.[9]
- Non-Profits. Non-profit organizations similarly fall outside the FTC’s jurisdiction, provided that they meet the requirements under existing judicial precedent – i.e., they must satisfy a two-prong test that “looks to the source of the income, i.e., to whether the corporation is organized for and actually engaged in business for only charitable purposes, and to the destination of the income, i.e., to whether either the corporation or its members derive a profit.”[10]
- Franchisees. Although the term “worker” includes a natural person who works for a franchisee, it does not include the franchisee itself in the context of a franchisee-franchisor relationship.
Good Faith Defense
In addition to the other exceptions, the Final Rule states that it is not an unfair method of competition to enforce or attempt to enforce, or to make representations about, a non-compete where the company has a good-faith basis to believe that the Final Rule is inapplicable.
For example, this exception can offer a company a defense against charges that it violated the ban by attempting to enforce an existing non-compete against an employee who the company believed in good faith would qualify as a “senior executive”, or by attempting to enforce a non-disclosure or non-solicitation clause that the company believed in good faith would not be deemed a “non-compete” clause.
Required Notice that Existing Non-Competes are Invalid
For each existing non-compete clause that applies to a worker, the employer must provide clear and conspicuous notice to the worker by the Final Rule’s effective date (see below) that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. The notice must “be on paper,” delivered by hand, by mail, by email, or by text message. A model form of notice is provided in the Final Rule.
Definition of Non-Compete
“Non-compete” is defined as a contractual term or workplace policy, whether written or oral, 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 employer, or operating a business in the United States, after the conclusion of the employment.
Garden Leave; Severance
A “garden leave” arrangement would not be a post-employment restriction, and thus not a non-compete clause, if the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis, even though the worker’s job duties or access to colleagues or the workplace may be significantly or entirely curtailed.[11] However, a severance arrangement in which the worker is paid only if they refrain from competing would be a post-employment restriction, and thus a non-compete clause.[12]
Non-Solicit and Non-Disclosure Covenants
Non-disclosure and non-solicitation clauses are not “non-compete” clauses unless they “function to prevent” a worker from seeking or accepting other work or starting a business after their employment ends (i.e., they are “de-facto” non-competes). While this will ultimately be a fact-specific inquiry, the Final Rule notes some examples of such an agreement:
- “[A]n NDA that bars a worker from disclosing, in a future job, any information that is “usable in” or “relates to” the industry in which they work. Such an agreement would effectively prevent the worker from working for another employer in that industry. A second example would be an NDA that bars a worker from disclosing any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information. These agreements are so broadly written that, for practical purposes, they function to prevent a worker from working for another employer in the same field and are therefore non-competes…”[13]
Training Repayment Agreements
Some companies enter into training repayment agreements (“TRAP”) with their employees, in which the worker is required to repay the employer for training costs if the worker’s employment terminates within a specified time period. If any such TRAP agreement is deemed to be a de-facto non-compete, then it will constitute a “non-compete” for purposes of the Final Rule.[14]
Non-Competes Attendant to Grants of Options, Stock, Bonuses or Other Benefits
The Final Rule renders non-competes unenforceable even if agreed to as an inducement to grant a worker stock options, capital stock, bonuses or other benefits, including “forfeiture-for-competition” clauses. This may result in a windfall for workers who received substantial consideration in exchange for a non-compete which now cannot be enforced.
While acknowledging these concerns, the FTC contended that the adverse impacts to companies are partially mitigated by the exemption for existing non-competes of senior executives, “which are the most likely to have been exchanged for consideration,”[15] and by the fact that most non-competes are accompanied by non-solicit and non-disclosure covenants that may remain enforceable under the Final Rule.[16]
Effect of State Non-Compete Laws
The Final Rule does not limit or affect enforcement of State laws that restrict non-competes, but it preempts State laws that conflict with the Final Rule (e.g., by expressly authorizing non-competes).
Consequences of Violations
Violations of the Final Rule will be deemed an unfair method of competition, and therefore a violation of Section 5 of the Federal Trade Commission Act (the “FTC Act”). In the event of an alleged violation, the FTC can launch an investigation, which may include subpoenas and other forms of compulsory process. Thereafter, it can either pursue an adjudication against the violating party before an administrative law judge under section 5(b) of the FTC Act, seeking to impose a cease and desist order or to obtain a signed consent agreement, or else the FTC may seek an injunction in federal court against the violating party.[17]
The FTC cannot obtain civil penalties or other monetary relief against parties for such a violation, although it can obtain civil penalties in court if a party is ordered to cease and desist from a violation or violates a consent agreement and fails to do so.[18] Workers have no private right of action under section 5 of the FTC Act, although they can make complaints regarding violations to the FTC.
Effective Date; Expected Court Challenges
The rule becomes effective 120 days from publication in the federal register, but numerous legal challenges in court are expected and will very likely delay enforcement of the rule, and possibly prevent it from ever going into effect. As of the date of this writing, at least two lawsuits have already been filed.[19]
What Companies Should Be Doing
Companies should promptly commence a process to gather files and, in consultation with their legal counsel, make assessments concerning:
- What contracts do they have with current or former workers containing active non-compete clauses, or non-disclosure or non-solicitation clauses that may be deemed non-competes?
- Do they have any company policies or manuals which include non-compete clauses, or non-disclosure or non-solicitation clauses that might be deemed non-competes?
- Consider whether to seek amendment of any of the foregoing non-disclosure or non-solicitation clauses, so as to protect their enforceability.
- For workers with existing active non-competes, do any qualify under the “senior executives” exemption?
- For any “senior executives” who are not currently subject to a non-compete, should one be signed before the Final Rule’s effective date, in order to take advantage of the exemption for existing senior executive non-competes?
- Should any option plans or other employee benefit arrangements be modified to remove non-competes and implement alternative approaches (e.g., longer vesting periods to encourage lengthier employee retention, or garden leave).
Companies should also identify all current and former workers who may be required to receive a written notice of non-enforceability, along with their contact information, and prepare a plan for delivering notice if the Final Rule becomes effective.
What if I Have Legal Questions?
Our firm has closely followed the FTC’s non-compete ban since it was first proposed and will continue to monitor the Final Rule for any updates. If you would like assistance from our law firm, including how the non-compete ban may affect you, please do not hesitate to contact your Windels Marx relationship lawyer, Scott Matthews or Marky Suazo of our Employment and Employee Benefits Practice Group, or Jonathan Gray of our Corporate and Securities Practice Group.
Disclaimer
Possession of this material does not constitute an attorney/client relationship. This information is provided for your convenience and does not constitute legal advice. It is prepared for the general information of our clients and other interested persons and it may include links to websites other than the Windels Marx website. This information should not be acted upon in any particular situation without first consulting with an attorney and obtaining legal advice based on your facts and circumstances.
[1] Final Rule, Federal Trade Commission, Non-Compete Clause Rule (RIN: 3084-AB74) (April 23, 2024).
[2] See Press Release, Federal Trade Commission, FTC Announces Rule Banning Noncompetes (April 23, 2024) at https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes.
[3] “Worker” can include indirect employment relationships (e.g., through affiliates, professional employer organizations, joint employers and staffing agencies) and ban non-competes not technically with the hiring party. See Final Rule at pp.65, 98. “Worker” also includes an owner who provides services to or for the benefit of their business. See Final Rule at p.100.
[4] “Total annual compensation” is based on the worker’s earnings over the preceding year, and may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation. Fringe benefits, such as payments for medical insurance or contributions to retirement plans, are generally excluded.
[5] Senior executives will likely include the “C-suite”, as well as “partners in a business, such as physician partners of an independent physician practice” who have authority to make policy decisions. See Final Rule at pp.269-270.
[6] An officer of a subsidiary or affiliate is only considered to have “policy-making authority” if they have such authority over the entity making policy decisions for the common enterprise (e.g., an ultimate parent entity).
[7] Id. at p.342. Although the FTC declined to specifically list each kind of transaction which is not a bona fide sale, it noted that: “So-called “springing” non-competes and non-competes arising out of repurchase rights or mandatory stock redemption programs are not entered into pursuant to a bona fide sale because, in each case, the worker has no good will that they are exchanging for the non-compete or knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting. Similarly, sham transactions between wholly owned subsidiaries are not bona fide sales because they are not made between two independent parties.” Id. at p.342.
[8] See Final Rule at pp.269-270.
[9] 15 U.S.C. 45(a)(2).
[10] See Final Rule at pp. 51-52.
[11] See Final Rule at p.83.
[12] See Final Rule at p.77.
[13] See Final Rule at p.82.
[14] See Final Rule at p.77.
[15] See Final Rule at p.248-249.
[16] See Final Rule at p.245.
[17] See Final Rule at p.24; see A Brief Overview of the Federal Trade Commission's Investigative, Law Enforcement, and Rulemaking Authority (May 2021), at https://www.ftc.gov/about-ftc/mission/enforcement-authority.
[18] See Final Rule at p.24.
[19] See Chamber of Commerce of the United States of America et al v. FTC and Lisa Khan, Case No. 6:24-cv-00148 (E.D. Tex) (filed April 24, 2024) and Ryan, LLC v. FTC, Case No. 3:24-cv-00986 (N.D. Tex) (filed April 23, 2024).
