On April 23, 2024, the Federal Trade Commission (FTC) approved and issued an unprecedented new final rule that is intended to effectively ban employers’ use of noncompete agreements nationwide. Most strikingly, the new rule will even void most noncompetes entered into before the rule’s enactment. At the earliest, the final rule will take effect 120 days after it is published in the Federal Register (a compendium of federal agency regulations), which means the effective date could be as early as late-August. However, the new rule will be subject to legal challenges that could delay its implementation or even prevent it from being implemented at all. Nonetheless, businesses that maintain noncompete agreements with current or former workers need to be aware of the new rule and plan accordingly.
Specifically, the new rule declares it to be a prohibited “unfair method of competition” for an employer to (1) enter into or attempt to enter into a noncompete clause with a worker after the effective date; (2) enforce or attempt to enforce a noncompete clause entered into after the effective date with a senior executive or an existing or future noncompete clause with any worker; or (3) represent to a worker, other than a senior executive with an existing noncompete clause, that the worker is subject to an noncompete clause.
What types of agreements and policies are covered by the new rule?
Subject to limited exceptions, nearly every employer that uses noncompete agreements will be affected by this new rule. The new rule defines a “noncompete clause” as any contract or policy that prohibits, penalizes, or functionally prevents workers from seeking or accepting work in the United States with a different person or operating a business in the United States after the conclusion of the worker’s current employment.
Whether a contractual provision or policy functionally prevents workers from seeking or accepting work is a “fact-specific inquiry.” Thus, overly broad confidentiality, non-solicitation, or training-repayment agreements could be deemed to constitute unlawful “noncompete clauses” if the FTC determines such agreements functionally prevent workers from seeking or accepting new work or operating a business. On the other hand, appropriately tailored confidentiality, non-solicitation, or training-repayment agreements will remain enforceable.
Further, the FTC has noted that the definition of “noncompete clause” extends to terms and conditions that impose adverse financial consequences on a former employee for seeking or accepting other work or starting a business. For example, a severance agreement in which the worker is paid only if they refrain from competing constitutes a prohibited noncompete clause under the new rule.
Critically, the new rule defines “worker” very broadly, including, but not limited to, employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide services to others. Similarly, the new rule broadly applies to any “employer,” including, but not limited to, natural persons, partnerships, corporations, associations, or other legal entities subject to the FTC’s jurisdiction.
Are there any exceptions to the new rule’s ban on noncompete agreements for workers?
The new rule includes a narrow exception for noncompete agreements entered into with “senior executives” before the rule’s effective date. “Senior executives” are defined as workers in “policy-making” positions, such as presidents, CEOs or the like who earn more than $151,164 annually. After the effective date, employers will no longer be able to enter into new noncompete agreements with senior executives.
The new rule also includes an exception for noncompete clauses entered into pursuant to the bona fide sale of a business entity, of the person’s ownership interest in a business entity, or all or substantially all of the business entity’s operating assets.
Further, the new rule does not apply to non-profit organizations. The portion of the FTC Act on which the FTC relied to enact the new rule is inapplicable to non-profits.
Notably, the new rule does not ban litigation seeking to enforce noncompete agreements where the violation of the noncompete agreement occurred prior to the rule’s effective date. Thus, employers can continue to file or pursue ongoing lawsuits seeking to enforce noncompete agreements until the effective date.
The new rule includes a notice requirement
By the effective date, employers must provide workers whose noncompete agreements are rendered unenforceable by the new rule with “clear and conspicuous notice” that the noncompete clause will not be enforced against such workers. This includes current employees and former employees who remain subject to active noncompete agreements. The notice must be written and may be hand-delivered or sent via mail, email, or text message. The new rule includes model notice language employers may use to satisfy their notice obligations.
The new rule is already facing legal challenges
There are significant concerns that the FTC overstepped its authority by attempting to ban noncompete agreements outside of the legislative process. At least two lawsuits seeking to block implementation of the new rule have already been filed in the federal courts, including a lawsuit by the U.S. Chamber of Commerce and other business advocacy groups. It is impossible to predict how long it will take the federal courts to determine the lawfulness of the new rule. One or more of the lawsuits will likely reach the federal appellate courts, with the possibility of the U.S. Supreme Court eventually determining the legality of the new rule. It is also possible that a federal court might issue an injunction delaying implementation of the new rule until the federal appellate courts have had an opportunity to consider the rule.
What can you do now?
In the short term, employers should prepare to address questions from workers regarding the new rule. Due to the significant publicity generated by the new rule, some workers may be under the false impression that the new rule takes effect immediately. But, as noted above, it will be late-August at the earliest before the new rule is implemented, subject to court decisions that could delay implementation even further.
As the new rule’s effective date draws nearer, employers may wish to conduct an internal census to account for current and former employees subject to agreements that will become unenforceable. Employers should also work with employment counsel to develop a strategic approach to ensure their confidential information, trade secrets, and business relationships remain protected should the new rule take effect. Stoll Keenon Ogden’s Labor, Employment & Employee Benefits practice is closely monitoring the FTC’s new rule. We can provide counsel regarding the new rule and assist in crafting appropriate confidentiality and other protective clauses to protect your legitimate business interests.
