Federal Trade Commission Issues Final Rule Banning Noncompetes

On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule effectively banning all existing noncompete agreements and prohibiting new noncompetes, concluding that noncompetes are an unfair method of competition under Section 5 of the FTC Act. However, as will be discussed below, there are a few exceptions permitting the enforcement of a noncompete agreement. The ban will go into effect 120 days after the rule is published in the Federal Register.

What is a “noncompete”?

The rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (A) 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 (B) operating a business in the United States after the conclusion of the employment that includes the terms or condition.” It further defines “term or condition of employment” as including but not limited to “a contractual term or workplace policy, whether written or oral.”  Notably, non-solicitation of an employer’s clients or employees is not explicitly included in the definition of “non-compete clause.”

Employers should pay particular attention to the phrase “functions to prevent” in the above definition. As used here, it means that any term or condition that is so broad or onerous as to effectively (although maybe not explicitly) prohibit or penalize a worker from accepting other work or starting a new business after the conclusion of their employment will be considered a non-compete clause. A term that “functions” in such a way will be unenforceable against the worker. Per the comments to the rule, this scenario may arise if a non-disclosure or non-solicitation provision is so broad that it functions as a noncompete. Accordingly, it will be important for employers to review all of their existing employment agreements with post-employment restrictions.

When does the rule go into effect and what must an employer do?

The rule goes into effect 120 days after it is published in the Federal Register.

By the effective date, employers are required to notify workers that it is an unfair method of competition to enforce or attempt to enforce a non-compete clause, and that by the effective date the worker’s non-compete clause will not be, and cannot be, legally enforced against them. The notice must identify the person who entered into the non-compete clause with the worker. The notice can be delivered to the worker in one of four ways: (1) on paper delivered by hand to the worker; (2) by mail at the worker’s last known personal street address;  (3) by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address; or, (4) by text message at a mobile telephone number belonging to the worker. The notice must be clear and conspicuous. The FTC also states that mass communication, such as a mass email to current and former workers, is appropriate.

The rule contains model language for employers to use when notifying their workers. And while it does not appear that an employer must use this exact language, the rule contains a safe harbor provision which states that by following the model language the employer will comply with the rule.

Does this apply to all workers and all noncompetes?

No, there are a few exceptions to the rule.

First, the rule does not apply to current non-compete clauses for senior executives. With respect to senior executives, the rule only affects non-compete clauses entered into after the effective date of the rule. A senior executive is a worker who (1) was in a policy-making position; and (2) received a total annual compensation of at least $151,164 in the preceding year or its equivalent when annualized if the worker was employed during only part of the preceding year.

Second, the rule does not apply to a non-compete clause entered into pursuant to the sale of a business entity, the sale of the person’s ownership interest in a business entity, or the sale of substantially all of a business entity’s operating assets.

Finally, the rule does not apply where a cause of action related to a non-compete clause accrued prior to the effective date. In other words, if a worker violates his or her noncompete prior to the effective date of the rule, the employer can still pursue appropriate remedies for that violation even once the rule is in effect.

What about State laws?

The rule does not exempt any person from complying with state statutes and regulations regarding noncompetes. Nor does the rule limit a party’s authority or rights to bring a claim under state common law, antitrust law, and consumer protection law. However, the rule supersedes state laws to the extent that such laws would permit or authorize a person to engage in conduct that the rule deems unlawful.

Legal challenges are already here.

Merely one day after the final rule was announced, the FTC was sued by the US Chamber of Commerce and several other business groups seeking to invalidate the rule. A complaint filed in a Texas federal court alleges that the FTC lacks authority to issue rules defining unfair methods of competition. Felhaber will be monitoring this lawsuit and any other challenges to the rule that may arise. Stay tuned for more updates.

Bottom Line

Despite the pending legal challenge, employers should review their existing noncompete agreements and prepare to issue a notice to their workers. Employers should also review any current non-solicitation, non-disclosure, and other restrictive agreements because, if written broadly enough, such agreements may be unenforceable under the new rule. While this may seem like a daunting task, members of Felhaber’s labor and employment group are available and ready to help navigate this changing legal landscape.