iOn Tuesday, April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule to prohibit employers from enforcing noncompetes against workers. Noncompetes are a widespread and often exploitative practice with which employers limit workers’ ability to ‘compete’ with their former employer during or after employment. Studies have shown that noncompetes suppress wages, hamper innovation, and block entrepreneurs from starting new businesses. The FTC’s final rule provides broad protections for workers from a wide variety of restrictive agreements.
The FTC’s Final Rule
An estimated 30 million workers – nearly one in five Americans – are subject to a noncompete. “Noncompete clauses 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 noncompetes are banned,” said FTC Chair Lina M. Khan. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” Given the harm that noncompetes cause by restricting workers’ ability to seek better employment, the FTC’s final rule is excellent news for workers across the United States.
However, the language of the FTC’s final rule is deceptively simple. In January 2023, the FTC announced a Proposed Rule which would ban noncompetes. We explained the Proposed Rule, its potential implications, and potential legal challenges to the rule, in a blog published here. The FTC’s final rule retains most of the language from the Proposed Rule, but it is important for workers to understand the potential impact of this final rule on their potential (in)eligibility for noncompetes. This post explains the major provisions of the final rule, discusses the differences between the final rule and the Proposed Rule, and outlines potential next steps before the Rule goes into effect.
What is a Noncompete?
The final rule slightly modified the definition of a noncompete clause from that in the Proposed Rule to clarify its scope. In the final rule, a “non-compete clause” is defined as a term or condition of employment that either “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 term or condition.
The FTC provides examples of such prohibited agreements, including:
- A contractual term between a national sandwich shop chain and its workers stating that, for two years after workers leave their jobs, they cannot work for another sandwich shop within three miles of any of the chain’s locations;
- A contractual term between a steelmaker and one of its executives prohibiting the executive from working for any competing business anywhere in the world for one year after the end of the executive’s employment;
- A contractual term providing that, for two years after the worker’s employment ends, the worker may not engage in any business within a certain geographic area that competes with the employer unless the worker pays the employer liquidated damages of $50,000;
- A contractual term in a severance agreement in which the worker is paid only if the worker refrains from competing; and
- A forfeiture-for-competition clause, which imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee’s seeking or accepting other work or starting a business after the former employment ends.
Importantly, the FTC’s term “functions to prevent” could apply the FTC final rule’s ban on noncompetes to other types of restrictive employment agreements, such as nondisclosure agreements (“NDAs”), Training Repayment Agreement Provisions (“TRAPs”), or non-solicitation agreements. Those types of agreements do not by their terms prohibit workers from or penalize workers for seeking or accepting other work after they leave their job, and in many cases may not have that functional effect. But the FTC final rule’s term “functions to prevent” clarifies that, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term prohibiting or penalizing a worker from seeking or accepting other work after the worker’s employment ends, such a term is a noncompete clause, and is thus prohibited.
The final rule’s “functions to prevent” term provides little more clarity than the Proposed Rule’s “de facto” language, which we discussed in the blog on the Proposed Rule last year. Employers and workers both may still face confusion about whether contractual terms in non-solicitation and nondisclosure agreements will fall under the FTC’s noncompete ban. Many non-solicitation agreements limit former workers from working with any former or potential clients of the former employer. This often has the same impact as a noncompete, especially in certain fields such as sales, and is particularly unfair to former workers who brought their clients to the former employer in the first place. As written, the final rule’s “functions to prevent” term may well ban those restrictions on workers.
Who Is Affected?
The final rule states that noncompetes are an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act (“FTC Act”). As a result, the Rule broadly prohibits employers from entering into new noncompetes with all workers after the effective date. “Worker” is defined broadly as a “natural person who works or who previously worked, whether paid or unpaid…whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a person” and includes a person “who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.” This definition of “worker” includes small adjustments from the definition provided in the Proposed Rule.
Under the new rule, for all workers, no new noncompetes may be entered into after the effective date.
Notably, the Rule treats one category of worker differently: senior executives. The Rule is retroactive for all workers who are not senior executives: for workers who are not senior executives, the Rule prohibits all noncompetes on the effective date, whether the noncompete was entered into long before the effective date or not. However, for senior executives, existing noncompetes remain enforceable even after the effective date.
A “senior executive” is defined as a worker earning more than $151,164 annually who is in a “policy-making decision.” A “policy-making position” is defined as 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 person who has similar “policy-making authority” for the business entity. The definition continues: “an officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position for purposes of this paragraph” but a person “who does not have policy-making authority over a common enterprise may not be deemed to have a policy-making position even if the person has policy-making authority over a subsidiary or affiliate of a business entity that is part of the common enterprise.” Furthermore, “policy-making authority” is defined as “final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or an affiliate of a common enterprise.”
Senior executives represent fewer than 0.75% of workers. Therefore, while senior executives may still be bound by existing noncompetes even after the effective date of the final rule, the vast majority of workers currently bound by noncompetes will be freed from those burdens on their ability to seek or accept employment.
When Does the Noncompete Ban Go Into Effect?
The FTC’s final rule goes into effect 120 days after publication in the Federal Register (this date is not the same as 120 days after the FTC’s public announcement). We will update this blog once the Rule is published in the Federal Register and we have an estimated effective date.
Differences from the Proposed Rule
There are a few differences between the final rule and the Proposed Rule, likely reflecting the feedback the FTC received during the Notice and Comment period. The FTC stated that it received more than 26,000 comments on the Proposed Rule, with over 25,000 comments in support of the proposed ban on noncompetes.
The most notable difference between the Proposed Rule and the final rule is that under the final rule, existing noncompetes for senior executives can remain in force even after the effective date, as discussed above in Part II. However, as under the Proposed Rule, under the final rule, for all workers, no new noncompetes may be entered into after the effective date.
Additionally, the final rule eliminated a provision in the Proposed Rule that would have required employers to modify existing noncompetes by formally rescinding them. Instead, employers must provide notice to workers, other than senior executives, who are bound by an existing noncompete that they will not be enforcing any noncompetes against them. The FTC has included model language in the final rule that employers can use to communicate with workers. This is a slightly more streamlined approach for employers to comply with the requirements of the final rule.
As also discussed above in Parts I and II, the final rule made slight adjustments to the definition of noncompete clauses, and to the definition of worker, reflecting the feedback the FTC received during the Notice and Comment period last year.
Anticipated Impact and Next Steps
Given the FTC final rule’s retroactivity exception impacting senior executives, the language of the FTC’s final rule is now reflective of current State noncompete bans and partial bans. Many State noncompete bans include exemptions to the workers protected by the ban, and salary threshold exceptions are particularly popular. For example, the Illinois Freedom to Work Act, the Virginia law regulating noncompetes, Virginia Code § 40.1-28.7:8, and the Maryland Non-Compete and Conflict of Interest Clause Act each prohibit noncompetes only for employees earning less than a specified salary threshold. Similarly, the D.C. Noncompete Ban, which went into effect in October 2022, exempts certain types of workers from protection, including volunteers, babysitters, lay members elected or appointed to office within any religious organization and engaged in religious functions, broadcast employees, “highly compensated employees,” and “highly-compensated” medical specialists. The FTC final rule, with its retroactivity exception impacting senior executives, is thus comparable to many State noncompete bans in that it permits existing noncompetes for a defined category of workers, senior executives. However, the FTC final rule is more expansive than these State noncompete bans in that, following the effective date of the rule, noncompetes are prohibited for all workers, including senior executives.
Given the FTC’s retroactivity exception applying to senior executives, California now has the broadest ban of noncompetes and non-solicitation agreements, voiding “every contract,” including those agreed to before the law’s effective date. In addition, California requires employers to rescind existing noncompete clauses; the FTC removed the rescind requirement from its final rule.
As noted above, the final rule goes into effect 120 days after publication in the Federal Register. Just today, the U.S. Chamber of Commerce filed a lawsuit in a U.S. District Court in Texas arguing that the FTC did not have authority to issue rules that define unlawful methods of competition. The FTC indicated in both its Proposed Rule and final rule that it anticipated numerous legal challenges and provided hundreds of pages of arguments and responses to comments attacking its legal authority to issue such an expansive rule. Should the Supreme Court overrule Chevron v. Natural Resources Defense Council, which held that courts should defer to an agency’s reasonable interpretation of an ambiguous statute, as it is expected to do, this rule may be subject to even more robust challenge.
The Federal Trade Commission Act (“FTCA”) gives the FTC the power to prevent unfair methods of competition and investigate unfair or deceptive acts that affect commerce. Piggybacking on this principle, in the final rule the FTC defines “unfair methods of competition” to include when a person “enter[s] into or attempt[s] to enter into a non-compete clause” with a worker “other than a senior executive,” “enforce[s] or attempt[s] to enforce a non-compete clause;” or “represent[s] that the worker is subject to a non-compete clause.” Through this definition, the FTC clearly intends to forestall challenges to its authority by linking its general enforcement power to its regulatory effort in this new arena. The FTC voted 3-2 to issue the final rule, with Commissioners Melissa Holyoak and Andrew N. Ferguson voting no. Commissioners’ written statements will follow and may provide legal theories predicting the arguments on which legal challengers may rely.
We hope that the FTC’s final rule withstands the forthcoming legal challenges coming its way. However, as William Koviac, a former FTC chair, said, the agency may face an uphill battle in the challenge over its rule: “The F.T.C. believes that earlier jurisprudence and legislation has created a bridge over which its noncompete rule can travel,” Mr. Kovacic said. “The hazard for the commission and its rule is that the bridge is fragile, and the F.T.C. wants to drive a very heavy truck over it.”
