/>iOn April 23, the Federal Trade Commission (FTC) issued its Final Non-Compete Agreement Rule (final rule) banning non-compete agreements between employers and their workers. The final rule will go into effect 120 days after being published in the Federal Register. This final rule will impact most US businesses, specifically those that utilize non-compete agreements to protect their trade secrets, confidential business information, goodwill, and other important intangible assets. As is demonstrated by the recent litigation by Wynn Resorts attempting to enforce non-compete agreements against former Wynn employees now working for Fontainebleau, requiring employees to sign non-compete agreements has been an important tool for gaming industry operators to protect customer lists and other trade secrets.
The final rule prohibits employers from entering or attempting to enter into non-compete agreements with “workers” (employees and independent contractors). Employers are also prohibited from even representing that a worker is subject to such a clause. The final rule provides that it is an unfair method of competition for employers to enter into non-compete agreements with workers and is therefore a violation of Section 5 of the FTC Act.
There are a few exceptions under the final rule, however. For senior executives, existing non-compete agreements can remain in force, but employers are barred from entering or attempting to enter into a non-compete agreement with a senior executive after the effective date of the final rule. The final rule defines “senior executive” as a worker who is both (1) earning more than $151,164 annually and (2) in a “policy-making position” for the business. For workers who are not senior executives, existing non-competes are not enforceable after the effective date. If not invalidated all together, the final rule will likely have extensive litigation related to “policy-making position.” According to the current commentary on the final rule, the FTC will likely take the position that “senior executive” is a very limited definition.
Further, the final rule does not apply to non-competes entered into 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.” As a result, parties entering into transactions can continue to use non-compete agreements in the sale of a business. But transactional lawyers should note that any non-compete in a subsequent employment agreement with a seller will likely be subject to the final rule. The final rule also does not prohibit employers from enforcing non-compete clauses where the cause of action related to the non-compete clause occurred prior to the effective date of the final rule.
The final rule also states that agreements that “penalize” or “function to prevent” an employee from working for a competitor are banned and unlawful. For example, a non-disclosure agreement may be viewed as a non-compete when it is so broad that it functions to prevent workers from seeking or accepting other work or starting a business after they leave their job. Similarly, non-solicitation agreements may also be banned under the final rule “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.” The commentary makes clear that the enforceability and legality of these types of agreements will need to be analyzed on a case-by-case basis.
Under the final rule, employers are required to provide clear and conspicuous notice to workers who are subject to a prohibited non-compete. This notice must be sent in an individualized communication (text message, hand delivery, mailed to last known address, etc.) and indicate that the worker’s non-compete clause will not be enforced.
The final rule has already been challenged in at least two lawsuits, both filed in Texas. The US Chamber of Commerce filed suit in the US District Court for the Eastern District of Texas seeking a declaratory judgment and an injunction to prevent the enactment of the final rule. A second suit, filed by Ryan, LLC, a tax services firm, was filed in the US District Court for the Northern District of Texas. These cases are now essentially consolidated and both raise similar arguments: (1) the FTC lacks authority to enact the rule due to the major questions doctrine; (2) the final rule is inconsistent with the FTC Act; (3) the retroactive nature of the final rule exceeds the FTC’s authority and raises Fifth Amendment concerns; and (4) the final rule is arbitrary and capricious.
The US Chamber of Commerce has also filed a motion to stay the effective date of the final rule pending resolution of its lawsuit. The court recently issued an order setting a briefing schedule on the motion that seeks to stay the final rule until the litigation is resolved. According to the plaintiff’s motion, there are several reasons that the court should stay the effective date and issue a preliminary injunction, including (1) unrecoverable costs associated with the time and attention needed to review all existing non-compete agreements and notify existing and former employees that they are no longer bound; (2) unrecoverable costs associated with the risk of loss of employees, client relationships, and confidential information; and (3) the need, if the final rule is later found to be unenforceable, for employers to decide whether to enforce non-compete agreements against employees who left the employer for a competitor in the belief that the non-compete agreement was invalid (thus forcing the employee to leave their new job). According to the court’s order, a decision on that motion will be made by July 3.
The very nature of how business entities protect their intangible assets is at risk, and the final rule will change the contractual dynamic of the employer-employee relationship.
