FTC Issues Final Rule Banning Non-Competes

Over a year after it proposed a rule banning virtually all non-compete agreements, the Federal Trade Commission (“FTC”) voted to issue its long-awaited final rule.  The final rule is substantially the same as the proposed rule, with a new exception for “senior executive” agreements that were in place before the final rule’s effective date.  The rule’s effective date could be delayed by the lawsuits just filed by the United States Chamber of Commerce and other trade groups, which challenge the authority of the FTC to regulate issues of such vast economic and political significance.

Employers currently using non-compete agreements should consider making a plan for compliance if the final rule goes into effect.  These questions and answers below are applicable to entities subject to the FTC Act (the FTC Act does not apply to many nonprofit corporations[1], banks, savings and loan institutions, federal credit unions, or common carriers, among others).

What are the key elements of the final rule?

• The final rule bans new post-employment non-competes with all workers (including independent contractors) after the final rule’s effective date.  Specifically, the final rule provides that it is an unfair method of competition—and therefore a violation of the FTC Act—for employers to enter into non-competes with workers after the effective date.
• Existing post-employment non-competes with workers other than senior executives are not enforceable after the effective date of the final rule. The final rule makes it an unfair method of competition to enforce or attempt to enforce a non-compete clause, or to represent that a worker (except for a senior executive) is subject to a non-compete clause after the effective date.
• For senior executives, existing non-competes can remain in force.
• Before the effective date, employers must give notice to current and former employees that existing non-competes are no longer enforceable.
• There is a limited exception allowing new non-competes in certain “sale-of-business” agreements.

When does the final rule go into effect?

The final rule goes into effect 120 days from the date of publication in the Federal Register.  The current expected effective day is late August or early September, 2024, subject to any delays caused by litigation.

What is considered a “non-compete clause”?

Prohibited non-compete clauses are any term or condition of employment (including contracts and employer policies or handbooks, whether written or oral) that prohibit a worker from, penalize a worker for, or function to prevent a worker from seeking or accepting other work after the conclusion of employment.  Also prohibited are clauses that would prohibit, penalize, or function to prevent a worker from starting their own business after they leave employment.

Importantly, the rule does not prohibit employers from limiting employees from competing during employment.  The final rule also does not apply to non-competes if they restrict only work outside the U.S. or starting a business outside the U.S.

The FTC declined to carve out an exception for “forfeiture-for-competition” clauses, which are often a component of deferred compensation arrangements for executives.  These types of clauses will likely be considered prohibited non-compete clauses under the final rule.

What about confidentiality or non-solicitation agreements?

Well-drafted confidentiality, non-disclosure, and non-solicitation agreements are permissible under the final rule as long as they are not so broad that they would functionally prevent a worker from working for another employer in the same field. Under the FTC’s explanation, an agreement in which the worker agrees not to disclose certain confidential information to a competitor would not prevent a worker from seeking work with a competitor or accepting such work after a worker leaves their job.

Similarly, a non-solicitation agreement that restricts who a worker may contact after leaving a job, but does not prevent a worker from seeking or accepting other work or starting a business is not a prohibited non-compete clause.  Whether a non-solicitation agreement rises to the level of a non-compete, however, is a fact-specific inquiry.

Who is considered a “senior executive”?

In general, the term “senior executives” refers to workers earning at least $151,164 per year AND who are in a “policy-making position.”  A “policy-making position” is defined as:

• An entity’s president, chief executive officer or the equivalent.  These positions are automatically considered “senior executives” if they meet the compensation threshold.  Employers do not need to consider the further element of “policy-making authority”;
• Any other “officer” of a business who has “policy-making authority”;
  • “Officer” includes a vice president, secretary, treasurer, or principal financial officer, comptroller or principal accounting officer and other person routinely performing corresponding functions.
  • “Policy-making authority” means final authority to make policy decisions that control significant aspects of a business entity or common enterprise.

The FTC believes fewer than 1% of workers are estimated to be senior executives under the final rule’s definition, which the FTC meant to include only workers likely to have “bespoke, negotiated agreements—those with the highest level of authority over the organization.”

In its explanation of the final rule, the FTC noted that “C-suite” executives will likely be senior executives.  The FTC also explained that partners in a business, such as physician partners of an independent physician practice, would also generally qualify as senior executives under the duties prong, and would also likely fall under the sale of business exception if the partner leaves the practice and sells their shares of the practice.

Important to note is that having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise is not considered “policy-making authority.”  The FTC gave the example of a business operating in several states with its operations in each state organized as their own corporation. Assuming these businesses and the parent company are considered a common enterprise, the head of each state corporation would not be a “senior executive.” Rather, only the senior executives of the parent company (or whichever company is making policy decisions for the common enterprise) would qualify.

Are there any other exceptions?

Yes, non-competes 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 are not considered unfair competition. The proposed rule required the seller to hold at least a 25% ownership interest in the business entity, but this was not incorporated into the final rule.

The final rule only applies to non-competes between businesses and workers. Although the FTC sought comment on franchisor/franchisee relationships, the final rule does not apply to non-competes in franchisor/franchisee contracts (however, these are still subject to other antitrust laws).

Notably, causes of action that accrued prior to the effective date are excepted from the final rule. The FTC’s guidance states that it adopted this exception “to be clear that the final rule does not render any existing non-competes unenforceable or invalid from the date of their origin. Instead, it is an unfair method of competition to enforce certain non-competes beginning on the effective date.” Thus, if the final rule goes into effect, non-competes may still be enforced where the cause of action accrued prior to the rule’s effective date.

Finally, it is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a non-compete clause where a person has a good-faith basis to believe that the ban is inapplicable.

What type of notice do employers need to provide under the rule?

Prior to the effective date of the final rule, employers will need to provide notice to each worker who is subject to a non-compete in violation of the rule. The notice must identify the person who entered into the non-compete clause with the worker and be provided via mail, hand delivery, email or text message to the worker. The FTC has issued a model form of notice in various languages.  If an employer has no record of a street address, email address, or mobile telephone number for a worker, the employer is exempt from the required notice provision for that worker.

What about state non-compete laws?

State laws are not preempted if they do not conflict with the final rule, and states may continue to enforce laws that restrict non-competes if the scope of the state restrictions is narrower than the final rule.

What should employers do now?

Do not immediately send out notices to workers that their non-competes are unenforceable.  There is a strong chance that the final rule’s implementation will be enjoined by a court before its scheduled effective date, so keep abreast of the status of litigation challenging the final rule. However, it may be wise to prepare to send notices in case the rule goes into effect. This includes determining which past and current workers are subject to a non-compete that would be in violation of the final rule, and determining whether the business maintains contact information for these workers. Some businesses may also determine that it has “senior executives” not subject to a non-compete that should be before the final rule goes into effect.

Winthrop & Weinstine continues to monitor the situation and we will update you on this topic as the litigation unfolds.  Employers should keep in mind that narrowly-tailored agreements that protect legitimate business interests are more likely to be enforceable under the current framework of state and federal law. For more information about employment agreements, including non-competition, non-disclosure, and non-solicitation provisions, please feel free to reach out to any member of our Employment team.

[1] Not all entities claiming tax-exempt status as nonprofits fall outside the FTC’s jurisdiction. To be exempted from the FTC’s jurisdiction, a corporation must be organized for and actually engaged in business only for charitable purposes, and the corporation’s income must go toward public interests, rather than allowing the corporation or its members to derive a profit.