FTC Moves to Approve Final Rule Banning Non-Competes: A Simple Explanation

Occam's Razor holds that sometimes the simplest explanation is the right one. On April 23, 2024, the U.S. Federal Trade Commission ("FTC") took such a view, announcing in a 3-2 vote along party lines that, as the U.S. agency principally responsible for regulating "competition," it has the authority and is therefore moving ahead with a draft final rule to ban most "non-competition" agreements between U.S. employers and workers. While the FTC's final rule will not require compliance for 120 days after it is published in the Federal Register, and that date still has yet to occur (i.e., you have time to learn about the rule and make a plan for compliance), it will likely be challenged in the courts as an overreach of the agency's statutory authority and may never go into effect. In the meantime, most U.S. companies should read up on the rule's requirements: it has immediate implications for your workforce and your protection of competition-sensitive information.

First, here's what you need to know about the rule:

• Allows existing non-competition agreements with "senior executives" to stay in effect. But any existing non-competition agreements with other workers are banned after the effective date of the rule, which, again, is 120 days after publication in the Federal Register.
• Bans all new non-competition agreements with workers, including senior executives,
  after the Rule's effective date.
  • The agency rationalizes that non-competes with senior executives may not be exploitative in the same way as they are with other workers but that such agreements still sufficiently harm consumers through "new companies never formed" (among other reasons). The FTC uses that as a basis to justify labeling all such agreements as anti-competitive under Section 5 of the FTC Act.
• To grandfather in old agreements for "senior executives," the final rule applies both a compensation test and a job duties test.
  • The compensation test requires at least $151,164 in total annual compensation in the preceding year (or annualized if employed for only a partial year).
  • The job duties test considers the executive's duties, rather than titles, to determine whether the person operates at the highest levels of a business entity, and therefore covers (1) officers who (2) also have "policy-making authority."
  • The FTC's comments to the final rule expressly state that physician partners of an independent physician practice would generally qualify as "senior executives."
• The rule bans clauses that "function to prevent" future employment, not just traditional non-competes, and therefore raises the specter of invalidating employee non-solicitation clauses, customer non-solicitation clauses, no-hire agreements, training/tuition/signing bonus repayment provisions, or even overly broad NDAs that have the "effect" of limiting future employment.
• Comments to the final rule make clear the FTC intended to expressly permit "garden leave" non-compete agreements, meaning that if the employee remains employed (full salary and benefits) during a period of administrative leave post-active employment during which they are subject to a non-compete, this may be permissible under the rule.
• The rule applies retroactively, meaning not only are preexisting non-competes with workers other than senior executives no longer unenforceable, but employers are required to proactively give notice by the effective date (120 days after publication in the Federal Register) to those workers, both current and former, that their existing non-competes are no longer enforceable (though that does not affect any other provisions negotiated in exchange for the non-compete, such as a severance). The final rule includes model language intended to satisfy this requirement.
• The rule applies to "workers"—including employees and independent contractors.
• The rule applies to all "employers"—there are no exemptions for industries that pushed hard to be excepted from the rule, including healthcare (particularly for-profit hospitals and medical groups), technology, manufacturing, private equity, and finance.
  • However, certain companies are exempt from the FTC's jurisdiction under the FTC Act, so they should not be subject to the rule. This generally includes banks, credit unions, savings and loan institutions, some non-profits, and air carriers.
  • That being said, the Justice Department and FTC have previously raised concerns about non-competes as violating Section 1 of the Sherman Act, which does apply to these entities.
• No prospective exemption for the C-suite, executives, or other high-wage earners on future agreements—the "senior executive" grandfathering applies only to non-competes prior to the effective date of the rule. Unlike in states that have adopted specific salary thresholds for enforcing non-competes (e.g., Colorado, Illinois, Maine, Maryland, Massachusetts, New Hampshire, Nevada, Oregon, Rhode Island, Virginia, Washington state, and the District of Columbia), the FTC's rule says whether you are on the shop floor or in the boardroom, your non-compete clause will be void in the future.
• There is a narrow exception that allows non-competes in the "sale of business" context. The final rule adopts a totality of the circumstances approach to determine whether the non-compete is entered in connection with a "bona fide" sale of a business and is "reasonable" under the circumstances. Significantly, the final rule removed the proposed rule's former 25% ownership threshold for this exception to apply; you do not need to be a "substantial owner" of a business for this exception.
• There is also an exception for "existing causes of action" making clear that the final rule does not apply if a cause of action related to a non-compete provision accrued prior to the effective date. Workers who are in breach of non-compete provisions prior to the effective date can still be sued for those breaches.
• Supersedes all state laws that are in conflict with the rule.
• The final rule provides that issuing a non-compete or otherwise failing to comply with the rule is a violation of Section 5 of the FTC Act. As a consequence, non-compliance can result in fines, penalties, and injunctive relief.
• The final rule does not address franchisee/franchisor non-competes, which the FTC is still looking into regulating.

In sum, the final rule essentially mirrors much of the language of the proposed rule announced 16 months ago, except that it: (1) grandfathers in and allows existing non-competes with senior executives to stay in effect; (2) no longer requires formal "rescission" notices to be sent to workers whose agreements are now invalid, but does require notice to those workers whose clauses are unenforceable; (3) pushes up the effective date from 180 days to 120 days from the date of publication in the Federal Register; and (4) broadens the sale of business exception so there is no formal threshold for ownership in a business being sold for that exception to apply.

Second, here's what you need to know about what's likely to come next. On April 23, 2024, the FTC held its special Open Commission Meeting and voted to issue the proposed final version of the rule. Before the rule goes into effect, it will need to be published in the Federal Register—and there is no specific date that the FTC must adhere to in making this publication. But once it is published in the Federal Register, the final rule will go into effect 120 days thereafter. Thus, employers must comply with the new rule within 120 days after it is published in the Federal Register. We anticipate that enforcement will be further delayed by one or more legal challenges to the final rule.

Though the FTC argues Occam's Razor, i.e., the agency charged with regulating "competition" can regulate "non-competition" agreements, the legal challenge will be more complicated. The Commission will be pressed to defend the lack of specific delegation of authority under Section 5 of the FTC Act by Congress to regulate contracts historically governed by state law. Indeed, two of the Commissioners voted against adopting the final rule for this reason.

Third, regardless of whether the rule goes into effect and survives a court challenge, it is part of a growing trend towards greater scrutiny of non-competition agreements and worker oversight by the federal government, in particular by the FTC. The FTC and Department of Labor (DOL), on August 30, 2023, signed a Memorandum of Understanding that sets out coordination in investigations and sharing of information between the DOL and FTC related to labor and competition issues. The MOU specifically targets "one-sided and restrictive contract provisions, such as non-compete and non-disclosure agreements" and specifically calls out as a mutual area of interest misclassification of employees, labor market concentration, algorithmic bias and other areas that typically are outside the provenance of the FTC. The FTC's striking expansion of authority is in keeping with Commissioner Bedoya's February 2, 2024, remarks proposing more robust FTC involvement particularly in the area of worker misclassification.

Fourth, even if the federal ban never takes effect, it is part and parcel of a growing nationwide movement to narrow or ban the use of non-competition and other restrictive covenants. While some states have banned them in most contexts, such as California, Minnesota, Oklahoma, and North Dakota, many others have limited them to higher-wage earners only or passed other restrictions on their use. Even commercially focused states (such as New York) have debated legislation that would effectively narrow non-competes to a limited class of key personnel. In December 2023, New York Governor Kathy Hochul vetoed a bill that would have banned non-compete clauses in the state—with no exceptions—principally over concerns that the salary threshold pushed by the legislature was too high.

Fifth, the FTC's one-size-fits-all rule has the potential to impact how businesses large and small operate by enabling executives and other key personnel to bring intellectual property, including strategic plans and inside thinking, to direct competitors without a simple legal remedy to stop it from happening. This potential change is occurring at a particularly transformative time in the labor market, with an increasingly remote workforce that is mobile, more likely to switch jobs and flexing increasing bargaining power, with technology making it much easier for commercially sensitive data to be transferred from one location to another. Trade secret litigation in particular, is likely to grow (and has been growing) as a consequence of these events.

Companies would be wise to take several active measures to get ahead of the new non-competition landscape and to preserve competition-sensitive data that may not be able to be preserved through non-competition covenants.

This means you should consider at least the following steps:

• Inventory all agreements that could implicate the FTC's rule. Non-competition, non-solicitation, non-disclosure, no-hire, repayment, and other clauses may be found in offer letters, employment agreements, independent contractor agreements, severance agreements, operating agreements, signing bonus agreements, equity incentive award agreements, partnership agreements, stock option and profits interest unit agreements, and benefits plan agreements, among other documents. Create a list of those agreements, plans, and other materials that could be impacted by this rule and be ready for any notice that might need to be provided when the rule goes into effect.
• Develop a game plan for updating agreements, providing required notice, and communicating with current and former employees impacted by this rule.
• Beef up both the exit and entrance procedures for employee onboarding and off-boarding to protect your company data. Implement a robust off-boarding process with departing employees that emphasizes an ongoing duty to protect, and to not disclose, company proprietary information and/or trade secrets. Establish procedures for employees to return all company-owned property prior to departure.
• Remind employees of their ongoing duty to preserve, and not to disclose, company proprietary information and/or trade secrets on an intermittent basis. This may take the form of periodic employee training modules or requiring employees to acknowledge a log-in notification message when accessing information systems containing sensitive company information. Using these mechanisms will become ever more important as our laws move away from using contractual restrictions on the flow of top-sensitive-information-bearing talent from one competitor to another.
• Take technical measures to protect competition-sensitive data now. This means limiting information-system access to authorized company users. Create and enforce access-control protocols (i.e., network, file, and individual document access levels) that safeguard company proprietary information and/or trade secrets. Implement data-security policies and procedures that further describe employees' roles and responsibilities, coordinate among organizational entities, and allow for regular compliance monitoring. Eliminate all information-system access when no longer required. Consider data encryption and other technical measures to protect data when transmitted electronically. Prohibit downloading documents and other material to portable drives and monitor usage of laptops and other devices to forward or email sensitive documents.

The final rule, if enforced, would mark an extraordinary sea change in the law and business practice in the United States. Even the EU allows non-competes for certain employees (principally to protect IP and key personnel). The FTC messages its non-compete rule as an instrument of "economic liberty"—language that, quixotically, one would typically expect to find embedded in conservative policy manifestos rather than a federal agency dramatically expanding power to regulate private contracts. But the FTC estimates that prohibiting non-compete clauses could increase workers' earnings by $250 to $296 billion per year and result in greater economic liberty and worker freedom. That may be true, but there will be costs associated with upending the last half century of state law in this space too. Those will surely come into focus now as companies work to come into compliance with this new regulation. Stay tuned to this space as we track further developments on the FTC's rule to ban non-competes.