As we noted in a contemporaneous post, the Federal Trade Commission (FTC) voted on Tuesday in a 3-2 decision to pass a rule banning nearly all existing and future non-compete clauses. This rule would apply nationwide, notwithstanding state laws that permit such clauses. Following the submission of more than 26,000 public comments during the public comment period, the vote occurred at a Special Open Commission Meeting. If the final rule goes into effect (more on that below), the FTC’s action will send shockwaves through every sector of U.S. business (if it has not already).
The final rule
As laid out in a corresponding fact sheet published by the FTC after the Special Open Commission Meeting, the final rule categorically bans the use of new non-competes with all workers, deeming it an “unfair method of competition” under Section 5 of the FTC Act (“Section 5”) for any employer to enter into a non-compete with a worker after the rule’s effective date. However, there are several important carve-outs and nuances to consider.
Carve-out for existing non-competes with senior executives
For existing non-compete agreements as of the final rule’s effective, the final rule makes such agreements unenforceable for all workers except for “senior executives,” defined as workers that earn more than $151,164 annually and in a “policy-making position.” For senior executives, employers may leave existing non-compete clauses in place, but cannot execute new non-compete agreements after the effective date without violating Section 5.
Exception for the sale of a company
Importantly, as we discuss in detail in this post, the rule makes an exception for non-compete agreements entered in the context of certain business transactions. The exception leaves intact non-compete clauses entered 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.”
Notification provision
Employers with existing non-compete agreements (other than for senior executives) must inform their workers that such clauses are no longer enforceable by the effective date. The final rule also prohibits employers from representing to workers that they are subject to a non-compete clause.
Non-competes broadly defined
The final rule broadly defines the term “non-compete clause” to include an oral or written term or condition of employment that prohibits a worker from, punishes a worker for, “or functions to prevent a worker from” seeking or accepting work elsewhere or operating a business after the conclusion of such employment. That said, under the final rule, the continued use of non-disclosure agreements, as well as customer and employee non-solicitation agreements, appears to generally be permissible – unless they are so broad as to fit within the final rule’s definition of “non-compete clause” and so long as they comply with applicable state law.
Additionally, the rule covers all paid and unpaid workers, including independent contractors, interns, and volunteers. As to workers at not-for-profit entities, that is more of a gray area, as we detail in this post. The rule also does not address franchisee and franchisor agreements.
Commissioner findings and 3-2 vote
The FTC commissioners voted down party lines, with the three Democratic commissioners voting to pass the rule and the two Republican commissioners voting against its passage. The rule’s proponents, Chair Khan and Commissioners Slaughter and Bedoya, argued that non-competes inhibit the labor market by preventing mobility and suppress innovation by preventing workers from forming new business and developing new technology. The FTC indicated that the business justifications behind imposing non-competes on workers, such as protecting investments in employee training and safeguarding intellectual property or trade secrets, do not necessitate a narrower rule.
Commissioners Holyoak and Ferguson criticized the rule, arguing that the FTC is seeking to usurp the role of the legislature by making policy decisions. More specifically, the commissioners argued that promulgating a substantive rule exceeds the authority that Congress granted to the FTC, citing concerns under the Administrative Procedure Act and the nondelegation doctrine. These commissioners clarified that their rejection of the final rule should not be interpreted as an across-the-board approval of non-competes, stating that the FTC can still prosecute anticompetitive non-compete agreements on an individual basis where the law supports such an action – just not by such broad rulemaking action.
When will the final rule go into effect?
The final rule will go into effect 120 days from the date it is published in the Federal Register (which is expected to take place in the short term). There have, however, already been legal challenges to the final rule on multiple grounds, including that the FTC does not have the authority to regulate this issue – as previewed by the two dissenting Commissioners – and also that the FTC did not sufficiently tailor the rule to the purpose/justification underlying it, which could delay the effective date (if not invalidate the rule altogether). The U.S. Chamber of Commerce, which filed one such legal challenge yesterday in Texas federal court, released a statement following the Special Open Committee Meeting stating that “the FTC has never been granted the constitutional and statutory authority to write its own competition rules. Non-compete agreements are either upheld or dismissed under well-established state laws governing their use. Yet, today, three unelected commissioners have unilaterally decided they have the authority to declare what’s a legitimate business decision and what’s not by moving to ban non-compete agreements in all sectors of the economy.”
How should companies respond?
While the final rule remains pending, businesses that utilize non-compete clauses should begin to analyze the rule’s potential application to their business practices and work with counsel to develop new strategies to protect their competitive interests when workers leave to join a competitor, found a competing business, or develop a competing technology. Companies are likely to receive inquiries from their employees on the status of existing non-competes. It is critical to consult experienced counsel before responding to such inquires or taking any other affirmative action that may affect employers’ ability to enforce existing non-competes or the potential status of those non-competes under the new rule. If the final rule is implemented, employers should expect the same aggressive enforcement that has been a hallmark of the antitrust landscape in the Biden era.
Who should I contact for more information?
Various teams at Reed Smith, including the Antitrust & Competition, Labor & Employment, Private Equity, and Litigation & Dispute Resolution teams, have been closely monitoring this issue and will continue to track developments regarding the implementation of and challenges to the final rule, as well as the FTC’s enforcement of the final rule if and when it goes into effect. Please reach out to your usual Reed Smith contact or the authors of this alert for additional information.
Client Alert 2024-088
