Unless you have been living under a rock the past two months, you likely heard that on April 23, 2024, the Federal Trade Commission (FTC) approved (3-2) a new rule that effectively bars companies from enforcing non-compete clauses for nearly all employees and independent contractors. Yes, you read that right – independent contractors count, too.
The rule, as passed, prohibits companies from entering into any new non-compete agreements that are not part of a bona fide sale of a business. Moreover, the rule allows existing non-compete agreements with “senior executives” to survive. However, all other existing non-compete agreements will be unenforceable if (more on that below) the rule becomes effective on September 4, 2024, as scheduled. It will also be unlawful to enter into any new non-compete agreements (even with senior executives outside the sale of a business context).
Under the rule, “senior executives” are individuals in a policy-making position earning at least $151,164 annually. With few exceptions, “senior executives” are limited to a company’s president, CEO, other chief executives, any other officer of a company who has policy-making authority or their equivalent (such as a vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer). Essentially, unless an employee has final authority to make policy decisions that control significant aspects of an entire company, an employee is not a “senior executive.” And before you ask, no, just giving an employee the title of “executive” or “president” does not count. This is also not the same definition of executive under the Fair Labor Standards Act (FLSA) (for purposes of determining whether an employee is exempt from overtime). In fact, unlike the FLSA regulations, if employees or “executives” can only advise or exert influence over a company’s policy decisions, they are not “senior executives” for purposes of the FTC’s rule. “Division heads” and the heads of a subsidiary of a larger business enterprise also don’t count as “senior executives” in the eyes of the FTC – even if they have final policy – making authority over that division or subsidiary.
The FTC’s rule does not stop there. In addition to making existing non-compete agreements unenforceable, companies with existing non-compete agreements with non-senior executives must provide clear and conspicuous notice to those workers by September 4, 2024, that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. Fortunately, the FTC has provided model notices employers can use in seven languages.
Wait, there’s more! In addition to making it unlawful to enter into a new non-compete agreement with workers and enforcing a non-compete agreement with non-senior executives, the FTC’s rule also makes it unlawful to even represent to workers (other than those senior executives with existing non-compete agreements) that they are subject to a non-compete agreement. So, employers pay attention; the FTC takes the position that it is unlawful to even suggest to workers (other than those senior executives with existing non-compete agreements) that they are subject to any kind of non-compete agreement.
Notably, while the FTC rule bans almost all non-compete agreements between employers and employees/independent contractors, it does not explicitly ban non-disclosure agreements, customer non-solicitation agreements or employee non-solicit agreements. Therefore, while the non-compete portion of an employment contract may become unenforceable on September 4, 2024, all other aspects of those agreements will remain valid and enforceable, provided they do not otherwise violate another state or federal law or effectively constitute a “non-compete clause” as defined by the FTC rule.
Speaking of the definition of a “non-compete clause,” the FTC defines such clause as:
Therefore, if a company has a very broad non-disclosure agreement, customer non-solicitation agreement or employee non-solicit agreement with a worker that effectively prevents a worker from working in the U.S., the FTC will likely find that provision unlawful and unenforceable.
Importantly, the FTC rule does not limit or affect the enforcement of state laws that restrict non-compete agreements where those state laws do not conflict with the FTC rule, but the FTC’s rule preempts state laws that conflict with it. Simply put, the FTC rule does not preempt a state law that provides greater protection to workers when it comes to non-compete agreements. Therefore, if a state law prohibits non-compete agreements (such as California, Colorado, Oklahoma, North Dakota and Minnesota) or a state passes a new law banning all non-compete agreements, then those state laws will apply. Moreover, if a state prohibits certain non-solicitation agreements (such as Hawaii), then those non-solicitation agreements are still unenforceable even though the FTC rule does not ban them.
While all of this sounds like very bad news for companies who have used non-complete provisions to protect legitimate business and economic interests, all hope is not lost because as we alluded to at the beginning of this article, almost immediately after the rule was announced, a series of lawsuits were filed seeking to stop or delay the rule’s effective date as well as challenging the FTC’s authority to promulgate such a rule in the first place. Each of these lawsuits effectively argues that in banning non-compete agreements, the FTC violated federal law because:
These lawsuits remain pending, but on July 3, 2024, the Honorable Ada Brown of the United States District Court for the Northern District of Texas temporarily blocked the FTC from enforcing its rule banning noncompete agreements against the plaintiffs in the case only – tax preparation company Ryan LLC and the U.S. Chamber of Commerce – and suggested the regulation should be struck down entirely. Note that this is just a preliminary injunction and applies only to the plaintiffs of the action, but Judge Brown did indicate that she would make a final decision on the merits by August 30, 2024. Notably, Judge Brown agreed with the challengers to the FTC rule that the FTC’s statutory authority for promulgating the rule did not authorize substantive rulemaking, which is what the FTC rule purported to do. While this is good news for Ryan and the U.S. Chamber of Commerce, the rest of the country needs to wait and see what Judge Brown (or other federal judges) does when ruling on the merits of the challengers’ claims.
Moreover, on July 23, 2024, the Honorable Kelley Brisbon Hodge of the United States District Court for the Eastern District of Pennsylvania agreed with the FTC and denied a preliminary injunction request filed by ATS Tree Service LLC. Like Ryan LLC and the U.S. Chamber of Commerce, ATS sought to delay the FTC rule’s effective date and prevent its enforcement, arguing that without noncompete clauses, it would lose the return on its investment in specialized employee training. Judge Hodge ultimately determined that the alleged harm to ATS to be too speculative and noted that ATS was unlikely to succeed on the merits. In fact, contrary to Judge Brown, Judge Hodge found that the FTC does have the authority under the FTC Act to promulgate substantive rules to prevent unfair methods of competition.
Regardless of what happens in the federal courts in Texas and Pennsylvania, the losing party(ies) will almost certainly appeal to the federal court of appeals. Then, the losing party(ies) at the federal appeals court will almost certainly appeal to the U.S. Supreme Court. This is all to say that even if the federal district court stops the FTC rule from becoming effective (or strikes it down entirely), that could change after the FTC appeals the ruling, which could change again depending on how the U.S. Supreme Court rules. There are a lot of open questions, but we do know that we will not have a decision from the U.S. Supreme Court for many months.
Burn all their non-compete agreements? Find a way to make everyone a “senior executive?” Force those employees who signed non-compete agreements to give back the bonus, raise or stock they were granted to sign the non-compete agreements? None of the above.
Instead, while we wait to see what the courts do with the legal challenges to the FTC rule, employers should take this time to take inventory of all individuals with whom they have non-compete agreements in the event those workers need to be notified that those agreements are no longer enforceable.
Now is also a good time to determine whether those agreements are with senior or non-senior executives. And yes, this means doing a full review to determine if those individuals actually meet the definition of “senior executive” under the FTC rule (e.g., are they really senior executives or “senior executives in name only”). This may also mean employers need to dig into whether those “executives” actually have final authority to make policy decisions that control significant aspects of an entire company.
This would also be a good time to do a full review of the actual agreements to consider if (1) they are actually necessary (i.e., can a non-solicit or non-disclosure agreement accomplish the same goal) and (2) they comply with applicable state law. Employers routinely prepare “form” non-compete agreements that are enforceable in a few states but are unenforceable (or outright unlawful – sometimes with fines/penalties attached for non-compliance – in many other states).
Employers should also monitor what is coming out of the National Labor Relations Board (NLRB) (and yes, this includes non-union employers) because the NLRB has recently started cracking down on non-compete and employee non-solicit agreements, arguing that such agreements tend to chill employees from engaging in protected concerted activity, such as talking about leaving their existing employer for a competitor down the road because their competitor is unionized and may have better wages and benefits.
At the end of the day, now is not the time for employers to panic or sit on their hands when it comes to the FTC rule. While it is very possible that the FTC may be delayed (or never become effective), it is also possible that the rule will become effective on September 4, 2024 – which is not far off. The September 4, 2024, effective date, may also be paused for a period of time or halted entirely by the district court, only to be reinstated on very short notice by the federal appeals court. As such, employers should start preparing now in the event they have to issue the required notices with a quick turnaround.
Finally, even if the FTC rule is struck down in its entirety, there has been a trend in recent years for states to take matters into their own hands and restrict the usage of non-compete agreements (or ban them outright). Therefore, employers want to ensure they stay on top of the law in every state where they have workers.
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