After more than a year of questions and more than 26,000 comments on the Proposed Rule first released on January 5, 2023, commissioners of the Federal Trade Commission (“FTC”) voted 3-2 on April 23, 2024 to implement an amended final version of the rule, effectively banning noncompete agreements nationwide after it comes into effect (likely in late August or early September, barring court intervention). The FTC’s vote releases untold numbers of future employees from the burden of covenants not to compete with their current or former employers and continues a recent tidal wave of federal worker-friendly statutes, many of which resemble laws that used to exist only in California.
With two already-filed cases in Texas, it could still be a long road to enforcement, particularly in an election year, but employers would be wise to not wait much longer to assess how they might operate and protect their business interests without noncompetition clauses.
BFKN previously published a detailed writeup of the Proposed Rule. Here’s what to know about the proposed Final Rule:
Effective Date
The Final Rule is scheduled to become effective 120 days after its publication in the Federal Register, but publication may be delayed by court cases seeking injunctions.
The Final Rule does not apply where a cause of action related to a noncompete accrues before the effective date.
Bans New Noncompetition Clauses
Retaining a key feature of the original Proposed Rule, the Final Rule bans new noncompetition clauses and agreements with all workers, including senior executives, after the effective date. As we previously discussed, this catchall ostensibly includes employees and independent contractors, as well as volunteers, interns, and anyone else who works for an employer or contractor. Noncompetition covenants entered into after the Effective Date will be deemed an “unfair method of competition” under Section 5 of the FTC Act and will expose offending employers to potential civil claims and penalties.
Voids Most Existing Noncompetition Clauses
For existing noncompetes, the Final Rule provides for limited grandfathering for senior executives only—while existing noncompetes of senior executives can remain in force, existing noncompetes with workers outside of the C-suite will not be enforceable after the Final Rule comes into effect. To thwart any clever workarounds, the FTC points out that by its estimate, fewer than one percent (1%) of workers would qualify for “senior executive” status under the Final Rule. The term is limited to those workers earning in excess of $151,164 and occupying so-called “policy-making positions” within their organizations. While this narrow definition points clearly to executive leadership, there remains a sliver of hope for flat organizations with highly paid employees.
Includes a Business Sale Exemption
The Final Rule includes an exception for noncompetes that are ancillary to the sale of a business that is similar to one in the original Proposed Rule. However, after considering public comments concerning the ownership percentage threshold, the Final Rule no longer includes the proposed requirement that the restricted party be “a substantial owner of, or substantial member or substantial partner in, the business entity” to fall under the exception. The FTC notes that, “to address commenters’ concerns that employers will use sham transactions, stock-transfer schemes or other mechanisms designed to evade the rule, [the Final Rule] requires that, to fall under the exemption, a noncompete must be entered into pursuant to a bona fide sale.”
As we earlier noted, where the need for a noncompetition covenant is a pressing business matter, the structure of any transactions under consideration must be carefully considered.
Legal Challenges On the Horizon
Whether or even when the rule actually comes into effect remains to be seen. The rule has already been challenged in court, and we anticipate further challenges over the coming weeks.
First out of the gate was a lawsuit filed by Ryan, LLC, a Texas-based tax advisory firm, which filed suit in the Northern District of Texas on April 23. Ryan LLC v. FTC, Case No. 3:24-cv-986. Following an established pattern in other recent challenges to agency actions, Ryan’s suit alleges (1) that the FTC lacks the authority to issue the rule, invoking the now-famous “major questions doctrine;” (2) that the FTC lacks the authority to issue any rules because Congress’ grant of authority to the FTC itself is invalid under the “nondelegation doctrine” that prohibits overbroad or vague delegations of authority to administrative agencies; and (3) that the structure of the FTC itself is unconstitutional because the President lacks the authority to remove the FTC commissioners at will.
The U.S. Chamber of Commerce wasn’t far behind, filing suit on April 24, together with a coalition of other business groups in the Eastern District of Texas. Chamber of Commerce et al. v. FTC et al., Case No. 6:24-cv-148. The Chamber’s suit claims (1) that the rule falls outside the FTC’s statutory authority in various ways; (2) that Congress’ delegation of power to the FTC is invalid; (3) that the rule is impermissibly retroactive because of its effect on pre-existing agreements; and (4) that the FTC acted “arbitrarily and capriciously” in adopting the rule, in violation of the Administrative Procedures Act.
Both suits seek, among other things, declaratory and injunctive relief pausing the FTC’s enforcement of the rule pending resolution of these challenges. We anticipate that others filing suit over the coming weeks and months will make similar claims and seek similar relief.
Ultimately, it seems likely that injunctive relief will issue in one or more of these cases and that the future of the FTC rule is apt to be decided by the U.S. Supreme Court, as has been the case with many other high-profile regulatory actions over the last decade.
Employers Should Prepare Now
Employers should not hold out too much hope that the lawsuits challenging the Final Rule will save them from eventually needing to make changes to their employment agreements and noncompetition clauses. One or more court injunctions would stay its enforcement, but if the Final Rule is later cleared to go into effect, the FTC and aggrieved workers may still be able to make claims based on violations occurring while the injunction was in force.
Such claims may, in addition to challenging traditional noncompetes, take aim at other business restrictions such as confidentiality, non-disclosure, or non-solicitation covenants. Such restrictions, though not expressly banned, may fall within the definition of “noncompete clause” if they either “prohibit[]” a worker from, “penalize[]” a worker for, or “function[] to prevent” a worker from (A) “seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition”; or (B) “operating a business in the United States after the conclusion of the employment that includes the term or condition.” Notably, over the past year, other agencies such as the National Labor Relations Board and the Securities and Exchange Commission have each targeted confidentiality, non-disclosure, and non-solicitation covenants as potentially unlawful under their own operative statutes. Those other challenges will still be out there regardless of what happens with the FTC’s Final Rule.
At a minimum, inventory and close review of any agreements containing restrictive covenants now in existence and expected to last more than six months should happen now. Employers should also start thinking about the risks and rewards of various approaches during the pendency of any litigation, and how they want to manage those legal risks while ensuring that their business needs are met. For many employers, it may be advisable to take a conservative approach and act as if the Final Rule is in effect unless and until all legal challenges are resolved. Others, however, might conclude that their business needs justify acting on the assumption that the Final Rule will not in fact become effective in its current form, and assuming some risk that this assumption proves wrong.
In addition, employers should prepare to comply with the Final Rule’s requirement that, on or before the effective date, they notify current and former employees subject to noncompetes rendered unenforceable by the Final Rule that their noncompetes are unenforceable, with the exception of those for whom the employer has no record of a street address, email address, or mobile telephone number. Notably, the Proposed Rule’s original requirement that employers affirmatively rescind those unenforceable noncompetition provisions was removed in the Final Rule, and the FTC provided a model notice that employers can use. These steps should ease the administrative burden of the notice requirement.
We Can Help
BFKN’s Compensation & Employment and Antitrust & Commercial Competition Groups have decades of experience in counseling companies and litigating disputes about restrictive covenants and employee competition matters, as well as helping companies smartly navigate compliance issues pertaining to restrictive covenants. Please contact us to discuss any of these issues.
Key Contacts
Antitrust & Commercial Competition
- Edward F. Malone | T. 312.629.7310 | ed.malone@bfkn.com
- Owen H. Smith | T. 312.629.5125 | owen.smith@bfkn.com
Compensation & Employment
- Allison N. Powers | T. 312.629.5130 | allison.powers@bfkn.com
- Corwin J. Carr | T. 312.984.3190 | corwin.carr@bfkn.com
