Federal Trade Commission Issues Final Rule Banning Non-Competition Agreements - jason wiener

On April 23, 2024, the Federal Trade Commission (“FTC”) issued the Non-Compete Clause Rule (“Final Rule”) prohibiting non-competition agreements nationwide.[1] Noncompetition agreements (“non-competes”) generally are provisions in contracts whereby an employee agrees not to enter into competition with an employer after their employment period with that employer is over. While state statutes have targeted non-competes on their own prior to the Final Rule, ranging from full prohibitions to only permitting non-competes that are “no broader than [] reasonably necessary”,[2] the FTC’s Final Rule bans them altogether and supersedes state law. This blog post will discuss the Final Rule in detail, its application and practical effects, and the alternative agreements employers might use to protect their business interests otherwise.

The Final Rule

Generally. Non-competes generally are provisions in contracts whereby an employee agrees not to enter into competition with an employer after their employment period with that employer is over. For example, a non-compete might prohibit an employee from taking a similar position with a competing company after their current employment ends. Non-compete provisions have been the target of state, and now federal, regulations because of their effect on worker well-being and the economy. The FTC’s rationale for the Final Rule is that non-competes are harmful to workers, explaining “non-competes are a widespread and often exploitative practice…forc[ing] workers to either stay in a job they want to leave or bear other significant harms and costs, such as being forced to switch to a lower-paying field, being forced to relocate, being forced to leave the workforce altogether, or being forced to defend against expensive litigation.”[3] Further, the FTC believes the Final Rule will lead to new business formation each year, create higher earnings for workers, and is expected to lower health care costs.[4]

Unfair method of competition. The Final Rule provides that it is an unfair method of competition and violation of Section 5 of the Federal Trade Commission Act (15 U.S.C. 45) for an employer to enter into a non-compete clause with a worker, enforce an existing non-compete clause with a worker, or to represent that a worker is subject to a non-compete clause, beginning on the final rule’s effective date, which is anticipated to be September 4, 2024.[5] As noted, this is a federal law and supersedes state laws. States may still enact rules regarding non-competes, but they cannot alter the baseline prohibition of the Final Rule.

“Non-compete” definition. The Final Rule defines a “non-compete” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) seeking or accepting work…with a different person where such work would begin after the conclusion of the employment that includes [that] term or condition; or (ii) operating a business …after the conclusion of the employment that includes [that] term or condition.[6] A noncompete could be a contractual term or just a workplace policy, and may be oral or written.

Notably, this is a broad definition because it goes being just terms that expressly “prohibit” or “penalize” a worker, and includes anything that could “function to prevent” a worker from seeking other work. Through its inclusion of the term “functions to prevent,” the definition of “non-compete” in the Final Rule applies to terms and conditions in worker agreements that would, in practice, stop a worker from being able to seek or accept other work or to start a new business after their employment ends. This term does not categorically prohibit other types of restrictive employment agreements, for example, nondisclosure agreements (“NDAs”), training repayment agreement provisions (“TRAPs”), and non-solicitation agreements[7] because these types of agreements do not necessarily amount to non-competes. However, the term “functions to prevent” clarifies that, if an employer adopts a term or condition in a worker agreement that is so broad that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a “non-compete” clause under the Final Rule. Whether a given restrictive covenant rises to the level of being a functional non-compete will turn on the facts and circumstances of particular covenants and the surrounding market context. Accordingly, an NDA, TRAP, or non-solicitation agreement that is overly broad, could be unlawful under the Final Rule. These are discussed further below.

“Worker” definition. Next, we consider who the Final Rule protects. The Final Rule broadly applies to non-compete agreements affecting virtually all workers, not just those classified as “employees.” The Final Rule defines “worker” as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title…, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” [8] Accordingly, the Final Rule will apply to employers hiring all types of workers, whether through employment agreements, independent contractor agreements, or otherwise.

Exceptions and applicability. The Final Rule contains a few exceptions. First, there is a minor carve out from these rules for existing non-competes for “senior executives,” which is defined in the rule as a person in a policy-making position for a business, such as a president, CEO, or other similar officer, who received annual compensation of at least roughly $151,164.[9] Existing non-competes for such senior executives predating the Final Rule’s effective date are still enforceable.[10] However, new non-competes after the effective date are prohibited for all workers, including senior executives.

Further, is unclear whether this Final Rule – prohibiting new non-competes, enforcing existing non-competes, and representing workers are subject to non-competes – applies to all types of organizations. The FTC recognized that the Final Rule does not apply to entities that are not subject to the FTC Act, including certain financial institutions (such as banks) and nonprofit entities.[11] However, there is some ambiguity concerning its applicability to nonprofits because the FTC has taken the position that a nonprofit corporation will be subject to the Commission’s jurisdiction if it is a “corporation,” defined, in part, under the Final Rule as an entity that is “organized to carry on business for its own profit or that of its members.”[12] The FTC explained that it follows a two-part process, established under prior FTC cases, to determine whether an organization is actually organized for profit, and within the FTC’s (and the Final Rule’s) jurisdiction, which includes asking: “…whether the corporation is organized for and actually engaged in business for only charitable purposes,… and whether either the corporation or its members derive a profit.”[13] Because of this additional test, nonprofits are not necessarily categorically exempt from the Final Rule, and would be safest avoiding non-competes until the Final Rule has been tested or clearer guidance given.

Finally, the prohibition against non-compete clauses does not apply to a non-compete clause that is entered into pursuant to a bona fide sale of a business entity, of a person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.[14] So if a person sells their business on the condition that they will not then compete with the sold entity after the fact, such a restriction would be allowed.

Notice requirement. Lastly, the Final Rule requires employers to notify workers who have existing non-competes that are unlawful under the Final Rule that such non-competes are no longer in effect and will not be enforced.[15] The company who employed the worker under the non-compete must provide clear and conspicuous notice to the worker by the Final Rule’s effective date that the non-compete clause will not be, and cannot legally be, enforced against the worker.[16] However if the employer has no record of a street address, email address, or mobile telephone number for the worker, the employer is exempt from this notice requirement.[17] The FTC provides model language that employers can use to notify employees:[18]

“A new rule enforced by the Federal Trade Commission makes it unlawful for us to enforce a non-compete clause. As of [DATE EMPLOYER CHOOSES BUT NO LATER THAN EFFECTIVE DATE OF THE FINAL RULE], [EMPLOYER NAME] will not enforce any non-compete clause against you. This means that as of [DATE EMPLOYER CHOOSES BUT NO LATER THAN EFFECTIVE DATE OF THE FINAL RULE]:

You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
You may run your own business—even if it competes with [EMPLOYER NAME].
You may compete with [EMPLOYER NAME] following your employment with [EMPLOYER NAME].

The FTC’s new rule does not affect any other terms or conditions of your employment. For more information about the rule, visit ftc.gov/noncompetes. Complete and accurate translations of the notice in certain languages other than English, including Spanish, Chinese, Arabic, Vietnamese, Tagalog, and Korean, are available at ftc.gov/noncompetes.”

Enforcement. To enforce violations of the Final Rule, the FTC could initiate an administrative proceeding, or could seek an injunction in federal district court against any employer that is violating the Final Rule if the injunction is in the public’s interest. [19] The FTC is unlikely to be able to seek monetary relief for violations of this rule because, under the FTC Act, it may not have the authority to seek penalties for unfair method of competition. The FTC can, however, obtain civil penalties in court if a party fails to cease and desist from a violation after being ordered to do so.

Compliance:

Given the Final Rules’ application to all workers with limited exceptions, it is important for employers to be aware of their obligations and to comply with the Final Rule. The following are steps to help businesses comply with the Final Rule:

Prepare employment contracts and policies appropriately: businesses should not include non-competes in future employment contracts, paperwork (including employee handbooks and workplace policies), or websites. This applies to all workers, including senior executives.
Give notice: if a business has active non-competes, it will need to give notice to those current and former workers who are not senior executives, informing them that their noncompetes are not unenforceable, as of the effective date of the Final Rule. Businesses can use the notice language provided by the FTC, or if preferred, can write their own notice. The notice may be delivered by email, text message, or paper notice by hand or mail. If it does not have any contact information for a former worker, a business does not have to send the notice. However, because the Final Rule may likely be challenged between now and its effective date, businesses may want to wait on providing this notice until the Final Rule’s effective date, just in case any challenges to the Final Rule are successful and affect this requirement.
Future non-enforcement: businesses must not enforce existing non-competes in the future for workers other than senior executives. A business can, however still enforce a claim that a non-compete was breached before the Final Rule’s effective date.

Alternatives to Non-competes.

Non-competes have been used by businesses to ensure that a former employee will not use information learned during their employment to join a competitor or start a business and compete with the employer once their work is over. It also ensures that the employer maintains its place in the market. While the Final Rule outlaws non-competes, notably, the FTC explained that employers have several alternatives to non-competes that still enable them to protect their business interests without having to enforce non-competes that would have negative effects on workers. These include agreements such as nondisclosure agreements (“NDAs”) and non-solicitation agreements. The FTC also discussed training repayment agreement provisions (“TRAPs”) but did not squarely address whether these would be allowed.

Non-disclosure Agreements (NDA). A business may still be able to protect its interests by implementing an NDA that prevents a worker from sharing or using the business’s proprietary information that they learned during their employment. The FTC specifically discussed NDAs when issuing the Final Rule and ensured that most NDAs will be enforceable. For example, a garden-variety NDA 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 from accepting such work after the worker leaves their job. Therefore, such a provision would not be an unlawful non-compete.[20] However, if the NDA is so overly broad that it applies to information that arises from the worker’s general training, knowledge, skill, or experience, gained on the job or otherwise, then it will be unlawful under the Final Rule.[21]

Non-solicitation Agreements. Another alternative to a noncompete is a non-solicitation agreement, under which a worker must agree not to solicit the customers of its former employer (for future competitive business) or workers from its former employer (for future competitive employment). Non-solicitation agreements are generally not non-compete clauses under the Final Rule because, while they may restrict who a worker may contact after they leave a particular job, they do not by their terms, or necessarily function to, prevent a worker from seeking or accepting other work or starting a business. [22] However, non-solicitation agreements can satisfy the definition of non-compete clause under the Final Rule if they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.[23] The FTC failed to provide an explicit example of what may be prohibited, but each case will be considered within its own context and on its facts and circumstances.

Training Repayment Agreement Provisions (TRAP). A TRAP is a type of employment agreement, under which an employer will cover the cost for an employee to receive work-related training for a position in exchange for the individual’s continued employment. If the employee leaves the company before a designated time, they may be obligated to repay the business for the cost of that training. While these seem like they could be prohibitive to worker mobility, when preparing the Final Rule, the FTC declined to categorically prohibit all TRAPs related to leaving employment, or to exempt such provisions altogether. However, if a TRAP functions to force workers to remain in their current jobs, effectively preventing them from seeking or accepting other work or starting a business, then they may amount to non-competes. The FTC cited a few examples of TRAPs that would constitute unlawful non-competes, including a TRAP that required entry-level workers at an IT staffing agency who were earning minimum wage during their training periods to pay over $20,000 back to the company if they failed to complete a certain number of billable hours. [24] The FTC noted that TRAPs like this may function as non-competes because, faced with significant out-of-pocket costs for leaving their employment, workers may effectively be prevented from seeking or accepting other work or starting a business.[25] These determinations will likely be very dependent on the context and the facts and circumstances of each situation.

When considering any of these alternatives, though, businesses must consider whether they amount to unlawful non-competes. This determination will come down to the context, facts, and circumstances of each instance.

Conclusion

In conclusion, the FTC’s Final Rule represents a significant shift in employment law by broadly prohibiting non-compete agreements nationwide. This rule supersedes state laws and categorically bans non-competes, defined as any terms or conditions that prohibit, penalize, or function to prevent workers from seeking or accepting employment or starting a business post-employment that would compete with their former employer. While the Final Rule does allow for certain exceptions, such as for senior executives and in the context of bona fide business sales, it applies to a wide range of workers, including employees and independent contractors. Employers may focus on alternative agreements, such as NDAs and non-solicitation agreements, to protect their business interests, but must ensure these do not function as de facto non-competes.

Please note, this is not an exhaustive discussion of the Final Rule. Businesses with questions about non-competes and their future obligations should reach out to an attorney before making any definitive decisions.

[1] FTC Announces Rule Banning Noncompetes, Federal Trade Commission, available at: https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes

[2] State Noncompete Law Tracker, Economic Innovation Group, available at: https://eig.org/state-noncompete-map/.

[3] FTC Announces Rule Banning Noncompetes, Federal Trade Commission, available at: https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes

[4] Id.

[5] 16 C.F.R. § 910.2(a)(1).

[6] 16 C.F.R. § 910.1 (emphasis added).

[7] See Noncompete Clause Rule, 89 Fed. Reg. 38,342, 38,364-38,366 (May 7, 2024) (to be codified at 16 C.F.R. Part 910).

[8] 16 C.F.R.§ 910.1.

[9] See id.

[10] 16 C.F.R. § 910.2(a)(2).

[11] See Noncompete Clause Rule, 89 Fed. Reg. 38,342, 38,356 (May 7, 2024) (to be codified at 16 C.F.R. Part 910).

[12] See id. at 38,356.

[13] See id. at 38,357.

[14] 16 C.F.R. § 910.3(a).

[15] 16 C.F.R.§910.2(b).