FTC New Rule Bans Non-Competes
Mostly Everything You Need to Know About the New FTC Ruling Prohibiting Non-Compete Clauses
The New Rule
You’re probably familiar with a non-compete agreement or non-compete clause. It is likely you or someone you know and care about has signed one, so you are familiar with how they can impact one’s life. Non-competes are generally regarded as ways businesses protect themselves from harmful competition by key personnel. The Federal Trade Commission (“FTC”) engaged in research, conducted studies and sought commentary on there fairness in the market place. Ultimately, the FTC took a stern position that non-competes are unfair restrictions on trade, markets, and mobility, and they are hurting our economy. To that end, with few exceptions, the FTC has outlawed all non-compete agreements and non-compete clauses. I’ve saved you the trouble of combing through the complete (and exhausting) 570-page ruling. You can read it here if you’re a glutton for punishment.
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FTC New Rule Bans Non-Competes
In short, existing and future non-competes are prohibited. They are simply not enforceable. All aspects of them are defined in the rule, including, without limitation, the parties, definitions of employment and competition. It even defines “person” and “worker”. Frankly, I’m surprised it doesn’t define the word “define”. Kidding aside, these definitions are broadly construed to prevent clever circumvention of them. The implications of this rule on NDAs, non-solicitation agreements and TRAPs are discussed below. The rule covers employees, independent contractors, interns, etc.
Essentially, the FTC prohibits agreements or clauses preventing workers from seeking or accepting subsequent employment that are subject to certain unacceptable terms and conditions. It’s good for the economy right? Well, maybe, I’m not an economist. I’m just telling you what the rule is so you can either get a better job if you’re a “worker” or update your policies and legal if you’re an employer. In either case, while the law will become effective later this year, it has been challenged in court, and nobody knows whether the law will be upheld or found unconstitutional like the Corporate Transparency Act (which is paradoxically still being enforced).
Through its research, studies and surveys, the FTC’s found that:
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- Non-Competes Are Facially Unfair Conduct
- Non-competes are restrictive and exclusionary conduct.
- Non-competes are exploitative and coercive conduct.
- Non-competes with workers other than senior executives are unilaterally imposed.
- Non-competes with workers other than senior executives trap workers in jobs or force them to otherwise bear significant harms and costs.
- The Commission Finds That Non-Competes Tend to Negatively Affect Competitive Conditions
- Non-competes tend to negatively affect competitive conditions in labor markets.
- Non-competes suppress labor mobility.
- Non-competes suppress workers’ earnings.
- Non-competes tend to negatively affect competitive conditions in product and service markets.
- Non-competes inhibit innovation.
- Non-competes inhibit new business formation.
- Non-competes may increase concentration and consumer prices.
- Non-competes may reduce product and service quality and consumer choice.
The Rule Examined – “Functions to Prevent”
Section 5 of the FTC Act states that “Unfair methods of competition in or affecting commerce” are “declared unlawful.” The standard has two prongs: whether (1) the conduct is a method of competition as opposed to a condition of the marketplace, and (2) whether it is unfair, meaning that it goes beyond competition on the merits.
Here are the important definitions of the new rule:
Business entity means a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.
Employment means work for a person.
Non-compete clause means:
(1) 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 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
(ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
(2) For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.
Officer means a president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any natural person routinely performing corresponding functions with respect to any business entity whether incorporated or unincorporated.
Person means any natural person, partnership, corporation, association, or other legal entity within the Commission’s jurisdiction, including any person acting under color or authority of State law.
Policy-making authority means final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.
Policy-making position means a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. An officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position for purposes of this paragraph. A natural person who does not have policy-making authority over a common enterprise may not be deemed to have a policy-making position even if the person has policy-making authority over a subsidiary or affiliate of a business entity that is part of the common enterprise.
Preceding year means a person’s choice among the following time periods: the most recent 52-week year, the most recent calendar year, the most recent fiscal year, or the most recent anniversary of hire year.
Senior executive means a worker who:
(1) Was in a policy-making position; and
(2) Received from a person for the employment:
(i) Total annual compensation of at least $151,164 in the preceding year; or
(ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or
(iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.
Total annual compensation is based on the worker’s earnings over the preceding year. Total annual compensation may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during that 52-week period. Total annual compensation does not include board, lodging and other facilities as defined in 29 CFR 541.606, and does not include payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other similar fringe benefits.
Worker means a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, 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. The term worker includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.
Other Nuances (liquidated damages, forfeiture-for-compensation, severance, NDAs, TRAPSs, and non-solicitations)
The language of the new rule is intentionally broad. It is designed to capture, and therefore prohibit, cute and clever provisions.
For example, the FTC prohibits liquidated damages in its definition of the term “penalizes”. Likewise, an agreement that extinguishes an employer’s obligation to pay compensation or benefits as a result of a worker seeking or accepting work or starting a business after leaving the employment is also prohibited. This is often referred to as a forfeiture-for competition clause. Like a liquidated damage provision, this type of provision imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship. Severance agreements, where a worker is only paid if they do not compete, are also prohibited.
The common thread among these three prohibitions is that they prohibit or penalize post-employment work for another employer or business. They are “inherently restrictive and exclusionary ijn conduct, and they tend to negatively affect competitive conditions in both labor and product and service markets by restricting the mobility of workers and preventing competitors from gaining access to those workers.”
Expansion of the term, “functions to prevent,” within the definition of non-compete, is broadly construed to prevent a worker from seeking or accepting other work or starting a new business after their employment ends. Importantly, this prong of the definition (and the rule) does not automatically prohibit other types of restrictive employment agreements, for example, NDAs, TRAPs, and non-solicitation agreements. However, while these types of agreements are not prohibited, they can be. Specifically, these types of agreements and clauses may be prohibited if they are so broad or onerous 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.
Said differently, garden variety non-disclosure agreements, for example, are not on their face prohibited. They simply prevent disclosure of confidential information and do not prevent a worker from seeking or accepting work after the worker leaves their job. NDAs can, however, become prohibited if they are so pervasive in scope that they prevent workers from seeking or accepting work or starting a business after they leave their job. For example, protecting information that is “usable in” or “relating to” the industry in which they work, would be prohibited because it has the tendency to “function to prevent” the worker from finding alternative employment. Another example of an unacceptable NDA would be a prohibition from disclosing any information or knowledge the worker may obtain during their employment whatsoever, including publicly obtained information.
The same analysis applies to non-solicitation agreements. Non-solicitation agreements are also not on their face prohibited. They generally are not considered non-compete clauses. However, they could be construed that way if broadly drafted to “funciton to prevent” the worker from seeking or accepting alternative work after leaving their job. These will be evaluated on a case-by-case basis, especially when clever attorneys try to couch improper language in otherwise legally acceptable provisions.
Likewise, TRAPS, or agreements that require a worker to pay a fee upon termination of employment if certain conditions are not met, are not categorically prohibited either. For example, the FTC will treat a worker’s obligation to repay a bonus if the worker leaves before a certain period of time not to be a non-compete under 910.1 if the amount is equal to the bonus and the agreement does not otherwise prevent subsequent employment.
Effective Date
The law becomes effective 120 days after it is published in the federal register. It was published on the federal register on May 7, 2024. Therefore, 120 days to comply with the rule will be September 4, 2024. Read the federal register page here: https://www.federalregister.gov/public-inspection/2024-09171/non-compete-clause-rule
Who’s covered?
Every employer and every worker other than those specifically exempt must comply with this new rule.
What is prohibited exactly?
Any act or conduct that prevents workers from finding or accepting alternate employment or starting a new business in the same industry.
Who’s exempt?
There are a few exemptions to the new rule.
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- Existing senior executives – Senior executives presently earning more than $151,164 in total annual salary and who have policy-making positions because they are “least likely to be exploited or coerced, and are most likely to have bargained for meaningful compensation for their non-compete.”
- Definitions of nearly every word above are included in the rule but omitted here.
- Persons selling a business entity – Under §910.3(a), the final rule does not apply to a non-compete clause in connection with the “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.”
- Existing causes of action. The rule does not prevent continued litigation of existing claims.
- Good faith exception: The exception states: “It is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a noncompete clause where a person has a good-faith basis to believe that this part 910 is inapplicable.” A similar “good-faith basis” clause was in proposed § 910.2(a).
Note – there is a built-in severability provision, which means that if any provision of the final rule is held to be invalid or unenforceable either facially, or as applied to any person or circumstance, or stayed pending further agency action, such invalidity shall not affect the application of the provision to other persons or circumstances or the validity or application of other provisions. That gives the FTC greater ability to enforce the rule.
What compliance obligations do companies have right now?
Employers do not have to rescind all of their agreements to remove the non-competes. Instead, the employer must provide clear and conspicuous notice to the worker who entered into the non-compete that the non-compete is no longer in effect and it will not be and cannot be legally enforced against the worker. The employer has until the effective date (i.e. September 4, 2024) to give such notice.
The notice must be delivered in person, by mail or by email to an address belonging to the worker, or last known address of former workers. Text message is permitted too.
How Can Businesses Protect Themselves After This New Rule?
Businesses have ample ways to protect themselves after the issuance of this new rule. For example, businesses may protect their information in the form of confidentiality agreements. Non-disclosure agreements are permitted too, provided they do not unacceptably restrict the worker from finding alternate employment. Likewise, TRAPS and other forfeiture-type provisions are acceptable, as are non-solicitations that do not prevent workers from finding alternate employment. Lastly, businesses also enjoy the protection of their proprietary trade secrets under most states’ law and federal law. For example, for Florida’s trade secret act, click here.
In our view, business owners can aptly protect their primary assets and core competencies without non-competes. In fact, we sometimes counsel businesses to scrap the non-competes altogether, as we find that confidentiality and non-solicitation of key resources are more important to protect its interests anyway.
Conclusion
The FTC’s new rule prohibits non-competition by way of agreements or clauses. There are a few exceptions noted above. The law is being challenged, so we will see how it shakes out. In the meantime, workers are happy, and employers need to tighten up how they can legally protect their business interests. There are a few ways, including confidentiality clauses, NDAs, non-solicitations, and state and federal trade secret protections.
Helpful references:
https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf
