FTC Seeks to Ban Most Non-Compete Agreements

On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to issue a final rule that bans the use of non-compete agreements between employers and their “workers.”

This final rule, which follows the initial proposed rule in January 2023, delivers on President Biden’s July 2021 executive order directing the FTC to ban or limit “non-compete agreements and other clauses and agreements that may unfairly limit worker mobility.”

It also comes sufficiently far enough in advance of the upcoming presidential election to reduce the risk of challenge under the Congressional Review Act, which subjects the rule to a 60-day legislative review period. 

Scope of the Final Rule

The final rule, which will be effective 120 days after publication in the Federal Register (roughly, late August 2024) is largely similar to the initial proposed rule. Except for a narrow “sale-of-business” exception, the final rule:

• prohibits any new post-employment non-compete agreements between employers and workers after the effective date of the rule;
• prohibits existing post-employment non-compete agreements between employers and workers, except for “senior executives”—who are those “earning more than $151,164 annually who are in a policy-making position”; and
• requires employers to notify current and former workers that post-employment non-competes are no longer enforceable, but it does not contain a formal recission requirement.

The final rule broadly defines a non-compete clause as any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” This rule applies regardless of whether the worker is classified as an employee or an independent contractor.

What about the implications of non-solicitation agreements, which prohibit a worker from soliciting former clients or customers of an employer? According to the final rule, non-solicitation agreements generally do not fall under non-compete clauses in the final rule because they restrict whom a worker may contact after leaving their job but do not necessarily prevent the worker from seeking or accepting other work or starting a business. However, non-solicitation agreements can meet the definition of a non-compete clause if they effectively prevent a worker from seeking or accepting other work or starting a business after their employment ends. Whether a non-solicitation agreement—or a no-hire or no-business agreement—meets this threshold is a fact-specific inquiry.

What about non-competes included in equity awards? Often a worker is given some amount of equity in a business and, in exchange for other promises, agrees to be bound by a non-compete. These types of non-compete agreements would be invalidated under the final rule unless they are already in place and apply to a "senior executive" with policy-making authority. Policy-making authority is defined as the final authority to make policy decisions controlling significant aspects of a business entity or common enterprise. It does not include authority that is limited to advising, exerting influence over such policy decisions, or having final authority only within a subsidiary of or an affiliate of a common enterprise. Thus, this exception is very narrowly defined.

There is also a sale-of-business exemption. According to the final rule, it does not apply to a non-compete clause pursuant to a bona fide sale of a business or the person’s ownership interest in the business entity, including all or substantially all of the business entity’s operating assets. This assures buyers that the business they have just purchased will not turn around and directly compete with them.

Of note, the final rule does not apply to franchisee/franchisor contracts. It also only applies to entities subject to the Federal Trade Commission Act, which does not include bona fide non-profit corporations or certain banks, insurance companies, transportation and communications common carriers, or airlines, which themselves operate in heavily regulated arenas.

The non-profit exemption will be of particular note to employers in the healthcare industry. However, the final rule also holds that if a tax-exempt company is organized in a way that seeks to drive profit to its members, the FTC can treat that company as for-profit and make it subject to the ban. That could include certain cases where non-profit hospitals have relationships with for-profit physician practices.

Pursuant to the Federal Trade Commission Act, violation of the final rule can result in fines, penalties, and injunctive relief.

How Do Employers Protect Themselves Without Non-Competes?

This rule will be challenged and will thus need to withstand legal scrutiny before it is implemented. But how do employers protect themselves without non-competes? This is a very important question to be asking right now.

Many states, including California, Colorado, Illinois, and Washington, already ban or otherwise heavily restrict non-competes, with few narrow exceptions. Employers in those states have found creative solutions to nevertheless protect their businesses, and these solutions will serve as a roadmap for employers if and when the final rule goes into effect.

For example, employers in states where non-competes are banned or heavily restricted have focused on confidentiality agreements to protect their information, as well as carefully tailored non-solicitation and similar agreements.

In terms of specific policies, employers have taken steps to prevent and track the transfer of confidential information off of company devices and networks. For example, employers have:

• required the use of secure systems to transmit confidential information;
• restricted or prohibited access to confidential information;
• restricted or prohibited the use of personal email or cloud-based file-transfer sites on company devices (e.g., Gmail, Google Drive, Dropbox);
• restricted or prohibited the use of removable storage devices on company devices (e.g., thumb drives, USB, external hard drives); and
• utilized software to track attempts at transferring documents via off-system email, cloud storage, or external storage devices.

Employers have also enhanced their on-boarding and exit interview processes to specifically bring related company policies and confidentiality obligations to the employee’s attention. For departing employees, in particular, the best practice is to obtain written acknowledgment of these obligations and to account for all company devices assigned to the departing employee. Often times, forensic specialists can quickly identify any mass data transfers and attempted cover-ups.

What is Next?

This move by the FTC comes amid a recent wave of state-law activity that significantly limits the use of non-competes. Many of these state laws ban the use of non-compete clauses for low and mid-wage workers. The FTC’s final rule is much broader in imposing a blanket ban on non-compete provisions nation-wide with very few exceptions.

Now that the rule is finalized, it is guaranteed to draw legal challenges from the business community, as it would test the boundaries of the FTC’s rulemaking authority.

In fact, on the day the rule was announced, a lawsuit was filed in in the U.S. District Court for the Northern District of Texas challenging the rule. One day later, the U.S. Chamber of Commerce also filed a lawsuit challenging the rule.

These legal challenges will likely be resolved by the U.S. Supreme Court, which has recently shown disdain for broad agency action of the type exercised by the FTC in enacting this rule. Indeed, such rulings suggest that the FTC rule will not fare any better.

Because the final rule will not be effective until 120 days after publication in the Federal Register, it is likely that its implementation will be stayed until these legal challenges are resolved. 

Quarles & Brady will continue to follow rule-related developments, including legal challenges to the final rule.

For additional information and questions about how these potential changes may affect your business, please contact your Quarles & Brady attorney or:

• Christopher Nickels, Milwaukee: (414) 277 5519 / chris.nickels@quarles.com
• Aaron Schu, San Diego: (619) 243-1574 / aaron.schu@quarles.com