The Federal Trade Commission issued a "Final Rule" That Effectively Bans the Use of Non-Compete Agreements

On April 23, 2024, the Federal Trade Commission (FTC) issued, by a 3-2 vote, a sweeping final rule ("Final Rule") that effectively bans the use of non-compete agreements as a term or condition of employment.  The Final Rule has limited exceptions and is scheduled to go into effect 120 days after it is published in the Federal Register (the "Effective Date").

Key Takeaways:

• After the Effective Date, employers are banned from entering into non-compete Agreements, including de facto non-competes agreements, with "all workers;"
• Non-Compete Agreements entered into with senior executives prior to the Effective Date are enforceable, but all other non-compete agreements entered into prior to the Effective Date are not enforceable;
• Employers must notify applicable employees that their existing non-compete agreements are void;
• The Final Rule preempts all state laws that would otherwise permit non-compete agreements.

What types of agreements are covered under the Final Rule?

The Final Rule defines non-compete agreements as a "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 employment that included 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."

A de facto non-compete clause is one that is functionally equivalent to and has the same effect as a non-compete clause.  Examples of de facto non-compete agreements include non-disclosure agreements written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker's employment, and training repayment agreements that require workers to repay the employer or third party entity the costs of training that are not reasonably related to the costs incurred by the employer to train the worker.

Under the Final Rule, terms or conditions of employment include contractual agreement or workplace policies, whether written or oral -  including provisions of employee handbooks - that could function to prevent a worker from seeking or taking alternative employment or opening a new business in the same field of work.  

What workers are covered by the Final Rule?

The Final Rule covers all workers regardless of whether other state or federal labor laws would have otherwise held that such workers are not "employees."  Examples include independent contractors, those hired through staffing agencies, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a person. 

What conduct is banned under the Final Rule?

The Final Rule prohibits three classes of conduct after the Effective Date: (1) entering into or attempting to enter into a non-compete agreement with a worker; (2) enforcing or attempting to enforce an existing non-compete agreement with a worker other than a senior executive whose non-compete agreement was in effect prior to the Effective Date; and (3) representing to a worker that they are subject to a non-compete agreement, unless the worker is a senior executive who entered into the non-compete prior to the Effective Date.

What is the status of existing non-compete agreements? 

Under the Final Rule, non-competes for all workers entered into prior to the Effective Date are unenforceable, unless the worker qualifies as a "senior executive."  For purposes of the Final Rule, a senior executive is a worker who:  (1) is in a "policy-making position"; and (2) earns an actual or annualized income of $151,164.  The total annual income includes income through salary, bonuses, and commissions, but excludes fringe benefits, board, lodging, retirement contributions, and medical and/or life insurance premium payments.

What is a Policy-Making Position under the Final Rule?

A policy-making position is any position within a business (typically a business entity's president, CEO, or any other officer of a business) with "policy-making authority," which is defined as the ability to make policy decisions that control significant aspects of a business entity or a common enterprise.  Notably, "policy-making authority" does not include authority limited to advising or exerting influence over policy decisions, nor does it include having final authority to make policy decisions for only a subsidiary of an affiliate of a common enterprise

What about other restrictive covenants, including non-solicitation and confidentiality agreements?

The Final Rule defines non-compete clause as a term or condition of employment that either "prohibits" a worker from, "penalizes" a worker for, or "functions to prevent" a worker from either (1) seeking or accepting employment 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 of condition.

While the Final Rule does not explicitly prohibit other types of restrictive covenants, such as non-disclosure agreements (NDA), Training Repayment Agreement Provisions (TRAP), non-solicitation agreements, and confidentiality agreements, the FTC stated that such agreements would be subject to a fact-specific inquiry to determine whether the agreements "function to prevent" a worker from seeking/accepting other work or starting a business after their employment ends.  The Final Rule defines "Functions to Prevent" as a term or condition that is so broad or onerous, or restrains such large scopes of activity so as to functionally prevent a worker from seeking or accepting other work or starting a new business after their employment ends. 

However, the FTC noted that like all restrictive employment agreements, non-solicitation agreements, no-hire, and no-business agreements are subject to the prohibition of unfair trade methods of competition, regardless of whether such agreements are covered by the final rule.

Other exceptions to the Final Rule

In addition to the exception for non-compete agreements entered into with senior executives prior to the Effective Date, the Final Rule does not apply to non-compete agreements entered into by a person pursuant to a bona-fide sale of a business entity or otherwise disposing of all of the person's ownership interest in the business entity, or selling all or substantially all of the business entity's operating assets, so long as the person is also "a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete."

Additionally, the Final Rule does not apply "where a cause of action related to a non-compete clause accrued prior to the effective date."  Accordingly, the Final Rule does not preclude or make unlawful any ongoing litigation seeking to enforce a non-compete agreement that was initiated prior to the Effective Date.

My state allows non-compete agreements, does the Final Rule apply to my business?

Yes.  The Final Rule specifically states that it preempts any and all state laws, regulations, orders, and interpretations that are inconsistent with the Final Rule.  However, state laws that are not inconsistent with the final rule (i.e., afford greater protections) are not preempted.  For example:  a state law bars non-competes only for workers who earn less than $150,000 per year, the state's law is not inconsistent with the Final Rule, and the state may continue to enforce its ban for workers earning less than $150,000.  However, all non-competes covered by the Final Rule, regardless of a worker's earnings, remain an unfair method of competition and are therefore unlawful.

What happens next?

The Final Rule will go into effect 120 days after it is published in the Federal Register; however, it is certain to face immediate challenges to its validity.  In fact, several entities, including the Chamber of Commerce, initiated litigation on April 24, 2024 seeking to block the Final Rule from going into effect.  Whether these lawsuits prevail, and the timeframe in which courts provide additional guidance, remains uncertain. 

Because the Final Rule requires employers to notify affected employees that their non-compete agreements are unenforceable, employers should be proactive in identifying the affected employee agreements, and reviewing existing policies, handbooks, and other agreements that may be affected by the Final Rule.  Employers may also want to explore the development of tailored agreements that protect confidential and proprietary information, trade secrets, and other legitimate business interests without acting as a de facto non-compete agreement.

If you have any questions or concerns regarding the Final Rule, please contact the MacDonald, Illig, Jones & Britton LLP Labor & Employment team.