The Federal Trade Commission (FTC) has taken a definitive step by approving a Final Rule that effectively prohibits noncompete clauses for most workers in the United States. The Final Rule is set to take effect on September 4, 2024 (Effective Date). However, ongoing legal challenges question the FTC’s authority to enforce this ban, potentially leading to delays in its implementation.
Introduction
The FTC’s Final Rule establishes a complete prohibition on noncompete clauses, including all terms and conditions that limit an employee’s capacity to pursue alternative employment opportunities or entrepreneurial ventures after leaving their current job. The definition of a “noncompete clause” is extensive, and includes any employment-related term that hinders an employee’s future career prospects. These clauses, typically seen as restrictive agreements between employers and workers, are now subject to stricter regulations under the new ruling.
Scope of the Final Rule
The Final Rule, effective September 4, 2024, bans employers from imposing or enforcing “noncompete clauses” on workers, including both new and existing non-competes. However, the Final Rule does allow a limited exception for non-competes for senior executives that were in place before the Final Rule’s effective date. These non-competes can remain enforceable to the extent permitted by current law.
Definition of Workers
The Final Rule defines the term “worker” in a broad sense. According to the rule, a worker is a natural person who has either worked or is currently working, regardless of their job title or status under any State or Federal laws. This includes employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide services to another person. It should be noted that the definition of worker goes beyond just low-wage employees, who are often the focus of opposition to noncompete agreements.
Interpretation of Noncompete Clauses
The Final Rule defines a “noncompete clause” expansively, covering any term or condition of employment that inhibits, penalizes, or effectively prevents a worker from either pursuing employment with another entity post-employment or engaging in entrepreneurial endeavors within the United States. This definition not only includes explicit noncompete agreements but also extends to clauses that impose penalties or financial repercussions on workers for seeking alternative employment or venturing into entrepreneurship after leaving their current job.
Regulation of Other Restrictive Covenants
FTC clarifies that functional non-competes, which may not mention non-compete provisions explicitly but still restrict the post-employment options of workers, are subject to regulation. These functional non-competes include various restrictive covenants like non-disclosure agreements (NDAs), training repayment agreements (TRAPs), non-solicitation agreements, no-hire agreements, and no-business agreements.
While the rule does not categorically prohibit NDAs, training repayment agreements, or non-solicitation agreements, the FTC notes that these agreements could fall within the ban’s scope if they are “so broad and onerous” that they effectively prevent a worker from seeking or accepting other employment or starting a business. For example, confidentiality agreements and NDAs can be deemed non-competes if they restrict employees from disclosing information that could be used in or related to their industry, thus preventing them from working for another employer in that industry.
However, other restrictive covenants that do not impede employees from seeking or accepting employment after their current job ends may still be permissible under the Final Rule. These covenants are subject to individual consideration to determine whether they constitute an unfair method of competition, even in the absence of the Final Rule.
Exclusions from Noncompete Clauses
- Senior Executive Limited Exclusion: The Final Rule permits the enforcement of existing non-compete agreements with senior executives but prohibits the establishment or enforcement of new non-competes with any existing or newly appointed senior executives after the effective date. The regulation defines a “Senior Executive” as someone who (a) holds a “policy-making position” and (b) earns an actual or annualized sum of $151,164 (including salary, bonuses, and/or commissions, but excluding fringe benefits, retirement contributions, and medical/life insurance premium payments). A “policy-making position” includes roles such as a company’s president, CEO, or equivalent, or any other person with “policy-making authority” like a corporate officer. This authority entails making policy decisions that control “significant aspects of a business entity or common enterprise.” Positions that merely advise or influence policy decisions, or have final authority only over subsidiaries or affiliates, are explicitly excluded. Businesses will therefore need to carefully evaluate which existing employees qualify as senior executives under this definition.
- Bona Fide Business Sale Exception: Non-compete covenants entered as part of a bona fide sale of a business entity are exempt from the Final Rule.
- Existing Causes of Action: The Final Rule does not apply to causes of action related to non-compete clauses that accrued prior to the Effective Date.
- Alternative Protections: Employers concerned about protecting trade secrets and business interests are encouraged to explore alternative measures such as nondisclosure agreements and tailored confidentiality clauses. Non-solicitation agreements, garden leave arrangements, and contingent bonuses are also viable options.
Key Considerations for Employers:
- Retroactive Effects: Employers should be mindful of the retroactive impact of the Final Rule. While new non-competes will be unenforceable for all workers after the Effective Date, existing non-competes will only be enforceable for workers who are senior executives as defined in the new regulations. Despite potential legal challenges that may affect the implementation of the Final Rule, employers are strongly advised to review all agreements, policies, and plans containing noncompete clauses and identify employees requiring notice by the Effective Date.
- Notices: Pending any legal challenges, employers utilizing noncompete clauses in their agreements are required to provide explicit notice, by the Effective Date, that these clauses will no longer hold validity or enforceability for covered workers. This notice, identifying the employer, must be delivered in a clear and conspicuous manner, and can be disseminated through physical delivery, mail, email, or text message to the worker’s last known address.
Legal Challenges to Rule:
The Final Rule faces immediate legal challenges, as business groups swiftly moved to block it following the FTC’s finalization. The U.S. Chamber of Commerce, alongside the Business Roundtable, Texas Association of Business, and Longview Chamber of Commerce, filed a lawsuit in a Texas federal court. They argue that the FTC lacks the authority to regulate “unfair methods of competition” through rulemaking, asserting that the Federal Trade Commission Act allows the FTC to challenge specific practices but not to create broad rules against such methods. The lawsuit seeks to vacate and permanently enjoin the non-compete ban, among other reliefs. These challenges could delay or entirely prevent the enforcement of the rule.
KPPB LAW is closely monitoring these regulatory changes regarding noncompete clauses and their implications for employers and employees alike. If you have any concerns, questions, or require guidance regarding noncompete agreements or any other employment-related legal matters, please don’t hesitate to contact Corporate Attorney Parav Patel.
KPPB LAW has provided legal services to small and mid-size companies since 1983. We have offices in Atlanta, New York City, Chicago, Northern Virginia, and Connecticut. And our business law firm is certified as a Minority Business Enterprise by the National Minority Supplier Development Council (NMSDC). Learn more about KPPB LAW.
