Update: On August 20, 2024, the U.S. District Court for the Northern District of Texas issued a final ruling in Ryan, LLC v. FTC, striking down the FTC’s non-compete rule on a nationwide basis prior to its initial effective date of September 4, 2024. The ruling expanded the Court’s preliminary injunction, issued in July that struck down the rule as it applied to the parties in the case. In its opinion, the Court reasoned that the FTC rule was both overbroad and outside of the FTC’s rulemaking authority. The rule is no longer in effect and employers are not required to discontinue non-competes or issue notices to employees with non-compete agreements as required under the rule. It is important to note that the ruling has no effect on existing state laws related to non-compete agreements or the FTC’s ability to investigate individual non-compete agreements that may be overbroad. The FTC has indicated that it is potentially interested in appealing the ruling to a higher court in hopes of reversing the Texas decision.
On April 23, 2024, the Federal Trade Commission (FTC) released its final rule regarding the use of non-compete agreements following an increased scrutiny against unfair business practices related to non-competes in the past two years. The landmark rule bans the use of non-compete agreements for covered workers beginning 120 days after the rule is published in the federal register. The rule, if it stands, is likely to take effect around September 4th, 2024.
What does the rule prohibit?
The FTC rule dictates that the use of non-compete agreements violates Section 5 of the FTC act as an unfair method of competition. The rule is a broad prohibition on entering into or enforcing non-compete clauses after the rule’s effective date, except for existing non-competes that apply to “senior executives” (explained further below) entered into prior to the effective date.
With respect to non-senior executive workers, businesses may not:
- enter into or attempt to enter into a non-compete clause;
- enforce or attempt to enforce a noncompete clause; or
- represent that the worker is subject to a non-compete clause.
With respect to senior executives, only non-competes entered into prior to the law’s effective date will remain enforceable. Under the new rule, business may not:
- enter into or attempt to enter into a non-compete clause after the rule’s effective date;
- enforce or attempt to enforce a non-compete clause entered into after the effective date; or
- represent that a senior executive is subject to an enforceable clause, where the non-compete clause was entered into after the effective date.
Who is considered a “worker” under the rule?
Instead of the term “employees,” the FTC selected the term “worker” to encompass a broader range of individuals who may be subject to non-competes. “Worker” for this purpose is defined in Section 910.1 as “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.”
Who is considered a “senior executive” under the rule?
To be considered a senior executive a worker must 1) be in a “policy-making position” at the company and 2) have received at least total compensation of at least $151,164 in the prior year (or if the employee was employed for only part of the year, the equivalent of $151,164 annualized). A senior executive is only considered to be a policy maker if they have the authority to make decisions for the entire business or common enterprise. This does not include workers that only exert influence on, consult on, or have the authority to make decisions for a subsidiary or affiliate of a common enterprise. The FTC estimates that only 1% of workers will fall under the definition of senior executive.
How is a “non-compete agreement” defined?
The rule defines a non-compete agreement 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 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.”
The rule clarifies that whether a contract term is a non-compete is a fact-specific inquiry, and that non-competes are not limited to an employment contract, but may be a written or oral workplace policy. It further clarifies that related employment terms, such as non-solicitation agreements, are not automatically considered to be non-compete agreements but can if they effectively prevent a worker from searching for or accepting other work.
Is there a notice requirement?
Employers must provide a notice to current and former workers (other than senior executives as defined under the rule) that have non-competes still in place, informing them that the clauses are no longer effective and cannot be enforced after the law’s effective date. The notice must be provided no later than the rule’s effective date (120 days after the rule’s publication in the federal register). Model language for this notice is contained in the rule. The notice can be delivered to employees in office (if applicable), by mail, by email or by text message.
Are there exceptions to the rule?
In addition to the exception for existing agreements for senior executives outlined above, the rule does not apply to non-compete contract terms in the sale of a business, the sale of the ownership of a business, or the sale of substantially all of a business’ assets. The final rule, unlike the proposed rule, also does not contain a requirement that the party restricted by the agreement be a substantial (at least 25%) owner.
What about state laws on governing non-compete clauses?
The final rule will not affect broader protections against non-compete agreements afforded to employees under state law. Several states, including California, North Dakota, Oklahoma and Nebraska have laws that largely ban non-competes subject to limited exceptions. Several other states have laws prohibiting non-compete agreements for employees earning below a certain threshold. Employers should review any agreements containing non-compete clauses to ensure they also meet the relevant state requirements.
Is the rule likely to take effect?
Since the final rule’s release, there have been multiple legal challenges from states and businesses seeking to prevent it from being enforced. The legal challenges note potential regulatory issues with the rule, including the FTC’s authority to make rules that apply broadly to all types of businesses, including non-profits (some businesses like banks and airlines that are governed by other federal agencies are viewed to be outside of the FTC’s scope). In addition, limitations around employment law and contracts are often left to the states to determine. Given the surmounting legal challenges, commentary suggests that the rule may not pass.
Employer Next Steps
Prior to the rule’s effective date, and pending any further updates, employers should:
- Continue to consider and abide by non-compete agreements that are in place for potential candidates.
- Inform management and individuals responsible for hiring and employment agreements of this upcoming rule, including the prohibition of oral workplace policies that may be considered a non-compete.
- Analyze and record who in their organization may be considered a senior executive and whether they have a non-compete agreement in place.
- Catalog any non-compete agreements that are in effect for current and former employees in advance of the rule’s effective date to prepare to comply with the notice requirements.
- Review any agreements (employment or otherwise) that contain non-solicitation clauses to ensure they comply with the new rule, and that provisions are in place to protect sensitive or trade secret information in the event any non-compete provisions are unenforceable.
Resources
Connect with a Sequoia consultant to learn how Sequoia’s compliance services are integrated in our benefits services and tailored solutions. And if you’re already a Sequoia client, stay on top of your employer obligations with your Compliance Checklist that highlights important compliance dates, action items, and resources.
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