On May 7, 2024, the Federal Trade Commission (FTC) published a final rule effectively banning the use of many non-competition clauses (the “Rule”).[1] The Rule will become effective on September 4, 2024 (“Effective Date”) barring intervention by any of the Federal District Courts currently considering legal challenges to the Rule.[2]
Currently, non-competition clauses in employment agreements, as well as standalone non-competition agreements, are subject to varying degrees of enforceability depending on state law.[3] Given the FTC’s perceived failure of the existing “case-by-case and State-by-State approach,” the FTC introduced a proposed rule in January 2023 to proactively govern the enforceability of non-competition agreements at the federal level (the “Proposed Rule”).[4]
The FTC believes that implementation of the Rule will allow employees to pursue better employment opportunities, increase competition for workers, increase wages, and bolster entrepreneurship and innovation.[5] The FTC estimates the Rule will increase workers’ earnings in the aggregate between $400 billion and $488 billion per year.[6] In Georgia, specifically, the FTC estimates that 3 million workers will be covered by the Rule and experience an increase in total earnings of over $2 billion per year.[7]
The Rule requires employers to: (1) discontinue the use of non-competition agreements for certain workers, and (2) notify employees subject to existing non-competition agreements of their rescission and invalidity, where the existing non-competes do not qualify for one of the limited exceptions to the Rule (see below for more details).
- The Rule effectuates this change by deeming it an “unfair method of competition”[8] for an employer to enter into or enforce a non-competition agreement with certain workers.[9] Worker is defined broadly to include employees, independent contractors, externs, volunteers, etc.[10]
- In addition to the prohibition on new non-competition agreements, the Rule also requires employers to rescind existing non-competition agreements via notice to employees by the Effective Date.[11] The Rule prescribes a methodology for delivering the notice and provides model language.[12]
Under the Rule, a non-competition agreement means a standalone agreement or contractual term within a broader agreement (e.g., an employment agreement) that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking or accepting employment, or operating a business, after the conclusion of the worker’s employment with the employer.[13] The FTC intends this to be a functional test, applying not only to those contractual terms labeled “non-competition” within an agreement, but also to those terms that have the same effect as a non-competition agreement.[14]
The Rule has a few limited exceptions:
- Senior executive exception: For senior executives, the Rule only prohibits entering into and enforcing non-competition agreements entered into after the effective date of the rule.[15] Senior executive is generally defined as a worker in a policy-making position, including, for example, a president or CEO, who receives total annual compensation in excess of $151,164.[16]
- Sale of a business exception: Non-competition agreements are permissible in conjunction with the sale of a business, of a person’s ownership interest in a business entity, or of all or substantially all of the assets of a business.[17] The sale of the business must be “bona fide,” meaning the transaction must not be entered into for the purpose of evading the Rule.[18]
- Existing cause of action exception: The Rule also excepts enforcement of non-competition agreements after the effective date if the cause of action related to non-competition agreement accrued prior to the effective date.[19]
Additionally, the definition of non-competition agreement under the Rule excludes other types of covenants restricting a worker’s post-employment actions like non-disclosure or non-solicitation agreements.[20] Further, the FTC’s rules do not apply to certain types of entities, including certain non-profits.[21] Accordingly, the Rule does not wholly prohibit the use of non-competition agreements in all scenarios.
The Rule is currently subject to litigation questioning its enforceability.[22] On July 3, 2024, a Texas federal court granted a preliminary injunction challenging the Rule’s enforceability, holding that the plaintiffs were likely to succeed in establishing that the FTC lacked authority to issue the Rule and that the Rule is unlawful under the Administrative Procedure Act.[23] Notably, the Ryan LLC v. Federal Trade Commission preliminary injunction only enjoins enforcement of the Rule for the plaintiff and plaintiff-intervenors in that case.[24] All other employers subject to the Rule will be required to comply with the Rule’s requirements unless and until a nationwide injunction is issued.[25] A nationwide preliminary injunction could come from the Ryan court, which will enter a final, appealable decision before August 30, 2024, or from a Pennsylvania federal court considering a challenge to the Rule, which is expected to issue a decision before the end of July.[26]
Pending a decision regarding the Rule’s enforceability, employers must evaluate whether they are: (a) required to provide notice to employees and contractors subject to existing non-competition agreements of those agreements rescission and invalidity; and (b) limit the use of non-competition agreements going forward.
If you need assistance in assessing your business’s responsibilities under the Rule, please contact Andrew Hazen (ahazen@fh2.com; 770-771-6818) or Anne Marie Simoneaux (asimoneaux@fh2.com; 770-771-6811) or visit FH2.com to learn more about how the attorneys at Friend, Hudak & Harris can help.
____________________
[1] Non-Compete Clause Rule, 89 Fed. Reg. 38342, 38342–506 (May 7, 2024) [to be codified at 16 C.F.R. pt. 910] [hereinafter Final Rule]. The Final Rule is available at https://www.federalregister.gov/documents/2024/05/07/2024-09171/non-compete-clause-rule.
[2] Final Rule at 38342.
[3] Non-Compete Clause Rule, 88 Fed. Reg. 3482, 3493–94 (Jan. 19, 2023) [hereinafter Proposed Rule]. The Proposed Rule is available at https://www.federalregister.gov/documents/2023/01/19/2023-00414/non-compete-clause-rule.
[4] Final Rule at 38343; Non-Compete Clause Rulemaking, FTC (Jan. 5, 2023), https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.
[5] Final Rule at 38433.
[6] Id.
[7] Id. at 38505.
[8] 16 C.F.R. § 910.2(a). Under the Federal Trade Commission Act, “unfair methods of competition” are unlawful. Final Rule at 38348. The Act gives the FTC authority to make regulations carrying out this provision, and the FTC cites this as its authority to define this new category of unfair competition. Id.
[9] 16 C.F.R. § 910.2(a).
[10] 16 C.F.R. § 910.1.
[11] 16 C.F.R. § 910.2(b).
[12] Id.
[13] 16 C.F.R. § 910.1.
[14] Final Rule at 38361.
[15] 16 C.F.R. § 910.2(a)(2).
[16] 16 C.F.R. § 910.1.
[17] 16 C.F.R. § 910.3(a).
[18] Id. at 38438.
[19] 16 C.F.R. § 910.3(b).
[20] Final Rule at 38634.
[21] Final Rule at 38357.
[22] See Bryan Koenig, Chamber OK’d To Intervene Against FTC Noncompete Rule, Law360 (May 10, 2024), https://www.law360.com/articles/1835663/chamber-ok-d-to-intervene-against-ftc-noncompete-rule.
[23] Memorandum Opinion and Order at 12–23, Ryan LLC v. Federal Trade Commission, No. 3:24-CV-00986-E (N.D. Tex. July 3, 2024).
[24] Memorandum Opinion and Order, supra note 23, at 32.
[25] Id.
[26] See id.; Koenig, supra note 22.
