Federal Trade Commission Adopts Final Rule Imposing Near-Total Ban on Employee Non-Compete Agreements

After more than a year of considering tens of thousands of public comments, the Federal Trade Commission (“FTC”) has voted 3-to-2 to adopt a Final Rule (the “Rule”) that would effectively ban almost all employee non-compete agreements in the United States.  The Rule purports to preempt all state and local laws that are in conflict. The Rule is slated to go into effect around the end of August 2024 (120 days after publication in the Federal Register), but the FTC is already facing litigation that could delay and ultimately bar implementation of the Rule.  Two FTC Commissioners voted against the Rule in part because they believed it exceeds the FTC’s authority.

Application of the Rule and Timing

After the Rule’s effective date, the text of the Rule states that a for-profit employer may not enter into a “non-compete clause” with a worker, including a “senior executive.” The text of the Rule further states that, non-competes entered into prior to the effective date will be deemed void and unenforceable unless the employee bound by the agreement is a “senior executive.”  A senior executive is defined in the Rule as an employee who earns more than $151,164 annually and is in a “policy-making position.”  Salary, bonuses, and commissions, but not fringe benefits, retirement contributions and medical/life insurance premium payments, count toward the $151,164 threshold.  The Rule defines “policy-making position” as “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.” “Policy-making authority” is defined to mean “final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.”

The Rule sets forth specific definitions of “non-compete clause,” “employment” and “worker.”  A non-compete clause covered by the Rule is “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 the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment.”  The Rule further defines “employment” as “work for a person” and a “worker” 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.”  

The FTC’s commentary to the Rule specifically states that “forfeiture for competition” clauses, liquidated damages provisions, and agreements that make the payment of severance contingent on non-competition are all prohibited agreements that “penalize” employees for engaging in competition.  The FTC comments, however, that the Rule does not “categorically prohibit other types of restrictive employment agreements, for example, NDAs, TRAPs [“training repayment agreement provisions”], and non-solicitation agreements,” so long as such an agreement is not “so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends.”  Whether such an agreement “functions to prevent” an employee from working will, among many other aspects of the Rule, be a “fact-specific inquiry.”

Exceptions

The Rule contains an exception for non-competes entered into pursuant to “a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.”  The FTC also stated that it would view a “garden leave” clause “whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis” as not subject to the Rule, because such an agreement is not a post-employment restriction.  The FTC noted that this view would continue to apply even “where a worker does not meet a condition to earn a particular aspect of their expected compensation, like a prerequisite for a bonus [and] the employer did not pay the bonus or other expected compensation” as a result of the garden leave.

The Rule does not apply where a cause of action related to a non-compete agreement “accrued” prior to the Rule’s effective date.  Also, it is not unlawful for an employer to enforce or attempt to enforce a non-compete or to make representations about a non-compete if the employer has a good-faith basis to believe that the agreement is not prohibited or banned by the Rule.

Notification Requirements

Employers are required to notify employees who are subject to existing agreements that are voided by the Rule no later than the effective date.  Such notice may be provided by hand delivery, mail to the worker’s last known personal street address, email to an email address belonging to the worker (including the worker’s current work email address or last known personal email address), or text message to a mobile telephone number belonging to the worker. The Rule includes sample notice language to be provided to employees.

Looking Ahead to Challenges to FTC’s Authority

Challenges to the Rule have already been filed, including a lawsuit by the U.S. Chamber of Commerce and others challenging the FTC’s authority to implement a nationwide ban on employee non-competes and otherwise seeking to invalidate the Rule. These lawsuits could delay and/or ultimately block implementation of the Rule.  Indeed, the two dissenting FTC Commissioners voted against the Rule in part because they believed it exceeds the scope of the FTC’s rule-making authority under the FTC Act and is invalid under the “non-delegation” and “major question” doctrines.  If the Rule does become effective in its current form, applying the provisions of the Rule to specific facts and circumstances will likely result in various potential disputes, disagreements and related litigation, including as to the applicability of key definitions and the prohibitions purportedly instituted under the Rule.  Dechert will continue to monitor and provide further updates concerning this rapidly evolving development.