Background
On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule (“Final Rule”) banning the use of non-compete agreements and their functional equivalents in most circumstances. The Final Rule, which is now facing numerous legal challenges, is set to take effect on September 4, 2024.
The Final Rule, with limited exceptions, broadly bans the use and enforcement of written or verbal non-compete clauses. Under Section 910.1 of the Final Rule, non-compete clauses are defined as a term or condition of employment that prohibits or penalizes a worker from “seeking or accepting work,” “operating a business” or “functions to prevent” the same.
The Final Rule applies to all current and former workers, with a limited exception for senior executives. The Final Rule defines “worker” very broadly, covering current and former workers, paid or unpaid, regardless of the worker’s title or status under 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 services to another person, and/or person who works for a franchisee or franchisor.
What are the exceptions to the Final Rule?
The Final Rule adopted a different approach for senior executives. Pursuant to the Final Rule, a “senior executive” is defined as a worker who is in a policy-making position and is compensated at least $151,164 annually. The Final Rule allows existing non-compete agreements with senior executives to remain in effect; however, non-compete clauses executed after the Final Rule’s effective date will be unenforceable. The FTC’s rationale for this exception is that highly paid senior executives who exercise the highest levels of authority in an organization are the only group of workers likely to have bargained meaningful compensation in exchange for their non-compete.
The Final Rule has no bearing on non-competes that are used in the course of bona fide sales of businesses, allowing buyers of businesses to enter into and enforce non-competes against sellers. Lastly, the Final Rule does not apply to causes of action related to breaches of a non-compete clause that accrued before the Final Rule’s effective date.
Do employers have duties under the rule?
Prior to the Final Rule taking effect, employers must notify workers who were subject to a non-compete clause that it is unenforceable under the law. The Final Rule requires that the notice identifies the person who entered into the non-compete with the worker, and the notice be “on paper” to the worker either by hand, by mail to the worker’s last known address, by email, or by text message. The Final Rule provides a safe harbor for employers if the employer has no record of the worker’s street address, email address, or mobile telephone number. To aid employers in the notification process, the Final Rule includes model language that satisfies the notice requirement and is available for use.
Who is challenging the rule?
Numerous lawsuits have been filed challenging the legality of the Final Rule. On April 23, 2024, Ryan LLC, a tax firm, brought a suit in the US District Court for the Northern District of Texas against the FTC seeking to prevent the Final Rule from going into effect while litigation ensues. A day later, the US Chamber of Commerce filed a nearly identical suit in the Eastern District of Texas. The US Chamber of Commerce’s suit was stayed, forcing the US Chamber to intervene in the Ryan LLC lawsuit. The lawsuits have since been consolidated and a Motion to Stay Effective Date and for Preliminary Injunction is now pending before the US District Court for the Northern District of Texas.
The intervenor lawsuit seeks to invalidate the Final Rule on grounds including that the FTC exceeded its statutory authority, attempts to designate all non-compete agreements as unfair methods of competition, constitutes an unconstitutional delegation of power, is impermissibly retroactive, and is an arbitrary and capricious exercise of the FTC’s powers.
A third lawsuit was filed on April 25, 2023, in the US District Court for the Eastern District of Pennsylvania. ATS Tree Services, LLC, a tree service company, brought an action challenging the rule on statutory and constitutional grounds, similar to those raised in both the Ryan LCC and US Chamber of Commerce case. The ATS lawsuit also seeks injunctive relief and emphasizes the need for non-compete agreements to protect specialized training provided to employees. While these cases are pending, it is important to note that no court has ruled on the legality of the rule, and it is still scheduled to take effect in September.
What’s next for employers?
Employers should continue to exercise caution and narrowly tailor all restrictive covenants, including non-compete clauses, in order to protect their legitimate business interests. Because the Final Rule is not yet in effect, employers may still reap the benefits of non-compete clauses until the effective date. Given the legal uncertainty, employers should carefully assess the time and effort needed to identify and provide notice to workers affected by the Final Rule. Importantly, determining whether a non-compete or similar term of employment is enforceable under current law and how the Final Rule may impact its terms, is a fact-specific inquiry.