Please see our August 20, 2024 Alert for the most recent developments. Read here.
On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to adopt a final rule broadly banning post-employment noncompete agreements. This federal ban prohibits for-profit employers from entering into noncompete agreements with workers (including employees, independent contractors, and volunteers) and invalidates existing noncompetes with limited exceptions. The final rule is scheduled to take effect 120 days after its publication in the Federal Register.
The final rule largely mirrors the prior proposed rule from January 2023, which we reported on here, with the following notable changes and clarifications:
Exception for Existing Noncompetes with Senior Executives
- The final rule allows employers to enforce existing noncompetes entered into with senior executives prior to the effective date. However, employers may not enter into new noncompete agreements with senior executives on or after the effective date.
- A “senior executive” means a worker who (1) earns more than $151,164 in total annual compensation, inclusive of salary, commissions, nondiscretionary bonuses, and other nondiscretionary compensation and (2) is in a policymaking position, such as the company’s president, chief executive officer, or any other officer or natural person in the equivalent position of an officer with policymaking authority.
New Notice Required for Existing Noncompetes with Others
- For workers currently bound by a noncompete agreement (other than senior executives), employers will not be required to formally rescind their agreements, but they are required to notify employees by the effective date that such agreements will no longer be enforceable.
- The FTC created a model notice, which can be found on its website.
Broader Sale-of-Business Exception
- In the previous proposed rule, the FTC carved out an exception for noncompetes entered into in connection with the sale of a business, provided that the individual held at least a 25% ownership interest in the business. The final rule retains the sale-of-business exception, but it does not require any minimum ownership percentage.
- Under the final rule, for the exception to apply, the FTC only requires that the noncompete be “entered into by a person 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 final rule does not define what constitutes an “ownership interest,” and it remains unclear whether, and to what extent, stock options, restricted stock units, or other equity incentives would be considered an ownership interest. Critically, the final rule makes clear that state law will continue to govern sale-of-business noncompetes. As a result, sale-of-business noncompete agreements must satisfy both federal and state requirements in states such as California, which requires the individual being bound by the noncompete to have a substantial ownership interest in the business being sold.
Expanded Definition of Noncompete
- The final rule expands the definition of a “non-compete clause” to include a term or condition of employment that “prohibits” a worker from, “penalizes” a worker for, or “functions to prevent” a worker from seeking or accepting employment or operating a business in the United States following the conclusion of employment. Accordingly, other restrictive covenants may be considered functional noncompetes prohibited by the final rule, depending on the circumstances.
- The final rule prohibits terms that require workers to pay liquidated damages or forfeit compensation or other benefits if they compete with an employer following employment.
- Conversely, the FTC’s official commentary to the rule points out that other types of restrictive provisions, such as non-solicits, nondisclosure agreements, and training-repayment agreements are not categorically prohibited and would not be considered a functional noncompete in many instances.
Legal Challenges and Next Steps
Despite its very recent adoption, the final rule already faces legal hurdles. Since the FTC’s announcement, two lawsuits have been filed against the FTC challenging the final rule. The first lawsuit was filed in the Northern District of Texas on April 23, 2024, by Ryan LLC, a global tax services firm. The second lawsuit was filed in the Eastern District of Texas on April 24, 2024, by the U.S. Chamber of Commerce. Both lawsuits challenge the FTC’s authority to regulate noncompete agreements and its interpretation of the FTC Act, echoing the view of the two recently appointed dissenting commissioners. They also take issue with the rule’s sweeping prohibitions that fail to consider individual circumstances, reasonableness, and necessity. Notably, the lawsuit filed by the U.S. Chamber of Commerce seeks to delay the final rule’s effective date until the matter can be fully litigated.
The federal court is likely to issue a temporary restraining order, but that remains to be seen. In the meantime, employers should begin taking inventory of all existing agreements that contain restrictive covenants to determine whether they may fall within the purview of the final rule—and work with counsel to identify any potential changes to current form agreements with employees and other service providers. In light of the rule’s exception for senior executives, employers may also consider entering into noncompetes with such individuals, subject to applicable state law.
We will continue to monitor and report on developments to the FTC’s final rule. Fenwick lawyers are available to answer questions about the final rule, its implications, how to prepare, and how to comply with current state laws regulating and restricting noncompetes.
