FTC Announces Rule Banning Noncompetes

On April 23, 2024, the Federal Trade Commission (FTC) voted to issue a final rule that would ban noncompete agreements in most employment relationships. The final rule was published in the Federal Register on May 7, 2024, and is scheduled to take effect 120 days after such date on Sept. 4, 2024.

Final Rule

The final rule defines a non-compete clause as 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 that includes the term or condition.

Such terms or conditions include employee contracts or workplace policies, whether written or oral.

Subject to very limited exceptions, the final rule provides that:

• The use of non-compete clauses will be banned as of the effective date of Sept. 4, 2024;
• Any existing non-compete clauses (other than those entered into with senior executives, as defined in the final rule) will be invalidated;
• Employers must notify all employees (other than senior executives whose existing noncompete agreements will remain enforceable under the final rule) that their existing noncompete agreements will not be enforced.

Currently, the enforceability of non-compete clauses is generally determined by state and local legislatures and courts. The FTC rule would instead govern the enforceability of non-compete clauses at the federal level and supersede any less restrictive state laws or judicial interpretations.

Action Steps

Employers that use noncompete or similar protective clauses should familiarize themselves with the rule’s requirements and take steps now to prepare for its effective date. This article provides an overview of the key provisions of the final rule and steps employers may take to prepare for the FTC’s ban on noncompete clauses.

Employers should note, however, that at least three lawsuits (including one brought by the U.S. Chamber of Commerce) seeking to block the final rule have already been filed, so employers should monitor for additional legal challenges and prepare for potential uncertainty.

Overview of the FTC’s Noncompete Ban

In general, a noncompete clause is a contractual term between an employer and a worker that blocks the worker from working for a competing employer or starting a competing business, typically within a certain geographic area and period of time after the worker’s employment ends. Currently, the enforceability of a noncompete clause is determined by state and local legislatures and courts. In January 2023, the FTC issued a proposed rule to govern the enforceability of noncompete clauses at the federal level and supersede any less restrictive state laws or judicial interpretations. The FTC then accepted comments on the proposed rule, which it reviewed and considered in drafting the final rule. The final rule was issued on April 23, 2024, and filed in the Federal Register on May 7, 2024. The final rule is scheduled to take effect 120 days after such filing date, on Sept. 4, 2024.

Important Provisions in the FTC Noncompete Ban

The final rule states that noncompete clauses are an unfair method of competition. Therefore, the FTC has voted to ban the use of noncompete clauses in most circumstances and to invalidate most existing noncompete agreements. Specifically, the final rule:

• Bans future noncompete clauses: The final rule prohibits employers from entering into or enforcing noncompete clauses in most circumstances beginning on the effective date. Note that employers may still enforce existing noncompete clauses with senior executives but may not enter into new noncompete clauses with senior executives in most circumstances.
• Invalidates existing noncompete clauses: The final rule also prohibits employers from enforcing most noncompete clauses entered into with current or former employees. The rule provides an exception for existing noncompete clauses entered into with senior executives, which may remain enforceable under the rule. However, this exception is very narrow, as the FTC estimates that only approximately 0.75% of workers are likely to be considered senior executives.
• Requires employers to notify employees: Employers must also provide notice to any current or former employees with existing noncompete clauses (other than senior executives whose existing noncompete clauses may be considered enforceable) that such clauses will not be enforced. The notice must be provided on or prior to the rule’s effective date.

The final rule applies to noncompete agreements with all current and former workers, whether full-time or part-time, including but not limited to employees, independent contractors, interns, externs, and apprentices. However, employers should note that the FTC ban will only prohibit post-employment noncompetes. Employers may still restrict employees from engaging in competitive activities while employed with the employer.

Enforcement of the Final Rule

The final rule states that the use of noncompete clauses in violation of the rule is considered an unfair method of competition in violation of the FTC Act. The FTC may enforce the final rule either through enforcement actions or civil litigation. Moreover, while the final rule does not contemplate a private right of action, an employee can file an action seeking court judgment that any illegal noncompete clause is unenforceable. Employers may be subject to additional actual and punitive damages if they attempt to enforce an illegal noncompete.

Steps to Prepare for the Noncompete Ban

1. Audit Existing Employment Agreements and Employer Policies
   To prepare for the noncompete ban, employers should consider conducting an audit of existing agreements, handbooks, and other policies to determine whether any such documents contain noncompete clauses. As noted above, a noncompete clause may be clearly identifiable or explicitly labeled as a noncompete. However, there may be other provisions or agreements that function as a noncompete clause, even if they are not labeled as such. Therefore, employers should carefully review any agreement or policy terms that may prevent an employee or former employee from accepting employment with another employer.
2. Update Existing Agreements
   Because the final rule will not take effect until September 2024 and is already subject to legal challenges, employers may consider waiting to implement any changes to existing agreements and policies until there is more certainty as to when and if the final rule will take effect. However, after identifying any applicable agreements or policies, employers should begin preparing updated form agreements and policies that do not contain noncompete clauses or other provisions that may be considered so overbroad or burdensome that they function as noncompetes.
3. Prepare Communications for Affected Employees
   The final rule requires employers to notify employees (other than senior executives) who have entered into noncompete clauses that the employer will not enforce such clauses against the employees. Consistent with updates to existing agreements, employers may consider waiting to issue any notices until there is more certainty as to when and if the final rule will take effect. The final rule contains model language that an employer may use to satisfy its notice requirement. Employers should note that the final rule requires notice to both existing and former employees. Therefore, employers should confirm that they have contact information on file for all applicable employees.
4. Prioritize Employee Retention
   Following the effectiveness of the final rule, employers may consider focusing on employee retention as a method of preventing employees from leaving to work for competitors. For example, employers could offer long-term incentives that require continued employment as a condition of eligibility, such as equity awards subject to time-based vesting or deferred compensation programs. Employers may also consider offering greater compensation packages or more generous employee benefits than those offered by competitors.
5. Prepare for Uncertainty
   While employers may begin preparing for the FTC’s ban on noncompetes now, they may want to wait to implement any final changes. The ban is already subject to multiple legal challenges—at least three lawsuits have been filed seeking to block the final rule, including one filed by the U.S. Chamber of Commerce in the U.S. District Court for the Eastern District of Texas—which may result in the ban being delayed, modified or even vacated. Further, a number of provisions in the final rule are ambiguous as drafted. For example, the final rule bans clauses that “function to prevent” a worker from seeking or accepting work or operating a business. The FTC stated that whether a clause functions as a noncompete clause is a “fact-specific inquiry.” It is unclear how that will operate in practice and the extent to which other protective agreements, such as nonsolicitation agreements, may violate the noncompete ban. Therefore, if the ban takes effect, employers should continue to monitor for additional legal challenges or clarification regarding such ambiguous provisions.

Additional Resources

Employers may also refer to the following resources in preparing for the FTC’s final rule banning noncompetes:

• Fact Sheet on the FTC’s Noncompete Rule
• Business and Small Entity Compliance Guide

Provided by Choice Insurance This Legal Update is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact their own independent legal counsel for legal advice. © 2024 Zywave, Inc. All rights reserved.