The Federal Trade Commission’s Final Rule on Non-Competes: the Baby or the Bathwater?

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From JDSupra, Marcia Goodman, Gail Levine, Andrew Rosenman, Richard Snyder, and Ruth Zadikany discuss the rule issued by the Federal Trade Commission (FTC) banning non-compete agreements with workers, including independent contractors. Marcia, Gail, Andrew, Richard, and Ruth write:

For decades, many courts and legislatures at the state and federal level have largely approved the use of non-compete covenants between employers and employees. The legality of a non-compete provision is routinely determined by careful analysis of the underlying circumstances to assess whether the covenant comports with employment laws, such as the reasonableness of an employer’s legitimate business reasons for implementing a non-compete, and, as applicable, antitrust law considerations, including whether the anticompetitive effects of the non-compete outweigh the benefits.

On April 23, 2024, the Federal Trade Commission (“FTC”) issued its 570-page, final Non-Compete Clause Rule (“Final Rule”), which upends non-compete laws nationwide. Absent judicial intervention, the Final Rule will take effect 120 days after its publication in the Federal Register, and will invalidate many state statutes and decades of established precedent with regard to non-competes. With limited exceptions, an employer’s agreement to, or enforcement (or attempted enforcement) of, a non-compete clause with an employee or independent contractor will be per se unlawful as of the effective date. Moreover, the Final Rule saddles employers nationwide with a mandate to provide clear and conspicuous written notice to countless employees that their existing non-compete covenants will not be, and cannot legally be, enforced against them as of the Final Rule’s effective date.

WHEN WILL THE FINAL RULE TAKE EFFECT?

The Rule will become effective no earlier than 120 days from its publication in the Federal Register (likely by the end of April). Legal challenges to the Final Rule, discussed below, may delay the Final Rule significantly, if not prevent it from ever taking effect.

WHY DID THE FTC ADOPT THE FINAL RULE?

The FTC’s focus on anticompetitive non-competes appears inspired by anecdotes that include egregious $100,000 penalties imposed on minimum-wage security workers if they sought work with a competing security firm. Similarly, recent private litigation confirms the existence of non-competes covering bartenders and other hourly workers, in positions where the non-compete benefits inure primarily to the employer without a corresponding, compelling business need for such covenants.

Conversely, the Final Rule does not articulate a compelling case why non-compete agreements which employers long have utilized—often with court and/or legislative approval—should be nullified across the board. Indeed, courts routinely have upheld non-compete agreements which reasonably protect an employer’s legitimate business interests, such as its investments in developing and maintaining customer relationships and goodwill, protecting technological innovations and product development, and ensuring that an employee cannot use their knowledge of the relative strengths, weaknesses and strategies of the employer’s business for the benefit of competitors. For example, a private fund portfolio manager moving to a competing fund might immediately exploit prior access to sensitive information and trading strategies. Similarly, if a hospital expends thousands of dollars to entice a nurse to a rural community—and thousands more to help the nurse obtain specialized certifications required at a rural hospital with leaner medical staffing—a non-compete of reasonable duration protects the hospital’s investment and prevents a competitor from free-riding on the hospital’s efforts. The Final Rule ignores that non-compete agreements are often socially valuable, provided that they are also of reasonably limited scope.

THE FINAL RULE IS BROAD, WITH SOME USEFUL EXCLUSIONS

Generally, the Final Rule provides that, with respect to most workers, it is an “unfair method of competition” for an employer to (1) enter into or attempt to enter into a non-compete clause; (2) enforce or attempt to enforce a non-compete clause; or (3) represent that a worker is subject to a non-compete clause. Key provisions include:

  • Definition of Worker: The Final Rule defines “worker” broadly to include employees, independent contractors, externs, interns, volunteers, apprentices and certain sole proprietors, and largely ignores distinctions based on the role of the worker, the trade secrets and confidential information that the worker accesses, or the bargaining power of the parties involved. A “worker” does not include a franchisee in the context of a franchisee-franchisor relationship.
  • Definition of “Non-Compete Clause”: The Final Rule defines a “non-compete clause” broadly to include a term or condition of employment that either “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” seeking or accepting work with a competitor, or operating a competing business. The Final Rule, therefore, captures agreements that “penalize” a worker who takes (or seeks to take) a job with a competitor. The FTC asserts that a “forfeiture for competition” clause in an incentive plan or equity agreement would be invalid under this definition. So too would a covenant in a severance agreement between an employer and employee that conditions payment on non-competition. There are, however, meaningful exclusions from the scope of a “non-compete clause.”
    • The Final Rule explains that “garden leave” and similar arrangements would not be a non-compete clause under the Final Rule, provided that the worker remains employed during the relevant period.
    • The Final Rule also explains that there is no non-compete if the agreement imposes no restrictions on where the worker may work following employment. Non-solicitation covenants (as to customers or employees) and training assistance repayment agreements therefore are not categorically prohibited by the Final Rule, but employers should be mindful that these types of agreements, if too onerous in scope, may “function to prevent” a worker from competing.
    • The Final Rule does not apply to most not-for-profit entities, and certain financial institutions, because those entities are outside the FTC’s jurisdiction.
    • The Final Rule applies only to restrictions on accepting work from a US employer or operating a business in the United States.
  • Senior Executive Limited Exclusion. The Final Rule allows enforcement of existing non-competes with “senior executives,” but prohibits employers—as of the effective date—from agreeing to or enforcing new non-competes with senior executives.
    • The Final Rule defines “senior executive” to mean a worker who is in a “policy-making position” and received “total annual compensation” of at least $151,164 in the preceding year (or the equivalent amount when annualized if the worker was employed during only part of the year).
    • A senior executive’s “total annual compensation” under the Final Rule may include salary, commissions, nondiscretionary bonuses, and other nondiscretionary compensation earned during the preceding year, but does not include the cost of, or contributions to, fringe benefit programs.
    • The Final Rule allows the employer to choose to define the “preceding year” as the most recent 52-week period, the most recent calendar year, the most recent fiscal year, or the most recent anniversary of hire year.
    • The Final Rule also defines those in a policy-making position to include the entity’s President, CEO or equivalent, or others with “policy-making authority,” which, in turn, means “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.”
  • Bona Fide Business Sale Exception. The Final Rule permits employers to enforce non-compete covenants that are entered pursuant to the bona fide sale of a business entity, of the person’s ownership in a business entity, or of all or substantially all of the entity’s operating assets.
  • Existing Causes of Action. The Final Rule does not apply where a cause of action related to a non-compete clause accrues prior to the effective date.

MANDATORY NOTICE BY EMPLOYERS TO EMPLOYEES

The Final Rule imposes a substantial procedural burden on employers. In particular, with respect to an employer’s existing non-compete clauses with all workers who do not fall within the “senior executive” or sale-of-business exceptions, such covenants not to compete will be invalid as of the effective date. In that regard, the Final Rule requires employers, by the effective date, to provide “clear and conspicuous notice” in writing to such workers that their non-compete clauses will not be, and cannot legally be, enforced against them (and the FTC included an approved form of notice with the Final Rule). This will be an important decision point for employers, as they determine whether certain executives fall within the scope of “senior executives” under the Final Rule.

The Final Rule applies nationally, but neither interferes with broader protections for employees under state law, nor limits state agency and/or private enforcement under state laws. Thus, while the Final Rule expressly preempts all state statutes and case law that permit non-compete covenants, the Final Rule is not intended to displace laws in states like California, Minnesota, North Dakota, and Oklahoma, each of which prohibits or substantially restricts enforcement of non-competes to the extent they are more restrictive than the Final Rule, nor would it displace more restrictive laws that may be enacted in the future, such as in New York City.

LITIGATION CHALLENGING THE FINAL RULE

Within the first two days after the FTC issued the Final Rule, at least three groups of plaintiffs filed federal lawsuits challenging the Final Rule. Certain aspects of the challenges focus on the scope and breadth of the FTC’s rulemaking authority. At least one motion for a preliminary injunction to invalidate the Final Rule, and a motion to stay the effective date of the Final Rule, already have been filed. We anticipate that many additional lawsuits challenging the enforceability of the Final Rule will be filed in the coming weeks. A successful challenge to the Final Rule on any of the below bases likely would invalidate the Final Rule in its entirety. The plaintiffs have argued or will argue that:

  • The Final Rule exceeds the FTC’s authority under the Non-Delegation Doctrine, which holds that Congress cannot delegate its legislative power to administrative agencies without providing adequate guidance.
  • The Final Rule violates the Major Questions Doctrine, which bars agencies from resolving questions of “vast economic and political significance” without clear statutory authorization. When it adopted and amended the FTC Act, Congress did not intend to authorize the FTC to regulate all employer-employee relationships. The Supreme Court has rejected agency claims to have discovered “in a long-extant statute an unheralded power” representing a “transformative expansion in [its] regulatory authority.” Repeated efforts in Congress to achieve the same result as the Final Rule through the Workforce Mobility Act confirm that non-competes are a topic for legislation, not administrative rulemaking.
  • The Final Rule exceeds the FTC’s statutory authority. The Final Rule exceeds the FTC’s authority under Sections 5 and 6(g) of the FTC Act. Section 6(g) of the FTC Act, relied upon by the FTC to support its rulemaking authority, only empowers the FTC to develop internal rules, not to promulgate substantive rules that govern the actions of private parties.
  • Unconstitutionality of the FTC itself. One of the recently-filed lawsuits takes the FTC on directly, alleging that the FTC’s structure itself violates Article II of the Constitution.

Even if the Final Rule survives these legal challenges, enforcement of the Final Rule may be delayed and/or limited. The FTC’s issuance of the Final Rule relies upon its asserted authority to regulate “unfair methods of competition.” But as the Final Rule notes, although Congress has authorized the FTC to seek civil monetary remedies against a party that violates a rule regarding unfair or deceptive acts or practices (see 15 U.S.C. 45(m)), Congress has not authorized the FTC to seek civil monetary remedies for violation of FTC rules regulating unfair methods of competition. But as the FTC notes on page 24 of the Final Rule (citing 15 USC 45(l)), “it can obtain civil penalties if a party is ordered to cease and desist from a violation and fails to do so.” Further, unlike other antitrust statutes and some state statutes regulating noncompete agreements, the Final Rule includes no private right of action, because the Final Rule was issued under the FTC Act. Thus, only the FTC can enforce the Final Rule. Neither the DOJ, state agencies, nor private plaintiffs may enforce the Final Rule.

TAKEAWAYS FOR EMPLOYERS

Employers should consult with experienced employment and antitrust counsel to consider how they can proactively address their existing non-compete agreements, and related employment arrangements, to mitigate the impact if the Final Rule takes effect several months from now. For example, because the Final Rule does not invalidate non-compete clauses with senior executives that are entered into prior to the effective date, employers may wish to review whether any employees who qualify as “senior executives” are not yet subject to a non-compete clause. Employers may also wish to consider whether implementation of “garden leave” or similar arrangements may be a workable alternative.

As noted above, the earliest date on which the Final Rule would take effect is 120 days from publication of the Final Rule in the Federal Register. Accordingly, employers have time to consider how matters progress in the pending lawsuits against the FTC. It is noteworthy that federal courts in recent years have halted other efforts by the Biden Administration to impose sweeping obligations on employers—such as OSHA’s unsuccessful effort to require large US employers to ensure COVID-19 vaccination of their employees. The FTC’s Final Rule may suffer a similar fate.


1 See, e.g., Chamber of Commerce of the U.S., et al. v. FTC, et al., Case No. 24-cv-00148 (E.D. Tex.); Ryan, LLC v. FTC, Case No. 24-cv-00986 (N.D. Tex.); ATS Tree Servs., LLC v. FTC, et al., Case No. 24-cv-1743 (E.D. Pa.).

Source: The Federal Trade Commission’s Final Rule on Non-Competes: the Baby or the Bathwater? | Mayer Brown – JDSupra

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