Reprinted with permission from Crowell Morning, LLP
On April 23, 2024, the Federal Trade Commission (“FTC” or “the Agency”) voted 3-2 along partisan lines in a special public meeting to adopt the “Non-Compete Clause Rule” (the “Final Rule”), which will prohibit most employee non-competes with retroactive effect, except existing non-compete provisions of “senior executives.” The Final Rule will also ban future non-compete agreements, including for senior executives, with limited exceptions. The rule will not become effective until 120 days after publication in the Federal Register, and covered employers will be required to comply with the Final Rule by that effective date, which could come as early as August this year. By the FTC’s own estimate, this ban could affect up to one-in-five American workers.
The Final Rule, however, is already facing legal challenges one day after the FTC finalized the rule. Earlier today, for example, in Texas federal court, business groups (including Business Roundtable, Texas Association of Business, and Longview Chamber of Commerce) led by the U.S. Chamber of Commerce sued the FTC to block its non-compete ban, arguing that the agency lacks the authority to issue rules that regulate “unfair methods of competition.” In its complaint, the lobby group said that while the Federal Trade Commission Act granted the Agency the ability to challenge particular practices, it did not allow the Agency to promulgate “unfair methods of competition” rulemaking. The suit requests that the court vacate and permanently enjoin the non-compete ban, among other forms of relief. Such challenges could further delay—or bar altogether—enforcement of the rule.
Notably, the two dissenting Republican commissioners, Melissa Holyoak and Andrew N. Ferguson, vigorously questioned the FTC’s ability to promulgate such a rule at the public hearing this week. Echoing arguments previously set out in January 2023 by former Commissioner Christine S. Wilson’s detailed dissent on the proposed rule, Holyoak expressed concerns that the Final Rule undermines the U.S. Constitution’s separation of powers, and that the FTC lacks legislative authority through Section 6(g) of the FTC Act to promulgate a rule designed to prevent “unfair methods of competition.” In agreement with Holyoak, Ferguson added that the Final Rule is unlawful, arbitrary, and capricious, as it nullifies millions of preexisting contracts, preempts the laws of forty-six states, and usurps the role of Congress to regulate areas of “tremendous economic and political significance” by redistributing nearly half a trillion dollars by “regulatory fiat.”
As these legal challenges play out, however, companies should stay the course and continue to hew very close to state and local laws on non-competes, where most of the action on non-competes is happening. Companies should also continue to work closely with antitrust, labor, or trade secrets counsel to ensure they use all tools available to protect their investments and business strategies.
Overview of the Final Rule
After review of over 26,000 comments submitted on the FTC’s publicly proposed rule, the Final Rule is similar in many respects. (For more information on the proposed rule, see our January 2023 client alert.) As with the proposed rule, the Final Rule deems virtually all non-compete agreements with workers to be “unfair methods of competition” in violation of Section 5 of the FTC Act. Below are the key elements of the Final Rule:
- The rule bans all new non-competes, including with senior executives, after becoming effective.
- The rule contains a “grandfathering” exception for existing non-competes with “senior executives,” defined to include very high-level, “policy-making” officers meeting certain salary thresholds (as described below).
- The only exemption to the Final Rule is non-competes that are entered into in connection with the sale of a business.
- By the effective date of the rule, employers will be required to provide written notices to relevant employees informing them that their non-competes are unenforceable and will not be enforced.
- The Final Rule preempts conflicting state laws, thus banning otherwise lawful employee noncompete clauses in the 46 states that permit them.
Key Definitions of the Final Rule
Below are key definitions in the Final Rule:
“Non-Compete” provisions are broadly defined to include “[a] term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” (a) “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” (b) “operating a business in the United States after the conclusion of the employment that includes the term or condition.” The Final Rule therefore does not extend to restraints on concurrent employment but is limited to post-termination non-compete agreements.
Notably, the Final Rule departs from the FTC’s original proposal to prohibit contractual terms that may be considered de facto non-compete clauses in response to vagueness concerns raised in public comments, and confirms that other types of restrictive covenants, such as non-disclosure agreements, non-solicitation agreements, and training repayment agreement provisions (or TRAPs), do not by their terms alone prevent a worker for working for another employer. However, the FTC confirmed its intention to bring any agreement deemed to “function” as a non-compete within the scope of the ban. The rule therefore retains the “functional test” to determine whether a specific term or condition that operates as a non-compete clause, even if the contractual term is not explicitly called a “non-compete clause,” such as an NDA.
- “Worker” is defined broadly to include any employee regardless of whether they are paid or unpaid, irrespective of title or status, including “independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.”
- “Senior executives” are treated differently than other workers under the Final Rule, as existing non-competes of “senior executives” are grandfathered in, but new non-competes would be banned after the Final Rule becomes effective.
The Final Rule defines “senior executives” to include either: (1) a business entity’s president, Chief Executive Officer, or the equivalent, or (2) an officer with “policy-making position, meaning any individual who earns more than $151,164 annually and has final authority to make controlling policy decisions on significant aspects of a business.
- Covered employers include certain sectors and entities—such as banks, non-profits not organized to carry on business for their own profit or that of their members (e.g., 501(c)(3) organizations), insurance companies, transportation and communications carriers, air carriers, and employers subject to the Packers and Stockyards Act—that fall outside of the FTC’s jurisdictional reach under the FTC Act. Notwithstanding these exemptions, Commissioner Rebecca Slaughter, who supported the ban, acknowledged that certain non-profits are exempted from the FTC Act’s reach, but suggested the ban could apply to other non-profit organizations in cases where entities “claim nonprofit tax status but are organized to the profit of [their] members who are within [their] jurisdiction and covered by the rule, which nonprofits are not,” thus, creating a grey area regarding the ban’s application with respect to certain non-profits.
Effect of the Ban on Trade Secret Protections
Though non-compete agreements have been unenforceable in jurisdictions like California for many years, the FTC’s nationwide expansion of the ban on non-compete agreements nonetheless raises significant concerns around IP theft. In particular, where non-compete agreements are enforceable, they have provided at least some deterrent to trade secret misappropriation, and without them, employers will be faced with increased risk that misappropriated trade secrets will make their way into the hands of competitors. Companies should begin taking steps to mitigate the heightened risks that will result from a ban on non-compete agreements. For example, companies should consider whether non-disclosure and non-solicitation agreements can be drafted to provide some protection against flagrant theft and disclosure of trade secrets.
In addition, companies can begin auditing and diligently practicing good hygiene around trade secret protection through employment policies and written agreements and acknowledgments regarding the confidentiality of company information and procedures governing access to trade secrets, among other best practices. Companies should also routinely confirm their employees’ understanding of these policies and, where possible, obtain contractual agreements from departing employees that they will return all confidential and trade secret information to the company upon their exit.
Finally, companies seeking the return of misappropriated trade secrets through litigation should consider whether they can fill the gap left by the FTC’s ban on non-compete agreements through the “inevitable disclosure” doctrine. In jurisdictions that recognize the doctrine, courts can enjoin an employee from taking on particular job responsibilities at the competitor’s company where it is “inevitable” that they will disclose trade secrets in performing those job duties. However, there is a split in authority on whether the “inevitable disclosure” doctrine can support the issuance of an injunction. The doctrine is currently only recognized in about half of the states, and a portion of those impose a high evidentiary burden before granting such relief. And although the Defend Trade Secrets Act (DTSA) provides that an injunction may issue to prevent actual and “threatened” misappropriation, it does not expressly refer to “inevitable disclosure.” Thus, although the FTC points to the DTSA as providing adequate protections against trade secret misappropriation, and the DTSA’s protections against “threatened” misappropriation may justify injunctions under the inevitable disclosure doctrine in some states, it remains to be seen whether and to what extent the doctrine will survive in the remaining jurisdictions should the FTC’s ban on non-competes take effect.
Key Takeaways
As described, the FTC’s Final Rule is already being tested in the courts by the U.S. Chamber of Commerce and certain business groups on various grounds, including on constitutional grounds, seeking to vacate and permanently enjoin the rule in its entirety, as well as other forms of relief. In a statement following the FTC’s vote to finalize the ban, U.S. Chamber of Commerce President and CEO Suzanne P. Clark said that the FTC’s rule “to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive.” Enforcement of the rule will therefore likely be delayed or thwarted completely.
In the meantime, companies that rely heavily on non-compete agreements should review their policies and practices, focusing on determining which employees are senior or non-senior executives and what provisions in employment contracts may operate on as a non-compete agreement. Companies should also continue to remain in compliance with the panoply of state and local laws regarding non-competes and stay abreast of recent state law changes in this area as well, such as the California’s recent strengthening of the state’s ban on non-compete agreements and accompanying notice requirements. (For more information on these developments, see our April 1 client alert.)
Companies that want to re-examine their existing non-compete agreements and audit their protections and controls over confidential and trade secret information can contact Crowell’s antitrust, labor, or trade secrets teams, including the contacts for this alert.
For more information about this rule contact: Rosa M. Morales, Counsel, Crowell Morning, Two Manhattan West, 375 Ninth Avenue, New York, NY 10001, rmorales@crowell.com, 212.895.4261
If you know of a business owner who’s thinking of selling or buying a business and who might benefit from a complimentary, confidential, consultation with us, have them contact me directly at: mertel@transworldma.com, or one of the other managing directors at Transworld M&A Advisors.
Mike Ertel, CBI, M&AMI, CM&AA
Managing Director
Transworld M&A Advisors
813.299.7862 Direct
©2024 J. Michael Ertel PA