FTC Issues Final Rule Banning Most Non-Compete Agreements

Aug. 20, 2024 Update: On Aug. 20, 2024, the U.S. District Court for the Northern District of Texas set aside the FTC’s Final Rule on a nationwide basis. See our latest alert on the topic.

On April 23, 2024, the Federal Trade Commission (FTC) voted 3-to-2 to issue a final rule that will ban most employer-employee non-compete agreements if it survives legal challenges from the U.S. Chamber of Commerce and other opponents of the rule.

The Final Rule

The 570-page final rule has been a long time coming: McGuireWoods outlined the proposed rule and potential challenges to the rule in previous updates starting with the initial release of the proposed rule in January 2023.

The final rule provides that it is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for employers to enter into non-competes with most workers going forward and to enforce most existing non-competes. In the FTC’s words, the final rule is “a comprehensive ban on new non-competes with all workers” and will invalidate most non-competes in place.

What non-compete clauses are covered by the rule? The final rule defines “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 (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.” This definition includes forfeiture-for-competition clauses, certain training-repayment agreements and certain liquidated damages provisions. Other agreements, like nondisclosure agreements or agreements preventing former employees from soliciting customers, are not categorically barred, but could fall within the final rule’s prohibition depending on the particular circumstances.

What employees are covered by the rule? The final rule applies to “workers.” A “worker” is defined as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other 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 a service to a person.”

What will happen to non-compete provisions already in place? For workers who are not “senior executives” — employees earning over $151,164 who work “in a policy-making position” — the final rule would render existing non-competes unenforceable after the final rule’s effective date (120 days after the rule is published in the Federal Register). The final rule would prohibit entering or attempting to enter into a non-compete, enforcing or attempting to enforce a non-compete, or representing that a worker is subject to a non-compete.

What are the immediate next steps employers need to take? Companies or individuals who entered into non-compete clauses with workers (other than senior executives) “must provide clear and conspicuous notice to the worker by the effective date that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.” The final rule provides guidance on acceptable forms of notice and model language for notices.

The final rule applies differently with respect to senior executives, however. Existing non-competes with senior executives can remain in force, but companies and individuals are prohibited from entering into new non-competes with senior executives after the final rule’s effective date. Companies and individuals are likewise prohibited from attempting to enforce non-competes with senior executives entered after the effective date of the rule.

As with the proposed rule, there are some noteworthy exceptions to the scope of the final rule.

The final rule will “not apply to a non-compete clause that is 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,” regardless of the amount of equity owned by the restrained person. Non-competes that are ancillary to covered transactions thus may still be enforceable.

The final rule will not apply “where a cause of action related to a non-compete clause accrued prior to the effective date.” For example, if an employer sued to enforce a former employee’s non-compete before the final rule’s effective date, the final rule will not retroactively extinguish that claim.

The final rule defines the term “worker” to include a natural person who works for a franchisee or franchisor, but not a franchisee in the context of a franchisee-franchisor relationship. This definition operates to limit the applicability of the final rule in the franchisor-franchisee context.
The final rule has additional limitations and exceptions to its applicability — while key terms are summarized here, companies and individuals will need to assess its application to their contracts on a case-by-case basis.

Litigation and Potential Stay of Final Rule

Challenges to the final rule already have been filed. On April 23, 2024 — the same day the final rule was issued — an initial challenge was filed in the U.S. District Court for the Northern District of Texas. The complaint argues the FTC lacks the statutory authority to issue the rule, or such authority violates the U.S. Constitution.

Likewise, the Chamber of Commerce has stated that it plans to sue the FTC. In a statement issued by U.S. Chamber of Commerce President and CEO Suzanne Clark, she said “the FTC’s decision to ban employer non-compete agreements across the economy is not only unlawful, but also a blatant power grab that will undermine American businesses’ ability to remain competitive.”

With these and similar challenges likely, there remains substantial uncertainty regarding the ultimate viability of the final rule and the timeline on which it may go into effect. For example, one or more of the courts entertaining these challenges could enter orders staying the rule during the pendency of the litigations. McGuireWoods will monitor developments in these cases.

What This Means for Employers and Businesses

While the legal challenges to the final rule introduce uncertainty regarding when the final rule will take effect (if at all), the rule is scheduled to take effect as soon as 120 days from when it is published in the Federal Register. Publication may take several days from the April 23, 2024, announcement.

Notwithstanding the uncertainty related to litigation challenges, companies should assess their current and projected use and enforcement of non-competes, consider whether any actions should be taken with regard to non-competes in the lead up to the effective date, and plan to make any notices required under the final rule.

McGuireWoods industry teams will publish targeted guidance in the coming days. The firm is ready to assist in assessing the effect the final rule may have on businesses and anticipates providing further industry-specific guidance.