In a significant move to reshape competition in the labor market, the Federal Trade Commission (FTC) has issued a final rule regarding non-compete clauses, impacting millions of American workers and businesses across all industries. This rule, which will become effective 120 days after its publication in the federal register, aims to address purported concerns about the effects of non-compete agreements on fair competition, wages, and job mobility.
The Final Rule's Provisions
The final rule, first proposed on January 19, 2023, categorizes non-compete clauses as an unfair method of competition, thus violating section 5 of the FTC Act. Pursuant to this rule, it will now be unlawful for employers to enter non-compete agreements with workers on or after the rule's effective date. The rule applies broadly to all workers, paid or unpaid, including employees, independent contractors, and sole proprietors. However, the rule adopts a differential approach for existing non-competes based on whether they apply to senior executives or other workers.
Non-Competes for Senior Executives v. Other Workers
For senior executives, existing non-compete agreements can continue to be enforced while those for other workers become unenforceable immediately upon the rule's effective date. This distinction arises from considerations regarding the potential harm caused by non-competes, with senior executives seen as less susceptible to ongoing harm compared to other workers. The rule defines senior executives as employees in policy-making positions earning at least $151,164 annually.
The rule specifies that for workers other than senior executives, non-compete clauses are deemed an unfair method of competition and illegal under the new rule.
Definition of Non-Compete Clause and Exclusions
A non-compete clause, as defined by the final rule, is 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 work in the United States with a different person where such work would begin after the conclusion of the employment that includes a term or condition; or
- Operating a business in the United States after the conclusion of the employment that includes the term or condition.
The final rule further provides that, "a term or condition of employment" includes, but is not limited to, a contractual term or workplace policy, whether written or oral.
It is important to note that the final rule does not apply to:
- Non-competes entered pursuant to a bona fide sale of a business entity.
- In instances where a cause of action related to a non-compete accrued prior to the effective date.
- A person has good faith basis to believe that the final rule is inapplicable.
Preemption & Severability
The final rule does not limit or change enforcement of state laws that restrict non-competes where the state laws do not conflict with the final rule, but it will preempt, or override, state laws that conflict with the final rule.
The final rule also includes a severability clause which states that if a court reviewing the validity of a noncompete clause were to hold any part of any provision or application of the final rule invalid or unenforceable, the remainder of the final rule shall remain in effect.
Policy Rationale and Stakeholder Reactions
The FTC's final rule stems from growing concerns about non-competes' negative impacts on competition, wages, and innovation in various markets. The Commission found that the existing state-by-state and often case-by-case determination of potential harm caused by noncompete agreements was not enough to adequately address the issue. Before the new rule was approved, non-competes between employers and workers were generally subject to greater scrutiny under State common law than other employment terms "because they are often the product of unequal bargaining power and because the employees is likely to give scant attention to the hardship he may later suffer through loss of is livelihood." Restatement (Second) of Contracts, sec. 188, cmt. g (1981) . The Commission estimated that about one in five American workers- or approximately 30 million workers- are subject to a non-compete, including middle and low income workers, which is what spurred this investigation and review by the FTC in the first place.
In support of its final rule, the FTC pointed to empirical research results showing that non- competes tend to harm competitive conditions in labor, product, and service markets. It also leaned on the public comments that overwhelmingly supported the FTC's move to ban most non-compete agreements. However, the rule faces opposition from business groups, such as the U.S. Chamber of Commerce, which argues that non-competes protect trade secrets and incentivize investment in employees.
Almost immediately after the final rule was issued, the U.S. Chamber of Commerce and the Business Roundtable filed a lawsuit against the FTC in federal court in the Eastern District of Texas. The Chamber was vehemently opposed to the rule even before it was passed asserting that the FTC was overstepping its administrative authority by unilaterally banning noncompete agreements. The lawsuit claims that the agency needed a legislative mandate from Congress before proceeding in such a far-reaching action. The parties requested that the court issue a stay to prevent the rule from going into effect until after the case is decided. This leaves the business world stuck in uncertainty not knowing whether they can legally continue to enforce non-compete agreements or enter into new agreements in the interim.
Key Takeaways for the Business Community
- Employers may no longer enter, or attempt to enter into new non-compete agreements with workers after the final rule becomes effective. This includes new non-competes with senior executives.
- Some existing noncompete agreements in place between employers and senior executives may remain in effect. The agreements must have been entered before the date that the final rule becomes effective.
- The rule does not apply where a cause of action related to a non-compete accrued prior to the effective date.
- Any employees currently subject to a noncompete agreement who are not categorized as a senior executive will no longer be bound by the agreement upon the effective date. The employer is responsible for notifying employees that the non-compete will not be enforced.
- The final rule is not applicable to a non-compete agreement entered as part of a bona fide sale of a business entity.
- FTC highlighted alternatives to non-competes: Trade secret laws and non-disclosure agreements (NDAs) can provide employers protection to proprietary and other sensitive information.
- The final rule will become effective 120 days after publication in the Federal Register.
Conclusion
The FTC's final rule on non-compete clauses represents a significant regulatory shift aimed at fostering fair competition, increasing wages, and enhancing job mobility for millions of American workers. While it faces legal challenges from business interests the broader societal implications signal a renewed focus by the federal government on balancing employer interests with worker rights. As the rule takes effect, its impact on labor markets and business practices will be closely monitored by the team at Wood Smith Henning & Berman. Should you have an questions or concerns about the implications of this new development please do not hesitate to reach out to a member of our team.