FTC Issues Final Rule Banning Non-Compete Agreements; Legal Challenges Have Already Begun

• The Federal Trade Commission’s (FTC) final rule bans and invalidates virtually all non-compete agreements for nearly all workers, including both employees and independent contractors.
• The rule will go into effect 120 days after its publication in the Federal Register.
• Pre-existing non-competes with “Senior Executives” will remain enforceable, but the rule prohibits entering into new non-competes with Senior Executives.
• Employers will be required to notify workers who are not Senior Executives with existing non-competes that their non-competes are unenforceable under the final rule.
• The final rule excepts non-competes entered into pursuant to a bona fide sale of a business or a person’s ownership in a business, and, unlike the proposed rule, does not require the seller to have a minimum ownership stake for the exception to apply.
• Legal challenges have already begun, including a lawsuit filed by the U.S. Chamber of Commerce.

On April 23, 2024, the FTC issued its final rule banning employers’ use of non-compete agreements. The rule is broad, applying nationwide and to all non-compete agreements, with a few narrow exceptions. The ban has not gone into effect—it’s scheduled to go into effect 120 days after being published in the Federal Register—and legal challenges have already been filed.

What agreements are covered by the final rule?

The final rule applies to any “non-compete clause,” which is broadly defined to include term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from either (a) seeking or accepting work in the United States with a different person where the work would begin after the conclusion of the employment that includes the now-unlawful term or condition, or (b) operating a business in the United States after the conclusion of the employment that includes the term or condition. A “term or condition of employment” is defined to specifically include contractual terms and workplace policies, whether written or oral.

This sweeping prohibition bans non-compete agreements with any worker, which includes employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person. It applies to any person or employer, including natural persons and business entities of all types, within the FTC’s jurisdiction.

Does the rule invalidate existing non-compete agreements?

Yes, the final rule effectively nullifies existing non-compete agreements with all workers except those who qualify as “Senior Executives” (more on that below). The rule makes it unlawful not only to enter into (or attempt to enter into) a non-compete agreement, but also to enforce (or attempt to enforce) a non-compete agreement or even represent that a worker is subject to a non-compete agreement.

The rule requires employers to provide all workers subject to non-compete clauses with “clear and conspicuous notice” that the non-compete will not and cannot be enforced against the worker by the rule’s effective date. That notice must be written and delivered by hand, mail, email, or text message. The FTC has provided model language for this notice in the final rule.

Who qualifies as a “Senior Executive”?

Unlike with other workers, existing non-compete agreements with “Senior Executives” will be enforceable after the rule goes into effect. But, the rule still bans entering into new non-competes with Senior Executives after the effective date.

Under the final rule, a “Senior Executive” is a worker who (a) was in a policy-making position, and (b) received actual or annualized compensation of at least $151,164 in the preceding year, including salary, commissions, and bonuses.

The regulation defines “policy-making position” as a business entity’s president, CEO or equivalent officer, or any officer or similar person who has “policy-making authority” within the business. “Policy-making authority” means having final authority to make policy decisions that control significant aspects of a business entity or common enterprise, but does not include authority that is limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary or affiliate of a common enterprise.

Are there any other exceptions?

The rule does not apply to a non-compete clause entered into as part of the sale of a business, including the sale of a person’s ownership interest and the sale of all (or substantially all) of a business entity’s operating assets. This differs from the proposed rule, which limited the sale-of-a-business exception to sellers who held at least a 25% ownership interest in a business entity. Under the final rule, there is no minimum ownership threshold for this exception to apply.

The rule does not apply where a cause of action accrued prior to the rule’s effective date. In other words, the rule does not render any existing non-competes unenforceable or invalid from the date of their origin, and instead provides that it is an unfair method of competition to enforce non-competes beginning on the effective date of the rule.

The rule also includes a “good faith” exception, which states that it is “not an unfair method of competition” to enforce, attempt to enforce, or make representations about a non-compete clause when a person has a “good-faith basis to believe that” the non-compete ban is inapplicable.

Does the rule also ban other restrictive covenants, like non-solicitation or confidentiality agreements?

Possibly. The rule does not explicitly ban other types of restrictive covenants. But, as explained above, the rule broadly defines “non-compete clause” to include any term or condition of employment that would “prohibit,” “penalize,” or “function to prevent a worker from” seeking or accepting work after their employment ends. It’s conceivable that in some instances, a non-solicitation or confidentiality agreement could in effect act as a non-compete by functionally preventing a worker from accepting new employment.

In the supplementary information provided along with the final rule, the FTC states that whether a particular contractual provision constitutes a “non-compete clause” will be a “fact-specific inquiry,” meaning the issue has to be decided on a case-by-case basis. If the final rule survives legal challenges, this “fact-specific inquiry” is almost certain to be a significant and hotly contested issue in future litigation.

What’s next?

The final rule is already being challenged in court. On April 24, 2024, the U.S. Chamber of Commerce, along with two other plaintiffs, filed a lawsuit in the U.S. District Court for the Eastern District of Texas arguing that the rule is unlawful because (1) the FTC lacks authority to issue regulations proscribing “unfair methods of competition,” particularly one this sweeping; (2) even if the FTC did have that sort of regulatory authority, it cannot categorically ban all non-compete agreements because not all non-competes constitute “unfair methods of competition”; (3) the rule is impermissibly retroactive; and (4) the categorical ban on virtually all non-competes is arbitrary and capricious because it applies to a host of contracts that could not harm competition in any way.

Other lawsuits have been filed, including by a tax services and software provider, that also challenged the regulation in Texas, and more litigation may follow. It’s unclear how long it will take for courts to determine whether the rule should be upheld or struck down, and it seems very likely that any decision will be appealed.

Stites & Harbison attorneys are closely monitoring the status of the FTC’s final rule and the legal challenges to it. If you have questions about how the rule or ongoing litigation may impact your business, contact a Stites & Harbison attorney for guidance.