Are Non-Competes Non-Existent? Not Yet.
Update:
After this blog was published, on August 20, 2024, U.S. District Court Judge Ada E. Brown issued a nationwide Order setting aside the FTC’s rule banning non-competes in Ryan LLC v. Federal Trade Commission, Case No. 3:24-CV-00986-E. For more details, please see Strowhiro Law’s more recent blog post: Ryan LLC v. FTC: Texas Court Blocks the FTC’s Non-Compete Ban Nationwide.
On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to approve its non-compete final rule. While much remains unclear, including if or when the rule will take effect, there are a few key things that employees, employers, and those engaged in M&A transactions should know.
Five Key things to know about the ftc’s non-compete final rule
1. The FTC’s non-compete final rule is not effective yet.
The rule is set to take effect 120 days after its May 7, 2024 publication date. If it survives — and that’s a big “if” — the rule would become effective on September 4, 2024. Until then, the ability to enforce or enter into non-competes remains unaffected by this final rule.
2. The FTC’s non-compete final rule may never take effect.
September 4 is just a few months away. But within the first 24 hours after the FTC approved its rule, multiple lawsuits were filed attempting to block it, including lawsuits by Ryan, LLC and the US Chamber of Commerce in Texas and by ATS Tree Services, LLC in Pennsylvania.
The lawsuits each make several arguments regarding why the FTC’s non-compete final rule may be unlawful, including that the rule itself exceeds the FTC’s statutory authority, both in its ability to prohibit unfair methods of competition through this type of rulemaking and in its ability to apply such rule retroactively; the classification of all non-competes as unfair methods of competition contradicts Section 5 of the FTC Act; and even if the FTC had such authority, the rule is a product of flawed decisionmaking that lacks evidentiary support, ignores better alternatives, and suffers from an incorrect cost-benefit analysis.
The courts in the Ryan, LLC and ATS cases are expected to issue preliminary decisions in July that could pause the non-compete final rule’s effective date or temporarily stop the FTC from enforcing the rule. These decisions, whatever they may be, will likely be appealed and could eventually find their way to the U.S. Supreme Court where similarly broad administrative rules have been killed before.
It was just two years ago that SCOTUS voted 6-3 to stop the U.S. Occupational Safety and Health Administration (OSHA) from enforcing its vax-or-test Emergency Temporary Standard (ETS) that would have required large employers to require masking and weekly COVID-19 testing of unvaccinated employees, among other things, on the general premise that OSHA’s ETS was overbroad, indicating that general application of such rule to all workforces went beyond OSHA’s authority but that it might have the authority to issue a narrower, industry- or job-specific rule for industries where COVID-19 posed a special danger.
Here, too, litigants are arguing that the FTC’s rule is overbroad for many reasons, including that it applies a blanket “no-noncompete” standard irrespective of industry and, going forward, irrespective of job title or responsibility.
While it remains to be seen what will happen next, it is possible that the FTC’s rule will get held up in court and never take effect.
3. But what if the FTC’s non-compete final rule does take effect? Here’s what it does.
Let’s take a quick look at the substance of the rule. For reference, a link to the final rule and its supplementary information — all 570 pages of it — can be found here.
Despite the voluminous, 570-page PDF you’d find if you click through, the FTC’s non-compete rule is pretty simple.
After the rule’s effective date:
New non-competes with workers (executives and non-executives alike) are banned.
Non-competes that existed before the effective date that are with non-“senior executive” workers become unenforceable.
Non-competes that existed before the effective date that are with “senior executives” remain in effect.
The rule is drafted to specifically target and ban non-competes that are entered into as a term or condition of “employment,” where “employment” can mean actual employment of an employee, engagement of an independent contractor, or other worker relationship — paid or unpaid — including interns and volunteers.
If the rule goes into effect, any person or business that has a non-compete with someone that is no longer enforceable will be required to give notice to that person by the effective date of the rule.
4. Even if the rule takes effect as-is, employers maintain rights to protect their customers, employees, and confidential information.
In the FTC’s rule, “non-compete” is referring to a term or condition that stops a worker from, or penalizes a worker for, seeking or accepting work in the United States post-employment, or operating a business in the United States post-employment.
First, the “post-employment” distinction is an important one because, as drafted, it would still allow employers to continue to require employees and other workers to comply with “no conflict of interest” policies and exclusivity clauses during employment or engagement.
Second, the rule does not prevent employers from requiring employees to enter into other restrictive covenants so long as those restrictions are not drafted so broadly or in such a way that they are essentially non-competes themselves. For example, non-solicits of customers, non-solicits of employees, and non-disclosure or confidentiality agreements are not prohibited by the FTC’s non-compete final rule as long as they are not drafted overly broadly. (That said, state law may further restrict an employer’s ability to enter into these types of restrictions. In California, for example, customer non-solicits are generally viewed as non-competes and are prohibited; and employee non-solicits are highly disfavored by courts.)
5. Sale-of-business non-competes are still fair game.
Under the proposed rule that the FTC released in 2023, there would have been a 25% threshold of ownership that would be required in order to secure a non-compete with a seller of a business. In the FTC’s final rule that would take effect in September 2024, the 25% threshold has been deleted.
Specifically, the FTC's final rule prohibiting non-competes does not apply to non-competes entered into "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."
This carve-out and the elimination of the 25% threshold gives buyers some relief from what may have otherwise served to disincentivize certain acquisitions or drive down purchase prices. That said, the final rule still leaves some ambiguity about how or whether the rule or exception may apply to transactions that are not straightforward “sales” (for example, the rule leaves some to question its application to beneficial ownership interests and JV efforts).
What to do now
Here are a few things to keep in mind as we wait to see if the FTC’s rule will survive:
The rule is not yet in effect and may never take effect. Whatever may happen in the future, people who are bound by valid non-competes today remain bound until and unless the FTC’s rule takes effect or the non-compete expires.
Until and unless the FTC’s final rule takes effect, employers can continue to enter into non-competes with workers, subject to applicable state and local laws.
If the FTC’s rule goes into effect, businesses and others who have bound others to non-competes will be required to provide notice to those individuals whose non-competes are rendered unenforceable by the FTC’s rule. The notice must be given before the rule takes effect, so businesses should be prepared. Getting ready to send the notices may be a bigger task than some companies may anticipate, particularly those with larger workforces and voluminous non-compete agreements or less-than-perfect records of who is currently bound to a non-compete and their contact information. Therefore, it would be prudent to get those lists ready in case the rule survives challenge and notices are required.
Fortunately, the FTC’s rule provides a sample notice and there is a safe harbor for anyone who uses that sample, so there is no need to reinvent the wheel in drafting the notice itself.
Even outside of the FTC’s non-compete rule itself, courts in the United States have grown increasingly wary of broadly-drafted non-compete agreements and will often narrow or strike down agreements that are not carefully and narrowly drafted. Moreover, more and more states are implementing laws that curtail the widespread use of non-competes in employment, often limiting non-competes only to those employees who are exempt or who earn above a certain threshold; while other states have imposed laws that prohibit or limit use of non-competes with certain types of professionals such as physicians. Given this environment, it is prudent for companies that use non-competes to review their agreements with counsel regularly to ensure that the agreements work in the states where they operate.