FTC’s New Restrictions on Noncompetes

On April 23, 2024, the Federal Trade Commission (the “FTC”) issued the Non-Compete Clause Rule (the “Rule”) that will ban employers from imposing future noncompetes on certain workers. This will void nearly all current noncompete agreements with workers once the Rule goes into effect on September 4, 2024 (the “Effective Date”).

Background

Historically, noncompete agreements in employment contracts have been addressed separately by state courts and legislatures. Agreements have generally been enforced if they are appropriate in geographic scope, scope of employment restrictions, and duration. Some states, including Colorado, Oklahoma, and California, have banned outright noncompete agreements for employees, citing concerns of unfair restrictions on competition and potential negative impacts on innovation and new business formation. The FTC announced last year a proposed rule similar to these state restrictions that would eliminate the use of most noncompetes nationally and recently announced the Rule as final.

What is the Rule?

The Rule imposes a national ban on enforcing noncompete agreements and makes it unlawful for any employer or person to enter into, enforce, or attempt to enter into or enforce any such agreement with a worker on or after the Effective Date, with a few exceptions. The Rule defines workers as any person that works for a person or employer, including both employees and independent contractors.

The Rule has different outcomes for noncompete agreements based on whether or not a worker qualifies as a senior executive.

• Non-Senior Executives

For workers that do not qualify as a senior executive under the Rule, any noncompete that is in effect will be immediately unenforceable on the effective date of the Rule, and employers are banned from enforcing or requiring workers to sign any noncompete agreements on or after the Effective Date. Employers must also provide notice to affected workers, on or before the Effective Date, that their noncompete agreement is unenforceable.

• Senior Executives

The Rule bans enforcement of all noncompete agreements made on or after the Effective Date. The Rule, however, does allow employers to continue enforcing only noncompetes existing before the Effective Date for qualifying “senior executive” workers. An employer may continue to enforce these senior executive noncompete agreements for workers who meet both of the following requirements:

1. 1. Annual Compensation over $151,164. Workers must make at least $151,164 in total annual compensation over the year before the Effective Date to be classified as senior executives. Total annual compensation includes salaries, nondiscretionary bonuses, and other nondiscretionary compensation. Total annual compensation does not include fringe benefits like board, lodging, insurance payments, or retirement contributions.
   2. Policy–Making Position. Properly compensated workers must also have the “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.” Presidents, CEOs and equivalent officers are expressly identified as “policy-making positions” in the rule. Policy-making positions do not include mere advisory roles or positions that have influence over, but no actual ability to make, policy decisions.

Workers must meet both tests to qualify as senior-level executive employees. The FTC estimates that only 0.75% of the current workforce will qualify as senior executives under this definition. Please note that merely identifying an employee as a “senior executive” or “policy maker” in an employment agreement or on company documents is not sufficient to uphold a noncompete agreement if they do not meet the above requirements. Any noncompete agreement entered into with a senior executive on or after the Effective Date of the Rule is invalid.

What notice does an employer have to provide to affected workers?

Employers must provide “clear and conspicuous” notice to every worker with whom they have entered into a noncompete agreement by the Effective Date that the noncompete agreement is no longer legally enforceable against the worker. Notice must be in writing and properly mailed, emailed, or texted to the worker on or before the Effective Date. The FTC has provided model language in the Rule that employers can follow when providing notice to employees.

How else can I protect my business from competitors?

The FTC has narrowly tailored this Rule to apply only to any restriction that “prohibits…penalizes…or functions to prevent a worker” from seeking or accepting work from competitors or past clients, or operating a separate business, after ending an employment relationship with the employer. However, the Rule prohibits neither restrictions on competition during an employment relationship, nor other restrictive covenants unrelated to employment, that protect a business’ sensitive information or proprietary interests. Employers may still require workers to sign confidentiality agreements or non-solicitation agreements to prevent employees from disclosing important trade secrets and other sensitive information that would affect the business’ proprietary interests; provided, however, that these restrictive covenants do not prohibit, prevent or penalize the employee’s future employment.

Are there limitations to the Rule?

The Rule does not apply to businesses or industries over which the FTC does not have jurisdiction, including banks, insurance companies, transportation and communications common carriers, air carriers, and non-profit entities.

The Rule does not restrict use of noncompete language in transaction agreements for a bona fide sale of the assets or equity of a business entity – that is, sales (or equity redemptions) made in good faith by independent parties. For the purpose of this Rule, such bona fide sales include equity sales and sales of all or substantially all of the assets of a business entity. The Rule also does not prohibit noncompete agreements in a franchisor-franchisee relationship.

Lastly, the Rule does not prohibit employers from enforcing noncompete clauses that prevent their employees from seeking employment with competitors while they are employed with that employer, so long as the noncompete clause terminates when the worker’s employment ends.

When does the Rule go into effect?

The Rule will go into effect on September 4, 2024. However, there are several pending lawsuits nationwide challenging the Rule’s enforceability. One of these lawsuits, Ryan v. Federal Trade Commission, filed in the Northern District of Texas, is expected to have a final opinion as to the enforceability of the Rule by August 30, 2024. If the court determines the Rule is unenforceable, the Effective Date would be delayed indefinitely. Other similar lawsuits have not provided an estimate of when a final ruling will be issued, but we do not expect to hear other final opinions until after the Effective Date.

What should businesses do now?

Businesses should begin to review and modify employment agreements, independent contractor agreements, severance agreements, and employee handbooks to remove any noncompete language and to provide notice to workers regarding invalid noncompete agreements by the Effective Date. Employers should also consider appropriate alternative restrictive covenants, including confidentiality and non-solicitation agreements, to protect their business’ sensitive business information and relationships.

For clients of Rapp & Krock, PC, we recommend contacting one of our transactional attorneys as soon as possible to begin reviewing any employment agreements containing noncompete language to ensure compliance with the Rule. We also recommend contacting a transactional attorney to discuss distribution of notices to affected employees prior to the Effective Date, as required by the Rule. While we firmly believe that a court will ultimately enjoin or delay the Rule, or make certain modifications to the Rule, we cannot be certain that such an order will come into effect on or before the Effective Date. As such, we believe employers and businesses should make efforts to comply with the Rule now as if it will become effective on the Effective Date.