FTC Ban on Non-Compete Clauses: What it Means and Next Steps

On April 23, 2024, the Federal Trade Commission (FTC) released the "Non-Compete Clause Rule" (the "Final Rule") that will prohibit employers nationwide from including non-compete clauses in employment contracts and company policies for most employees. This rule will take effect on September 4, 2024.

The FTC determined that employers using and enforcing non-compete clauses engage in unfair competition, violating Section 5 of the FTC Act, which prohibits unfair trade practices. This led to the FTC's proposed rule in January 2023, which received over 26,000 comments, with 25,000 supporting the ban.¹

Summary of the Final Rule

Coverage

The Final Rule applies to any contractual provision or condition of employment that: (1) “prohibits” a worker from, (2) “penalizes” a worker for, or (3) “functions to prevent” a worker from seeking or accepting work or operating a business after their employment ends.²

• Clauses that penalize a worker for competing include liquidated damages clauses, which require workers to pay a hefty sum for seeking or accepting work or starting a business after leaving their job.³ The rule also applies to clauses that terminate a worker’s right to promised compensation or benefits if they seek or accept work or start a business after their employment ends. Examples of such clauses include forfeiture-for-competition clauses and severance arrangements that only pay workers if they refrain from competing.⁴
• Clauses that “function to prevent a worker” from competing include provisions that, even if not explicitly labeled as non-competition clauses, act like non-competition clauses. This category can encompass other restrictive covenants, such as non-solicitation or non-disclosure agreements, which may still be prohibited under the rule.⁵

Notably, non-competes connected with the bona fide sale of a business entity, a person’s ownership interests in an entity, or substantially all of an entity’s operating assets qualify for an exception.⁶ However, non-compete clauses arising from repurchase rights, mandatory stock redemption programs, or "springing non-competes" that become effective upon the breach of a contractual obligation or other duty do not qualify for this exception.⁷

Impact

• Prohibition on Non-Compete Clauses: In general, employers cannot enter into or enforce new non-compete clauses with workers after the effective date of the Final Rule. Any new non-compete clauses will be void and unenforceable. Additionally, employers cannot claim that a non-compete clause applies to a worker. The rule applies broadly to all workers, regardless of position or compensation.⁸
• Senior-Executive Carve-out: For employees not classified as senior executives, any non-compete clauses entered into after the effective date will be void and unenforceable. Additionally, employers cannot enter into or enforce these clauses and will be subject to the same prohibitions.
  • Senior executives, defined as workers earning more than $151,164 and holding policy-making positions, will still be subject to existing non-compete clauses entered into before the effective date.
  • The exception for senior executives in a "policy-making position" remains quite narrow. This category includes roles such as a business's president, CEO, or equivalent title, as well as other senior executives with similar authority to make policy decisions that control significant aspects of the business.⁹
• Notice Requirements: Employers must notify workers with existing non-competes that they will not enforce these clauses by the effective date. The FTC provides language and model notices to help with compliance in seven different languages, which can be found in the FTC rule.

Effective date

The Final Rule will take effect 120 days after publication in the Federal Register¹⁰, currently expected on September 4, 2024. However, legal challenges from the U.S. Chamber of Commerce¹¹ and others¹² may delay or block the rule's implementation. If these challenges reach the Supreme Court, they might significantly delay or overturn the rule.

Analysis of the Rule

Scope

Although the FTC rule covers clauses that function like non-compete clauses, the rule applies to broad non-solicit clauses or other restrictive covenants only if they reach far in their circumstances. This assessment occurs on a case-by-case basis and varies by industry. For instance, a non-solicit clause in a small industry with few players might fall under this scope.

The scope of bonus clawback provisions or equity vesting arrangements varies based on the employee’s income level or ability to pay. Standard bonus clawback provisions, such as requiring repayment of a sign-on bonus if the employee leaves within a certain period, likely avoid the ban. However, provisions with broader consequences fall within the rule's scope. For example, asking a low-paid employee to repay an amount far exceeding their annual salary or estimated profitability would be included in the rule's scope.

The Final Rule applies only to non-compete obligations that exist after employment. This rule does not cover moonlighting clauses or individuals sitting on a board in another company.

Challenges with notice requirements

The notice requirements present logistical challenges.

Firstly, the Final Rule rule could theoretically apply to every former employee with an unexpired non-compete clause since no cut-off date exists for “existing non-compete” clauses. This rule contrasts with California’s ban on non-competes, Assembly Bill 1076, which requires notice only for employees hired after January 1, 2022.¹³ The broader application would increase the number of employees receiving notice from companies.

Secondly, the rule imposes strict notice requirements, demanding fulfillment before the effective date with no grace period. The uncertainty about the Final Rule's effective date and implementation complicates companies' efforts to determine the necessary steps and timing.

Next Steps

1. Review Contracts: Counsel should review employment agreements, handbook policies, and other communications to evaluate non-competition clauses and other restrictive covenants to determine which would be prohibited. Companies with employees in California must still comply with AB 1076. Compliance with this non-compete clause legislation remains crucial, regardless of any delays or legal challenges to the Final Rule.

2. Encourage Compliance: Employers may encourage senior executives without existing non-compete clauses to sign new ones before September 4, 2024 to qualify for the senior executive carve-out.

3. Document Notice Requirements: Employers should also begin documenting which employees and former employees need to receive notice under the Final Rule. To fulfill notice requirements, employers can use a mass email, hand delivery, mail, or text message.¹⁴ Employers should choose a delivery method that provides proof of receipt to demonstrate they have met their notice obligations. Additionally, using the model language provided by the FTC ensures a safe harbor defense.¹⁵

4. Protect Confidential Information:

   • Implement a robust trade secret monitoring program to inventory, review, and evaluate trade secrets and other proprietary assets of the company.
   • Invest in front-end forensic infrastructure to analyze or track extraction of confidential company data or trade secrets when an employee leaves. This approach allows companies to collect evidence against employees who may bring trade secrets to a competitor.
   • Require employees to sign a robust and updated confidentiality and proprietary rights agreement. Regularly review this agreement to ensure enforceability.

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