FTC Non-Compete Ban: What Employers Need To Know

Labor & Employment

On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule (the “Rule”) that would ban almost all non-competition agreements in the United States.  The Rule comes a little over a year since the FTC proposed its initial non-compete ban in January 2023.  After evaluating more than 26,000 comments on the proposal, the FTC made modest changes from its original proposal, and retained the sweeping ban on non-competes.  While the states have been actively regulating non‑competes for years, the Rule marks the first time a federal standard will apply nationwide.

The following Q&A guidance will help employers prepare for the implementation of the Rule.

Q: Why has the FTC adopted the Rule?

A: The FTC’s principal missions are to protect American consumers and to promote competition in the marketplace.  In adopting the Rule, the FTC stated that banning non-competes would protect the fundamental freedom of workers to change jobs, increase innovation, and foster new business formation.  The FTC estimated that the Rule will lead to more than 8,500 additional new businesses being created each year and would put more money in workers’ pockets, with estimated earnings increasing for the average worker by an additional $524 per year.  The FTC also touted an estimated reduction in health care costs by up to $194 billion over the next decade.  Finally, the Rule is expected to help drive innovation, leading to an estimated average increase of 17,000 to 29,000 more patents each year for the next 10 years.  Finally, the FTC estimated that 101,785,552 workers in the forty‑six states that currently permit non-competes will be affected by the Rule.

Q: What does the Rule do?

A: The Rule declares that it is an unfair method of competition for a person:

  • To enter into or attempt to enter into a non-compete clause;
  • To enforce or attempt to enforce a non-compete clause; or
  • To represent that the worker is subject to a non-compete clause.

    For example, this means that once the Rule goes into effect, it will be unlawful for a company to demand or ask a worker to sign a non-compete agreement, even if the agreement would otherwise be enforceable under state law.  Similarly, it would also be unlawful for a company to send a cease and desist letter to a former employee (or his/her new employer) asserting that the worker is subject to a non-compete.

    Q: What workers are included in the Rule?

    A: The Rule applies to all workers, not just W-2 employees.  For purposes of the Rule, the term “worker” is broadly defined as any natural person who worked or previously worked for another person.  The worker may be an employee, independent contractor, intern, volunteer, apprentice, sole proprietor, minority owner, or any other natural person who provides services.

    Q: What is a “non-compete clause” for purposes of the Rule?

    A: A non-compete clause 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 the term or condition; or
    • operating a business in the United States after the conclusion of the employment that includes the term or condition.

    A non-compete clause would typically be found in a written contract, but the Rule also encompasses workplace policies.  In addition to a typical non-competition provision, the FTC’s discussion makes clear that forfeiture for competition clauses, which do not directly prohibit competition but impose a loss of financial benefits if the restricted party chooses to compete, are considered non-compete clauses within the meaning of the Rule.

    The Rule does not prohibit anti-moonlighting policies.  In other words, the Rule would allow an employer to prohibit an employee from working for a competitor during employment.

    Q: What about our company’s existing non-compete agreements?

    A: Enforcement of all existing non-competes is prohibited as of the Rule’s effective date, with one important, but narrow, exception: a company may continue to enforce non-competes against workers the Rule calls “senior executives.”

    Importantly, the senior executive exception applies only to non-competes that are entered into before the Rule’s effective date.  Under the Rule, a person is not permitted to enter into a new non-compete with a senior executive after the effective date.

    Q: Who are senior executives?

    A: Under the Rule, a senior executive is a worker who was in a policy-making position and received total annual compensation of $151,164 in the preceding year.

    A policy making position means the company’s president, CEO, or equivalent; an officer of a company who has policy-making authority; and any other person who has policy-making authority for the business entity similar to an officer.  Policy-making authority means final authority to make policy decisions that control significant aspects of a business as a whole and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise, or an individual department or line of business.

    While the exact scope of what positions constitute senior executives remains unclear, FTC commentary suggests that C-suite executives will generally be senior executives, along with partners in businesses (like medical practices) that have authority to make policy decisions about the business.  In enforcement, we anticipate that the FTC would take a narrow view of which workers qualify as senior executives, focusing on those most senior workers who have sufficient pay and authority such that they are more likely to have had meaningful bargaining power and to have actually negotiated their non-competes.

    For purposes of determining total annual compensation, a company may look to the most recent 52‑week year, the most recent calendar year, the most recent fiscal year, or the most recent anniversary of hire year.  Total annual compensation is based on the worker’s earnings over the preceding year, including salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during such period.  Total annual compensation does not include payments for medical or life insurance, contributions to retirement plans, the cost of other similar fringe benefits, board, or lodging.

    Q: What about other types of restrictive covenants, like non-disclosure agreements (NDAs) and non‑solicitation agreements?

    A: Generally speaking, NDAs and non-solicitation agreements are not prohibited under the Rule.  The FTC acknowledged that these types of agreements do not by their terms prohibit a worker from seeking or accepting other work or starting a business after they leave their job.

    It is possible, however, that an NDA or non-solicitation agreement could be prohibited if it is so restrictive that it functions as a non-compete by preventing a worker from seeking or accepting employment or operating a business.  For example, the FTC stated that an NDA that bars a worker from disclosing, in a future job, any information that is “usable in” or “relates to” the industry in which they work would go far beyond protecting an employer’s confidential information and would effectively prevent the worker from working for another employer in the industry.  Similarly, an NDA that bars a worker from disclosing any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information, would likewise have the practical effect of functioning to prevent the worker from working for a competitor.

    Put another way, an NDA would not be a non-compete under the Rule where the NDA’s prohibitions on disclosure do not apply to information that (1) arises from the worker’s general training, knowledge, skill or experience, gained on the job or otherwise; or (2) is readily ascertainable to other employers or the general public.

    Similarly, non-solicitation agreements generally will not be non-compete clauses under the Rule because, while they restrict who a worker may contact after they leave their job, they do not usually prevent a worker from seeking or accepting other work or starting a business.  However, non‑solicitation agreements can constitute a non-compete under the Rule where they are so broad that they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.  Unfortunately, the FTC did not provide examples of the sorts of non-solicitation clauses that might be deemed to function as non-competes.  Potentially, a non-solicitation clause reaching all prospective customers of a business, without any limitation, might be considered to function as a non-compete because it could be read to entirely prohibit competition within a universe of customers.  On the other hand, a non-solicitation clause covering only actual customers and active prospects would more likely not be deemed to function as a non-compete, especially if limited to contacts developed by the worker during employment.

    Q: Are there any other exceptions?

    A: In addition to the carveout for existing non-competes for senior executives and most NDAs and non‑solicitation agreements, two additional exceptions to the Rule are noted.

    First, the Rule does not apply where a cause of action related to a non-compete clause accrued prior to the Rule’s effective date.  This includes not just litigation pending as of the effective date, but also situations where an employer alleges that a worker accepted employment in breach of a non-compete if the alleged breach occurred prior to the effective date.

    Second, the Rule does not apply to a non-compete that is entered into by a person 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.

    A bona fide sale is one made in good faith, as opposed to, for example, a transaction whose sole purpose is to evade the Rule.  In general, the FTC considers a bona fide sale to be one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.  In discussion outside of the text of the Rule itself, the FTC added that non‑competes arising out of repurchase rights or mandatory stock redemption programs are not entered into pursuant to a bona fide sale because, in each case, the worker has no goodwill to exchange for the non-compete or knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting.

    Importantly, the FTC removed the qualification included in its original proposal that the seller must have a 25% ownership interest in the company being sold.  Any selling owner may be covered by a non‑compete in connection with a bona fide sale.

    Q: What about existing state law?

    A: The Rule generally leaves most state laws regarding non-competes (and non-solicits) in place, except to the extent that such laws would otherwise permit or authorize a person to engage in conduct that is deemed an unfair method of competition under the Rule.  Other provisions of state laws, like notice requirements, salary thresholds, and time/territory limits will continue to apply to any non-competes that survive under the Rule.

    Q: Are employers required to amend all existing non-competes?

    A: No, employers are not required to affirmatively take action to rescind or amend existing non‑competes.  The FTC’s original proposal included an affirmative rescission obligation, but the FTC dropped this requirement, concluding that rescission would have imposed an unnecessary additional burden on employers.

    The Rule does, however, require that for each existing non-compete clause, the person who entered into the non‑compete with the worker must provide clear and conspicuous notice to the worker, by the Rule’s effective date, that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.  To be clear, this obligation requires notice to both current and former workers.

    The notice to each worker must identify the person who entered into the non-compete with the worker and be sent by mail, email, or text message, to the worker’s last known street address, email address, or mobile telephone number.

    The FTC has prepared a model notice, but employers are permitted to use alternate forms.  We recommend that employers consult employment law counsel for advice on how best to prepare and deliver these required notices to applicable workers.

    Q: When does the Rule go into effect?

    A: The effective date of the Rule is 120 days after publication of the Rule in the Federal Register.

    At least one lawsuit has already been filed against the Rule in the Northern District of Texas, arguing, among other things, that the Rule exceeds the FTC’s legal authority (a point also made by the two FTC Commissioners who voted against adopting the Rule).  The U.S. Chamber of Commerce has also announced that it intends to file a lawsuit challenging the Rule as well.  Either of these lawsuits could delay implementation of the Rule or even invalidate the Rule entirely.

    Q: What should employers do now?

    A: Given the legal challenges to the Rule, employers probably do not need to start making changes to their practices immediately.  Still, because of the relatively short time before the Rule goes into effect, some preparations are warranted:

    • Identify senior executives.  Existing non-competes for these workers can remain in place and they do not need to receive the mandatory notice.
    • Prepare for worker notices.  Identify all current and former workers subject to a non-compete who will need to receive the required notice by the effective date.  Work with legal counsel to prepare an acceptable notice.
    • Plan for future agreements.  With non-competes off the table, make sure your NDAs and non‑solicitation agreements are up-to-date and provide as much protection as possible.
    • Monitor litigation.  Lawsuits may delay or even halt implementation of the Rule.