Today, April 23, 2024, the Federal Trade Commission (FTC) issued a final rule on employment non-competes. The Commissioners voted 3-2 to issue the final rule.
The FTC estimates that by banning non-competes that there will be a 2.7% rise in new business entities formed each year and a $400-488 billion in increased wages over the next ten years. In addition, there would be reduced health care costs of $74-194 billion as more physicians and associated health care workers can move more freely in the job market. Finally, they are estimating an additional 17,000-29,000 new patents each year for the next ten years.
Inside the Final Non-Compete Rule
In the final rule, effective in 120 days (September 4), employers are prohibited from requiring non-compete agreements in employment situations. In addition, existing non-compete agreements are limited – only those for senior executives are permitted. All other non-competes, for workers that are not senior executives, are unenforceable.
This is different from the proposed non-compete rule issued in 2023 which applied to senior executives, franchisors, and additional workers.
What is a Senior Executive?
The final rule starts with a difference between senior executives and non-senior executives. For senior executives, new non-competes are not permitted going forward; however, prior non-competes may be enforceable.
A senior executive, under the new non-compete rule, is someone in a policy-making position and who receives total annual compensation of at least $151,164 in the preceding year.
A policy-making position is a person with policy-making authority, or the authority to make policy decisions that control significant aspects of a business entity or common enterprise. Policy-making authority does not include those that are limited to advising or exerting influence over the decisions or for having final authority to make policy decisions for only a subsidiary of or an affiliate of a common enterprise.
Notice to Employees
Employers will be required to notify those current and former employees that their existing non-compete clauses are no longer valid and cannot be enforced. This is different than the proposed rule where employers would have been required to legally modify existing contracts.
The notice may be in the form of a paper letter or email or even text message (look at the FTC keeping up with modern employee communication methods!) When it comes to email addresses, such notification may be to the current work email address or the last known personal email address.
The FTC did provide a model notice that can be sent to employees.
Does the Final Rule on Non-Competes Apply to Independent Contractors?
Yes! The new final rule defines a worker as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. (emphasis added)
That means that the new rule prohibiting non-competes applies to independent contractors, as well as a variety of other conditions that mimic employment.
See Also: Employee or Independent Contractor? New Rules for 2024
Who does the Rule not apply to?
The new non-compete rule specifically excludes prohibiting non-competes in the sale of a business. Yes, that’s a negative of a negative making it possible to enter into and enforce a non-compete pursuant to the sale of a business.
The new rule also excludes the franchisor-franchisee relationship. This would be between the main brand and the owner of the franchise location. However, the employees of both the franchisor and franchisee (ie front-line workers) cannot be subjected to a non-compete agreement.
Further, the FTC does not have jurisdiction or authority over non-profit entities. The FTC clarified in its comments of the final rule that this prohibition does not apply to non-profit organizations. However, they were emphatic that the mere status of a tax-exempt entity is not dispositive. Specifically, the non-profit organization cannot be for its own profit nor that of its members to remain outside the jurisdiction of the FTC.
What is a Non-Compete Agreement?
A non-compete agreement, aka a non-competition or an agreement not to compete, is a contract between two parties in business that prohibit one or both parties from competing in a business or trade. Typically found in employment contexts, as well as franchisor-franchisee relationships and when selling companies, these non-competition agreements often limit who, where, and how someone may work or conduct business.
In the context of employment non-competes, these agreements are often “take it or leave it” with little to no negotiation by the employee. They have the effect of limiting employment movement, making it more difficult for current employees to negotiate pay raises or better benefits or working conditions. This can cause depressed wages and create toxic workplaces.
Employers say that they are providing valuable training and access to confidential information which must be protected. Employers argue that their investments to get workers up to a high level of efficiency and productivity should be protected, prohibiting other employers that have not made that investment to poach their employees prior to the original employer from getting a return on that investment.
Non-Competes Limited at State Level
California, Colorado, Minnesota, North Dakota, and Oklahoma have all virtually banned non-competes. In addition, many states have severe restrictions on non-competes, most commonly with income thresholds, below which, non-competes are not enforceable and are prohibited.
In the states where non-competes are permitted and enforceable, non-competes must be reasonable in time, scope, and geographic restrictions. Non-competes that are unreasonable are found to non-enforceable. Some states allow courts to modify the agreements to make them enforceable, using the blue pencil rule, but that is often limited to deleting unenforceable clauses or phrases.
What about other Restrictive Covenants or Agreements?
In addition to non-competition agreements, employees are often required to enter into contracts like non-disclosure agreements, non-solicitation agreements, assignment of intellectual property, arbitration agreements, and non-disparagement agreements.
The FTC did not limit these additional agreements. In fact, part of the reason that the FTC did not limit these agreements is that these agreements can protect many of the rights, investments, and other concerns that opponents raised. The existence of these agreements made it possible to prohibit the use of non-competes.
Expected Legal Challenges to Today’s FTC Rule on Non-Competes
The U.S. Chamber of Commerce has been very vocal in expressing its disagreement with any proposed rule that would prohibit non-competition agreements in the future and/or make existing non-competition agreements unenforceable.
According to the Chamber, the FTC is overstepping its authority by passing this rule non-competition agreements in employment.
Ryan LLC v Federal Trade Commission
OK, I will admit it. I didn’t have Ryan, the global tax company, as the first to file a lawsuit against the FTC for their final rule against non-competes. But alas, here we are.
As expected by legal commentators, Ryan challenges the FTC’s underlying authority to issue a final rule prohibiting non-competes. Ryan invoked the new “major questions doctrine” as well.
Ryan argues that its non-compete agreements, specifically with shareholders, are valid and that by “nullifying these agreements, the Non-Compete Rule puts Ryan’s confidential business information at risk, permits departing shareholders to poach clients, and enables competitors to poach shareholders for whom Ryan expended training resources.” (Here I am asking what training Ryan provides to partners/shareholders? Wouldn’t they already be trained prior to making partner status?)
Ryan also argues that the non-competes help reduce prices to its tax clients as they “allow firms to provide better prices, because they do not need to compensate for the risk of losing the client to a departing consultant.” (And here I ask, is it because you can prevent them from leaving, for higher compensation elsewhere?)
And this was filed in the Northern District of Texas (Dallas division) in the 5th Circuit. The case number is 24-CV-00986. The case has been assigned to Judge Ada Brown, a Trump appointee.
U.S. Chamber of Commerce v FTC
As expected, the U.S. Chamber of Commerce has also filed a lawsuit challenging the FTC’s ban on non-competes.
Now that I have this complaint, I will start off with the U.S. Chamber’s complaint is a better written complaint than that of Ryan. But the arguments presented by the Chamber are the same arguments we’ve seen and we all expected.
- That non-competes serve a valuable business interest in allowing the companies to invest in training their employees and that employees get valuable consideration – like increased severance payments or would lose compensation if they didn’t sign.
- That states already limit their enforcement to reasonable agreements, in terms of time, territory, and type of activity. Some states have additional restrictions on their non-competes as well.
- That when a bill has been introduced to Congress that they have failed to pass it.
- That prior to the Biden administration, the federal agency have not pursued non-competes as anti-competitive.
- That the FTC’s interpretation of Sections 5 and 6 of the FTC Act is unprecedented and overbroad.
- That the FTC does not have the ability to issue retroactive regulations (the part about existing non-competes being unenforceable)
- That the record (including the comment period) does not support the issuance of a nationwide ban and rests on a flawed cost-benefit analysis.
- That the FTC did not consider alternatives for a narrower rule – like excluding independent contractors, exempting non-competes with severance agreements, only applying to new agreements and not retroactively, etc.
This case was filed in the Eastern District of Texas, also in the 5th Circuit. The case number 24-cv-00148. The case has been assigned to U.S. District Court Judge J. Campbell Barker.
Scheduling Order Sets Expected Timeline for Chamber Non-Compete Challenge
On April 26, Judge Barker issued a scheduling order in the U.S. Chamber non-compete case.
- May 31, 2024: The FTC has until May 31 to file briefs responding to the Chamber’s request for preliminary relief.
- June 12, 2024: The Chamber can reply to FTC’s response by June 12.
- June 19, 2024: The FTC can make a final response by June 19.
After the briefs are submitted, the Court will set a hearing date sometime after June 19. The scheduling order says that “should allow prompt resolution of the case with sufficient time, before the rule’s effective date, for any desired appellate review.”
Chamber Case Paused Pending Ryan Outcome
On May 3, 2024, Judge Barker decided to stay the U.S. Chamber lawsuit, pending the outcome of the Ryan litigation.
Long-story short, the courts really don’t like multiple cases that are going to deal with the exact same issues. It is not efficient. And since Ryan got to the courthouse first, their case gets to continue.
In addition, there was the chance that Ryan could be subject to multiple, conflicting orders or outcomes. This is because Ryan is a member of the Texas Association of Business which is a co-plaintiff in the U.S. Chamber lawsuit. So if the U.S. Chamber lawsuit determined that the ban could not stand but the Ryan lawsuit said that it could, Ryan would have a conflict between the two cases.
ATS Tree Services, LLC v. FTC
The third lawsuit challenging the FTC’s rule on non-competes has been filed by ATS Tree Services. This group was a little slower to the courthouse, waiting till Thursday to file after Tuesday’s announcement.
ATS is a “tree service company” that operates solely in Pennsylvania and uses non-competes in its business. The company argues that it provides “training that lasts a lifetime” and that it uses non-competes to ensure that its investment in training doesn’t immediately go work for a competitor.
This case uses the same arguments that the Ryan and U.S. Chamber cases make, so I won’t go through the legal arguments again. But we will watch to see how the case progresses. Normally, I would say that the cases coming from different Circuits would increase the likelihood that the Supreme Court takes this case up, but we all know it is going there eventually.
The ATS case was filed in the Eastern District of Pennsylvania. The case number is 24-CV-01743.
Next Steps for Employees with Non-Competes
Most employees are going to just need to hold their horses. Nothing about today’s announcement changes your status or whether you are prohibited from working for someone because of a non-compete.
Now is not the time to be quitting your job to go and work for someone else. If you are laid off or do want to quit, then talk with a qualified attorney about your non-compete. I will say that I have reviewed a ton of non-competes recently. Many of them were really bad and wouldn’t be enforceable, with or without the FTC’s action (a common thread is that the agreement looks to be written by ChatGPT – a prime example of why you can’t leave legal to the machines just yet).
Stay up-to-date on the legal challenges to the FTC’s rule, especially once the Supreme Court gets involved. And check back here periodically. We will try to keep everyone updated on this rule as developments happen.
Unfortunately for many of you with valid, enforceable non-competes, you’ll be well through the time restriction on your non-compete before this is settled.
Next Steps for Employers with Non-Competes
Like employees, you should take a deep breath before you act. There’s at least 120 days before the rule kicks in, and with those legal challenges, it may be a lot longer (if ever).
This is a good time though to meet with your HR team to see what you have, and how well it is documented. You may find that your HR records are spread out, across systems and disorganized. Not a good scenario in general, but definitely not when it comes time to figure out next steps with any of the multiple changes coming your way right now. (See also: DOL Increases Minimum Salary for Overtime Exemption)
For the purposes of this non-compete rule, you’ll want to gather up all the non-competes and determine whether they are enforceable under current laws, which ones have expired, and which may qualify for senior executive status. If the rule stands, you’ll have to send out notices to all the workers with non-competes that they are no longer enforceable. Don’t forget that it will also include contractors and 1099 workers and even shareholders/members/owners.
If you haven’t seen this as a reason to get your HR documents in order and systematized, this is a really good reason. Before any DOL audits happen.
This is also a great time to review the other restrictive covenants that you have with your employees, especially the non-solicit, non-disclosure, and intellectual property assignments. We can work to make sure that these are strong agreements, in place to protect you and your business – no matter what happens with the non-compete ban.
Final Note on Non-Compete Agreements
And California, stop laughing at the rest of us. We know, we know.