FTC issues final rule banning noncompete clauses
UPDATE 7/29/24: On July 23, in a separate case challenging the FTC rule, a federal court in Pennsylvania added to the existing confusion when it denied the plaintiff’s motion for preliminary injunction in a ruling based on findings that diverged significantly from those in the Texas case. The Pennsylvania court held that the plaintiffs could not show irreparable harm and – even if they could – that the FTC likely had the statutory authority to promulgate the substantive rule under Section 5 of the FTC Act, which empowers the FTC to prevent “unfair methods of competition.”
UPDATE 7/3/24: On July 3, 2024, a federal court preliminarily enjoined the FTC Rule from going into effect in September. The court found that the FTC lacked the authority to promulgate the substantive rule and the FTC’s process in creating the rule was arbitrary and capricious. The court further found that the plaintiffs were likely to suffer irreparable harm if the noncompete rule were to go into effect. The court’s injunction is limited to the plaintiff and plaintiff-intervenors (but not their member entities) in the case. The court said it would rule on the ultimate merits of the plaintiffs’ challenge to the rule by August 30, 2024.
UPDATE 5/7/24: On May 7, 2024, the FTC’s final rule was published in the Federal Register. It is scheduled to take effect 120 days later on September 4 (subject to legal challenges). The court overseeing the lead case challenging the rule has promised to rule on the merits of the preliminary injunction of the rule by July 3, 2024.
On April 23, 2024, during a special open meeting, the Federal Trade Commission (FTC) voted 3-2 along party lines to finalize a rule banning any new noncompete restrictions for workers in the US. This new rule follows a lengthy comment and review period, during which the FTC received more than 26,000 comments from members of the public – the vast majority of which the FTC leadership claimed supported its rule – after the FTC first proposed the rule in January 2023.
The final rule mirrors, in significant part, the original proposed rule, banning all new noncompetes and rendering most existing noncompetes unenforceable. Unlike the original proposal, it allows existing noncompetes applicable to a limited number of senior executives to remain in place.
If it survives expected legal challenges, the FTC’s final rule will invalidate most noncompetes, including almost 30 million existing noncompete agreements as well as millions of future contracts, and preempt less restrictive state laws governing noncompetes.
Regardless of the outcome, the rule may be viewed as part of a broader trend toward promoting worker mobility at both the federal and state levels.
Restrictions under the final rule
The final rule prohibits employers from entering into and renders unenforceable terms or conditions of employment that limit a worker’s ability to seek or accept employment or to operate a business after the end of their current employment. The rule covers “workers,” which includes employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person. The rule also requires that employers notify impacted workers that any existing prohibited noncompete provisions are unenforceable.
The rule does not, however, prohibit contractual terms that prevent workers from working for two firms simultaneously. It also does not prohibit noncompete clauses in the context of a “bona fide” sale of a business, eliminating the 25-percent ownership interest threshold included in the initially proposed rule.
In a presentation by FTC staff on the new rule, staff claimed that noncompete agreements reduce wages, stifle innovation, and decrease labor conditions. Since proposing the original draft rule, the FTC has suggested that objectives traditionally advanced by noncompete agreements – including the protection of trade secrets and confidential information – are better accomplished by other means, such as non-disclosure agreements and litigation.
The final rule most significantly differs from the original proposed rule by providing a limited exception for existing (but not new) noncompete agreements with a limited number of senior executives, defined as workers who earn more than $151,164 annually and are in “policy making positions” at the “common enterprise” level. The FTC estimates that fewer than 1 percent of all workers will qualify for this exemption.
Interaction with state laws
State laws historically have governed noncompete clauses, and numerous states (which have enforcement authority independent of the FTC) have their own laws – many recently enacted or expanded – that ban or regulate noncompetes.
For example, California recently amended its laws (including Assembly Bill 1076 and Senate Bill 699) to make clear that noncompete clauses are unenforceable regardless of where they were entered into and to make it unlawful to impose a noncompete agreement on an employee (with limited exceptions). Similarly, Minnesota recently passed a law banning virtually all noncompete agreements entered into on after July 1, 2023. Several other states have enacted laws limiting the use of noncompete agreements by, for example, banning noncompetes for non-exempt employees or low-wage earners or requiring employers to pay some or all of the employee’s salary during the post-employment restricted period.
While the FTC’s final rule preempts state laws that currently allow noncompete agreements, it does not preclude enforcement at the state level of state laws that are consistent with the FTC rule. Thus, even if anticipated litigation (as outlined below) results in changes to or invalidation of the FTC’s final rule, enforcement at the state level by the growing number of states with noncompete bans or restrictions may continue.
Effective date and potential challenges
Employers have 120 days after the rule is published in the Federal Register to comply with the rule. We can expect this compliance deadline to be in late August 2024. Compliance will require that employers provide written notice to workers with existing, prohibited noncompete clauses that those clauses are now unenforceable. The FTC provided model language for such notices with the final rule.
However, various groups have pledged immediate court challenges to the rule, and protracted litigation could mean that there may not be final resolution on the rule’s validity or ultimate provisions for several years. These challenges likely will include challenges to the FTC’s rulemaking authority, as previewed by a former FTC commissioner’s dissenting statement when the rule was first proposed, and by comments by the two dissenting commissioners during the open Commission meeting.
Even while the rule faces pending legal challenges, employers may note that both the FTC and Department of Justice’s Antitrust Division – joined by numerous other federal agencies, such as the National Labor Relations Board and Federal Deposit Insurance Corporation, as part of a “whole of government” approach to competition enforcement – maintain a hostile posture toward restrictions on labor market competition (see here, for example). The federal government has vowed to closely scrutinize and challenge restraints on workers, consistent with the Biden Administration’s commitment to enforcement of antitrust laws in labor markets.
Next steps
Employers are encouraged to take proactive steps to account for and evaluate their existing use of any noncompete restrictions. In doing so, they should consider analyzing the business justifications and goals for imposing any worker noncompete restrictions (such as protecting confidential information or intellectual property) and consider alternative means of achieving these goals. Additionally, employers are urged to ensure that they comply with the developing laws on noncompetes in all states where they do business.
For more information about noncompete restrictions, see our prior publications, including, “What US employers should know about noncompetes in 2024,” “Washington law creates new noncompete considerations for employers,” and “Noncompetes around the world: Top issues and strategies for global employers.” If you have any questions regarding the FTC’s new rule or other noncompete restrictions, please contact the authors or your DLA Piper relationship attorney.
