By S. Eric Bass
The Federal Trade Commission (FTC) issued a final rule banning non-competition agreements, expected to take effect on September 4, 2024.
This new rule covers most private employers. It attempts to prevent any “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… or… operating a business in the United States.” The rule also covers any written or oral contract term or workplace policy that attempts to restrict these activities. Further, the term “worker” as used in the rule covers any natural person, which includes employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a person, paid or unpaid.
This far-reaching new rule preempts state laws and will, in many ways, reshape the terms of employment for numerous small to mid-size businesses and their employees. Any attempt to enter into a new non-competition agreement or clause, enforce or attempt to enforce a non-competition clause, or represent to anyone that a non-competition clause binds an employee will be deemed a violation of this new rule.
There are only two primary exceptions to the new rule.
Senior Executive Exception
The first exception covers “senior executives” who entered non-competition agreements before the rule’s effective date. To be clear, this exception does not exist for agreements proposed or signed after the rule takes effect.
The rule defines a “senior executive” by their compensation as a “worker who: (1) Was in a policy-making position” and (2) essentially makes total annual compensation of at least $151,164, including bonuses or other monetary compensation.
Note: total annual compensation does not include board, lodging, and other facilities” and “does not include payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other similar fringe benefits.”
To determine whether an employee is a senior executive in a policy-making position, the employee is typically the business entity’s president, chief executive officer, or the equivalent, or another officer who has “policy-making authority” for the business entity similar to these types of officers.
“Policy-making authority” means final authority to make policy decisions that control significant aspects of a business entity or common enterprise 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.”
Business Sale Exception
The second exception is for agreements entered in connection with the bona fide sale of a business. The rule does not apply to a clause that is entered into 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.
Confidentiality and Non-Solicitation Agreements
In its publication materials, the FTC explicitly states that businesses can still effectively use confidentiality and non-disclosure agreements and trade-secret laws to protect their confidential and proprietary information.
The rule does not explicitly discuss non-solicitation agreements that would attempt to prevent the worker from soliciting the business’ customers for competing business. Thus, whether the rule would prevent non-solicitation agreements is still being determined. While it does not explicitly prohibit non-solicitation agreements, companies should be careful about how they are drafted. If the contract appears to prohibit, prevent, or penalize a worker from working in the industry at all because of the non-solicitation clause, it seems the FTC would likely view the agreement as a pure non-competition agreement and prohibit its use.
These types of agreements would also be subject to applicable state laws. The relevant facts and circumstances of each situation would also likely be enforceable. Lastly, agreements that force a worker to forfeit a benefit (like a bonus) or that are subject to liquidated damages for doing certain acts may be prohibited by this rule.
Other Limitations
There are three limits on this new rule that are important to note.
- The rule applies to workers and does not apply to entities or other legal persons who are not natural people. Thus, business entities can have restrictive covenants between them.
- The rule does not apply to franchisees (natural people or entities).
- The rule applies to covenants that cover periods after termination of employment. Therefore, it appears that non-competition and other restrictive covenants can still apply during a worker’s employment.
Notice Requirements
The rule requires every business with a non-competition covenant in place with a worker prohibited by the rule to provide a written notice to the person restricted by the covenant by September 4, 2024. This notice requirement applies to current and former workers regardless of how soon after that date the restrictions end.
The rule states that the notice to the applicable workers must:
“(i) Identify the person who entered into the non-compete clause with the worker.
(ii) Be on paper delivered by hand to the worker, or by mail at the worker’s last known personal street address, or by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address, or by text message at a mobile telephone number belonging to the worker.”
If a business has no record of a street address, email address, or mobile telephone number for a worker, it then does not have to give the notice to that worker. The FTC has also published its suggested “model language” to put in the notice to workers that can be found on its website.
Attempts to Stop the Rule
As of late May, at least three lawsuits have been filed asking federal courts to invalidate the new Rule and, in the meantime, to stay its effective date of September 4, 2024. The parties filing these claims include the U.S. Chamber of Commerce. Claims include (among others) that the FTC does not have substantive rulemaking authority, banning all non-compete provisions exceeds the FTC’s authority, and Congress has not delegated this type of rulemaking authority such that the FTC Rule violates the “major questions doctrine.” Although it is impossible to predict how federal courts will rule, the challenges to the FTC Rule appear to have merit.
What Should Employers Do Now?
While there is a chance the rule may be invalidated, businesses should still consider the following steps to take now:
- Review existing non-competition agreements, plans, and policies with restrictive covenants. Although no immediate changes are required, businesses should ensure they are aware of all their existing agreements, plans, and policies regarding non-competition covenants. Businesses should compile a list of any agreements in place, including those with senior-level executives. The company may enter into a non-competition with a senior-level executive before the rule also takes effect.
- Prepare a list of those current and former workers (and their contact information) who may need to be sent notices, assuming the rule takes effect as planned.
- Consider entering into “garden leave” agreements with current key executives and sales personnel. The rule does not cover these agreements, and employers may consider entering into these agreements with certain key employees and sales personnel who do not qualify as senior executives under the rule. However, businesses should balance the cost of these agreements with the competition they seek to prevent.
- Even if the rule does not take effect as drafted, the FTC will likely make further attempts to prevent these types of agreements. Businesses should be prepared for that possibility and review their non-competition agreements regularly to ensure they are drafted to protect only legitimate business interests and comply with applicable state laws.
The attorneys at Venn Law Group have experience helping businesses deal with employee incentives and restrictive covenants of all kinds. To learn more about how Venn Law Group can help you prepare for the potential requirements of this new FTC rule, please get in touch with us here.
Eric Bass holds both a JD and an MBA, providing him with a wealth of knowledge and insight regarding the challenges business owners face. His practice focuses on helping business owners understand, assess, and best address business risks, resource allocation, and reachable goals. Eric also helps his client business owners prosper and grow by connecting them with other advisors who can help them move forward. Practice areas: contracts, mergers and acquisitions, succession and exit planning, and employment issues for employers.