Article by Ralph Monico, Esq. and Samuel Evans, Esq.
On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to issue a final rule (Rule) banning the use of non-compete agreements in most employment relationships. The Rule will take effect on 120 days from that date of its publication in the Code of Federal Regulations (Effective Date), if it survives legal challenges by U.S. Chamber of Commerce, and others.
The Rule
The Rule characterizes non-compete agreements as creating unfair methods of competition that violate Section 5 of the Federal Trade Commission Act. The Rule will enact “a comprehensive ban on new non-compete agreements with all workers” and invalidate most existing non-compete agreements, unless the worker qualifies as a “senior executive”.
The Rule defines “non-compete clauses” as “[a] term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.” The definition includes various clauses, including those pertaining to forfeiture-for-competition, training repayment agreements and certain liquidated damages provisions. While not expressly banned, clauses creating other common post-termination obligations, like non-disclosure or non-solicitation of customers, might also fall within the Rule’s prohibition.
The Rule applies to “workers”, which it defines 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.”
The employee’s status determines the Rule’s application to existing non-compete agreements
On the Effective Date, the Rule will neuter existing non-compete agreements, rendering them unenforceable, unless the subject employee is a “senior executive”. The Rule uses a two part test focused on the employee’s earnings and job duties to determine whether one qualifies as a “senior executive.” Criteria for both are required to enforce a non-compete agreement after the Rule’s effective date. A senior executive is a worker who was in a policy-making position and who received from a person for the employment:
- Total annual compensation of at least $151,164 in the preceding year; or
- Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or
- Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete.
The FTC explains the term “total annual compensation” may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during that 52-week period. Additionally, the term “preceding year” is defined as a person’s choice among the following time periods: the most recent 52-week year, the most recent calendar year, the most recent fiscal year, or the most recent anniversary of hire year.
In addition to meeting the compensation threshold, for a worker to qualify as a senior executive the worker must be at the level of a president, chief executive officer or the equivalent, or in a position that has similar authority to a president or officer. Further, an officer or other qualifying person must have policy-making authority. The Rule defines “policy-making authority” as final authority to make policy decisions that control significant aspects of a business entity or a common enterprise. The definition further states that policy-making authority 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.
Employers may not enter into new non-compete agreements with senior executives after the Effective Date.
The Rule imposes a notice obligation on employers
Employers must notify affected workers that their non-compete agreements will not be enforceable after the Effective Date. The Rule provides guidance regarding the content for acceptable forms of notice.
The Rule’s Exceptions
- The Rule does not apply to non-compete clauses/agreements that relate to the bona fide sale of a business entity, or to one’s ownership interest in a business entity, or to a sale of a business entity’s operating assets.
- The Rule does not apply to pending litigation or to causes of action that accrued prior to the Effective Date.
- The Rule does not apply to obligations agreed to by franchisees under a franchisor-franchisee agreement.
Legal Challenges to the Rule
A private company sued the FTC on April 23, 2024 – the date the FTC issued the Rule – claiming the FTC lacks the statutory authority to issue the Rule, or alternately, that its exercise of such authority violates the U.S. Constitution.
The U.S. Chamber of Commerce sued the FTC a day later stating, “[t]he sheer economic and political significance of a nationwide noncompete ban demonstrates that this is a question for Congress to decide, rather than an agency.”
Conclusion
Absent court action, employers will be required to inform their individual workers subject to non-compete agreements that after the effective date the employer will not enforce any non-compete against the worker by August 21, 2024. Senior executives are not subject to this notice requirement.