FTC Votes to Issue Ban on Non-Compete Agreements

On April 23 the Federal Trade Commission (FTC) held an open meeting during which they voted 3-2 to issue a proposed final rule (Final Rule) to ban almost all post-employment non-compete agreements.

The Final Rule is substantially the same as the initially proposed rule. Key elements of the Final Rule are:

1. Ban on all new post-employment non-compete agreements between employer and employee, regardless of industry or type of worker (e.g., senior executive versus lower level), after the effective date.
2. Allows existing post-employment non-compete agreements to remain in effect for senior executives only. Senior executive is generally defined as an employee “earning more than $151,164 annually who are in a policy-making position.”
3. Formal rescission of existing non-compete agreements is not required, however, notice to employees that post-employment non-compete agreements are no longer enforceable is required.
4. Exception for sale of business, regardless of ownership percentage.
5. Does not apply to franchisee/franchisor contracts (though does apply to employees working for a franchisee or franchisor).
6. Rule will be effective 120 days after publication in the Federal Register.
7. The Rule pre-empts state laws governing noncompete agreements to the extent those laws are less restrictive. If a state law limits or prohibits noncompete agreements that fall outside this Rule (e.g., physician non-compete agreements, senior executive non-compete agreements), the state law can still be enforced.

In the Final Rule, “non-compete clause” is defined 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 Final Rule applies to entities subject to the FTC Act.¹ Notably the FTC Act does not apply to non-profit corporations, which is often the status of health care corporations. However, the FTC has said, and has brought complaints against, tax exempt entities that seek to make a profit on behalf of their members, therefore tax-exempt status is not enough to exclude an entity from the FTC’s jurisdiction.

To be clear, the Final Rule applies only to post-employment non-compete agreements.  It does not apply to in-term non-competes that prohibit an employee from competing against the employer while still employed. In addition, although the Final Rule still does not apply to franchisee/franchisor relationships, Commissioners Slaughter and Bedoya called for more work on this front.

Further, although the Final Rule does not explicitly prohibit non-solicit provisions, in the supplementary information accompanying the Final Rule, the FTC explained that “non-solicitation agreements can satisfy the definition of non-compete clause in [the Final Rule] where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.” Whether a non-solicit – or a no-hire or no-business – agreement meets the Final Rule’s definition of a non-compete is a “fact-specific inquiry.” And, of course, any restrictive employment agreements are always subject to a potential challenge under the FTC Act.

As to the comments the FTC received supporting the business justifications that some offered that post-employment non-compete agreements are necessary did not outweigh the harm non-competes caused. The FTC reasoned that company confidential information can be protected through other avenues such as confidentiality agreements and trade secret laws. The FTC also noted that if companies want to keep employees, the company can make “human capital investments” such as entering into defined duration employment contracts and increase pay and/or benefits.

Companies that violate this rule may be subject to civil penalties.

Each Commissioner was able to offer comments when announcing their vote. Commissioners Khan, Slaughter, and Bedoya fully supported the Final Rule for all the reasons that are laid out in the Final Rule supplementary information. . Commissioners Holyoke and Ferguson both opposed the Final Rule on the basis that the FTC does not have the power or authority to promulgate such a rule, pointing to case law that support this position. Both argued that Congress must be the one to issue such a rule or very clearly give the FTC such authority. Commissioner Holyoke also noted that she was “disappointed” the Commission used its scarce resources on this effort. Commissioner Khan, in her comments, disagreed and pointed to conflicting case law that supports the authority of the FTC to promulgate this rule.

The US Chamber of Commerce announced immediately that it will file a lawsuit on Wednesday challenging the FTC’s rule. The Chamber also released a statement that “The Federal Trade Commission’s decision to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive.” The Chamber filed a complaint and a motion for a preliminary injunction or stay of the Rule in federal court in Texas on April 24. Two other private plaintiffs, including another one in Texas (Ryan LLC. v. FTC), have also filed complaints against the Final Rule. The U.S. Chamber of Commerce had expected a decision as to whether the Final Rule will be stayed within 8-10 weeks. However, the Texas court recently stayed the Chamber’s case pending the resolution of Ryan LLC. v. FTC because it was filed before the Chamber’s. At this point, there is uncertainty on several fronts. There is uncertainty now as to the timeline of the court’s decision and uncertainty as to whether a stay will apply to only the single plaintiff, only members of the U.S. Chamber of Commerce, or would apply to any entity subject to the Final Rule.

While companies are in a “wait and see” mode, it is advisable to take stock of any post-employment restrictions currently in place with employees in order to be ready to make adjustments if necessary. Regardless of the Final Rule, the FTC, as well as private plaintiffs and state enforcers, do not need this Rule to challenge overbroad noncompete agreements. The FTC has challenged noncompete agreements recently without the Rule. And of course, there are always private plaintiffs bringing cases under state laws, which are all still in effect.

Buchanan will continue to follow the developments relating to the rule and the anticipated lawsuit. Buchanan attorneys are always available to advise companies on these issues.

Please note this advisory has been updated, reflecting additional information and recent changes to the lawsuits challenging the Rule.