On April 23, 2024, the FTC (Federal Trade Commission) voted 3-to-2 along party lines to approve a final rule (Rule) that prevents all for-profit employers nationwide from using non-compete agreements for any worker (whether an employee, independent contractor, or other), regardless of whether they are designed to protect legitimate business interests of employers. The Rule declares that it is an unfair method of competition—and therefore a violation of section 5 of the FTC Act—for businesses to impose non-compete restrictions (non-competes) on workers on or after the Rule’s effective date.
The Rule will have a sweeping impact on businesses in the U.S., rewriting millions of contracts and eliminating the patchwork of state laws that have governed for hundreds of years. The Rule is set to take effect 120 days after its publication in the Federal Register. However, the Rule has already been challenged in court and may be stayed during judicial review.
The Scope of the Rule and Its Exceptions
If the Rule goes into effect, no person, company, or other entity will be permitted to enter into new post-employment non-competes with any worker. Non-competes that were entered into prior to effectiveness of the Rule also will be unenforceable against most workers, but they will continue to be enforceable against “senior executives.” To be considered a “senior executive,” a worker must meet both a minimum compensation test and a duties test. The minimum compensation will initially be set at $151,164 annually as measured in the preceding year. The duties test will be satisfied only if the worker is an officer who has the final authority to make policy decisions that control significant aspects of a business or enterprise or an executive who has policy-making authority for the business similar to such an officer.1
For purposes of the Rule, a non-compete includes a term or condition of employment that prohibits or functions to prevent a worker from seeking or accepting work or operating a business in the United States after termination of a working relationship that is subject to the non-compete. It also includes provisions that would penalize a worker for doing the same; thus, so-called “pay-to-compete” or “forfeiture-for-competition” clauses are also banned under the new rule.
The Rule does not apply to non-competes entered into in connection with the bona fide sale of a business entity, the sale of a person’s ownership interest in a business entity, or the sale of all or substantially all of a business entity’s operating assets. This approach brings the Rule closer in line with California’s law prohibiting non-competes, which is one of the most stringent in the nation.
Notably, the Rule also does not apply to “in-term” restrictive covenants, which restrict competition or solicitation during the term of employment. Nor does the Rule modify any existing requirements prohibiting a worker from unlawfully using or disclosing an employer’s confidential and trade secret information, whether personally or for the benefit of a future employer or other third party.
Notice Requirements
According to the Rule, companies have 120 days after the publication of the Rule in the Federal Register to send written notice to any person or business that had previously entered into a non-compete rendered unenforceable by the Rule informing them that their non-compete will not be, and cannot be, legally enforced. The notice must:
- Identify the person or entity with which the worker entered into the non-compete;
- Be in writing; and
- Be delivered to the worker on paper by hand or by mail at the worker’s last known personal street address, or be delivered electronically by email at an email address belonging to the worker or by text message at a mobile telephone number belonging to the worker.
The Rule does not limit how far back an employer must look when sending these notices, so strict compliance will require notices to be sent to all current and former workers who may have entered into a now unenforceable non-compete. An employer is exempted from the notice requirements with respect to a particular worker only if the employer does not have record of a street address, email address, or mobile telephone number for such worker.
The FTC has provided a sample notice that satisfies the requirements of the rule.2
The Rule Already Faces Legal Challenges
One significant obstacle to the FTC's Rule remains: legal challenges brought by a coalition of businesses that rely heavily on non-competes and a broader array concerned about the breadth of the FTC's reach generally. Just hours after promulgation, a professional services firm headquartered in Texas—Ryan, LLC—filed a lawsuit in the Northern District of Texas challenging the validity of the rule.3 It argued that the 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.”4 The lawsuit asks the court to vacate the rule under the Administrative Procedure Act and to declare that the structure of the FTC is unconstitutional as a general matter.
The U.S. Chamber of Commerce and Business Roundtable also filed a lawsuit the same day as the FTC issued the rule. Also favoring the Fifth Circuit, that lawsuit is in the Eastern District of Texas.5
The Rule Showcases FTC Chair Lina Khan’s Broad Interpretation of the FTC Act, Including a Long-Promised Venture into Competition Rulemaking
The FTC's Rule is the latest in a series of moves to meet this Administration's ambitious competition- and labor-related policy goals. The Rule will serve as an example of the FTC's expansive approach to Section 5 of the FTC Act, which prohibits "unfair methods of competition." The FTC set onto this path in 2022, when it issued a new policy statement claiming Section 5 of the FTC Act reaches much further, and allows the FTC much more discretion, than the more commonly used antitrust laws: the Sherman and Clayton Acts. The non-compete ban is the most explicit example to date of the FTC reaching beyond settled antitrust law under the Sherman Act. Sherman Act cases have allowed non-competes when they are reasonably necessary and tailored to accomplish legitimate business goals, such as protecting a business's investment in employee training and its relationships with clients.
The Rule also makes good on a promise of FTC Chair Lina Khan to develop competition law through rulemaking rather than relying exclusively on case-by-case adjudication.6
These ambitious policy changes have supporters as wells as their critics. Commissioners Holyoak and Ferguson, two of the five FTC commissioners, expressed support for curtailing non-competes generally, but opposed the Rule on the ground that the FTC lacks the authority to promulgate a rule that redefines a commonly used method of competition as "unfair." Although the majority of FTC commissioners point to Sections 5 and 6(g) of the FTC Act as a broad delegation of competition rulemaking authority from Congress, the dissenting commissioners argue that the FTC does not have the authority to issue competition rules or to invalidate tens of millions of contractual provisions and preempt the laws of 46 states. Some legal scholars, on the other hand, have praised the decision and pointed to potential benefits such as a wider hiring pool and greater ease in forming start-up companies.
If the Rule Survives Legal Challenge, Companies Will Need to Take Steps to Ensure Compliance
Many believe it is likely that a federal court, or the FTC itself, will stay enforcement of the Rule in light of the lawsuits challenging it. In January 2024, the FTC issued an order postponing the effective date for its rule addressing car retail disclosures. The FTC stayed the rule indefinitely after two industry groups challenged the rule in the Fifth Circuit.7 If the FTC declines to do so in this case, the Administrative Procedure Act, 5 U.S.C. § 705, would allow a reviewing court to stay the rule instead.
Looking at recent challenges in the Fifth Circuit, where plaintiffs have met with considerable success in cabining regulatory authority, the FTC’s Rule could be stayed for years while courts review whether it is lawful.
Although there is a reasonably high probability that one of the legal challenges will result in a stay of enforcement, companies may start preparing to comply with the Rule by working with legal counsel to conduct a careful review of their contractual provisions and policies relating to the protection of trade secrets to ensure that they are properly drafted, and to enact a plan for protecting business interests in the event that the Rule survives court scrutiny. If the Rule is enacted, employers also will need to work with their counsel to issue the appropriate notices and to review and revise their employment agreements, consulting agreements, and other agreements with any type of worker, ensuring they do not contain any unlawful covenants not to compete. To the extent that employers wish to continue using non-competes with senior executives, they should consult with counsel to develop appropriate procedures for determining which workers qualify.
If the Rule is enacted, companies will be able to hire desired candidates from around the country more easily, but they will need to follow best practices to reduce the risk of trade secret disputes when doing so.
Companies may have a large task ahead of them in providing notice to employees and in considering their options for protecting non-public, competitively sensitive information, while also weighing the benefits of hiring more freely. Wilson Sonsini can help your business with this period of transition. Reach out to Marina Tsatalis, Jason Storck, Rebecca Stuart, or Matt Gorman in Wilson Sonsini’s employment and trade secret litigation group or Maureen Ohlhausen, Taylor Owings, or any member of the antitrust and competition group for assistance.
[1] Officers or executives who have policy-making authority over only a subsidiary, affiliate, or other entity that is just one part of a common enterprise are not considered senior executives for purposes of the rule, and therefore their existing non-competes will be unenforceable.
[2] Federal Trade Commission, Non-Compete Clause Rule, at 566, https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf.
[3] Ryan, LLC Press Release, https://www.ryan.com/about-ryan/press-room/2024/ryan-challenges-new-non-compete-rule/.
[4] Complaint, Ryan, LLC v. Federal Trade Commission, Case No. 3:24-cv-00986, Dkt. 1, Apr. 23, 2024.
[5] U.S. Chamber of Commerce, Chamber of Commerce v. FTC, April 24, 2024, https://www.uschamber.com/cases/antitrust-and-competition-law/chamber-v-ftc.
[6] R. Chopra and L.M. Khan, “The Case for ‘Unfair Methods of Competition’ Rulemaking,” University of Chicago Law Review: Vol. 87: Iss. 2, Article 4, 2020. https://chicagounbound.uchicago.edu/uclrev/vol87/iss2/4.
