On April 23, 2024, the five-member Federal Trade Commission, in a three to two vote, approved a new rule that prohibits employment-based noncompete agreements in the United States. The rule is scheduled to become effective 120 days after its publication in the Federal Register, so likely in late August 2024.
Employment-based non-competition agreements, commonly known as "noncompetes," are agreements in which an employer and an employee agree that the employee will not work for a competitive business after the employee leaves his or her employment, usually for a specified period of time in a defined geographic area. A typical noncompete might say, "Employee may not work for a competitor of the Company in the same or similar position Employee worked for the Company anywhere in the State of Indiana for a one-year period after Employee's employment ends for any reason." The FTC estimates that about 30 million American workers are subject to noncompete provisions, which the FTC has decided constitute "unfair methods of competition" that run afoul of Section 5 of the FTC Act. According to the FTC, the vast majority of those agreements will become invalid when the rule takes effect in late August of this year.
Under the new rule, with respect to all workers other than senior executives, it is unlawful for an employer to enter or attempt to enter into a noncompete clause, to enforce or attempt to enforce a noncompete clause, or to represent that the worker is subject to a noncompete clause. A "noncompete clause" is defined in the rule as a term or condition of employment that prevents a worker from either working for another person or operating another business after the worker's employment with the employer ends.
The rule does not invalidate existing noncompete clauses with senior executives, but new noncompete agreements with senior executives after the effective date are also prohibited. "Senior executives" are defined as individuals who earn at least $151,164 per year and who are in a policy-making position such as president, CEO, another officer with policy-making authority, or another person with similar authority. Policy-making authority means "final authority to make policy decisions that control significant aspects of a business entity or common enterprise[.]"
The rule further states that, on or before the effective date, employers that have noncompete agreements with their employees must notify those employees in writing using "clear and conspicuous" language that the employer will not enforce those noncompete agreements and cannot lawfully do so.
This rule does not specifically apply to other types of post-employment restrictive covenants, such as confidentiality agreements, restrictions on soliciting or servicing the employer's customers, or prohibitions on hiring or soliciting the employer's employees, so those restrictions likely remain valid to the extent they otherwise comply with applicable law. The new rule also states that it does not apply non-competition restrictions in the context of the sale of a business, assets, or ownership interest; it does not apply to claims that have accrued prior to the effective date of the rule; and it is not unlawful to enforce or attempt to enforce a noncompete clause where the person has a good faith basis to believe the rule does not apply.
We anticipate that there will be several legal challenges to this rule, and two lawsuits have already been filed against the FTC in an attempt to invalidate the rule, including one by the United States Chamber of Commerce. Because of how broadly the rule is written, including the fact that the FTC, by its own admission, is attempting to invalidate about 30 million U.S. contracts with this single rule, there is a good likelihood that the effective date of the rule may be delayed, the rule may be modified or it may be struck down altogether.
In the meantime, employers should take an inventory of their existing agreements with employees to determine which contracts may be subject to the rule – including determining which employees fall into the "senior executive" category – and to develop a strategy to comply with the rule when (and if) it becomes effective. Employers may also wish to evaluate whether to enter into noncompete agreements now with senior executives, to the extent such agreements are not already in place. It is not necessary to make any changes yet, however, given the uncertainty that the rule will ultimately take effect as currently constituted.
As always, we will keep you apprised of any material developments in this area.
Originally published Apr 25, 2024
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