On April 23, 2024, the Federal Trade Commission ("FTC") issued a Final Rule (the "Rule") that will enact a "comprehensive ban on non-competes with all workers" as of September 4, 2024.1 The Rule aims to prohibit employers from using or enforcing non-compete agreements with employees or independent contractors when their employment ends, in order to address what the FTC deems "unfair methods of restricting competition."2 The full text of the Rule can be accessed here.3. If the FTC rule becomes effective, it will supersede and supplant Virginia law that has recognized that reasonably drawn non-compete restrictions are enforceable, with the exception of "low wage" employees.4
The implications of the Rule are significant. Indeed, any existing non-compete agreement entered into before September 4, 2024 will no longer be enforceable, and employers will not be permitted to enter into new non-compete clauses with their workers after September 4, 2024.5 Equally important, once the Rule become effective, employers have a duty to send written notice to each worker who is subject to a non-compete agreement that the provision is not enforceable, and this includes severance agreements. One exception (there are few) is for pre-existing noncompete agreements with senior executives, provided that their annual compensation is more than $151,164. According to the FTC, these senior executives are "less likely to be subject to the kind of acute, ongoing harms currently being suffered by other workers subject to existing non-competes."6] For these senior executives, existing non-competes can remain enforceable after the effective date, but companies will be barred from requiring or entering into non-competes with senior executives after September 4, 2024. 7
Predictably, this proposed ban has caused considerable upheaval in the business community, leading to early legal challenges against the Rule in federal courts in both Texas and Pennsylvania. Among the legal challenges made is the assertion that the FTC does not have the authority to adopt such a nationwide ban, and that the Rule's attempt to impose this ban is unconstitutional.
In Ryan, LLC v. Federal Trade Commission, Ryan, LLC filed a lawsuit in Texas federal court challenging the FTC's authority to issue the Rule. Ryan, an international tax firm, and four plaintiff-intervenors, including the U.S. Chamber of Commerce, sought a nationwide preliminary injunction to halt the enforcement of the Rule while the issues are litigated on the merits. The court issued a stay of enforcement until it could rule on the motion for a preliminary injunction, stating that "the FTC lacks substantive rulemaking authority with respect to unfair methods of competition ... and thus plaintiffs are likely to succeed on the merits."8 However, the court declined to grant a nationwide injunction, limiting the stay to Ryan, LLC and the other plaintiffs named in the case (but not their members). The Texas court stated that it will issue its ruling on the preliminary injunction by August 30, 2024. In its ruling later this month, the Texas federal court is expected to determine whether the FTC ban is enforceable, and whether broader injunctive relief is warranted.
A similar challenge to the FTC's authority and the enforceability of the Rule was filed by a tree service company in the Eastern District of Pennsylvania.9 In ATS Tree Services, LLC v Federal Trade Commission, the plaintiff asserted that the FTC ban on non-competes is "unconstitutional and contrary to law"10 and likewise requested a nationwide injunction that would bar enforcement of the Rule and its ban on non-competes. On July 23, 2024, the court denied plaintiff's request for an injunction, reasoning that the risk of any harm caused by this ban was too speculative, and that the FTC did, in fact, have the authority to promulgate the Rule.11
Because of the contrasting outcomes in these two cases – and these are just the first two cases to render decisions on challenges to the Rule – and the existing patchwork of state laws governing and often limiting the use of noncompete agreements, companies are left without full-proof answers to questions about whether to continue to use of non-compete agreements going forward and what actions to take as of September 4, 2024.
By understanding the implications of the FTC's Rule and implementing a combination of these strategies, you can better identify the major risks to your business in the absence of an ability to rely on non-competes. During this next month, businesses should consider taking some or all of the following steps to ensure the protection of their trade secrets and other confidential information:
- Non-Disclosure Agreements ("NDAs"): Bind employees with NDAs that clearly protect trade secrets and restricts the disclosure and use of proprietary and confidential information, without making the NDA so broad that it could be considered a non-compete restriction, or that it could construed to prohibit the disclosure of unlawful conduct.
- Non-Solicitation Agreements: Require senior executives and key workers to sign carefully tailored non-solicitation agreements to prevent them from soliciting either the clients they worked with during employment or other company employees for a reasonable period of time after separation from employment.
- Garden Leave: Consider the use of this type of provision in severance agreements with executives and key employees to keep them on the payroll for a restricted period and thereby prevent unwanted competition for a period of time.
- Legal Review: Work with legal counsel to conduct a privileged review of existing agreements to assess potential exposure prior to September 4, 2024.
- Intellectual Property ("IP") Agreements: Ensure employees have executed Work for Hire Agreements and an agreement to assign any IP they develop to the business and acknowledge the company's ownership via an IP agreement.
- Tailored Company Policies: Develop company policies and agreements that are specifically tailored to your business needs, avoiding reliance on generic boilerplate language.
- Cloud Services and Data Security: Monitor the Cloud services that employees use to store company data, such as Dropbox, iCloud, or Google Drive. Implement Data Loss Prevention tools that can detect the type of data within files and enforce predefined rules regarding what can and cannot be transferred to a Cloud service.
- Customer Relationship Management Systems: Review the systems used to manage customer relationships and sales. Ensure that access controls and data management settings are tailored to your business needs, specifying who can access what data and for how long.
- Positive Work Environment: Foster a positive work environment that encourages loyalty and reduces the desire for employees to leave and compete. Implementing incentive programs such as profit-sharing, stock options, and bonuses can encourage long-term commitment and reduce turnover.
Absent an unexpected change, it does not appear that a nationwide ban on the FTC's Rule will be imposed. Each business subject to FTC jurisdiction will need to determine what steps it will take in light of the legal challenges to the FTC's authority to ban the use of non-compete agreements as well as the exposure to possible enforcement action by the FTC if required notices are not sent by September 4, or banned agreements continue to be required of workers or steps are taken to seek enforcement of a banned agreement.
For legal assistance with navigating these changes and implementing protective measures, reach out to a member of Gentry Locke's Employment Team who can provide personalized guidance and support to safeguard your business. We can also review any non-compete provisions that your business currently has in place to ensure that they are enforceable under Virginia law.
Footnotes
1 FTC Non-Compete Clause Rule, 16 C.F.R. § 910 (2024).
2 Id.
3 There are limits to FTC's ban. While the Rule defines non-competes broadly, it does not apply to restrictions that prohibit the solicitation of clients, and the disclosure and use of confidential information/trade secrets. The Rule does not to the following organizations because the FTC has limited jurisdiction: (i) non-profit organizations, (ii) banks, savings and loan institutions, and federal credit unions, and (iii) common carriers, air carriers, and foreign air carriers. Additionally, the Rule, by definition, does not apply to non-competes entered into in connection with a bona fide sale of a business, or to enforcement actions where the cause of action accrued before September 4, 2024.
4 Assurance Data, Inc. v. Malyevac , 286 Va. 137, 144 (2013); Update Inc, v Samilow, 311 F. Supp.3d 784(ED Va 2018)(granting preliminary injunction on a one-year, 50 mile non-compete agreement). Since July 1, 2020, Virginia has prohibited non-compete agreements with those workers are considered to be "low wage" Va. Code §40.1-27.3.
5 Id. The Rule makes it clear that it applies to agreements with independent contractors as well as employees, and also applies to severance agreements. In contrast, commentary to the Rule makes it clear that "garden leave" agreements are permissible. Under a garden leave agreement, the worker remains on the payroll for the entire period of the restriction but is required to do little or no actual work.
6 Id.
7 16 C.F.R.§910.2(a)(2). There are also unresolved issues involving the ability to use non-compete provisions and/or forfeiture/claw back provisions in new deferred compensation agreements which are or maybe governed by ERISA.
8 Ryan LLC v. FTC, Civil Action No. 3:24-CV-00986-E, 2024 U.S. Dist. LEXIS 117418 (N.D. Tex. July 3, 2024).
9 ATS Tree Services, LLC v. FTC, 2:24-cv-01743, (E.D. Pa. 2024)
10 Id.
11 Id.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.