The FTC's Non-Compete Ban: Litigation Updates And Practical Considerations

On April 23, 2024, the U.S. Federal Trade Commission (FTC) issued its final rule (the Final Rule) invalidating virtually all new and existing non-compete clauses (non-competes) that prohibit a service provider from working or operating a business in the U.S. during any post-employment period, with limited exceptions. The Final Rule also requires companies to provide written notice to all current and former service providers subject to unenforceable non-competes that such clause is now illegal and unenforceable. Additional details of the Final Rule can be found in our previous bulletin.

In this article, we turn to the recent challenges to the non-compete ban and provide practical tips for companies to prepare ahead of the Final Rule's effective date.

Challenges to the FTC's non-compete ban

As of this writing, there are two noteworthy pending lawsuits challenging the Final Rule.

Ryan, LLC v. Federal Trade Commission

Ryan, LLC, a tax services firm, filed a complaint against the FTC on April 23, 2024, in the U.S. District Court for the Northern District of Texas¹. The next day, the U.S. Chamber of Commerce, Business Roundtable, Texas Association of Business and Longview Chamber of Commerce filed a nearly identical challenge in the Eastern District of Texas². In Ryan, the plaintiff sought to vacate and set aside the Final Rule, declare that the authorizing section of the Federal Trade Commission Act violates the U.S. Constitution's nondelegation doctrine and declare that the FTC is unconstitutionally structured. The U.S. Chamber of Commerce and its co-plaintiffs intervened as plaintiffs in the Ryan action on May 8, 2024, and their original action was dismissed without prejudice.

All Ryan plaintiffs moved to stay enforcement of the Final Rule and for a preliminary injunction. On July 3, the Court stayed the effective date of, and enjoined, the Final Rule, but only as to the plaintiffs. In doing so, the Court held that (1) the plaintiffs are substantially likely to prevail on the merits of their claim, (2) the plaintiffs will suffer irreparable harm absent an injunction, (3) the balance of harms favours the plaintiffs and (4) the public interest favours the plaintiffs. The preliminary injunction will remain in place until the Court issues a final merits adjudication on or before August 30.

Given the Court's reasoning, coupled with the U.S. Supreme Court's recent decision in Loper Bright Enterprises v. Raimondo³, we think it is more likely than not that the Court will award plaintiffs the ultimate relief they seek.

ATS Tree Services v. FTC

The second recent challenge to the FTC's non-compete ban is ATS Tree Services v. FTC⁴. In this case, the plaintiff filed suit in the Eastern District of Pennsylvania on April 25, 2024, seeking (1) a preliminary and permanent injunction against the enforcement of the Final Rule and (2) an order declaring it unlawful and set aside. The ATS preliminary injunction motion was heard by the Court on July 10, 2024, and we expect a ruling to be issued by July 23, 2024.

For a summary of these legal challenges, with additional practical tips for companies, watch the video below.

What companies can do to prepare for the FTC's non-compete ban

Unless either litigation challenge prevails and the Final Rule's implementation is delayed or permanently enjoined nationwide (instead of only as to the plaintiffs), the Final Rule will become effective on September 4, 2024 (the Effective Date). Although the Final Rule will affect each company differently, companies should consider taking the following steps to prepare ahead of the Final Rule coming into force.

• Determine who is subject to a non-compete and prepare the required notice. A non-compete may be included in multiple documents, including an employee handbook or workplace policy. Depending on how widespread the use of non-competes is, a company may be inclined to send the required notice to all current and recently terminated service providers, as opposed to only sending it to the service providers it determines are subject to an unenforceable non-compete. Companies should prepare the notice in advance of the Effective Date based on the model notice provided in the Final Rule, determine the method of delivery for the notice (which can be in writing, by email or via text message) and gather the relevant contact information of the applicable service providers.
• Identify "senior executives". A non-compete with a "senior executive" will remain enforceable following the Effective Date so long as it was entered into by the Effective Date. Generally, in order to be considered a senior executive, an individual must satisfy both the Final Rule's "compensation" prong (total annual compensation of at least $151,164 in the preceding year) and the "role" prong (e.g., final policy-making authority), with the role prong to be applied narrowly to primarily refer the authority of C-suite executives. Identifying senior executives may be complicated if the company has various subsidiaries, affiliates or divisions. If those subsidiaries, affiliates or divisions are viewed as a "common enterprise" with the parent company, then a senior executive of only a subsidiary, affiliate or division will not be treated as a "senior executive" under the Final Rule. If a company finds a non-compete desirable for its senior executives, it should ensure that all existing and new senior executives have entered into non-competes before the Effective Date.
• Ascertain which non-competes may be exempt from the Final Rule. Some non-competes may not be subject to the ban under the Final Rule, including those that are entered into pursuant to a bona fide sale of a business (i.e., a bona fide, arms' length transaction with a reasonable opportunity to negotiate the terms of the sale) or in connection with the issuance of equity. However, absent further FTC guidance, it is unclear whether the sale of business exception under the FTC rule is intended to cover non-competes entered into by an employee-shareholder of a business who, in connection with the bona fide sale of the business, sells a portion (but not all) of its ownership interest in the business, such as where the seller rolls over its ownership interest in the business to the buyer or re-invests a portion of the seller's sale proceeds into an equity interest of the buyer. Similarly, it is unclear whether the Final Rule permits non-competes that are executed in the capacity of a partner of a partnership, member of an LLC or shareholder of a corporation if the individual is employed by a subsidiary or affiliate of the issuer.
• Ensure other restrictive covenants are robust. Companies should consider whether their service providers are subject to sufficiently robust confidentiality, trade secret, intellectual property and non-solicitation covenants and, if necessary, enhance those protections. Conversely, the Final Rule defines "non-compete" broadly to include any agreement that "functions" to prevent a worker from seeking or accepting work or operating a business, such as an overly broad non-solicitation or confidentiality covenant. As a result, companies should examine whether any of the restrictive covenants currently in place could be viewed as functional non-competes.
• Consider using garden leave, notice period or other retention tools. The Final Rule does not prohibit enforcing non-competes during employment, and employees on garden leave or during a notice period may be subject to a non-compete so long as they receive the same compensation as when they were active employees. Historically, contractual severance provisions have served both as consideration for entering into a non-compete, as well as a retention tool. If the Final Rule becomes effective, companies may be inclined to pivot from severance arrangements towards retention bonuses or other deferred compensation arrangements. Consequently, companies may consider increasing their use of reasonable "garden leave" or notice periods, or retention or other deferred compensation arrangements in an effort to retain service providers who otherwise may join a competitor.

Footnotes

1 Ryan, LLC v. Federal Trade Commission,No. 3:24-00986-E (N.D. Tex.).

2 Chamber of Commerce v. FTC, No. 6:24-cv-00148 (E.D. Tex.)

3 Loper Bright Enterprises v. Raimondo, 603 U.S. ___, 2024 WL 3208360 (2024).

4 No. 2:24-cv-01743

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.