As explained below, the effective date of the Federal Trade Commission's ("FTC") rule banning the use of post-employment noncompete agreements has been stayed indefinitely by a federal court in Dallas, pending a final ruling on the merits.
Eighteen months ago, we first reported on the FTC's proposed rule-making that would enact a comprehensive nationwide ban on worker noncompete agreements, so broad as to include fully negotiated contracts for senior executives who would receive millions of dollars in compensation in exchange for not working for their former employer's competitors. The outpouring of public comments concerning this potentially groundbreaking upheaval of more than a century of well-developed fact-based jurisprudence was striking—more than 26,000 suggestions concerning the federal government's first attempt to regulate noncompete agreements on a nationwide basis. Nonetheless, the FTC voted to finalize its noncompete rule on April 23, 2024—virtually unchanged and stunning in its breadth—which flatly prohibits any contractual provision that "penalizes a worker for, or functions to prevent a worker from," "seeking or accepting work" or "operating a business" that competes with their former employer in the United States (the "Noncompete Rule"). (Final Rule at 561-562) The Noncompete Rule, which does not distinguish on the grounds of salary, job responsibilities, title or length of employment, was to become effective on September 4, 2024, a mere 120 days after its publication in the Federal Register.
The immediate and retroactive impact of the Noncompete Rule would have been drastic—not only prohibiting the use of these post-employment restrictions prospectively, but also re-writing existing agreements and requiring employers to notify almost all prior employees that they are no longer bound by the terms of their existing contracts. As we predicted, litigation immediately ensued challenging the propriety of the Noncompete Rule and the constitutionality of the FTC's rule-making authority. The principal challenge is taking place in the U.S. District Court for the Northern District of Texas, Ryan LLC v. FTC, Civil Action No. 3:24-cv-986-E (filed on May 1, 2024), in which the Chamber of Commerce of the United States and others filed a Complaint for Declaratory and Injunctive Relief seeking, among other things, a temporary stay of the Noncompete Rule's effective date. The FTC's Noncompete Rule is being contested on several grounds, including that: (i) the FTC does not have the authority to issue regulations proscribing unfair methods of competition and that its recent rule-making offends the major-questions doctrine which the Supreme Court has used to curb administrative authority; (ii) not all noncompete agreements are categorically unlawful under Article 5 of the FTC Act (15 U.S.C. § 45(a)(1)); (iii) the Noncompete Rule is impermissibly retroactive which requires clear congressional authorization which was never granted; and (iv) the FTC's rulemaking reflects an arbitrary and capricious exercise of its powers.
On July 3, 2024, with more than a dozen amici curiae filing briefs on both sides of the controversy, United States District Judge Ada Brown issued a 33-page decision granting the Plaintiffs' motion for a preliminary injunction which stays indefinitely the effective date of the Noncompete Rule, pending a determination on the merits of Plaintiffs' claims which the Court expects to deliver on or before August 30, 2024. While the Court issued injunction technically applies only in favor of the Plaintiffs in that case, the Court's scathing rebuke of the FTC bodes well for a ruling on the merits that would be nationwide in effect.
What does this mean going forward? Well, for the time being it's business as usual. Based upon the Court's extensive preliminary findings, we expect that the Noncompete Rule will be struck down based upon one or more of the stated grounds challenging its constitutionality and the scope of the FTC's authority. The Court's decision will most assuredly be appealed to the U.S. Court of Appeals for the Fifth Circuit, during which time the stay of the effective date of the Noncompete Rule will likely remain in place. Ultimately, the case will end up before the U.S. Supreme Court for a final determination regarding the propriety of the Noncompete Rule. Until then, the state and federal courts will continue to apply the existing laws established by each state.
Takeaways and Recommended Steps Forward
Regardless of the ultimate fate of the FTC's Noncompete Rule, and despite the genuine business interests that support the legitimate need for noncompete agreements, the continued viability of post-employment noncompete terms in employment and separation agreements is notably trending downwards. For decades, most state laws have allowed noncompete agreements on a case-by-case basis to the extent that they are imposed reasonably with respect to duration, geographical scope and the type of restricted activity, and some states (like Michigan, Massachusetts and Texas) have codified these elements through legislation. However, a growing number of states, California, Minnesota and Oklahoma, for example, have outlawed or significantly restricted the use of noncompete agreements. In just the last year, 33 states have considered new legislation (with several bills still pending in Congress) that would restrict or prohibit outright the use of post-employment noncompete agreements, with six new states, including Colorado, Iowa, Louisiana, Maryland, Rhode Island and Washington, recently enacting laws making it more difficult to enforce noncompetes. And the debate is still ongoing in New York. In June 2023, the New York Legislature passed a bill that would have banned the use of noncompete agreements for all workers. After much consideration, Governor Hochul vetoed the bill in December 2023, noting that "New York has a highly competitive economic climate and is home to many different industries. These companies have legitimate interests that cannot be met with the legislation's one-size-fits-all approach." Many in Albany predict that the noncompete bill will soon return to the Governor's desk with a modified profile, likely prohibiting noncompetes for lower wage earners who are not executive level employees.
Given the uncertainty concerning the future of post-employment noncompetes, we recommend a thoughtful and proactive approach. Employers should be able to retain noncompete agreements for high-level executives and other significantly compensated employees, considering that the pending litigation is likely to force a modification of the FTC rule to permit restrictions for highly paid executive level employees. However, it also makes sense for employers to more narrowly tailor their noncompetes, since Congress and many states (including New York) are still heading in the direction of limiting the use of noncompete covenants.
Employers would also be wise to carefully examine their employment and separation agreement templates with their counsel with a view toward strengthening the other contractual post-employment protections that remain in the toolbox. For example, post-employment confidentiality, trade secret and nondisclosure agreements can provide substantial protections against a potentially pernicious employee and, at least for now, these restrictions remain fully enforceable. And, if carefully drafted to avoid conspicuous aspects of unfair competition, nonsolicit restrictions can provide much of the same protection that employers have sought from their noncompete agreements.
Finally, it is worth noting that contract terms which apply during an employee's tenure (as opposed to those intended to apply post-employment) remain beyond the scope of the Noncompete Rule and the federal and states' legislative agendas to protect against unfair methods of competition. Successfully safeguarding against a potentially rogue ex-employee starts with establishing policies applicable during the term of employment which can and should include full-bodied provisions that define the employee's duty of loyalty, rules to ensure no conflicts of interest, and the employee's obligations to use their best efforts and to give full time attention to their work. Every employment agreement should also include robust confidentiality, trade secret, non-disparagement, non-solicitation; and work shop agreements, all of which are enforceable during the term of employment and should provide the employer with the best possible posture in the event of a post-employment dispute. Additionally, a thoughtful and well-designed program of garden leave (which was expressly excluded from the scope of the Noncompete Rule) will extend the employer's ability to monitor and control a soon-to-be former employee's conduct even beyond their period of active employment.
Employers need not idly await the final adjudication of the legal challenge to the FTC's Noncompete Rule. Win, lose or draw, Congress and the various state's legislatures are likely to continue to focus on post-employment noncompete agreements and the extent to which they may under certain circumstances reflect unfair methods of competition. It is only logical to use this time productively to work within the existing framework and get ahead of the legislative and judicial hurdles that lay ahead.
We will be monitoring closely the developments in this and other legal challenges to the FTC's rules-making.
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.