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Client Alert: FTC Issues Final Rule Banning Non-Compete Provisions Nationwide

On Tuesday, April 23, 2024, the Federal Trade Commission issued a Final Rule banning non-compete provisions nationwide, with limited exceptions. It is estimated the Rule will become effective in early September 2024.

The Final Rule defines a “non-compete clause” as “a term or condition” that “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” (1) seeking or accepting work in the United States with a different person; or (2) operating a business in the United States after the conclusion of the employment. This is broader than typical non-compete clauses which explicitly prohibit individuals from working for a competitor located within a given geographic area and/or for a certain period of time following the conclusion of the employment giving rise to the non-compete.

According to the FTC, non-compete provisions decrease competition by preventing employees from taking a new job or starting a new business. The FTC states on its website that non-compete provisions “often force workers to either stay in a job they want to leave or bear other significant harms and costs, such as being forced to switch to a lower paying field, being forced to relocate…. or being forced to defend against expensive litigation.”

The FTC’s Rule bans all post-employment non-compete clauses, with two exceptions:

1.  Non-compete clauses with Senior Executives in effect prior to the Rule’s effective date. A Senior Executive is defined as a worker earning more than $151,164 who is in a “policy-making position”. A “policy-making position” is defined as (i) an entity’s president, CEO or equivalent, (ii) other officers with policy-making authority, and (iii) other persons with policy-making authority similar to an officer with policy-making authority; and
2.  Non-compete clauses between a seller and a buyer in connection with the sale of a business. There is no specified minimum ownership requirement for this exception (unlike the Proposed Rule which required the employee to have at least a 25% ownership for this exception to apply).

Under the Final Rule, “policy-making authority” means final authority to make decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such decisions or having final authority limited to a subsidiary or an affiliate of an enterprise.

Because the Rule is federal law, less restrictive state laws are superseded by the federal Rule. Restrictions that remain effective and that are not banned by the new Rule include (i) non-compete provisions that are effective during the term of employment, (ii) non-disclosure agreements, (iii) trade secret protections, (iv) “garden leave” arrangements, and (iv) non-solicitation of former clients or employees, provided the above do not function like a non-compete.

Prior to the Rule’s effective date, employers will need to provide individualized written notice to each worker then subject to a non-compete that will be deemed invalid under the Rule. The notice must inform the worker that the non-compete will no longer be valid under federal law once the Rule becomes effective.

The Rule does not result in a private right of action, rather, the FTC may remedy violations by either engaging its own internal processes to issue a cease and desist order or seeking an injunction in federal court to stop the prohibited activity.

Non-compete provisions in employment contracts have become subject to increased scrutiny in recent years, with a number of states advancing bans, or restrictions. New York, for example, requires that, in order to be valid, a non-compete provision “(1) is necessary to protect the employer’s legitimate interests, (2) does not impose an undue hardship on the employee, (3) does not harm the public, and (4) is reasonable in time period and geographic scope.”

Massachusetts statutes (M.G.L. Ch 149, Sec. 24L) provide for specific requirements that limit non-compete clauses as detailed in the Sherin and Lodgen blog post linked here. Beyond these statutory requirements, Massachusetts courts recognize that such provisions must be necessary to protect a legitimate business interest, are reasonably limited in time and space and are consonant with the public interest (Automile Holdings, LLC v. McGovern, 483 Mass. 797 (2020)). Massachusetts further prohibits non-compete provisions for certain professions, including for doctors, nurses, psychologists, social workers, broadcast industry employees and lawyers.

Lawsuits opposing the federal ban have already been filed, including a suit by the U.S. Chamber of Commerce filed in the Eastern District of Texas the day after the FTC decision. The U.S. Chamber of Commerce notes at the outset of its claim that “[h]aving invested in their people and entrusted them with valuable company secrets, businesses have strong interests in preventing others from free-riding on those investments or gaining improper access to competitive, confidential information. For centuries, businesses throughout the United States have relied on reasonable noncompete agreements to protect those critical interests.” The suit argues that the FTC’s assertion of power breaks with tradition and centuries of state and federal law where the states always regulated non-compete agreements and constitutes an “unlawful” and “blatant power grab.”

While such lawsuits will likely force the U.S. Supreme Court to weigh in on the Rule’s enforceability, employers will have to consider the general current trend towards a ban on such provisions. Companies will need to review current policies and practices to ensure their IP and trade secrets are appropriately protected, and that non-disclosure and non-solicitation provisions are correctly drafted and enforceable. These restrictive covenants above should be drafted carefully to avoid becoming overbroad and to not constitute in themselves, non-compete provisions.

Please contact a Sherin and Lodgen attorney for further guidance.