FTC Final Rule Bans Most – But Not All – Non-Competition Agreements

With the Federal Trade Commission's (FTC) recent approval of its Final Rule banning non-competes, almost all existing and future such agreements are no longer worth the paper they're printed on. Though litigation challenging the rule's validity was launched almost immediately after its issuance, the ban represents a sea change in employment law that all employers will need to adapt to as they consider alternative ways to protect their trade secrets, confidential information, and other business interests.

Adopted with a 3-2 party-line vote, the Final Rule approved on April 23, 2024 largely incorporates the substance of the proposed non-compete rule the FTC published in January 2023, with three notable changes and exceptions discussed below. Barring any judicial intervention, the Final Rule becomes effective on September 4, 2024.

Both the proposed and final rules are premised on the rationale that it constitutes an "unfair method of competition" and, therefore, a violation of Section 5 of the FTC Act for a person other than a "senior executive" to enter into or attempt to enter into a non-compete clause, enforce or attempt to enforce a non-compete clause, or represent that the worker is subject to a non-compete clause.

As with any widely applicable regulation, the Final Rule contains many ambiguities and nuances that will be the subject of confusion and litigation in the months and years to come. That said, here are the key elements of the final non-compete rule that U.S. employers need to understand.

Definition of "Non-Compete Clause" Prohibited by the Final Rule

The Final Rule defines a now-prohibited "non-compete clause" as "a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

• Seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or
• Operating a business in the United States after the conclusion of the employment that includes the term or condition."

Under the Final Rule, "term or condition of employment" includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

Subject to the specific exceptions set forth below, these restrictions have the effect of nullifying current non-compete clauses and prohibiting future non-compete clauses with covered workers. However, the Final Rule will not apply to nullify a non-compete where a cause of action related to the non-compete accrues prior to the effective date.

The Non-Compete Ban Applies to Almost All Workers

The Final Rule covers almost all workers other than "senior executives," as discussed below. Non-competes are prohibited for employees, independent contractors, externs, interns, volunteers, apprentices, sole proprietors who provide a service to a person, and a person who works for a franchisee or franchisor but does not include a franchisee in the context of a franchisee-franchisor relationship.

Three Notable Exceptions Where Non-Competes are Still Allowed

“Senior Executives”

One significant element of the Final Rule that was not contained in its proposed predecessor is a carve-out for non-competes involving "senior executives." Any existing non-competes involving employees who fit that definition remain valid. However, the Final Rule prohibits employers from entering into or enforcing new non-competes with senior executives after the Final Rule's effective date.

The Final Rule defines a "senior executive" as a worker in a "policy-making position" who earns an actual or annualized sum of $151,164 (through salary, bonuses, and/or commissions, but excluding fringe benefits, retirement contributions, and medical/life insurance premium payments). In turn, a "policy-making position" is a business entity's president, chief executive officer, or the equivalent, any other officer who has policy-making authority or any other person who has policy-making authority for the business, similar to an officer with policy-making authority.

As Part of The Sale of a Business

Another significant exception to the rule's broad prohibition of non-competes involves agreements executed in connection with the bona fide sale of a business. Such provisions are valid so long as the sale consists of the disposition of the person's ownership interest in the business entity or all or substantially all of the entity's operating assets. 

Overseas Employment

The Final Rule only applies to workers who work in, or own a business in, the United States.  Non-compete clauses that would effectively prevent a worker from seeking or accepting work or owning a business solely outside of the United States are not covered by the ban.

Some Not-For-Profits and Other Businesses Outside the FTC’s Jurisdiction Are Not Affected By The Ban

Some businesses are outside the FTC’s jurisdiction and are therefore not subject to the commission’s non-compete ban. These include:  

• Banks;
• Savings and loan institutions;
• Federal credit unions;
• Common carriers;
• Air carriers; and
• Certain nonprofits.

While the healthcare industry is generally subject to the FTC’s jurisdiction, certain not-for-profit hospitals and healthcare entities may be exempt from the ban. However, in the Final Rule, the FTC emphasized that “not all entities claiming tax-exempt status as nonprofits fall outside the Commission’s jurisdiction.” The FTC went on to say that “some portion of the 58% of hospitals that claim tax-exempt status as nonprofits and the 19% of hospitals that are identified as State or local government hospitals… likely fall under the Commission's jurisdiction and the final rule's purview.”

Accordingly, not-for-profit hospitals and other healthcare employers should not presume that they are excluded from the non-compete ban and should consult with counsel to determine whether they are subject to the rule.

Attempted Workarounds Will Be Heavily Scrutinized

The Final Rule does not prohibit non-disclosure or non-solicitation agreements. However, if any such agreement effectively "prohibits," "penalizes," or "functions to prevent a worker from" seeking or accepting work after the end of their employment, it may be deemed to be a prohibited non-compete. The FTC states that whether any given provision constitutes a "non-compete clause" is a "fact-specific inquiry." 

Streamlined Notice Requirements Regarding Voided Non-Competes

Unlike the FTC’s initial proposal, the Final Rule attempted to streamline the process for employers to inform employees of this change regarding non-competes. Under the proposed rule, employers would have had to legally modify existing non-competes by formally rescinding them. The Final Rule no longer mandates rescission. Instead, employers only need to notify workers, advising them that their non-compete agreement will not be enforced against them in the future. The Final Rule includes model language employers can use to communicate with workers and satisfy this requirement. LLF is available to assist clients in preparing communications to employees about their non-competes.

Preemption of State Laws

Though the Final Rule "supersedes" any inconsistent state laws, any such laws that are more protective of worker rights would still be valid. As the Final Rule places more restrictive limits on the use of non-competes than does the Illinois Freedom to Work Act passed in 2021, the Final Rule (if upheld in the courts) is the final word on non-competes in the state. That being said, Illinois employers still need to follow the Illinois Freedom to Work Act requirements regarding non-solicitation and non-recruitment clauses.

What Should Employers Do Now and How Can LLF Help?

As noted, litigation has already commenced challenging the Final Rule, with the U.S. Chamber of Commerce suing the FTC in federal court in Texas mere hours after the rule's approval.

While the rule's ultimate fate in the courtroom is unknown, employers should nevertheless work with counsel to review existing non-competition language in employment agreements and consider other options for protecting their interests. In other words, take an inventory of the employees and former employees that do have an agreement containing a current non-compete. This will serve as a baseline for you to take action when and if you need to.

If the rule does go into effect, there may be more action to take. LLF will be assisting employers on all aspects of compliance when the time comes, including preparing a form notice, evaluating which employees should enter into a new agreement re-stating other restrictive covenants (non-solicit, non-recruitment, non-disclosure), and which employees do not need a new agreement.

If you have questions or concerns about the Final Rule or if you would like assistance reviewing your existing non-competes, please contact one of the Labor and Employment Law attorneys at Latimer LeVay Fyock.