FTC Outlaws Noncompetes—What You Need to Know

On April 23, 2024, the U.S. Federal Trade Commission approved a proposed rule banning use of noncompetition agreements. The Rule will become effective four months after it is published in the Federal Register, an event expected soon to occur. Several groups immediately challenged the Rule in Federal Court. The U.S. Chamber of Commerce, for example, filed suit in the Federal District Court for the Eastern District of Texas seeking to enjoin enforcement of the Rule. The following outlines the provisions of the Rule and explains how it could affect you if it becomes effective. 

The Rule is a reaction by the FTC to perceived abuses and overuse of noncompetition agreements. The FTC determined that noncompetition agreements increased the costs of goods and services, inhibited the formation of new businesses, stymied innovation, and depressed worker earnings.

The Rule declares it to be an unfair method of competition to enter into a noncompete agreement after the effective date. The Rule also declares the enforcement of a noncompete agreement after the effective date to be unfair competition, except in circumstances in which the agreement was entered into before the effective date and the agreement is with a “senior executive.” Prohibited noncompetes are any agreement that “prohibits,” “penalizes,” or “functions to prevent” a worker from seeking or accepting work or operating a business in the U.S. after his or her employment. A “worker” is broadly defined to cover any paid or unpaid person who provided service, regardless of title or status, and includes “independent contractors, externs, interns, volunteers, apprentices, or sole proprietors,” but excludes franchisees.

Agreements existing as of the effective date with “senior executives,” however, may be enforced. The FTC reasoned such an exception was appropriate in light of the greater likelihood such agreements were negotiated or exchanged for consideration. A “senior executive” is a person in a “policy-making position” whose total annual compensation exceeds $151,163. Policy-making positions are limited to the President, CEO or equivalent, or persons who have “final authority” to make policy decisions that “control significant aspects” of the business. Policy making does not include merely advising or exerting influence over such decisions, nor does it include persons having final authority for decisions related to only a subsidiary or affiliate of a common enterprise. 

The Rule further requires that employers who have entered into noncompete agreements notify all existing and former workers of the fact that those agreements are no longer enforceable.  The notice must be “clear and conspicuous” and announce that the noncompete “will not be, and cannot legally be, enforced against the worker.” The notice must identify the worker, be on paper and delivered by hand or mail, or alternatively be made by email or text message. The FTC provides a model notice with language explicitly advising the worker that they may seek and accept a job with any company, including a competitor, that they may run their own competitive business, and they are authorized to compete with the employer.

Noncompete agreements that form part of a bona fide sale of a business, of a person’s ownership interest in a business, or of substantially all of a business’ operating assets, are exempt. The FTC’s commentary also suggests that non-solicitation agreements and agreements that require workers to repay their training expenses (so-called TRAP agreements) may be allowable under the Rule, provided that they are not so broad or coercive as to function as a noncompete. The Rule also will not affect causes of action under an existing noncompetition agreement that have accrued before the Rule’s effective date.

The Rule overrides any contrary State statutes to the extent that they would approve conduct prohibited by the Rule. However, the Rule does not affect the entry into, or the enforceability of, confidentiality, non-disclosure or non-use obligations that are not functionally equivalent to a noncompete, or State laws relating to protection of trade secrets.

Assuming that the Rule takes effect as scheduled, businesses who have employed noncompete agreements to protect their trade secrets and confidential information need to prepare. Of course, before taking any action, businesses will need to evaluate the potential that courts may ultimately enjoin implementation of the Rule in the pending challenges. 

First, you should consider compiling an inventory of non-expired noncompete agreements with current and former employees. This will not only be necessary to meet the notification requirements of the Rule, but also to assess the impact caused by unenforceability of these commitments. 

Second, if you have relied upon noncompetes to protect trade secrets and confidential information shared with an employee, alternative steps to minimize risk of that employee’s later misuse of that information are now paramount. You should consider ensuring that nondisclosure and/or nonuse agreements are in place with such employees, if appropriate and permissible under relevant State and local laws. The FTC has indicated that non-solicitation agreements may remain enforceable despite the Rule. You may wish to consider whether such agreements are appropriate and permissible. It may be prudent to reexamine and, if necessary, tighten procedures that restrict employee access to confidential information and robustly document such access should such evidence become necessary to enjoin later misuse. The FTC also suggests that employers consider fixed term employment agreements, rather than at-will arrangements. If the concern is customer relationships, similar longer-term relationships might be negotiated with key customers, provided such contracts are consistent with other Federal and State laws governing competition. 

Third, the Rule exempts enforcement of actions accruing prior to its effective date. Thus, it may be important to identify any present violations of existing noncompetes and consider whether litigation is warranted.

Fourth, it may be advisable to evaluate existing noncompetition agreements to ascertain if, and to what extent, you have committed to compensation in exchange for the noncompete. In light of the looming unenforceability of such agreements, modification or termination of your obligations thereunder may be prudent, if permitted. This is particularly true if the agreements include severability clauses.

Fifth, because only agreements with “senior executives” will remain enforceable after the Rule’s effective date, you might wish to examine whether or not you may legally secure such agreements from persons who do or who could qualify. 

Sixth, if you are engaged in the purchase of a business in which you have relied upon the retention of key personnel and the existence of noncompetition agreements, you may need to reassess whether those key employees will remain bound by these commitments following the acquisition.

If you have questions about the FTC’s recent Rule, please contact Tom Duston at [email protected] or your Marshall Gerstein contact.

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