By: Steven R. Vanderlinden
In a significant move aimed at bolstering worker mobility and fostering economic growth, the Federal Trade Commission (FTC) has issued a dynamic final rule banning non-compete agreements across the United States. This groundbreaking regulation marks a pivotal shift in employment practices, with the FTC asserting its authority to curtail what it views as an impediment to job changes, innovation, and entrepreneurship. The resulting sea change created by this ruling, which also applies retroactively, will have long reaching effects on employers and employees alike.
Overview of the Rule and Its Objectives:
After an extensive commentary period, the final rule, articulated by FTC Chair Lina M. Khan, contends that non-compete clauses not only stifle wage growth but also inhibit the emergence of novel ideas and limit the formation of new businesses. By dismantling these agreements, the FTC anticipates a surge in entrepreneurial activity, estimating an annual increase of more than 8,500 startups. Moreover, the rule is projected to augment worker earnings by an average of $524 per year and reduce healthcare expenditures by up to $194 billion over the next decade. In that same time, it is anticipated to catalyze innovation, yielding up to 29,000 new patents annually.
The new rule expressly precludes entering into, attempting to enforce, or representing to a worker that they are subject to a non-compete agreement. The ban extends to any agreement that restricts a worker from pursuing employment with a new business entity and is set to take effect beginning in September or early October 2024 (120 days after its publication in the Federal Register). Importantly, once in effect, essentially any individual will be permitted to quit their current employer and immediately begin working for a direct and major competitor.
Benefits to Workers, Businesses, and the Economy:
The FTC underscores the alleged exploitative nature of non-compete agreements, which often compel individuals to remain in undesirable positions or face significant economic repercussions. With approximately 30 million workers—nearly one-fifth of the American workforce—bound by such agreements, the FTC's prohibition is poised to afford greater autonomy to those employees seeking job transitions or entrepreneurial pursuits.
Under the new rule, existing non-competes will be unenforceable for the majority of workers. An exception applies for senior executives, who represent less than one percent of the workforce. Notably, employers are barred from entering into or enforcing new non-compete agreements, irrespective of the employee's senior executive status. The FTC's decision is informed by a rigorous review process, during which it received over 26,000 comments, overwhelmingly in support of the ban.
Alternatives to Non-Competes:
Recognizing the legitimate need for employers to safeguard proprietary information, the FTC suggests utilizing alternative mechanisms such as trade secret laws and non-disclosure agreements (NDAs). These avenues should afford recourse protecting investments without imposing undue restrictions on employee mobility. To that end, the Rule does not ban Non-Solicitation Agreements (which prohibit a person from soliciting the employees, clients or customers of their former employer), nor does it ban Confidentiality and Non-Disclosure Agreements. In the same way, Restrictive Covenants of a business owner in the sale of said business will also not be precluded under the ban. However, employers should note that restrictive covenants that effectively prevent an employee from working in the same field would violate the rule, because such agreements essentially operate as a non-compete.
Key Changes from the Proposed Rule:
In response to feedback, the final rule was ultimately revised to permit existing non-competes for senior executives to remain in force but prohibits the execution of new agreements going forward. After the effective date, senior executives will become fully subject to the ban and no new non-compete agreements will be permitted.
Importantly, the final rule applies a two-pronged test to define “senior executives” by establishing both an earnings threshold and a job duties requirement: senior executives must earn more than $151,164 annually and be in “policy-making positions.” A policy-making position is defined as a “ president, chief executive officer or the equivalent, any other officer [or] other natural person who has policy-making authority for the business entity”, in that they have “final authority” and “control significant aspects of [the] business entity”. Authority limited to advising or exerting influence or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise will not suffice to meet the definition. Without question, this class of workers will be very narrowly construed, as the FTC expects less than 0.75% of employees to qualify as senior executive status.
Notably, employers are no longer obligated to formally rescind existing non-competes; rather, they must provide notice to affected employees. The rule outlines clear definitions and parameters to streamline compliance efforts, requiring a notice to be sent to all non-senior executive workers who have existing non-compete agreements, explaining that those agreements will no longer be in effect and will not be enforced upon the effective date of the rule.
To assist employers, the FTC published a model notice on its website. The compliance model sets forth certain recommended language explaining that the employer will not enforce any non-compete clause against the employee, the employee may seek or accept a job with any company or any person (even if competitive), the employee may run their own business (even if competitive), and the employee may compete with the employer following their employment. The model notice also refers employees to the FTC’s website to learn more about the ban.
Implications and Uncertainties:
Despite the FTC's resolute stance, uncertainties loom over the rule's enforcement, with litigation already challenging the agency's authority. The prospect of prolonged legal battles and potential injunctions introduces ambiguity, leaving employers in a state of flux regarding compliance measures.
Future Outlook:
Pending these foreseeable legal challenges, employers are advised to prudently navigate the evolving regulatory landscape, preparing for contingencies while remaining cognizant of their obligations. Should the ban be upheld, businesses must promptly communicate changes to affected employees, ensuring seamless adherence to the new regulatory framework.
In essence, the FTC's prohibition on non-compete agreements heralds a paradigm shift in labor relations, prioritizing worker mobility, innovation, and economic vitality. As stakeholders adapt to the new regulatory reality, the broader implications of this landmark ruling are poised to reverberate across industries, shaping the future trajectory of employment practices in the United States.
For now, employers should take active measures to carefully evaluate their use of non-compete agreements by identifying the business justifications and goals for imposing such restrictions and the range of employees for whom such covenants are presumed.
Aronsohn Weiner Salerno & Kaufman’s litigation team will continue to follow developments relating to the FTC rule. Our attorneys remain available to discuss the rule and to assist with reviewing or revising restrictive covenant agreements. Employers with questions about the use of restrictive covenants and Employees concerned about existing covenants should contact our office directly for any further inquiries.
Learn More: FTC Fact Sheet - Proposed Final Non-Compete Rule
*The foregoing is not intended to be, and does not constitute, legal advice. The applicability and/or impact of the FTC’s Non-Compete Rule requires a fact-sensitive analysis on a case-by-case basis.