FTC approves final rule banning non-compete agreements: Employer highlights and next steps

Following yesterday’s announcement on the Federal Trade Commission’s national ban on workplace non-competes, McDonald Hopkins has identified critical elements of the new rule and put together information on what employers can expect over the next several months.

The FTC approved the rule imposing a national prohibition against non-competes along partisan lines (3-2) during an open meeting on April 23, 2024. The rule becomes effective 120 days after publication in the Federal Register, absent any further legal and/or other action.

Updated highlights of the FTC’s ban on non-compete agreements include:

1. All existing non-compete agreements for workers other than “senior executives” are invalidated and unenforceable as of the Rule’s effective date.
2. Existing non-compete agreements with “senior executives” shall remain in effect, but once the final Rule is effective, any new non-competes for “senior executives” will be illegal.
3. The rule does not explicitly prohibit other types of reasonably tailored restrictions, such as non-solicitation or non-disclosure agreements, provided they are not “so broad or onerous that it has the same “functional effect” as a non-compete.
4. Employers must provide “notice” to affected workers that their non-competes are now invalidated, but employers do not need to formally “rescind” them.
5. An exception exists for non-competes agreed to with regard to the sale of a business.
6. The Rule is effective as between “for profit” persons and their “workers” as defined below.

Employers will certainly have questions about what these rules mean and who is impacted. Some of those key questions are addressed below.

What is a “non-compete”?

The rule defines a prohibited “non-compete clause” as a term or condition of employment that either “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.

Who is a “worker"?

The term “worker” is broadly defined to include, without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.

Who is a “person” for purposes of this rule?

Under the rule, a “person” is “any natural person, partnership, corporation, association, or other legal entity within the Commission’s jurisdiction, including any person acting under color or authority of State law.” Thus, all persons and/or business entities operating for profit are subject to the rule’s restrictions on non-compete agreements unless specifically excluded.

Under the rule, all “non-competes” between “persons” and “workers” are prohibited upon the effective date of the rule, with the exception of “senior executives” discussed immediately below.

Who are “Senior Executives” and how are they treated differently than “workers” under the rule?

Under the rule, “Senior Executives” are generally defined as those individuals earning more than $151,164.00 annually and who are in “policy making” positions. The rule further provides that the definition of “senior executive” uses “both an earnings test and a job duties test.”

There will undoubtedly be legal wrangling over what qualifies as a “policy making” position even though a worker may make more than the threshold amount to be considered a senior executive.

Under the rule, non-competes existing between employers and “senior executives” before the effective date of the rule will remain enforceable, unlike non-competes with “workers” as described above. However, after the effective date, non-competes with “senior executives” will be prohibited.

What about Non-Solicitation and Confidentiality Agreements/Clauses?

Employers often use additional restrictions with non-competes, such as non-solicitation of customers and employees and confidentiality/non-disclosure agreements. The rule does not explicitly prohibit the continued use of these types of agreements.

However, if an employer adopts “a term or condition that is so broad or onerous that it has the same “functional effect” as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.”

What this means for employers is that they can expect scrutiny of their non-solicits and confidentiality agreements to see if the terms of such are so expansive as to constitute de facto non-competes under the rule. Again, anticipated legal battles over the breadth of these lesser restrictive agreements is expected.

What “notice” do employers need to provide to covered “workers”?

Employers will have to provide notice to “workers” who are subject to existing non-competes that the non-compete will not be enforced against them in the future. To aid employers’ compliance with this requirement, the FTC has included model language in the final rule that employers can use to communicate with their workers. Employers that rely on the model language will be granted safe harbor for compliance purposes.

What about a non-compete tied to the sale of a business?

The proposed rule also does not apply to non-competes entered into by a person during a “bona fide sale of a business,” of the person’s ownership interest in a business entity of all or substantially all of the business’s operating assets.

Will not-for-profit or tax exempt organizations be covered by the rule?

As a general comment, the FTC has authority over “for profit” organizations. Accordingly, many nonprofit or tax exempt entities under 501(c)(3) may attempt to avoid coverage. Many employer commentators to the rule before its adoption, including several healthcare organizations, discussed their potential exemption from the rule as a result of their nonprofit status. In response, while the FTC acknowledged its “for profit” limitation, it warned against such employers liberally applying this title without ensuring this legitimate status under the law.

Thus, the takeaway is don’t assume your non-profit is exempt without closely scrutinizing that your organization is legally a nonprofit entity.

What is next?

As foreshadowed by the two Republican Commission dissenters during the April 23 hearing, the FTC’s rule has already been legally challenged by the U.S. Chamber of Commerce. On April 24, the Chamber filed a lawsuit in a Texas federal court alleging that the FTC has exceeded its constitutional authority in promulgating what is, in fact, national “legislation” banning non-competes. Several more legal challenges are expected.

In the meantime, employers must remain alert and prepared for the rule to take effect. That means, among other things, examining who in your organization is subject to a non-compete, what their classification is under the rule (i.e., “worker” or “senior executive"), what lesser restrictions such as non-solicitation or confidentiality agreements you already have in place or may need to effectuate, and beginning to prepare the required “notices” to affected “workers” under the rule. To be sure, legal counsel is needed to navigate this uncertain time for restrictive covenants in the workplace and the team at McDonald Hopkins is ready to assist.

McDonald Hopkins will be following developments on this closely and continue to provide updates as they unfold.