Background

On April 23, 2024, the Federal Trade Commission (“FTC”) voted to adopt a rule (the “FTC Rule”) that, as a matter of federal law, bans “non-compete” contract clauses as “unfair methods of competition,” with few exceptions and requires employers with existing non-compete clauses to notify workers of such unenforceability, as applicable.

The FTC’s noncompete ban will take effect on September 4, 2024.  Multiple lawsuits have already been filed seeking to vacate or set aside the FTC Rule.

The Rule

The prohibition on non-compete clauses broadly applies to all “workers”[1] irrespective of compensation, exempt/non-exempt, tax status, contractor status, level within an organization, and ownership in the organization.

The FTC Rule “grandfathers in” non-compete clauses applicable to “Senior Executives,”[2] meaning pre-existing contracts with Senior Executives will remain effective.  This exception only applies to Senior Executives; all other pre-existing noncompete clauses will be voided as of September 4, 2024.

The FTC Rule defines a “Non-compete clause” as a term or condition (whether contractual or by workplace policy, written or oral), of employment that prohibits, penalizes, or functions to prevent a Worker from (i) seeking or accepting work with a different person after the conclusion of employment that includes such term or condition, or (ii) operating a business in the United States after the conclusion of employment that includes such term or condition.[3]  The FTC Rule only bars noncompete clauses that restrict workers’ autonomy after the conclusion of the current work relationship.

The Exceptions

Exceptions to the FTC Rule are narrow and specific: (a) enforcement of clauses entered into pursuant to a bona fide sale of a business entity,[4] (b) enforcement of claims related to non-compete clauses that accrued prior to the effective date of the rule,[5] and (c) enforcement of clauses where the person had a good faith basis to believe that the rule did not apply.[6]

“A bona fide sale is one made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule. In general, the Commission considers a bona fide sale to be one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.”[7]

Further explication of which transactions would constitute a bona fide sale are left to judicial interpretation.

Required Notice

The FTC Rule also requires organizations to notify workers with whom they have imposed such non-compete clauses that the non-compete clause will not, and cannot, legally be enforced against the worker.[8]  Such notice must also be clear and conspicuous to the worker.[9]

The FTC has provided model language in its announcement to facilitate compliance for affected organizations.[10]

This notice requirement includes an additional exception that for workers with no record of street address, email address, or telephone number, no notice is required with respect to that individual worker.

Alternative Strategies

Generally, the FTC Rule does not affect existing law protecting trade secrets, non-solicitation clauses and agreements, non-disclosure and confidentiality clauses and agreements, and contingent compensation plans; however, the FTC notes that non-solicitation agreements can satisfy the definition of non-compete clauses in § 910.1 if they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.[11] The FTC Rule’s reach and breadth is likely to be heavily tested by courts. The FTC Rule also does not affect non-compete restrictions during the duration of the work arrangement.  These strategies largely remain available to protect organizations’ competitive advantages.

Legal Challenges

The FTC adopted this rule by a three-to-two vote of its governing body, and the subsequent announcement and publication indicated that it anticipated legal challenges.  On the same day, the U.S. Chamber of Commerce (a lobbying group) filed suit in the U.S. District Court for the Eastern District of Texas, seeking declaratory judgement against the FTC Rule.[12]  The Chamber of Commerce alleges that the FTC Rule violates the Administrative Procedure Act in multiple ways, including because the rule is outside the FTC’s rulemaking authority, the rule is unlawfully retroactive, and, if statutorily authorized, the rule rests on an unconstitutional delegation of authority to the FTC.[13]

The Chamber of Commerce also requested a preliminary injunction prohibiting the FTC’s enforcement of the rule during the litigation. Judge Baker of the Eastern District of Texas District Court initially entered a scheduling order; however, the action has been stayed under the “first filed” doctrine as of this writing.[14]

The professional services firm, Ryan, filed suit in the U.S. District Court for the Northern District of Texas also seeking to prevent implementation of the FTC Rule.[15]  Ryan brought claims similar to those brought by the Chamber of Commerce; consequently, the Chamber of Commerce was granted a motion to intervene on the N.D. Tex case.[16] On May 7, Judge Brown of the N.D. Tex. issued an order setting the case for expedited briefing.[17]  The Court confirmed that it will rule on Ryan LLC’s request for injunction by July 3, 2024.

It is possible that either of these courts enter an injunction against the enforcement of the FTC Rule before the rule comes into effect.  Any potential injunction could be limited as to named parties, or it might enjoin the FTC from enforcing the rule across the United States.

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[1] “Worker means a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. The term worker includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship”. Federal Trade Commission, 16 CFR Part 910, Non-Compete Clause Rule (April 23, 2024) (pp. 563-64).

[2] Senior Executives means a worker who: (1) Was in a policy-making position; and (2) Received from a person for the employment: (i) Total annual compensation of at least $151, 164 in the preceding year; or (ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or (iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause. 16 CFR Part 910.1.

[3] 16 CFR Part 910.1.

[4] 16 CFR Part 910.3(a).

[5] 16 CFR Part 910.3(b).

[6] 16 CFR Part 910.3(c).

[7] 16 CFR Part 910, Non-Compete Clause Rule (April 23, 2024)at 342.

[8] 16 CFR Part 910,2(b).

[9] Id.

[10] Non-Compete Clause Final Rule (ftc.gov)

[11] 16 CFR Part 910, Non-Compete Clause Rule (April 23, 2024) at 81.

[12] See Chamber of Commerce et al v. FTC et al, No. 6:24-CV-00148 (JCB) (E.D. Tex. April 23, 2024).

[13] See Doc. 20, Chamber of Commerce.

[14] See Doc. 27, Chamber of Commerce.

[15] See Ryan, LLC v. FTC, No. 3:24-CV-986-E (AB) (N.D. Tex. April 23, 2024).

[16] See Doc. 34, Ryan.

[17] See Doc. 31, Ryan.