IMPORTANT UPDATE: FEDERAL TRADE COMMISSION ISSUES FINAL RULE BANNING NON-COMPETES
On April 23, 2024, the FTC announced its Final Non-Compete Clause Rule (“Final Rule”), which bans nearly ALL post-employment non-compete clauses between employers and their workers.
The Final Rule was published on May 7,2024, which means that the Effective Date is September 4, 2024 (120 days after publication).
The Final Rule prohibits an employer from entering into, or attempting to enter into, a non-compete clause with a “worker” (which importantly includes both employees and independent contractors).
The rule is retroactive - it bans new non-competes and invalidates existing non-competes.
Limited exceptions:
Recall that Virginia law already prohibits non-competes with “low wage earners”; with this Final Rule, non-competes would now be prohibited across the board with very limited exceptions: The rule does not apply to certain industries, including banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act. Outside of those industries, the major exceptions to the Rule include (1) existing agreements for “senior executives” (see below); (2) non-competes entered into in connection with the bona fide sale of a business, and (3) non-competes enforced where the cause of action accrued prior to the rule’s effective date.
Regarding the “senior executives” exception, employers are permitted to maintain existing non-compete agreements with “senior executives,” (those with over $151,164 annual compensation and in a policymaking position for the business) but may not enter into, or attempt to enter into, a non-compete clause with a senior executive after the Effective Date of the Final Rule.
Notice must be provided to employees:
Prior to the Effective Date, the Final Rule requires that employers provide notice in an individualized communication to each worker who is subject to a prohibited non-compete that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. This notice must be provided by hand-delivery, by mail at the worker’s last known street address, by email, or by text message.
No right to sue created:
Importantly, while the Final Rule allows the FTC to file an enforcement action against an employer who violates the Final Rule, there is no private right of action created by the Final Rule, meaning employees and ex-employees can not sue an employer based upon the employer’s use of a prohibited noncompete. Compare the Virginia law, which does create a private right of action, allowing an employee to sue his or her employer for violating the Virginia statute which prohibits non-competes for “low wage earners.”
Non-competes during employment:
Employment agreements with non-competes during the employment term are not covered by the ban. Only post-employment non-competes are banned.
Non-solicitation and non-disclosure agreements:
On its face, the Final Rule only applies to non-competes and does not ban other restrictions like confidentiality agreements, non-disclosure agreements, training repayment agreements, customer non-solicitation agreements, or employee non-solicit agreements. However, the Rule makes clear that these other forms of restrictive covenants could be covered by the ban if they are “so broad or onerous” that they have 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 that they would in effect be a prohibited non-compete. For example, the Final Rule provides that a non-disclosure clause operates as a non-compete “where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.”
With respect to non-solicitations, the FTC has made clear that its ban does not “categorically prohibit” non-solicitations and recognizes that non-solicits "are generally not non-compete clauses under the final rule because, while they restrict who a worker may contact after they leave their job, they do not by their terms or necessarily in their effect prevent a worker from seeking or accepting other work or starting a business.” However, whether a non-solicit is written in a manner that is in fact so broad as to function to prevent a worker from seeking such outside work or starting a business will be a fact-specific inquiry. If a narrowly tailored non-solicit, for example, applies only to the customers an employee actually serviced or sold to, but the employee in reality serviced all the customers in a small industry and wants to continue working in that industry, such a non-solicit might be viewed with criticism by FTC.
What rises to the level of “functionally operating” as a noncompete will most assuredly be litigated in the future.
Vesting of Equity Compensation:
To be determined is whether a prohibited (and thus void) post-employment noncompete could affect post-employment vesting of equity compensation, which would depend on the terms of the equity compensation plan and agreements and scope of the restrictive covenant.
Effect on right to severance pay?
The ban would not affect any right to severance pay prior to the effective date. For any severance payments scheduled to be paid after the effective date which are conditioned on compliance with specific restrictive covenants, the ban only affects restrictive covenants relating to non-competition (as discussed above) and the payee may still be required to comply with any remaining valid restrictive covenants such as protection of trade secrets.
In the discussion section for the Rule, the FTC indicates that provisions in severance agreements that require forfeiture of severance if the worker competes would be prohibited.
Legal challenges:
There are already two pending lawsuits against the FTC with challenges focused on the authority of the FTC to enact this type of law and the expectation is that there will be numerous other challenges filed. The challengers have sought injunctions in the lawsuits, and legal experts believe that there is a significant chance of the rule being enjoined, such that the law would not take effect pending resolution of these lawsuits.
Recommendations:
This is obviously a huge change in the employment landscape, and we are here to help you navigate this process. Our initial recommendations include that employers DO NOT send notices right away. We recommend all employers monitor whether the Rule is enjoined due to legal challenge; flag the deadline for compliance should the rule remain intact. Sample notice language is included in the Rule.
It may be beneficial in the meantime that you compile a list of current and former employees with whom you have non-competes so that notices can be sent when and if necessary. Sample notice language is included in the Rule.
If the ban on non-competes takes effect, employers should expect to use other agreements, such as non-solicitations and NDAs, to protect their trade secrets, customers and good will, but must be mindful of carefully crafting those agreements to not be so broad as to “functionally operate as a non-compete” and thus run afoul of the Final Rule.
Please contact the Babcock Moore & Lambert employment team with any questions.
Thank you for reading!
