On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule that would generally prohibit companies from utilizing non-compete clauses with employees, independent contractors, consultants, and similar workers.[i] The final rule will become effective 120 days following its publication in the Federal Register. As discussed in more detail below, the U.S. Chamber of Commerce and other business groups have challenged the final rule in a lawsuit filed on April 24, 2024.
Key Points
- The final rule is scheduled to go into effect on August 21, 2024.
The final rule broadly bans non-compete clauses entered into with workers, but generally does not apply to customer and employee non-solicitation clauses or non-disclosure agreements (to the extent such clauses do not have the effect of functioning as a non-compete). - The final rule retroactively bans non-compete clauses entered into prior to the effective date of the final rule, with the exception of non-compete clauses entered into with “senior executive” workers before the effective date of the final rule.
- Companies may enter into non-compete clauses with workers until the final rule becomes effective, with the understanding that the non-compete clauses may be rendered invalid upon the final rule becoming effective.
- Upon the final rule taking effect, companies must provide written notice to workers (except for senior executives) informing them that the worker’s non-compete clause “will not, and cannot legally be, enforced against the worker.”[ii]
- The U.S. Chamber of Commerce and other business groups have filed a lawsuit challenging the final rule that may delay or block the final rule from taking effect.
Potential Next Steps for Employers
The final rule represents a considerable expansion in the FTC’s regulatory activity and as such there is possibility that the federal district court hearing the Chamber of Commerce’s lawsuit may issue a temporary restraining order or a preliminary injunction, which would likely delay the final rule from becoming effective during the course of the litigation. Given this uncertainty, companies have a number of options in assessing how to proceed now and in the near future.
- Companies may wish to simply wait and see what happens with the challenge to the final rule. As noted above, the final rule becomes effective in late August 2024 (120 days after April 23, 2024) at the earliest. If companies take this approach, they can continue to operate business as usual, but they may have to act quickly in revising their agreements and preparing notices to come into compliance if / when the final rule is set to become effective.
- On the other hand, companies may choose to proceed as if the final rule will become effective on the 120 day timeline set forth in the final rule, including removing non-compete clauses from any agreements signed with workers prior to the effective date, limiting any non-solicitation and non-disclosure clauses to avoid such clauses being found to “function” as a non-compete clause, and preparing notices to be sent to non-senior executives upon the final rule becoming effective.
- Lastly, companies may elect to take an approach somewhere between the two options described above. For example, companies may choose to review their agreements to identify any restrictive covenants that may need to be removed or revised if / when the final rule is effective, but continue to utilize non-compete clauses in agreements that are signed with workers prior to the final rule becoming effective.
Although every company will have to make its own decision, Koley Jessen suggests that the third option will best serve businesses by balancing the need to prepare for the implementation of the final rule with the uncertainty of if, and how, legal challenges will affect the rule.
Categorical Ban on Non-Compete Clauses
As noted above, the final rule bans the use of non-compete clauses with respect to a company’s workers, which include any employee, independent contractor, consultant, or any other person who works for such company. The final rule prohibits the use of a non-compete clause signed after the effective date of the final rule with any worker. The final rule further invalidates non-compete clauses signed with workers prior to the effective date of the final rule, with the exception of non-compete clauses entered into with “senior executive” workers prior to the date the final rule becomes effective. Non-compete clauses entered into with “senior executives” prior to the effective date of the final rule will remain enforceable. It is necessary to note, however, that any non-compete clause entered into with a senior executive after the effective date of the final rule will be unenforceable under the final rule.
The term “non-compete clause” is broadly defined as any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) seeking or accepting work in the United States with a different person” after the conclusion of the workers’ service with the company; or “(ii) operating a business in the United States” after the conclusion of the workers’ service with the company.[iii] A “senior executive” means a worker who “[w]as in a policy-making position” and received total annualized “compensation of at least $151,164 in the preceding year.”[iv]
The final rule does not directly address the use of non-disclosure agreements or non-solicitation agreements and the comments provided with the final rule explain that the definition of “non-compete” would include any contract term that is sufficiently broad so as to “function” as a non-compete as determined pursuant to a “fact-specific inquiry.” In other words, there is a possibility that a broad customer-based restriction might be deemed to “function” as a non-compete and, as such, be prohibited under the final rule.
