Unless blocked by a court order, most non-compete agreements issued by employers throughout the United States will be impermissible as of September 4, 2024.  New rules issued by the Federal Trade Commission (FTC):

• Invalidate current non-compete agreements, except for select senior executives;
• Ban all new non-compete agreements, for all employees and executives; and
• Require employers to notify workers with existing non-competes that they are no longer enforceable.

“Non-Compete” Clauses Are Defined Broadly

A non-compete clause is defined under the new rules to include language in an agreement with a worker that prohibits, penalizes or otherwise prevents the worker, after the conclusion of the work relationship, from either (i) seeking or accepting work with someone else or (ii) operating a business.  Note that this definition is not limited to the employer/employee relationship, but also restrictions following the conclusion of any other form of contracted work engagement as well, whether paid or unpaid.

The FTC rule is written to encapsulate a broad universe of covenants restricting future work, regardless of whether or how the contracting organization defines their scope.  Clauses that preclude a former employee from working for any other employer in a specific industry are invalidated, as are more narrowly-tailored clauses that preclude a former employee from working for a direct competitor during a discrete, limited time period subsequent to the termination of the individual’s employment.  Similarly, clauses that do not outright preclude such activities, but impose monetary penalties on an individual for doing so, are equally impermissible.

Non-Solicitation Clauses Are Suspect as Well

While not denominated as “non-competes,” clauses in worker agreements that only purport to restrict solicitation may nevertheless run afoul of the new regulations.  This is because “non-solicitation” clauses often restrict employees from providing goods or services to, becoming engaged by, or otherwise having business dealings with a customer, client, or other competing business.  The practical effect of such provisions can be to restrict a worker from working for or with someone else, and they therefore may be invalidated under the new FTC rules.

Similarly, more narrowly tailored non-solicitation clauses that permit engagement with another individual or entity but then limit the type of work the individual can perform in their new role, may also be at risk.  For example, clauses that preclude “soliciting” or “interfering in” relationships with the current or prospective customers or clients of a former employer or other contracting organization thereby restrict the type of work a departing worker can do.  Depending on the industry and the range of opportunities still available to the departing worker, this type of restriction could be deemed an impermissible restriction on accepting work with someone else.

Workers Need to Receive Notice That Non-Compete Clauses Are Invalid

The rules require organizations to provide clear and conspicuous notice to their current and former workers by no later than the September 4, 2024, effective date that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.  The notice can be paper or electronic, and the rules provide a model notice.  Employers that use the FTC’s model notice enjoy the benefit of a “safe harbor,” that they are thereby compliant with the notice requirement.

Exception for Current Agreements with Senior Executives

Organizations that currently have agreements with certain senior executives that contain restrictions on future competitive activity are permitted to maintain those existing agreements even after the new rules take effect.  This is a very limited exception, however, for several reasons:

• It applies only to existing agreements; after September 4, 2024, any new agreements entered into with a senior executive is covered by the general rule prohibiting non-compete agreements;
• “Senior executives” are defined as individuals who (i) earn more than $151,164 in combined salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation over a 52-week period, and (ii) are in a “policy-making position;” and
• A “policy-making position” means the president, chief executive officer or equivalent, or someone at an officer level who has policy-making authority for the business entity. If the business entity is part of a “common enterprise,” then the individual must have policy-making authority over the entire common enterprise; authority over a subsidiary or affiliate will not suffice under the rule.  The FTC’s objective is to limit this exception to the truly most senior leaders in an organization.

Sale of Business Exception

The rules recognize one context in which organizations and individuals can continue to use non-compete clauses.  That is in the sale of a business, whether the sale is just of one person’s ownership interest or of the entirety of the business.  The purchaser in that situation can limit the seller from opening a competing business, under whatever terms the parties choose to define.

Exclusion of Entities Outside the FTC’s Jurisdiction

Also, the rules only apply to those entities that fall under the FTC’s general regulatory authority.  The FTC does not have the authority to regulate banks, most not-for-profits, and several other discrete categories of entities in the commercial transit and government spheres.  Those organizations therefore are not covered by the new rule.  This creates an incongruity in the financial services industry, as banks, savings and loans, and federal credit unions, are exempt from the rule, while hedge funds, private equity firms, and bank holding companies will be subject to the non-compete restrictions.

Legal Challenges

Various business and trade organizations, including the U.S. Chamber of Commerce, promptly filed suit to challenge the validity of the FTC’s new rule under constitutional and administrative law principles.  A preliminary injunction has been requested but thus far has not been granted.  The judge in that case has set a schedule to issue a decision by July 3, 2024.

What Employers Should Do Now

Given the pending court challenges, organizations are a bit in limbo at present and have varied options on how to respond.  Now is the time for organizations that wish to maintain non-competes at least for their senior executives, to take appropriate steps so those agreements are in place by no later than September 4, 2024 (or whenever the new rules take effect).  For some organizations, this may require adjustments to compensation to ensure their senior leaders reach the $151,164 threshold.  For other organizations, this may mean finalizing the terms of existing or pending agreements, or perhaps accelerating the hire of a new senior leader so that a non-compete agreement can be negotiated and in place prior to the effective date.

For all other workers, organizations may want to review their existing agreements with legal counsel to assess which clauses will remain enforceable, and which will not.  Organizations may choose to develop new clauses that protect trade secrets and confidential information, without restricting individuals from securing new work, so as to have agreements in place as of the effective date that comply with the FTC rule.  Alternatively, organizations may want to follow a wait-and-see approach until July 3, 2024, and delay taking further action until a decision is issued on the preliminary injunction request.

By Tracey I. Levy