FTC Non-Compete Rule Invalidated: What Employers Should Know

As previously reported by Erickson Sederstrom, earlier this year, the Federal Trade Commission (FTC) issued a landmark rule intended to ban non-compete agreements nationwide for employees and independent contractors. However, a federal court in Texas has now invalidated the rule, with a ruling that applies nationwide. As a result, the FTC Rule will not take effect unless a higher court overturns this decision on appeal.

A Look at the History of the FTC’s Non-Compete Rule

Non-compete agreements have long been a common tool for employers to protect trade secrets, client relationships, and other business interests. They restrict employees from joining a competitor or starting a competing business for a set period after leaving a company. While widely used, these agreements have also been criticized for limiting workers' mobility and bargaining power.

In January 2023, the FTC announced its plan to ban nearly all non-compete agreements, citing concerns that such agreements suppress wages, stifle competition, and limit entrepreneurial opportunities. The proposed rule, commonly referred to as the "FTC Rule," was part of a broader effort by the Biden administration to promote competition across various sectors of the economy.

The rule’s primary provisions included:

Prohibition on New Non-Competes: Employers, including independent contractors, would be banned from entering into non-compete agreements with workers.

Invalidation of Existing Agreements: Pre-existing non-competes would be rendered unenforceable, and employers would be required to notify affected workers.

Legal Challenges and Rulings

The FTC’s regulation immediately sparked controversy and led to legal challenges from various business groups, which argued that the agency lacked the authority to regulate non-compete agreements in this manner. Legal battles followed, with federal courts taking different approaches:

Pennsylvania: A federal court denied a motion to block the rule, indicating that the FTC might have authority over it.

Texas & Florida: Federal courts in these states ruled that the FTC Rule exceeded the agency's authority, but only applied their rulings to the plaintiffs involved in those cases.

However, the recent Texas federal court ruling invalidates the FTC Rule on a national scale. The court determined that the FTC had overstepped its regulatory power, citing statutory limits on the agency’s authority.

 Next Steps for Employers

Many employers have been actively preparing for the rule's implementation, reviewing their employment agreements, and exploring alternative approaches to protecting their business interests without relying on non-competes. Given the complexity of this situation, we encourage employers to consult legal counsel to assess the current status of their non-compete agreements and explore other options to safeguard proprietary information, customer relationships, and business strategies.

FTC Issues Rule Banning Non-Competes Nationwide – Now Subject to Pending Challenge in Lawsuit

On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule prohibiting specific non-competition clauses (the “Rule”), which is located here. The Rule goes into effect September 4, 2024, but enforcement could be delayed pending legal challenges to the Rule.

Who does the Rule apply to?

The Rule applies to “workers,” which is defined broadly to include an “employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor.” “Worker” also consists of a person who works for a franchisee or franchisor but expressly excludes a franchisee in its relationship with a franchisor.

However, there is a crucial difference between “workers” and “senior executives.” “Senior executives” are defined as a worker who:

1. Was in a policy-making position; and

2. Received from a person for employment:

a. Total annual compensation of at least $151,164 in the preceding year; or

b. Total compensation of at least $151,164 when annualized in the preceding year before the worker’s departure if the worker left their employment before the preceding year and is subject to a non-competition clause.

The Rule defines “policy-making position” to specifically include a president, chief executive officer or equivalent, or anyone with policy-making authority.

What does the Rule prohibit?

The Rule prohibits employers from entering into, attempting to enter into, enforcing or attempting to enforce a non-compete clause, or representing that a worker is subject to a non-compete clause.

A “non-compete clause” is broadly defined to include a term that “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” working in the United States with a different employer post termination of prior employment or operating a business in the United States post termination of previous employment.

For “senior executives” enforceable non-compete clauses that were entered into before the Rule’s effective date (which is currently set for September 4, 2024), will remain in effect and the Rule will apply only to new non-compete clauses entered into after the effective date.

What if you have existing clauses that will violate the Rule upon the effective date?

Suppose you currently have workers who are subject to non-compete clauses that will not be enforceable upon the Rule’s effective date. In that case, you will be required to provide notice to such workers. Such notice must be clear, conspicuous, and delivered to the worker by the effective date, stating that the non-compete clause will not and cannot be enforced. The FTC has provided model notices in various languages, which can be located here.

Are there exceptions to the Rule?

The Rule is not a blanket ban on non-competes. The Rule does not apply in the context of a bona fide sale of a business, existing causes of action, or if there is a good faith basis to believe the Rule is inapplicable.

What about non-solicitation clauses?

Commentary on the Rule indicates that non-solicitation clauses generally are not considered non-compete clauses since they do not prevent workers from seeking or accepting other employment or starting a business following termination of their prior employment. However, if a non-solicitation clause is so broad that it “functions to prevent a worker from” seeking or accepting work or operating a business, it would satisfy the definition of a “non-compete clause” under, and thus be subject to, the Rule.

What should employers do?

Employers should monitor the status of pending legal challenges to the Rule to determine whether such challenges will succeed in reversing it. In the meantime, Employers should review their current restrictive covenants and prepare policies and procedures in case the Rule does go into effect while continuing to comply with state law. Existing restrictive covenants that are enforceable under the laws of a particular state may already be compliant with the Rule, especially if state law is more restrictive than the Rule.

Where can you get more information? For more information regarding the Rule, businesses can review the Fact Sheet and Compliance Guide for Businesses and Small Entities provided by the FTC. These helpful resources provided information regarding the Rule and ways employers can comply.