FTC Bans Non-Competes Nationwide: Part 1 - The Rule

Introduction: The FTC And Non-Competes

On April 23 of this year, the Federal Trade Commission (FTC) voted to ban all new noncompete agreements nationwide, thereby rendering the majority of existing noncompete agreements unenforceable. As part of their Final Rule, the FTC found that employers’ use of noncompete agreements amounts to an “unfair method of competition” that runs afoul of Section 5 of the FTC Act.

When Does the FTC Ban on Non-Competes Take Effect?

The Final Rule was published on May 7, 2024. It’s currently under public inspection. If published on schedule and not enjoined by a federal court, the effective date will be September 4, 2024.

What Does the FTC Ban on Non-Competes Say?

The final rule provides that it is an unfair method of competition—and therefore a violation of Section 5 of the FTC Act —for persons to, among other things, enter into non-compete clauses (“non-competes”) with workers on or after the final rule’s effective date (May 7, 2024). With respect to existing non-competes—i.e., non-competes entered into before the effective date—the Final Rule adopts a different approach for senior executives than for other workers. For senior executives, existing non-competes can remain in force. All existing non-competes with non-senior executives are no longer enforceable after the effective date.

What is a Non-Compete Under the Final Rule?

The final rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the US with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the US after the conclusion of the employment that includes the term or condition.” The final rule further provides that, “term or condition of employment” includes, but is not limited to, a contractual term or workplace policy, whether written or oral. This also includes employee handbooks and policies.

Note that a “worker” is defined as a natural person who works for, has worked for, whether paid or unpaid, for an employer. A worker includes employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a person. The definition further states that 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.

The term “prohibits,” applies to terms and conditions that expressly prohibit a worker from seeking or accepting other work or starting a business after their employment ends. Two examples would be as follows:

1. A national pizza chain uses a contractual term prohibiting its workers for working at another pizza shop located within three miles of any of its chain locations for a period of two years post employment.

2. A contractual term between a steelmaker and one of its executives prohibiting the executive from working for any competing business anywhere in the world for one year after the end of the executive’s employment.

The term “penalizes,” applies to terms and conditions that require a worker to pay a penalty for seeking or accepting other work or starting a business after their employment ends. Some examples are as follows:

1. A term providing that, for two years after the worker’s employment ends, the worker may not engage in any business within a certain geographic area that competes with the employer unless the worker pays the employer liquidated damages. Since such an agreement penalizes the worker for seeking or accepting other work or for starting a business after the worker leaves their job, it would be a non-compete clause.

2. A term that extinguishes a person’s obligation to provide promised compensation or to pay benefits as a result of a worker seeking or accepting other work or starting a business after they leave their job. An example would be a forfeiture-for-competition clause, which, similar to a liquidated damages clause, imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee seeking or accepting other work or starting a business after their employment ends.

3. A severance arrangement in which the worker is paid only if they refrain from competing.

The commonality of these clauses, whether they “prohibit” or “penalize” a worker, is that on their face, they are triggered where a worker seeks to work for another person or start a business after they leave their job, meaning they prohibit or penalize post-employment work for another employer or business. Such non-competes are inherently restrictive and exclusionary conduct, and they tend to negatively affect competitive conditions in both labor and product and service markets by restricting the mobility of workers.

Lastly, the term “functions to prevent,” applies to terms and conditions that restrain such a large scope of activity that they function to prevent a worker from seeking or accepting other work or starting a new business after their employment ends. This does not categorically prohibit other types of restrictive employment agreements, such as NDAs, TRAPs, and non-solicitation agreements, since these do not inherently prohibit or penalize a worker for seeking or accepting other work or starting a business after they leave their job, and in many instances may not have that functional effect. However, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a non-compete, such a term is a non-compete clause under the final rule.

Next Article

The next article will cover: (1) what employees are covered, (2) maintaining compliance, and (3) exemptions.