FTC’s Ban on Noncompete Agreements Has Far-Reaching Impact

FTC’s Ban on Noncompete Agreements Has Far-Reaching Impact

On April 23, 2024, the U.S. Federal Trade Commission (FTC) voted to issue a rule that not only bans most employers from requiring workers to sign nonccompete agreements but also invalidates existing noncompete agreements for non-executive employees. Should the FTC’s rule stand, it will have far-reaching implications for business owners and could potentially upend how companies do business and protect their interests.

Final Rule and Rationale

According to the FTC, noncompete clauses harm the U.S. labor markets by preventing workers from seeking better employment opportunities, blocking employers from hiring the best available talent, discouraging entrepreneurs from forming businesses, and dissuading employees from voicing new and innovative ideas. This, the agency argues, constitutes an unfair method of competition and violates Section 5 of the Federal Trade Commission Act. 

To address these purported issues, the FTC’s final rule, which they argue is designed to block what the Commission claims is “a widespread and exploitative practice,” would prohibit employers from using noncompete clauses, making it illegal for employers to:

• Enter into or attempt to enter into a noncompete agreement with any employee;
• Maintain an existing noncompete with a non-executive employee; or
• Represent to a non-executive employee that they are subject to a noncompete.

Importantly, the final rule would apply retroactively to employees and independent contractors who have already signed noncompetes with their employers. Upon the rule’s effective date (September 4, 2024), companies will be required to notify their employees and former employees with existing noncompete agreements that they will not enforce the noncompetes.

Critically, however, existing noncompetes with “senior executives” (defined as those earning more than $151,164.00 annually, and who “are at the level of a president, chief executive officer or the equivalent, or in a position that has similar authority to a president or officer and have “final authority to make policy decisions that control significant aspects of a business entity or a common enterprise”) may still be enforced. But companies cannot enter into any new noncompetes even with senior executives.  

The rule also does not apply to noncompetes entered into as part of a bona fide sale of a business entity.

Countervailing Arguments

In general, the business community disagrees with the FTC, as noncompetes are often critical to protecting a company’s trade secrets, confidential information, clients, and employees. Indeed, there are many reasons why noncompetes promote economic development and employee well-being. When a company is secure that its interests will be protected, they are more likely to invest in and train its employees and allow employees access to sensitive confidential information and trade secrets. As a result, most common law jurisdictions have enforced noncompetes to some degree for centuries, and, in most states, noncompetes are enforceable by state statute or common law to the extent they protect the legitimate business interests of a company. 

This “legitimate business interests” limitation typically requires noncompetes to be reasonable in terms of geography, time, and scope. These state common law rules and statutes create a balance that generally protects employees against inappropriate enforcement while still protecting employer interests. The FTC’s ban is likely to upend this economic balance.

Legal Challenges

There is a strong case to be made that the FTC does not have the statutory or constitutional authority to enact the proposed rule. The FTC’s statutory mandate from Congress is limited to regulating “unfair or deceptive” trade practices. It is an interpretive stretch of this statutory authority to regulate and ban noncompetes as unfair or deceptive, especially in light of the long history of statutory and judicial approval of noncompetes in most common law jurisdictions. The agency does not have the authority to create laws; that is left to state legislatures and Congress. 

Now that the final rule has been issued, business and employment attorneys, chambers of commerce, and state attorneys general will likely seek injunctions, claiming that the FTC does not have the statutory authority to create such a rule. In fact, the United States Chamber of Commerce and several other business groups have already filed lawsuits in Texas federal court seeking an injunction to block the rule. The FTC has moved to transfer one of the lawsuits to the Northern District of Texas where a case filed by Ryan LLC is pending.

How Business Owners Can Protect Themselves

It’s unclear whether the courts will ultimately enjoin the FTC’s rule. If it is not enjoined, companies will have 120 days after its publication in the Federal Register to comply (September 4, 2024). 

In the meantime, employers should stay up to date on this issue and monitor developments closely. If the ban goes into effect, employers should revisit how they protect their business interests, employees, trade secrets, and confidential information, as they will no longer be permitted to use noncompetes to do so. 

Importantly, the rule will not invalidate other restrictive covenants, such as non-solicitation of customers and non-recruitment of employee provisions and confidentiality agreements. Thus, if an employer wishes to impose post-employment restrictions on their employees they will still be able to do so through reasonable non-solicitation and confidentiality provisions. 

Therefore, if the ban survives judicial challenge, businesses should thoroughly review and revise all of their restrictive covenants to remove noncompetes and strengthen customer and employee non-solicitation provisions to continue protecting their business interests and employee investments.  Employers should be careful not to overreach, however, as non-solicitation provisions that “function to prevent a worker from seeking or accepting other work or starting a business after their employment ends” will be considered noncompetition provisions that likely violate the rule.

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By Jay Ferguson and Nathan D. Chapman

Jay Ferguson is Randstad North America’s Chief Legal Officer and is based in Atlanta. Nathan Chapman is an Atlanta-based employment and business litigator and member of Kabat Chapman & Ozmer LLP’s employment and class action defense litigation team.

This story originally appeared on Todays General Counsel