FTC Issues Final Rule Banning New Worker Non-Compete Clauses And Nullifying Most Existing Worker Non-Compete Clauses

On April 23, 2024, the Federal Trade Commission ("FTC"), by a 3-2 vote, approved and issued a Final Rule, set to become effective 120 days after it is published in the Federal Register ("Effective Date"), that will ban all worker non-compete clauses except those entered into before the Effective Date with workers who qualify as "senior executives." When effective, the Final Rule will have a significant impact on the tools available to businesses for protection of their business interests.

Key Definitions and Points under the Final Rule

• Under the Final Rule, a "non-compete clause" means a "term or condition of employment that prohibits a worker from, or penalizes a worker for, or functions to prevent a worker from" either (a) seeking or accepting work with a different employer where such work is to begin after the conclusion of the employment that includes the term or condition, or (b) operating a business after the conclusion of the worker's employment with the employer. (More on this definition below.)

• "Worker" is defined very broadly — any "natural person who works or who previously worked, whether paid or unpaid, ... including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person." (Though this definition includes independent contractors who are natural persons, it does not include those that are corporations or limited liability companies, nor does it include franchisees.)

• Notice Requirement. By the Effective Date, employers must provide written notice to employees whose pre-Effective Date "non-compete clauses" are banned by the Final Rule that such clauses are unenforceable and will not be enforced. The Final Rule provides model language for this notice which, if properly used, provides a "safe harbor" against any claimed violation of the notice requirement.

• Prohibitions as to "non-compete clauses." As of the Effective Date, the Final Rule prohibits virtually all employers (except for a narrow group of non-profits) from:
  • Entering into or attempting to enter into "non-compete clauses" with any workers, including those that qualify as "senior executives" (discussed below);
  • Enforcing or attempting to enforce pre-Effective Date "non-compete clauses" with any workers except those with "senior executives";
  • Representing that any non-"senior executive" worker is subject to a non-compete clause; and
  • Representing that a "senior executive" is subject to a "non-compete clause" where that clause was entered into on or after the Effective Date.

• A "senior executive" is defined as a worker in a "policy-making position" earning an actual or annualized sum of $151,164 (including salary, bonuses, and/or commissions, but excluding fringe benefits, retirement contributions, and medical/life insurance premium payments).

• Sale of Business Exception. The Final Rule does not apply to or affect noncompete clauses that are "entered into by a person pursuant to a bona fide sale of a business entity, of the person's ownership interest in a business entity, or of all or substantially all of a business entity's operating assets."

• Existing Causes of Action. The Final Rule does not apply to causes of action for non-compete clause violations occurring prior to the Effective Date.

• Effect on State Law. The Final Rule provides that it preempts all state laws, regulations, orders, and interpretations thereof that are inconsistent with the Final Rule's requirements, except to the extent that they afford greater worker protections than those provided by the Final Rule.

Does the Final Rule Ban Non-solicitation, Non-interference, and Non-Disclosure Clauses?

The definition of "non-compete clause" in the Final Rule provides little guidance on what effect, if any, the Final Rule may have on the validity or enforcement of non-solicitation, non-interference, and non-disclosure clauses. As stated above, "non-compete clause" includes not only an employment "term or condition" that "prohibits" a worker from seeking or accepting work or operating a business after the end of their employment, but also those that "penalize" or "function to prevent" the same. The FTC states that whether any given contractual provision constitutes a "non-compete clause" is a "fact-specific inquiry." (Also, notably, the definition of "non-compete clause" does not include restrictive covenants that apply only during a worker's period of employment. As such, businesses should continue to use such clauses.)

If the Final Rule survives as written, we fully expect significant litigation concerning the "fact-specific inquiry" as to what provisions fall within the "non-compete clause" definition and, specifically, the precise meanings of "penalize" and "function to prevent" in this context.

It is Carruthers & Roth's view that, notwithstanding the Final Rule, the continued enforcement of reasonably and appropriately drafted non-solicitation, non-interference, and non-disclosure clauses is fully consistent with and critical to the concept of fair competition. Especially in states like North Carolina which recognize little to no common law or statutory duty of loyalty owed by employees to employers, the use of reasonably and appropriately drafted non-solicitation, non-interference, and non-disclosure clauses is essential to allowing businesses the means to protect their legitimate business interests.

What Should Employers Do Now?

The FTC's Final Rule is not cause for businesses to immediately rescind or nullify any non-compete clauses or other restrictive covenants in place or to immediately alter or curtail an otherwise appropriate and reasonable business interest protection program.

First, we can expect a number of significant and intense legal challenges to the Final Rule, including whether the FTC actually has authority to implement it. For example, the U.S. Chamber of Commerce, along with other groups, already has filed suit in federal court in Texas challenging the Final Rule and asserting that the FTC does not have authority to regulate non-compete clauses. It is quite possible that court rulings in some of these suits will affect the effectiveness, scope, and/or timing of the Final Rule. As such, precisely when, how, and to what extent the Final Rule will be deemed effective is unclear at this point.

Second, and in any event, employers will have 120 days after the Final Rule's publication in the Federal Register to adjust to and comply with it.

The above said, there are several matters and steps businesses should now consider vis-à-vis the Final Rule and protecting their business interests, including the following:

• Businesses should use this as an opportunity to review and evaluate their current business interest protection program to ensure that all elements of that program – including contracts with employees, independent contractors, and others – are adequate, appropriate, effective, enforceable under applicable law, and properly implemented. This is best done with the advice and assistance of appropriate counsel.
• Businesses should determine whether all their "senior executives" are subject to agreements containing "non-compete clauses" and other business protection terms such as non-solicitation, non-interference, and non-disclosure clauses. If not, now is the time to act on the same, as all opportunity to enter into those constituting "non-compete clauses" will be lost as of the Effective Date.
• Businesses that do not have a business interest protection program or do not use agreements to protect their customer relationships, proprietary information and business interests should promptly consider doing so, with the advice and assistance of appropriate counsel.
• Businesses should make sure that their employees are subject to contract provisions that do not allow them to engage in any activities competitive with the business during their term of employment with the business, especially within those states that do not recognize employee duties of loyalty concerning the same.
• Likewise, businesses should continue to use (and if they are not doing so, they should consider starting to use) reasonable and appropriately drafted non-solicitation, non-interference, and non-disclosure clauses unless and until relevant, applicable judicial guidance on the same indicates to the contrary. The following language from the Final Rule suggests support for this position: "It is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a non-compete clause where a person has a good-faith basis to believe that this [Final Rule] is inapplicable." Now also is the time to make sure that any such clauses used are, in fact, reasonable, appropriately drafted, and no broader than needed to protect the business's interests.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.