Breaking Down The FTC Rule Banning Non-Competes: What Employers Need To Know

The Federal Trade Commission (FTC) has voted to publish its final rule banning most worker non-compete agreements. If and when the rule becomes effective, it will ban non-competes going forward. It will also prevent businesses from enforcing existing non-competes, with some limited exceptions for a narrowly defined class of senior executives with existing agreements. The rule also adopts an exception for the sale of businesses. Because the FTC rule will apply nationwide, it will preempt conflicting state laws. However, businesses must still comply with any applicable state statutes and common law limitations that may apply restrictions in addition to those provided by the FTC rule. For these reasons, businesses using restrictive covenants to protect their trade secrets or confidential information should prepare for a sea change.

What Does the FTC Non-Compete Rule Prohibit?

First, going forward, businesses will be prohibited from entering into, or attempting to enter into, a non-compete clause. Second, non-competes already in place will not be enforceable with two exceptions discussed below. Third, businesses will be prohibited from attempting to enforce a non-compete. Fourth, businesses cannot make representations that a worker is subject to a non-compete clause. The non-compete does not need to be found in a formal contract. Handbook policies and oral statements that impose these restrictions are also prohibited.

The rule prohibits traditional non-competes — those that prevent workers from going to work for a competitor — but it goes much further by adopting a functional test. The rule defines a "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:

• Seeking or accepting work in the U.S. with a different business where such work would begin after the conclusion of employment, or;
• Operating a business in the U.S. after the conclusion of employment.

The FTC's final rule defines non-compete clauses to capture many other types of commonly used restrictive covenants such as:

• Overly broad confidentiality and nondisclosure agreements;
• Overly broad coworker non-solicitation agreements;
• Training repayment agreements; and
• Overly broad customer non-solicitation agreements.

Does the FTC Non-Compete Rule Contain Any Exceptions?

The rule contains four exceptions:

Non-competes with "Senior Executives" that were entered into prior to the rule's effective date will remain unaffected. Non-competes will be banned going forward with these Senior Executives.

For the purposes of existing non-competes, "Senior Executive" is narrowly defined. First, the worker must have earned annual compensation in the preceding year exceeding $151,164. Second, the worker must hold a policy-making position with final authority to make policy decisions that control significant aspects of the business. Simply having the power to advise or exert influence over such policy decisions will not meet the definition. This means that the Senior Executive definition will only capture the President, CEO, and other corporate officers with equivalent policy-making authority over the business.

The FTC Rule does not apply to non-competes 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. The FTC's prior proposal requiring that the ownership interest amount to at least 25 percent was not adopted in the final rule.

Non-compete-related causes of action that accrued prior to the rule's effective date are not limited.

The FTC rule also states that it is not an unfair method of compensation 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 the FTC's rule does not apply.

When Does the FTC Rule Become Effective?

The FTC rule was adopted on April 23, and will become effective 120 days after it is published in the Federal Register. But numerous federal lawsuits have already been filed seeking judicial review of the FTC's authority to promulgate the rule, and challenging the rule on other grounds. Some of these lawsuits ask the courts to prevent the FTC rule from becoming effective while the courts resolve the merits. It is difficult to predict how long the judicial process will take to decide the cases on their merits and resolve any appeals that may follow. We will continue to monitor these developments.

What Is the Notice Required?

The FTC rule requires businesses to provide clear and conspicuous notice to workers with prohibited non-competes. The notice must be provided on or before the rule's effective date. Businesses will need to deliver the notice by hand, by mail, by e-mail, or by text message. The FTC has provided a sample notice that will provide a safe harbor to businesses that use it, but no specific language is required.

What Are the Next Steps for Employers?

Businesses that have historically used non-compete agreements or other similar policies or restrictions should consider taking the following steps:

• Critically evaluate all of your restrictive covenants, including those found in existing agreements, handbook policies, or communicated verbally to workers.
• Determine whether your restrictive covenants are affected by the FTC's definition of non-compete clauses, including the functional definition.
• Determine which of your workers have agreed to non-compete clauses. This may include former workers, and may include "Senior Executives."
• Consider whether your existing agreements will be enforceable under applicable state laws that are not preempted by the FTC rule. For those businesses operating in states with more restrictive non-compete laws, including Washington, Oregon, and California, consider consulting with counsel to sort out applicable laws.
• Depending on the size of your workforce, you may need to start thinking about the logistics of notifying your workers about unenforceable non-competes.
• If your business relies on trade secrets or other confidential information, this is a good time to consider taking additional steps to protect your most valuable information from being misappropriated by departing workers who may no longer be subject to restrictive covenants. You may want to consider beefing up your confidentiality agreements, but if you do so, be sure to recognize limitations imposed by existing state laws, such as those imposed under Washington law. See Lane Powell's Legal Update on Nondisclosure Agreements.
• Develop a system to keep track of any restrictive covenants you use moving forward, and continue to ensure that your covenants comply with applicable state law. For example, Washington's Legislature has recently limited the use of certain non-solicitation agreements. See Lane Powell's Legal Update on Washington's Non-Compete Statute.
• And remember that only "Senior Executive" non-competes will survive after the FTC rule becomes effective. After the FTC rule becomes effective, businesses cannot use non-competes except in the case of the sale of a business, so long as doing so complies with state law.

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.