Working Together

A condensed version of this article was published in Providence Business News.

Now that the dust has settled on the Federal Trade Commission’s (FTC) April 23 final rule that might eventually prohibit virtually all employee non-compete agreements (with only extremely limited exceptions), where do things stand?

Actually, despite seeming hysteria in the press, nothing has changed. That’s right: the FTC rule has no impact on you whether you are an employee subjected to a noncompete or an employer trying to enforce one. At least not yet. This is due to several factors.

First, at the earliest, the rule will not take effect until September 4, 2024 (120 days from the rule’s May 7 publication date in the Federal Register). Second, several legal challenges to the rule may delay its effective date well into 2025. Third, Congress could also take action delaying or seeking to override the FTC rule.

I will discuss each of these scenarios below. But first, some background.

What the FTC noncompete ban means for employers

The new rule will make it illegal for a for-profit business to require employees to sign noncompete agreements that restrict a worker’s ability to seek employment at a competing firm or start a competing business. It applies to virtually all employees and independent contractors, except senior executives.

The reasoning behind the rule

The final rule defines a noncompete clause as a “term or condition of employment” that “prohibits,” “penalizes,” or “functions to prevent” an employee from finding work with another employer after completing employment. According to the rule, the “term or condition of employment” can include a contractual term or workplace policy and doesn’t necessarily have to be written.

In approving the rule, the FTC claimed that the new rule would benefit workers and the economy. In other words, the FTC believes that the free flow of “human capital” benefits everyone – employers, employees and our country by stimulating competition, economic growth and employee wages. In its announcement of the rule, the FTC said that banning noncompete agreements will increase worker earnings by up to $488 billion over the next decade and will lead to the creation of more than 8,500 new businesses each year.

The FTC clearly stated that it views noncompete agreements as unfair trade practices. Noncompetes are “restrictive and exclusionary” and “exploitative and coercive,” the Commission stated, adding that noncompetes hurt businesses and their employees. The Commission said that the ban on noncompetes will likely result in higher worker income, decreased healthcare costs, new business formation, and increased innovation.

The FTC was less concerned with protecting a business’s trade secrets -- since other laws currently do that -- or protecting customer relationships, which would continue through nonsolicitation covenants.  Neither of those restrictions are banned by the rule. Nondisclosure agreements, many “garden leave” arrangements (although those arrangements could run afoul of the ban), and training repayment agreement provisions (TRAPs) are also not affected by the rule.

Who is affected

The noncompete rule affects “workers” and “senior executives” differently. Existing noncompetes for senior executives – defined as employees with “policy-making positions” who make $151,164 or more a year – will still be effective after the rule goes into effect. But all other existing noncompete agreements between employers and workers, an all-encompassing term for employees who do not fit the senior executive criteria, will be unenforceable as of the date of implementation.

After the date of implementation, employers cannot ink any new noncompete agreements, even with senior executives, though there are some exceptions. Noncompetes that bar employees from competing against their employers during their employment will still be allowed, as will noncompetes that follow the sale of a business entity, and noncompete agreements between a franchisee and franchisor.

In most cases, tax-exempt and charitable organizations will not be subject to the rule, but the FTC did state that a nonprofit corporation may be affected if it is “organized to carry on business for its own profit or that of its members.” When determining if the rule applies to these entities, the FTC will consider “whether the corporation is organized for and actually engaged in business for only charitable purposes” and “whether either the corporation or its members derive a profit.”

Challenges to the rule

Currently there are three lawsuits challenging the rule and seeking a stay of the rule’s effective date. The lawsuits advance similar contentions, arguing that the FTC lacked the authority to implement the rule; the rule is an unconstitutional use of legislative power; and the rule is “arbitrary and capricious.”  Two of the cases were filed in federal court in Texas, and they were consolidated by the court there.  In that case, Ryan LLC v. FTC, the judge recently issued a preliminary order against the new FTC rule, staying the ban from coming into effect, with a final ruling expected by August 30.  But in another challenge to the FTC rule pending in Philadelphia, on July 23, 2024 the U.S. District Court for the Eastern District of Pennsylvania, in ATS Tree Services, LLC v. Federal Trade Commission, declined to block the FTC rule from being implemented by denying the plaintiff’s request for an injunction.  So the gauntlet is dropped and if the Ryan court grants the plaintiff’s injunction request, then the federal appellate courts will have to decide the matter – possibly (some would say likely) even the Supreme Court.

In addition to the federal lawsuits, the FTC rule may also be invalidated by Congressional action because it addresses a "major question" with broad implications for the U.S. economy, which the U.S. Supreme Court has said agencies can only undertake with explicit authorization from Congress. The argument is that the FTC lacks the authority to ban noncompetes and Congress has declined to pass legislation that would do so. However, nothing would prevent a state legislature from implementing a ban on noncompetes as California, Minnesota, North Dakota and Oklahoma have done.  Additionally, nine states and Washington, D.C. have restrictions on noncompetes based on an employee's income level.

While the legal challenges to the rule may be successful, every business should still spend time preparing for the implementation of the FTC rule.  A first step is identifying any restrictive covenants with employees that may be affected by the rule. Then a notice must be prepared informing workers that their noncompetes will be unenforceable. Lastly, consider the goals of your restrictive covenants and consider how those goals might be achieved in a new environment in which noncompete covenants no longer are valid. 

And, as mentioned above, if you use “garden leave” agreements -- which attempt to pay employees to sit on the sidelines for a period of time such as a long separation “notice period” -- you will need to confirm that those provisions will stack up in the event that the FTC ban becomes a reality.