The FTC strikes down most non-compete clauses

On April 23, 2024, in a three-to-two public vote, a divided Federal Trade Commission (FTC) upheld a final rule on the proposed ban to render non-compete clauses unenforceable in the United States. In reaching its decision, the FTC found that, in general, non-compete clauses suppress wages, negatively impact competitive conditions in product and service markets, suppress new business formation and innovation, and can be exploitative and coercive towards workers.   

Initially announced on January 5, 2023, the FTC proposed a rule to prohibit non-compete clauses in employment contracts broadly and retroactively. In response to the proposed rule, the FTC received in excess of 26,000 public comments, including 25,000 supporting the proposed ban. Supporters of the proposed prohibitions argue that non-compete clauses stifle competition and work mobility, impeding new business formation and innovation. Opponents of the proposed ban voiced concerns about protecting intellectual property, trade secrets, and confidential information from competitors, noting that such a prohibition is a departure from typical business practices where non-compete clauses are historically handled differently state-to-state, and on a case-by-case basis. 

Yesterday, the FTC held a public vote on the proposed ban, where it disclosed and passed a final rule, modifying in part the original proposed rule. The final rule provides that it is an unfair method of competition for employers to enter into non-compete clauses with workers on or after the final rule’s effective date. 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 United States 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 United States after the conclusion of the employment that includes the term or condition.”

The final rule differs from the proposed rule in some aspects, the most significant being its application to senior executives. The rule does ban non-compete clauses for senior executives, but only prospectively, whereas for all other workers, it applies retroactively and prospectively. Thus, existing non-compete clauses for senior executives are permitted to remain in force. The rationale for this modification is that less than 1% of workers are estimated to qualify as “senior executives” and those that do are more likely to have access to legal counsel and ability to negotiate, rendering such non-competes not as coercive. Nonetheless, because senior executives are more likely to start new businesses, the majority found justification to ban non-compete clauses to such executives prospectively. A “senior executive” is defined as a worker earning more than $151,164 annually who is also in a “policy-making position.” Thus, the final rule imposes a wages and functionality test in order to classify a worker as a “senior executive”. 

The economic research the final rule relies on showed that the final rule would likely increase earnings to workers by over $400 billion over 10 years and increase new business formation by 2.7%, resulting in over 8,500 new businesses. The FTC elaborated that in making non-competes less enforceable, the result would increase wages and result in a rise in innovation. Moreover, it is estimated that the final rule would reduce health care costs by up to an estimated $194 billion over 10 years due to eliminating, or reducing, the effects of non-competes increasing prices in the clinical markets.

The arguments raised by the FTC commissioners regarding the FTC’s authority to promulgate such a rule will likely be a heavily debated topic, subject to potential legal challenges. However, until and unless overturned, the FTC ban on non-competes will take effect within 120 days. 

Following the effective date, there will be significant changes to the competitive market impacting employers and workers alike. Most importantly, employers have an affirmative responsibility to do the following within 120 days:

• Identify any “non-compete clauses” in existing agreements;
• Identify which employees qualify as “senior executives” under the final rule to know whether or not previously agreed upon “non-compete clauses” can be enforced;
• Stop enforcing “non-compete clauses” in employment contracts with workers that do not qualify as “senior executives”;
• Provide notice to current and former employees that existing “non-compete clauses” will not be enforced; and
• Consider alternative agreement such as confidentiality and non-disclosure agreements in lieu of “non-compete clauses” for future agreements.

In light of the FTC’s recent decision, it would be prudent for employers to evaluate their existing agreements and practices moving forward. Employers should tailor employment agreements so as to ensure that they properly protect their intellectual property, trade secrets, and confidential information, while also remaining complainant with the new rule.