On Tuesday, the Federal Trade Commission (FTC) issued its long-anticipated final rule that would ban the use of non-competes nationwide with limited exceptions. There are details that all employers should know about the new rule, but perhaps the two most important are these: The ban may never end up taking effect, and even if it does, there will be ample time to prepare for these eventualities. So, while employers should monitor the rule and be mindful of their potential obligations under the rule, it may be premature to overhaul practices and agreements just yet. It is within that context that employers should view the rule’s requirements, and how they may need to react.
When would the FTC’s rule take effect?
The rule would take effect 120 days after publication, so likely sometime in the latter half of August 2024.
Would the rule apply only to employees, or does it cover other individuals, like contractors?
The rule would apply to anyone who formerly or currently works, whether paid or unpaid, for an employer. The rule would not be limited to employees. It also would cover independent contractors, interns, externs, volunteers, apprentices, and sole proprietors. However, the rule would not apply to a franchisee in the context of a franchisee-franchisor relationship.
How does the rule define “non-compete”?
The rule defines “non-compete” broadly as any contractual term or workplace policy, written or oral, that “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” seeking or accepting work with anyone in the United States, or operating a business in the United States, after their working relationship ends.
Are non-solicitation and confidentiality covenants prohibited too?
Both non-solicitation and confidentiality covenants can still be used. The rule would not have any impact on covenants that require employees to protect their employer’s confidential information and trade secrets, nor would it prohibit employers from imposing covenants that prohibit employees from poaching customers or employees. That said, employers should be mindful that overbroad non-solicitation or nondisclosure covenants that “function to prevent” someone from accepting employment or operating a business could be interpreted as a non-compete under the rule, and therefore proper drafting will be essential, just as is the case currently. In addition, employers should continue remain cognizant of any limitations under applicable state laws.
What would the rule prohibit?
The rule would prohibit employers from entering into, attempting to enter into, enforcing, attempting to enforce, or representing that an individual is subject to a non-compete after the rule’s effective date, subject to limited exceptions for “senior executives,” as discussed below. Employers should note that unless and until the rule takes effect, they are not prohibited from continuing current practices with respect to non-competes.
Would employers still be able to prohibit competition during employment under the rule?
Yes. The definition of non-compete focuses on the post-work period. The rule would not prohibit employers from having policies and contract terms that prohibit employees or contractors from competing during their employment or contractor relationship.
Would the rule apply retroactively?
Yes, the rule would apply retroactively to all agreements except for non-competes entered into by senior executives before the rule’s effective date. In addition, the rule would not apply “where a cause of action related to a non-compete clause accrued prior to the effective date” of the rule. According to the preamble to the rule, this would include situations “where an employer alleges that a worker accepted employment in breach of a non-compete if the alleged breach occurred prior to the effective date” of the rule.
Who is a senior executive?
A “senior executive” is someone in a “policy-making position” who has annualized total compensation of at least $151,164 in the preceding year. Employers can choose whether to define the “preceding year” as the most recent 52-week period, most recent calendar year, most recent fiscal year, or most recent anniversary year. Total compensation includes salary, commissions, nondiscretionary bonuses, and other nondiscretionary compensation, but it does not include payments for insurance, contributions to retirement plans, or “other similar fringe benefits.”
A “policy making position” means (a) a company’s president, chief executive officer or the equivalent, (b) an officer (defined as a president, vice president, secretary, treasurer, principal financial officer, comptroller or principal accounting officer, or any person routinely performing equivalent functions) with “policy making authority,” or (c) any other individual with “policy making authority” similar to that of an officer.
Finally, “policy making authority” means “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.” Notably, it does not include “authority limited to advising or exerting influence over such policy decisions” or “having final authority to make policy decisions for only a subsidiary or affiliate of a common enterprise.”
In other words, an individual who has policy making authority over an affiliate or subsidiary may not be considered a “senior executive” if the individual does not also have that authority over the entire common enterprise. Similarly, while an individual may have policy making authority over one department within the company (such as the head of marketing controlling a company’s marketing decisions), that would not necessarily mean that the individual is a “senior executive” because they may not have authority to make wider decisions for the company. Ultimately, whether someone is a “senior executive” will depend on the facts and circumstances of the individual’s job duties within the entity.
Does the rule have a sale-of-business exception?
Yes, the rule would allow non-competes entered into “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.” Notably, unlike in the proposed rule, the final rule does not require that an individual be selling a certain ownership percentage in order to be subject to a non-compete.
Does the rule have a notice requirement?
The rule would require that by no later than the rule’s effective date, employers notify all individuals (other than senior executives) subject to a non-compete that as a result of the rule, the company will not enforce any non-compete clause against the employee.
The FTC has provided a model notice for employers, and while employers can develop their own notice, use of the FTC’s model notice can act as a safe harbor against allegations that an employer is in violation of the rule.
One silver lining for employers is that the notice would not need to be individualized (unlike California’s recent notice requirement). To ease compliance, the model notice is designed to be sent to all current and former employees, regardless of whether that employee actually is subject to a non-compete. The rule gives employers several options for delivering notice to employees, including mail and email, and the rule provides an exception if an employer no longer has a record of the individual’s contact information.
What’s next?
Given the expected challenges to the rule – at least two lawsuits seeking to block the rule from taking effect have already been filed – employers should be careful not to overreact to the rule.
That said, employers should not simply ignore the rule. A wait-and-see approach for the time being may be prudent while the legal challenges play out. With the 120-day period before the new rule takes effect, there will be time for employers to take action if it appears that the rule ultimately will take effect.
In the meantime, and as we discussed when the proposed rule came to light over a year ago, employers should remember that while the FTC’s rule garners headlines, state law remains the primary consideration for employers using restrictive covenants with a multistate workforce. The new rule is, at the very least, a good reminder for employers to review the agreements they are using for compliance with current law. For assistance with reviewing your agreements and determining what response to the new FTC rule is best for your business, please contact your Much attorney.