FTC Ban on Noncompetes: What Comes Next?

The Federal Trade Commission’s (FTC) rule banning noncompete clauses in employment contracts, set to take effect on September 4, 2024, has sparked significant concern in the business community. With three lawsuits already challenging the rule, and more expected, businesses must prepare for potential legal battles. The rule broadly defines noncompete provisions and includes exceptions only for senior executives and business sales. Organizations are advised to explore alternative solutions like confidentiality agreements, nonsolicitation clauses, and training repayment agreements to safeguard their interests while remaining compliant. As legal challenges unfold, companies should consult with legal counsel to navigate this evolving landscape.

By Collin Williams | July 11, 2024 | Originally Published in the Weekly Legislative Update in Staffing World

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On April 23, 2024

The Federal Trade Commission issued a final rule banning noncompete clauses in employment contracts. The rule is set to go into effect on Sept. 4, 2024. The rule defines a “noncompete provision” 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.

In support of the rule, the FTC called noncompetes clear “unfair method[s] of competition.” FTC chair Lina Khan stated, “Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned. The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

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The Fine Print

The rule only recognizes two exceptions:

1. The continuing viability of existing noncompetes for senior executives—but even then, a noncompete with a senior executive entered into after the promulgation of the final rule would be considered unenforceable.

2. Noncompetes related to the sale of businesses.

Accordingly, the FTC effectively banned the signing of any noncompete for any employee post-April 23, while any existing noncompete for any nonsenior executive would be immediately unenforceable. For clarification, a “senior executive” is defined as a worker who earned more than $151,164 in the prior year and is in a “policy-making position.”

Additional exceptions exist based on industries exempt from the Federal Trade Commission Act, but those are relatively narrow and include banks, savings and loan associations, credit unions, and common carriers. Additionally, the ban only includes “for-profit” institutions.

Interestingly, the rule also includes a notice provision. Employers who have employees bound by existing noncompete provisions will have to provide notice to their employees that those noncompete clauses are no longer enforceable. The only exception to this would be if the employee violates the noncompete provision prior to the rule’s final implementation.

As for how the rule interacts with applicable state law(s), the rule provides a floor but not a ceiling. In other words, if a state law is less restrictive on the enforceability of noncompetes, then the rule’s provisions will preempt the state law and apply. In contrast, if a state law has more restrictive views on the enforceability of noncompetes, then the more stringent state law will apply.

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Challenges

There are currently three lawsuits challenging the propriety of the rule:

1. U.S. Chamber of Commerce and the Business Roundtable
   Filed suit in the Eastern District of Texas (Chamber of Commerce v. Federal Trade Commission, Case No. 6:24-cv-148).

2. Ryan LLC v. Federal Trade Commission
   Filed by the Ryan Tax Firm in the Northern District of Texas (Case No. 3:24-cv-986). Firm chairman and CEO G. Brint Ryan stated, “Just as Ryan ensures companies pay only the tax they owe, we stand firm in our commitment to serve the rightful interest of every company to retain its proprietary formulas for success taught in good faith to its own employees.”

3. ATS Tree Services LLC v. Federal Trade Commission
   Filed by a tree services company in the Eastern District of Pennsylvania (Case No. 2:24-cv-1743).

While all three lawsuits seek to stay or enjoin the implementation of the rule, decisions are expected soon (as of the time of this writing in July) in both the ATS case and the Ryan case. So, what comes next?

First, depending on the progression of the lawsuits, there may be a lengthy delay before the rule takes effect. If the plaintiffs win, the FTC will be forced to revisit the rule’s language. There will likely be additional lawsuits against the FTC seeking varying levels of relief as opposed to a total ban on the enforceability of noncompetes. There may even be additional challenges based on the nondelegation doctrine, which prevents Congress from delegating its legislative power to other entities.

Still, while many legal challenges seem likely, failing to prepare may be preparing to fail. What can organizations still do as it relates to preventing former employees from acting contrary to the interests of their former employer?

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Alternate Solutions

 

First, the rule does not ban confidentiality, nonsolicitation, or training repayment agreement provisions (TRAP), so these clauses can still be included in employment agreements. That said, given the broad definition of a “noncompete provision” under the rule, drafters should be careful not to over-inclusively include these clauses in an attempt to create de facto noncompete provisions.

Confidentiality provisions may be the key because employers can lawfully protect against the dissemination of confidential information and trade secrets and prevent competitors from using their information. The issue, however, is determining when a former employee may be using that information and what mechanisms are available for “putting the cat back in the bag.”

Because nonsolicitation clauses also ostensibly remain enforceable under the rule, they can be used to limit former employees’ ability to misappropriate trade secrets and confidential information by recruiting other employees. However, any such clause must be drafted with a keen eye toward not overstepping the rule’s definition of a noncompete.

“Garden leave” provisions also fall outside the scope of the rule’s technical language, but paying employees to simply not work is likely not a scalable solution.

Finally, the concept of TRAP is interesting because an employer can require an employee who leaves to repay training costs, sick leave, accrued bonuses, or other expenses. This would certainly act as a deterrent to resigning to work for a competitor, but if the employee is willing to pay these penalties, these provisions cannot limit who the employee can work for or in what capacity.

These are certainly interesting times when it comes to the concept of noncompetes in employment agreements. While there is likely ample concern in the business community about the impact of the rule, the reality is there are likely to be months, if not years, of legal fights over the propriety of its provisions. Regardless, now is an excellent time to meet with your outside counsel and develop a strategy to comply with the rules and protect the business moving forward.

 

Read other articles on by Collin Williams on employment law: Why Justices Should Rule on FAAs Commerce Exception