“No More Non-Competes,” Part Two: FTC Finalizes Rule Banning Essentially All Non-Compete Agreements with Workers

The final rule provides that it is an unfair method of competition, and therefore a violation of the FTC Act, for a business to enter into or seek to enforce a non-compete clause with any worker after the rule’s effective date, with two exceptions. First, the final rule preserves existing non-compete agreements with respect to “senior executives.” An employer is permitted to enforce non-compete clauses entered into with senior executives prior to the effective date of the rule. The rule defines a “senior executive” as a worker who makes at least $151,164 annually and is in a “policy-making position.” For purposes of this annual compensation minimum, the calculation may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during the 52-week period. A “policy-making position” means “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.” Further, “policy-making authority” means final authority to make policy decisions that control significant aspects of a business entity or common enterprise, but 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 of or affiliate of a common enterprise. Second, the final rule permits non-compete clauses entered into by a person pursuant to a bona fide sale of a business entity. This is one area in which the FTC made the final rule somewhat more business friendly than its proposed rule, which would have required the seller to be a substantial owner holding at least a 25% ownership interest in a business entity. The FTC dropped this substantial ownership requirement. The final rule also does not apply where a cause of action related to a non-compete accrued prior to the rule’s effective date.

Outside of these limited exceptions, the rule bars enforcement, or attempts at enforcement, and requires action by employers. With respect to workers who do not meet the FTC’s definition of senior executive, if an employer maintains any existing non-compete clauses with such workers, the final rule requires the employer to actively inform such persons, via an individualized communication by the time the rule takes effect, that the clauses are no longer in effect. The FTC included model notice language in the final rule.

The scope of the rule is broad. A worker includes not just employees, but also independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who perform services for a person. Under the rule, the term “non-compete clause” is defined as a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition. Of note with this language is the limitation on restrictions “after the conclusion of the employment,” suggesting that prohibitions on competition during an active service relationship are permitted.

While the FTC declined to expressly address in the rule specific categories of other restrictions that fall within the definition of a non-compete clause (such as customer non-solicits or employee no-hire provisions), in its commentary on the final rule, the FTC makes clear that in the event a non-solicitation, non-disclosure, or other provision is so broad that is effectively prevents a worker from performing a job for another business, such obligation will be an unlawful non-compete clause. The FTC explains that a non-disclosure agreement would not be a non-compete where its prohibitions on disclosure do not apply to information that (1) arises from the worker’s general training, knowledge, skill or experience, gained on the job or otherwise; or (2) is readily ascertainable to other employers or the general public. On the other hand, the FTC describes examples of a prohibited non-disclosure agreement is one that bars a worker from disclosing in a future job, “any information that is ‘usable in’ or ‘relates to’ the industry in which they work.” In addition, with respect to forfeiture-for-non-competition provisions, the FTC explained that such terms “penalize” a worker by extinguishing a business’s obligation to provide compensation or pay benefits or triggering repayment obligations as a result of a worker seeking or accepting other work or starting a business after they leave their job, thus, are unlawful.

The final rule does not limit or affect enforcement of state laws that restrict non-competes where such laws do not conflict with the final rule, but it does preempt state laws that conflict with the rule. Once the rule is effective, individuals can report information about a suspected violation of the rule by email to the Bureau of Competition.

So what does the final rule practically mean for employers? It is expected that a variety of litigation will be promptly filed seeking to prohibit the rule from taking effect. In fact, on the same day as the FTC’s vote to issue the final rule, a Texas-based tax services and software company, Ryan LLC, filed a lawsuit in the Northern District of Texas challenging the rule. The next day, the U.S. Chamber of Commerce also initiated litigation challenging the rule. Challengers likely would ask for a motion to stay enforcement of the rule while the case gets litigated. The final rule itself anticipates such challenges and stay requests, providing, “If any provision of this [rule] is held to be invalid or unenforceable by its terms, or as applied to any person or circumstance, or stayed pending further agency action, the provision shall be construed so as to continue to give the maximum effect to the provision permitted by law and such invalidity shall not affect the application of the provision to other persons or circumstances or the validity or application of other provisions.”

The FTC asserts that it maintains authority to enact the rule under Section 5 of the FTC Act (which directs the FTC “to prevent persons, partnerships, or corporations … from using unfair methods of competition in or affecting commerce”) and Section 6(g) of the FTC Act (which authorizes the FTC to “make rules and regulations for the purpose of carrying out the provisions of” the FTC Act, including the Act’s prohibition of unfair methods of competition). Drawing upon its recently expanded interpretation of  Section 5 of the FTC Act, the FTC classifies the use of non-compete clauses as an “unfair method of competition” in the new rule. With respect to workers who are not senior executives, the FTC determined the use of non-competes is: (1) restrictive and exclusionary conduct that tends to negatively affect competitive conditions in labor markets and in product and service markets; and (2) exploitative and coercive conduct that tends to negatively affect competitive conditions in labor markets and in product and service markets. As to senior executives, the FTC found the use of non-competes is restrictive and exclusionary conduct that tends to negatively affect competitive conditions in product and service markets and competitive conditions in labor markets.

When the proposed rule was issued, former FTC Commissioner Christine Wilson—who resigned immediately following her vigorous dissent in connection with the proposed rule—suggested that the FTC’s rule is subject to challenge based on a variety of theories that the FTC over-stepped its rulemaking authority. She wrote in her proposed rule dissenting statement, “The NPRM is vulnerable to meritorious challenges that (1) the FTC lacks authority to engage in “unfair methods of competition” rulemaking, (2) the major questions doctrine addressed in West Virginia v. EPA applies (which doctrine provides that courts reject claims of regulatory authority involving issues of “vast economic and political significance” when an agency has been unable to establish clear congressional authorization for such power), and the FTC lacks clear Congressional authorization to undertake this initiative; and (3) assuming the FTC does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the FTC has replaced the consumer welfare standard with one of multiple goals.”

The two current Republican members of the Commission—Melissa Holyoak and Andrew Ferguson—both voted against the fine rule, making similar arguments that the FTC was exceeding its rulemaking authority. Echoing Commissioner Ferguson’s dissenting commentary during the FTC’s open session meeting, the U.S. Chamber of Commerce also argues that the rule violates the Administrative Procedure Act due to what they characterize as the arbitrary and capricious nature of the FTC’s decision-making. The Chamber explained that the FTC’s justifications for a categorical ban on noncompete agreements rely on an inaccurate and selective assessment of research and that the rule will generate considerable uncertainty and frustrate compliance with other laws. In addition, some commenters suggested that retroactive application of the rule with respect to non-senior executives may constitute an unconstitutional taking with respect to prior bargains struck between businesses and individuals.

As we wait to see how such anticipated legal challenges proceed, for now we can say that the FTC’s rule represents a nationwide sea change in the law of non-compete clauses and a dramatic use of the FTC’s rulemaking authority to enforce Section 5 of the FTC Act. The rule is emblematic of the FTC’s emphasis on competition in labor markets, its expansive view of Section 5 of the FTC Act, and its aggressive stance regarding its rulemaking authority.