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FTC Issues Final Rule Banning Non-Compete Clauses

on Friday, 26 April 2024 in Labor & Employment Law Update: Sarah M. Huyck, Editor

On January 5, 2023, the Federal Trade Commission (“FTC” or the “Commission”) released a Notice of Proposed Rulemaking which aimed to broadly ban non-compete clauses in employment contracts. Baird Holm previously reported the proposed rules.  Over a year later, the FTC issued a final rule banning most non-competes nationwide on April 23, 2024.

This final rule will take effect 120 days after publication in the Federal Register. With anticipated legal challenges, however, employers should continue to watch for updates.

The FTC’s new rule makes it an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause, to enforce a non-compete clause, or to represent that the worker is subject to a non-compete clause. The FTC defines a “non-compete” 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 FTC noted that employers have several alternatives to non-compete agreements—including non-disclosure agreements and non-solicitation agreements. These agreements are not categorically prohibited under the FTC’s rule. The FTC warned, however, that these agreements may be similarly prohibited if a restriction “functions to prevent” work post-employment or new business, similar to a non-compete clause, in what the FTC refers to as a “de facto” non-compete. For those employers in Nebraska, this distinction and careful tailoring may sound familiar under Nebraska law.

Under this rule, the FTC purports to ban “existing non-competes for the vast majority of workers.” The FTC’s full Press Release can be accessed here. There are limited exceptions where non-competes may be permissible under the FTC’s rule. As previously reported, the non-compete prohibition does not apply to a bona fide sale of a business entity or ownership interest in a business entity, or a sale of all or substantially all of a business entity’s operating assets.

In one major change from the proposed rule, existing non-compete clauses may remain in force for senior executives, or those employees in a policy-making position with a total annualized compensation of $151,164 in the preceding year. Moving forward, however, new non-compete clauses would be banned, even for senior executives, under the FTC’s rule.

For existing non-compete agreements, the FTC’s rule directs that employers would have to provide notice to workers bound by an existing non-compete by the effective date. The notice must state that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. The FTC provided model language for this required notice.  For each worker, the notice would require the employer to:

  • Identify the person who entered into the non-compete clause with the worker;
  • Be delivered to the worker by one of the following means:
    • On paper delivered by hand to the worker,
    • By mail at the worker’s last known personal street address,
    • By email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address, or
    • By text message at a mobile telephone number belonging to the worker.

While the FTC’s non-compete prohibitions are broad, the scope of the agency’s jurisdiction is limited where it concerns certain nonprofit organizations exempt from tax under section 501(c) of the Internal Revenue Code. Generally, the FTC does not have jurisdiction to regulate such nonprofit entities—the agency, however, declined to define categorical exemptions for tax-exempt organizations (like the not-for-profit healthcare industry) in the final rule. The FTC expressed its intent to pursue enforcement of its non-compete ban in the healthcare industry to the full extent of its jurisdictional authority, which would still include for-profit entities that employ health care workers (such as a staffing agency or for-profit physician group).

While the FTC’s final rule will most certainly face legal challenges, employers should carefully scrutinize existing non-compete, non-solicitation, and non-disclosure covenants with the assistance of legal counsel. Particularly for employers outside of Nebraska, the FTC’s rule is likely to require revisions to many non-solicitation and non-disclosure covenants which are at risk for being “de facto” non-competes.

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