On April 23, 2024, the Federal Trade Commission (“FTC”) voted 3-2 along party lines to adopt a final rule (the “Final Rule”) banning most companies from entering into or enforcing non-compete clauses. Adoption of the Final Rule comes after more than a year of review following the publication of the Proposed Rule in early 2023.
The Final Rule is scheduled to go into effect 120 days from publication in the Federal Register (the “Effective Date”).
Summary of the Final Rule
With the Final Rule, the FTC has determined that non-compete clauses constitute an unfair method of competition in violation of Section 5 of the FTC Act, defining “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 does not apply to non-compete agreements if they restrict only work outside the United States or starting a business outside the United States.
Specifically, the Final Rule adopts the following restrictions:
- A complete ban on new non-competes with all workers of for-profit companies; and
- Existing non-competes for workers who are not Senior Executives are no longer enforceable after the Effective Date.
Importantly, the scope of the Final Rule is limited in two significant ways as applied to health care. First, the Final Rule allows existing non-competes with Senior Executives to remain in force. Second, the Final Rule does not generally apply to workers at non-profit entities.
Additionally, companies must provide notice to workers with existing non-competes that their employment-based non-competes are no longer enforceable.
Finally, the term “worker” is broadly defined and includes, but is not limited to, employees, independent contractors, externs, interns, volunteers and sole proprietors.
Who Qualifies as a Senior Executive?
Despite recognizing that there is no generally accepted legal definition of “Senior Executive”, in the Final Rule the FTC nonetheless adopted a two-prong test to define Senior Executives as a worker who:
- Was in a “policy-making position,”[1] (the “Job Duties Test”); and
- Received actual or annualized total annual compensation of at least $151,164 (the “Compensation Threshold”).
For workers who satisfy both prongs of the Senior Executive test, the Final Rule makes it illegal for a person to (1) enter into or attempt to enter into a non-compete clause; (2) enforce or attempt to enforce a non-compete clause entered into after the Effective Date; or (3) represent that the Senior Executive is subject to a non-compete clause, where the non-compete clause was entered into after the Effective Date. However, any existing non-compete agreement as of the Effective Date remains valid and enforceable.
Non-Profit Exception
Generally, the Final Rule does not apply to nonprofit organizations (e.g., 501(c)(3) organizations) as they have historically fallen outside the purview of the FTC’s jurisdiction under the FTC Act. However, the FTC’s Democratic commissioners noted that some non-profits may be subject to the Final Rule. For example, if entities claiming tax-exempt status are structured and operated to generate profits, they may still be covered by the Final Rule.
In their remarks, the FTC’s Democratic commissioners also noted the limits of their authority in the nonprofit space and urged Congress to enact additional legislation around non-competes for nonprofits. Nonprofit organizations should monitor for future developments in this area.
Notice Requirement
Under the Final Rule, companies are required to provide their employees who are currently subject to an existing non-complete clause with written notice that their non-competes are no longer enforceable. Note, that the notice requirement does not apply to Senior Executives subject to existing non-competes.
Notices must be delivered in writing prior to the Effective Date, meaning that companies have 120 days from the publishing of the Final Rule in the Federal Register to prepare and send employee notices. The Final Rule contains model language that companies may use to craft notices to their employees.
What Happens Next?
The party-line vote at the FTC signals a contentious future for the Final Rule. On April 24, 2024, one day after publication, business groups led by the U.S. Chamber of Commerce sued the FTC in Texas federal court to enjoin enforcement of the Final Rule. Similarly, other entities are lining up to file suit in various jurisdictions arguing that the Final Rule represents a significant overreach of the FTC’s rulemaking authority, as argued by the FTC’s Republican commissioners.
In practice, these lawsuits will likely cause significant further delays regarding the Effective Date of the Final Rule, including any applicable notice requirements, as the challenges make their way through the court system. Similar legal challenges were successfully pursued in federal court to undermine OSHA’s COVID-19 vaccine mandate rule in 2021, with one district court issuing a nationwide injunction that blocked the rule from taking effect.
Additional Takeaways
- The FTC’s lack of clear jurisdiction over nonprofit entities under the FTC Act may insulate a significant segment of the health care industry from enforcement under the Final Rule. However, given the clear focus and stated concerns from the FTC with competition for health care workers, companies should be mindful of other mechanisms that the FTC may use, including invoking Section 1 of the Sherman Act.
- The Final Rule only restricts non-compete clauses and their functional equivalents (i.e., they do not purport to ban other types of restrictive agreements such as Non-Disclosure Agreements, Non-Solicitation Agreements, etc.); however, if these other categories of restrictive agreement are so broad as to have the effect of “function(ing) to prevent” workers from competing they may fall under the purview of the Final Rule.
- The Final Rule does not apply to non-competes that are entered into by a person in connection with the bona fide sale of a business entity, so long as the transaction involves either (1) the sale of a business; (2) the sale of a person’s ownership interest in a business; or (3) the sale of all or substantially all of the assets of the business.
- Although the Final Rule provides clarity surrounding Senior Executives, the reach of the Final Rule as it applies to owners, members, shareholders and “owner non-competes” remains less than clear. The FTC appears to be focused on employment-related non-competes, but the definitions of “Employment” and “Worker” are exceedingly broad. If the Final Rule becomes effective, it will then be up to the Courts to clarify the contours of the Final Rule and its application to “owner non-competes.”
- The Final Rule supersedes all state laws, regulations, orders and interpretations inconsistent (e.g., more permissive) with the Final Rule. This means states may impose stricter requirements and restrictions with respect to non-competes provided that those restrictions afford greater protections to employees than those contained in the Final Rule.
- Companies currently involved in an action to enforce an existing non-compete that occurred prior to the Effective Date are not banned from enforcing the non-compete.
Hall Render continues to review the Final Rule, as well as monitor pending litigation and related challenges and will provide additional guidance and analysis on a rolling basis. If you have any questions or would like additional information about this topic, please contact:
- Dana Stutzman at dstutzman@hallrender.com or (317) 977-1425;
- John Bowen at jbowen@hallrender.com or (317) 429-3629;
- Abigail Kaericher at akaericher@hallrender.com or (202) 742-9674; or
- Your primary Hall Render contact.
Hall Render blog posts and articles are intended for informational purposes only. For ethical reasons, Hall Render attorneys cannot—outside of an attorney-client relationship—answer specific questions that would be legal advice.
[1] “Policy-making position” is defined in the Final Rule as “(1) 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.”
