Non-Compete No More: The FTC Rewrites the Rules of the Game
On April 23, 2024 the Federal Trade Commission (“FTC”) issued a final rule that effectively bans non-compete agreements between employers and workers except existing non-compete provisions of “senior executives.” This move by the agency aims to prevent anti-competitive practices, increase innovation and encourage new business formation.
Overview of the Final Rule
Unless enjoined by a court, the Final Rule will become effective 120 days from publication in the Federal Register making September 4, 2024, as the tentative effective date. The Final Rule also preempts conflicting state laws, therefore banning otherwise lawful non-compete clauses in the 46 states that permit them.
The Rule essentially prohibits:
Entering or attempting to enter a non-compete clause with any worker, including senior executives (§ 910.2(a)(1)(i))
Enforcing, or attempting to enforce a non-compete clause (§ 910.2(a)(1)(ii))
Representing that any worker is subject to a non-compete clause.
Additionally, the final Rule requires employers to notify all workers that existing non-competes are no longer enforceable. Workers for the purposes of this notification include all paid and unpaid persons like independent contractors, sole proprietors, interns, volunteers, and any other entity providing services to a client. The notification obligation on employers is similarly enforced in notifying former employees of the null-and-void non-compete clause that the parties previously entered into.
Exceptions to the Rule
There are certain exceptions to the otherwise extensive scope of the Final Rule including:
A “grandfathering” exception for existing non-competes with “senior executives”, defined to include individuals that earned $151,164 or more in total compensation and are in a “policymaking” capacity within the company.
Non-competes entered pursuant to a bona fide sale of business entity (a notable change from the earlier proposed 25% ownership threshold), of the person’s ownership interest in a business entity, or of all or substantially all business entity’s operating assets.
The Rule explicitly does not apply to businesses’ efforts undertaken to protect intellectual property including post-employment restrictions like non-disclosures, non-solicitation, confidentiality or Training Repayment Agreement Provisions (“TRAPs”) which require workers to reimburse employers for training expenses if they leave their job before a specified lock-in date.
Notwithstanding the above, it may be noted that general antitrust principles will still apply to the above provisions including enforcement actions against unreasonably expansive non-compete clauses in merger agreements.
Legal Challenges and Uncertainty
Like the 26,000 comments submitted to the proposed rule, the Final Rule is already facing legal challenges from business groups questioning the agency’s authority. While the rule is set to take effect 120 days from publication, its implementation will likely be delayed pending resolution of these legal challenges. The U.S. Chamber of Commerce and others have already filed complaints challenging FTC’s rule-making authority, setting the stage for a potential court battle. Additional legal challenges are to be expected from private entities seeking to enforce existing noncompete against former employees.
The rule’s fate also hinges on investigation of major-questions doctrine that limits administrative agencies from enacting rules that accrue as “major policy decisions” or that of “vast economic and political significance” without express congressional authorization.
The FTC may also face challenges for taking a starkly opposite approach with respect to forfeiture-for-competition provisions, effectively disregarding the recent Delaware ruling in Cantor Fitzgerald, L.P. v. Ainslie earlier this year. In Cantor, the Delaware Supreme Court expressly distinguished forfeiture provisions that permit forfeiture or repurchase of equity interests from traditional non-compete clauses holding that the two clauses should not be held to thea same level of scrutiny. The Final Rule, however, includes such forfeiture-for-competition provisions that penalize workers in its broad understanding of non-competition provisions.
Another area that remains unclear is the Rule’s application in connection with profit-sharing or sophisticated incentive plans. In special cases, employees are incentivized by a special purpose vehicle (like an LLC or a partnership) that lists the employee as a member or partner of the carry vehicle entity. The non-compete ban applies to any agreement entered with a “worker” performing services for a “person”. While the ambit of “worker” excludes partners and members from its definition, the definition of “person” notably includes any corporation, partnership or LLC. The expansive scope of the FTC rule suggests that they designed it to include indirect employment relationships with little regard for the label used. However, the lack of clarity regarding the rule’s applicability in the case of profit-sharing and creative incentive plans may invite litigation over opposing interpretations.
Remedies
Employers may note that the remedies available under the FTC Act are limited. Due to unavailability of a private right of action under the Act, workers will not be able to sue employers for a direct violation of these regulations, if brought into effect. Instead, to enforce the rule, an administrative proceeding under Section 5(b) or injunction under Section 13(b) of the FTC Act may be carried out. By contrast, the FTC cannot obtain monetary relief for violation of the rule unless the breaching party is first ordered to cease and desist from violation and fails to do so.
Key Takeaways
Retroactive effect: As far as FTC is concerned, noncompete clauses include both affirmative undertaking to refrain from competition as well as claw back of equity proceeds penalties. If the rule takes effect, all non-competes with workers shall be rendered unenforceable which is likely to affect a businesses’ ability to remain competitive.
Notice requirement: Employers must begin preparing notices for non-executives to fulfill the notice requirement under the new Rule, informing all former and current employees of non-enforcement of the anti-competitive provision. This notice requirement needs to be fulfilled by the employees prior to the effective date. The FTC, in its Final Rule also provides model language for employers to use in their notifications which will fulfill the notice obligation prescribed under the new rule.
Trade secret and IP protections: Employers may not worry about the dangers of intellectual property thefts and trade secret misappropriation as deterrents like non-disclosure and confidentiality agreements are still legal and enforceable. Companies may consider stricter drafting of these restrictive covenants to protect against flagrant theft. Other hygiene changes may include review and revision of employment policies, regular acknowledgement of confidentiality obligations, and new trade secret protection policies as best practices considering the impending rule. Stricter and more active enforcement post-termination consequences including return and destruction of company’s confidential information may be another way of preventing any proprietary information from reaching the competitors.
“Inevitable disclosure” as a counter strike: In jurisdictions where the “inevitable disclosure” doctrine is recognized, companies may want to consider using it as a strategy while seeking return of misappropriated trade secrets through litigation. Applicable courts can prevent an employee from taking on certain job responsibilities at a competitor firm where disclosure of former employer’s trade secret may be inevitable in performing the new responsibilities. This, combined with the Defend Trade Secrets Act (DTSA)-provided remedy to seek injunction for prevention of actual and “threatened” misappropriation may be able to grant employers with sufficient ammunition. However, employers considering this tactic must note the high evidentiary burden associated with seeking such relief.
Recommendations
While there is a possibility that the FTC Rule may be invalidated or delayed, employers must still consider the above-mentioned preemptive steps that may be taken before the rule takes effect. With the FTC aggressively seeking consent orders against companies using broadly drafted noncompete clauses even before it issued the final rule, it may be risky for employers to adopt the wait and see approach. While the legality of the rule is tested in courts, with significant shift in the perception of non-compete clauses, there may be a probability of pro-employee legislation being adopted at local and state level that has an FTC rule-like impact.
Companies who wish to reconsider the retention or alteration of restrictive provisions in their employment agreements and opting for best practices to safeguard their proprietary information can contact Ascend Law, which is specialized in assisting companies protect and control their confidential information.