Important Takeaways from the Final Rule Banning Non-Competes

By Hailey Golds and Michael Warner - Franczek P.C.

April 26, 2024

In an anticipated yet groundbreaking turn of events, on April 23, 2024, the Federal Trade Commission (“FTC”) voted 3-2 to issue a Final Non-Compete Clause Rule (the “Final Rule”) which bans U.S. employers from using non-compete agreements for almost all workers. The Final Rule provides that non-compete agreements constitutes an “unfair method of competition,” and therefore it is a violation of the FTC Act for employers to enter into these types of agreements with workers.

The Final Rule is already the subject of multiple legal challenges, but if not enjoined by a Court, the Rule is scheduled to become effective within 120 days of publication in the Federal Register.

I. Scope of Rule – Notable Inclusions and Exclusions

The Final Rule applies to agreements between employers and all “workers.” “Worker” is defined as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” The Rule provides that employers are prohibited from enforcing existing non-competes with workers other than senior executives after the compliance date (i.e. 120 days after the Final Rule is published in the Federal Register).

The Final Rule adopts a notice requirement—for workers who are not senior executives—requiring employers inform their workers and former workers that any preexisting non-compete agreement is no longer enforceable.  The Rule applies both to provisions that “prohibit” an individual from working for a competitor in subsequent employment as well as provisions that “penalize” an individual for working for a competitor such as liquidated damages or equity forfeiture provisions.  The Rule contains two limited exceptions to its ban on non-competes: (1) existing non-competes can remain in force for “senior executives,” defined as an “officer with policymaking authority” who earns in excess of  $151,164, but this exception will not be available  for new non competes entered into after the Rule’s effective data; and (2)  non-competes made in connection with the sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.

Notably, the FTC rejected requests to exempt certain industries, such as healthcare, in which not-for-profit entities are prevalent.  The FTC Act applies only to “persons, partnerships, or corporations.”  Under the Act, a corporation is defined as an entity that is “organized to carry on business for its own profit or for that of its members.” Thus, not-for-profit entities are often assumed to be exempt from the FTC’s enforcement authority to regulate “unfair methods of competition in or affecting commerce” because they are not considered “corporations.” In the Final Rule, the FTC disputed this common wisdom and noted that organizations which have not-for- profit status under Section 501(c)(3) of the Internal Revenue Code are “not categorically beyond the Commission’s jurisdiction.”

As an illustration, the FTC cited instances where it has been found that entities that are designated as 501(c)(3) actually carry out business for their own profit or that of their members. For instance, certain physician-hospital organizations, independent physician associations, and tax-exempt nonprofit hospitals that partner with for-profit entities have been found to not qualify as nonprofit entities under the FTC Act definition. As such, they would be subject to the non-compete ban under the Final Rule even though they are designated as 501(c)(3) under the Internal Revenue Code.

II. “De Facto” Non-Competes

As mentioned above, the Final Rule also applies even more broadly to “de facto” non-compete clauses that have “the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer” (the “functional test”). The FTC noted that the Final Rule’s definition of a non-compete does not categorically prohibit other types of restrictive employment agreements such as non-disclosure agreements (“NDAs”), non-solicitation agreements, training repayment agreement provisions (“TRAPs”), and “garden leave” provisions. However, the FTC did note that such a provision could be deemed to be “de-facto” non-compete if drafted so broadly that the provision would hinder the ability of a worker to seek or accept employment or operate a business after the conclusion of their employment. Such provisions would, therefore, violate the Final Rule.

III. Timing of Rule and Anticipated Challenges

The Rule is currently scheduled to become effective 120 days after publication in the Federal Register. On April 24, 2024, the U.S. Chamber of Commerce and other organizations challenged the Final Rule in Texas Federal Court, arguing that the FTC lacks authority to issue the rule. The plaintiffs are asking the court to overturn the new rule.

Although the FTC has broad authority under federal antitrust law to regulate potential anti-competitive activity, it has not previously used this authority to regulate the non-compete agreements in the employment context.

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