On April 23, 2024, the Federal Trade Commission (“FTC”) issued its final rule banning non-compete agreements under Section 5 of the FTC Act (the “Final Rule”) on a 3-2 vote. The FTC’s non-compete ban will upend the status quo between employers and their workers by generally preventing the use of non-compete agreements to protect employers’ trade secrets, confidential information, and historical investments into training executives, engineers, and sales teams. Notably, a lawsuit was filed against the FTC’s new rule within hours of its issuance. That lawsuit, and other expected litigation, may suspend the Final Rule’s implementation—at least for a while.
The Final Rule Purports to Limit Non-Competes, But Will Also Limit Non-Solicitation And Non-Disclosure Agreements
The Final Rule largely adopts the FTC’s Notice of Proposed Rulemaking (the “Proposed Rule”)—which we discussed in a news alert on February 14, 2023—and will ban almost all existing and future agreements that “function” to prevent a worker from seeking or accepting employment, or operating a business, after the worker’s employment with the employer. The breadth of the Final Rule will also impair businesses’ ability to enforce non-disclosure agreements, non-solicitation agreements, and intellectual property agreements, as the definition of “non-compete clause” bars any agreements that would restrict the ability of a worker to accept a position after employment. The Final Rule broadly applies to both W-2 employees and independent contractors.
Generally, the only exceptions recognized by the Proposed Rule are non-compete clauses in franchisor/franchisee agreements and those related to transactions involving the sale of a business. Those transactions, however, will still be reviewed for reasonability under antitrust laws.
The Final Rule Creates A Free-for-All And Endangers The Protection Of Trade Secrets
One of the key purposes of non-compete agreements is to prophylactically protect a company from workers with access to trade secrets or confidential information (e.g., technical, research, or financial information) being hired away by competitors or starting competing businesses using information learned in the course of their current work. The Final Rule explicitly outlaws these reasonable proactive precautions, and instead requires manufacturers and other businesses to rely on the courts to protect their trade secrets and confidential information. Accordingly, the certainty of narrowly tailored contractual limitations between parties regarding these issues have largely been pushed aside in favor of federal regulation.
The Final Rule Overturns The Legal Framework Of 46 States And The District Of Columbia, While Broadening Existing Bans
Since the Proposed Rule was issued last year, Minnesota has joined California, North Dakota, and Oklahoma in enforcing a general prohibition against the enforcement of employment non-competition agreements. Yet the Final Rule issued by the FTC sweeps broader than some of these state statutory schemes. For example, Minnesota expressly bans non-competition agreements, but largely permits non-solicitation agreements. The remaining states and territories generally enforce non-competes to the extent they are supported by a legitimate business reason and are limited to a reasonable scope. The Final Rule expressly preempts these well-developed legal structures, causing uncertainty and additional expense for employers who must navigate a new set of federal regulations. The Final Rule causes uncertainty regarding the extent to which trade secret and client protections may remain—particularly during the time period when the enactment of the Final Rule is initially challenged, and the subsequent period during which its parameters are expected to be further tested and refined through litigation.
Changes From The Proposed Rule
The Final Rule makes important—but limited—changes from the Proposed Rule. For example, while employers may not enter new non-compete agreements with senior executives (i.e., those making more than $151,164 per year and who are in policy-making positions) employers may continue to enforce existing non-compete agreements with those senior executives.
The Final Rule also does away with the requirement that employers legally modify or formally rescind existing non-compete agreements. But employers still must notify current and former workers that existing non-compete agreements will not be enforced. Accordingly, the Final Rule applies retroactively and disrupts settled expectations and executory contracts by which employers already provided benefits and other consideration to their workers.
A Lawsuit Was Filed Within Hours, With More On The Way
Echoing the themes outlined in Bowman and Brooke’s prior legal alert, tax services firm Ryan LLC (“Ryan”) filed suit against the FTC within hours of the Final Rule’s issuance. Ryan had submitted a lengthy public comment against the Proposed Rule, explaining how non-compete agreements are an important tool for businesses to protect their intellectual property and to prevent mercenary hiring of executives by competitors to obtain access to protected information.
Ryan’s suit was filed in a favorable judicial forum by a team led by Eugene Scalia—former Secretary of Labor and son of former Supreme Court Justice Antonin Scalia. The suit argues many of the expected legal theories, asserting violations of the major questions doctrine, the nondelegation doctrine, and, perhaps most ambitiously, that the FTC’s structure violates the unitary executive theory.
Judge Ada Brown in the United States District Court for the Northern District of Texas will preside over Ryan’s lawsuit. Judge Brown was nominated by former President Trump in 2019. Any appeal from Judge Brown’s decisions will be heard by the conservative United States Court of Appeals for the Fifth Circuit.
On April 24, 2024, the United States Chamber of Commerce, the Business Roundtable, the Texas Association of Business, and the Longview Chamber of Commerce filed a second lawsuit, arguing that the Final Rule violates the major questions doctrine and is impermissibly retroactive, among other arguments, in the United States District Court for the Eastern District of Texas. We will monitor both lawsuits in the coming weeks and months.
Pending And Future Legal Challenges Signal Additional Uncertainty For Businesses
The Final Rule itself does not go into effect for 120 days after its publication in the Federal Register—which will likely occur in the next week. However, the prospect of court intervention leaves businesses currently using non-competition and non-solicitation agreements in a quandary. May businesses safely limit their business risks by continuing their use of these agreements, or must they take steps to comply with the Final Rule in anticipation of its effective date?
We expect a motion for preliminary injunction will be filed by the plaintiff in the Ryan litigation seeking to bar enforcement of the Final Rule nationwide. A prompt favorable ruling on such a motion would provide assurances that businesses may delay notifying workers concerning termination of obligations currently owed under non-competes. A delayed ruling or one that permits the Final Rule to go into effect while the litigation proceeds would send the opposite signal.
Based on prior litigation against federal agencies in the Northern District of Texas, we also expect the FTC will seek to transfer the case to the federal court in the District of Columbia. But this prospect should be tempered by the Fifth Circuit’s distaste for the transfer of cases out of the Northern District of Texas. Notably, a panel of the Fifth Circuit granted a writ of mandamus against a similar transfer in In re Clarke on March 1, 2024. Here, transfer is less likely due to Ryan’s headquarters in Dallas, Texas, which is within the Northern District of Texas.
Steps Businesses Can Take To Limit The Effect Of The Final Rule
While the court system will have the final word on the Final Rule, businesses grappling with the Final Rule’s impact can take protective steps now.
As noted by the FTC in the papers accompanying the Final Rule, most employees who are covered by non-compete clauses are also subject to non-disclosure agreements, which remain legal, if limited, under the Final Rule. Businesses should consider leveraging their human resources and legal teams to evaluate their non-compete agreements, ensure that appropriate and compliant non-disclosure agreements are in place and up-to-date, and assess whether non-disclosure obligations should be separated from non-competition agreements affected by the Final Rule.
Additionally, employers should evaluate which of their employees meet the definition of “senior executive” defined above and ensure that appropriate non-competition clauses are in place for those employees before the Final Rule goes into effect, as existing non-competition agreements with these employees may be kept in place. And, if otherwise reasonable, employers may take prompt steps to ensure key employees fit within the definition of “senior executive” prior to the Final Rule going into effect.
Finally, businesses should ensure a coordinated message to current and former employees to make clear that existing non-compete clauses are no longer enforceable. Clear communication is crucial, as the Final Rule expressly calls out oral instructions contradicting the Final Rule as constituting unfair competition under the FTC Act, subjecting the business to fines, penalties, and enforcement action.
In any event, employers should have their standard employment agreements for both ordinary workers and executives reviewed for compliance with the new regulation by trusted legal counsel.