According to a 2019 report from the Economic Policy Institute, almost 50% of operating businesses use non-compete agreements and as many as 60 million private-sector workers are subject to non-compete agreements. In a historic move on April 23, 2024, the U.S. Federal Trade Commission (FTC) issued a ruling banning non-compete clauses in the vast majority of employer-employee contracts. The rule represents a significant shift, eliciting both support and dissent, with some arguing that such a blanket ban overlooks the nuanced nature of non-compete agreements and could lead to unintended consequences.

Until this ruling, the enforceability of these agreements was generally considered to be an issue of state law, with the majority of states requiring non-compete agreements to be reasonable in time and geographic scope and limited to protecting only legitimate business interests, such as trade secrets, confidential information, and proprietary customer lists. However, in early 2023, the FTC proposed the sweeping rule, basing its authority on a preliminary finding that non-competes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act. The proposed rule is the first of its kind since the FTCs creation in 1914.

At the heart of the issue is the balance between safeguarding against anti-competitive practices and preserving employers’ ability to protect legitimate business interests. The rule aims to curtail the perceived misuse of non-competes, particularly concerning low-wage workers and their mobility in the job market. Yet, it also raises questions about its potential implications for businesses, intellectual property protection, and executive compensation structures.

What you need to know:

How does the rule define “non-compete clause” for the purposes of the rule?

The FTC defines a “non-compete clause” as:

1. a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from
   • 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
   • operating a business in the United States after the conclusion of the employment that includes the term or condition.
2. For the purposes of the Rule, a term or condition of employment includes a contractual term or workplace policy, whether written or oral.

When will the rule go into effect?

• The rule is slated to go into effect 120 days after it is published in the Federal Register. Once the rule is effective, any suspected violations of the final rule can be reported to the Bureau of Competition by emailing noncompete@ftc.gov.

What are the key features of the rule?

The final rule is broad and would prohibit employers from imposing non-competes on workers, including independent contractors and unpaid workers.

• The ban goes further, encompassing any contract provision that would have the net effect of prohibiting workers from seeking or accepting employment. Therefore, a non-disclosure agreement that has the “effect” of limiting a worker’s ability to seek other employment may also be banned.
• The rule would apply retroactively. This means that pre-existing non-compete agreements are now unenforceable with a specific carve-out for “senior executives” discussed below.
• There is a narrow exception for non-compete agreements in the context of a “sale-of-business” agreement but this exception only applies where the individual has at least 25% ownership in the business.

What happens if an employer violates the rule?

• The rule provides that the use of non-competes is an “unfair method of competition” that violates Section 5 of the FTC Act. Violations of the Act can result in fines, penalties, and other injunctive relief.

How will the rule be enforced once effective?

• The FTC could bring an administrative action against an employer for violations of the rule.

Does the rule give an employee a private right to sue?

• No. There is no private right of action under the Act. Therefore, individual employees could not sue employers for violating the rule. However, it is possible for an employee to seek to void the non-compete provision in their employment contract with the employer, and cite in support of that action the FTCs rule.

What kinds of businesses are bound by the rule?

• Most employers are subject to the rule. However, the FTC claims to have jurisdiction to issue the rule under the FTC Act. Therefore, it is likely that any entity that is exempt from the FTC’s jurisdiction under the FTC Act would likewise be exempt from the rule.

What are the exceptions?

• It’s important to note that the FTC only has authority over for-profit enterprises, so the rule should not apply to non-profit organizations. However, this is still unsettled, as some nonprofits use management or administrative corporations that may, themselves, be for-profit entities. The FTC states that nonprofit, tax-exempt organizations that “are organized to carry on business for their own profit or the profit of their members” will fall under the purview of the rule.
• Further, there are industry-specific exceptions based on those industries exempt from the FTC Act. Specifically, this rule does not apply to certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers.
• Outside of those exceptions, there are specifically carved out exceptions for the remaining companies that include:
  • existing agreements for “senior executives”;
  • non-competes entered into in connection with a bona fide sale of business; and
  • non-competes enforced where a cause of action accrued prior to the rule’s effective date.

How does the rule impact non-competes entered into as part of an M&A transaction?

•  M&A transactions where the preservation of key personnel at the target company is integral to the buyer’s valuation will be particularly impacted by the rule. While traditional non-compete agreements made by sellers in bona fide sales of business will remain unaffected, companies may need to come up with creative ways to retain non-seller employees in the transaction. Further, they will need to consider restrictive covenants for employees who retain a portion of their equity or receive equity awards pursuant to a sale. 

Does the rule differentiate between executives and employees?

• Yes. Under the final rule, the FTC differentiates between “senior executives” and “employees” as follows:some text
  • Senior Executives: According to the rule, existing non-competes for senior executives can remain in force. Employers, however, are prohibited from entering into or enforcing new non-competes with senior executives.
  • The rule defines senior executives as workers earning more than $151,164 annually and who are in “policy-making positions”. Important definitions to note:
  • Policy Making Position: is defined as “a business entity’s president, chief executive officer, or the equivalent, any other officer of a business entity who has a policy-making authority."
  • Policy-making authority: is defined as “final authority to make policy decisions that control significant aspects of the business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.
  • Employees: defines “worker” as “a natural person who works, 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 states that for workers who are not senior executives, as defined above, existing non-competes are no longer enforceable after the final rule’s effective date.

What does a company need to do for existing non-competes?

• Employers will be required to provide notice to workers bound by an existing non-compete, other than senior executives, that they will not be enforcing any non-competes against them. However, the Commission has eliminated a provision in the proposed rule that would have required employers to legally modify existing non-competes by formally rescinding them. This was modified to help employers streamline compliance with the rule.

How does the rule treat “gardening leave”?

• Gardening leave is the practice whereby an employee leaving a job, either through a resignation or termination, is required to stay away from the workplace while remaining technically employed and paid by the employer. These provisions are generally treated as terms of continued employment. However, some courts have treated gardening leave and extended notice periods as non-compete provisions.The final rule states that an agreement whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis would not be a non-compete agreement under the definition because such an agreement is not a post-employment restriction and would therefore not fall under the rule.

What are alternatives to non-competes that employers can still use to protect their companies?

• Trade Secret Laws and Non-Disclosure Agreements are great tools that can help you protect your investments. Trade secrets last as long as the commercially valuable information remains confidential, protected by reasonable measures to keep it secret. Here are a few examples from the World Intellectual Property Organization on a few “reasonable measures” you can use to help keep your trade secrets safe:
  • Mark all trade secret information as confidential;
  • Limits access to all sensitive information by placing physical and/or technological restrictions;
  • Enter into non-disclosure agreements with employees, suppliers and partners, prohibiting the recipient from making unauthorized use or disclosure of confidential information;
  • Create an employee culture that makes maintaining confidentiality a priority.
• The Commission also specifically found that instead of using non-competes to restrict the ability of workers to take their talent to a competitor, employers that would like to increase employee retention can compete on the merits for the worker’s labor services by improving wages and working conditions.

What is the likelihood that the rule will be legally challenged and if so, what is the timing of such a legal challenge?

• There are likely to be several legal challenges under a number of different doctrines, including questions regarding the FTCs jurisdiction to even issue such a rule. An action challenging the rule can be filed in federal district court in the near term. Legal challenges are likely to be filed prior to the effective date of the final rule and seek injunctive relief in order to stop the rule from going into effect.

Would an employer have to comply with the rule during the pendency of a legal challenge?

• It depends. If a preliminary injunction were granted, the final rule would not become effective until after the resolution of the lawsuits. However, we won’t know until the final rule goes into effect.

If you’re looking to speak with an attorney on how the newly issued rule on non-competes will affect your business, consider consulting with an attorney at Founders Law today.

Erika Knierim is a startup and venture capital attorney based in Chicago, IL. She represents founders, startups and venture capital funds in a wide variety of corporate transactions, including raising capital and navigating issues associated with rapidly-growing startups. She can be reached at eknierim@founderslaw.com.

The opinions and recommendations expressed in this article are the opinions of the individual author and do not constitute legal advice or recommendations by Founders Law LLC. No attorney/client relationship or engagement is intended to be, or can be, created by the review of this content. Individualized advice can only be provided after a review of the circumstances of your business or matter.

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