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On April 23, 2024, the Federal Trade Commission (“FTC”) voted 3-2 to adopt a final rule that broadly bans the vast majority of employment related noncompete provisions. Specifically, the rule prohibits employers from enforcing existing noncompetes and entering into new noncompetes with workers, with limited exceptions (highlighted below).

The final rule also requires employers to provide written notice to covered workers that their noncompete clauses are no longer valid and will not be enforced. “Worker” is defined broadly to include independent contractors and sole proprietorships (i.e., consultants). The rule will be effective 120 days after the publication of the final rule in the Federal Register. However, the effective date may get delayed, or the rule may even be permanently enjoined in light of the significant legal challenges it already is facing, discussed below. Notably, the rule doesn’t provide employees with a private cause of action. Thus, what sort of claims employees may bring against employers that attempt to enforce noncompete restrictions, including any claims for monetary damages, remains to be seen. At a minimum, if the rule does survive legal challenge, we should expect employees to bring declaratory judgment actions to invalidate their restrictive covenants.

Exceptions

Only two narrow exceptions made their way into the final rule: 1) existing (but not new) noncompetes with “senior executives” and 2) noncompetes entered into in connection with the sale of a business.

The exception for “senior executives” was not in the proposed rule, although it invited comments on an alternative rule for highly compensated workers. A “senior executive,” however, is not excepted from the rule based on compensation alone. Rather, a “senior executive” is defined as a worker who earned an annual compensation of at least $151,164 in the preceding year and was in a “policy-making position.” A “policy-making position” included the president, chief executive officer “or the equivalent” or any other “officer” with “policy-making authority”. “Policy-making authority” means “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.” It doesn’t include advising on or exerting influence over policy decisions. Thus, the exception for “senior executives,” is fairly stringent. Moreover, it only applies to existing – not new – noncompetes.

The other exception to the broad noncompete ban is in the sale of a business context. The proposed rule would have reserved the sale of business exception for sellers with at least a 25% ownership interest. The final rule, however, does not specify any minimum ownership interest and also applies the exemption to sellers of all or substantially all assets of a business entity. Thus, this exception seems to apply to the sale of even a minority ownership interest.

Open Questions

The final rule leaves several issues unanswered, many of which seem ripe for litigation if the rule survives legal challenge. For example, it is not clear whether or not certain client and employee nonsolicits and/or nondisclosure or confidentiality provisions are banned. The definition of a noncompete clause includes not only terms and conditions that prohibit or penalize workers from competing but also such terms and conditions that function as a noncompete. Accordingly, employees will inevitably argue that their nonsolicits, nondisclosures and/or other restrictive covenants have the effect of preventing them from competing and therefore “function” as noncompetes.

Additionally, the rule only bans noncompetes that prevent a worker from conducting a competitive business or seeking or accepting competitive work in the U.S. The rule is therefore unclear on whether it applies to someone who opens a business outside of the U.S. (e.g., in the Cayman Islands) but may work in the U.S.

Whether the rule prohibits forfeiture or claw back of certain compensation for competition is also left unanswered. Likewise, how, if it all, the rule will impact “garden leave” is not specifically addressed. Garden leave, a very common contractual term in certain industries, requires an employee to provide a certain amount of notice (typically between 30 and 90 days) of intent to terminate employment. During this notice period, the employee continues to receive a base salary and is often relieved from performing duties but is still technically employed. Therefore, garden leave doesn’t fit squarely within the rule’s definition of a noncompete; however, one could argue – and employees likely will – that garden leave “functions” as a noncompete.

Challenges

Two lawsuits have already been filed. Only one day after the FTC unveiled its final rule, the Chamber of Commerce, the nation’s largest business lobby, made good on its promise to bring a lawsuit to invalidate the rule. The Chamber of Commerce filed a lawsuit in federal court in Texas on April 24, 2024, arguing, among other things, that the FTC lacks the statutory authority to issue the rule, it violates the major questions doctrines and non-delegation principles, and is in any event arbitrary and not narrowly tailored.

Ryan LLC, a Dallas-based tax service firm, also filed a lawsuit on April 23, 2024, raising similar arguments. As many business groups argue that the rule limits companies’ abilities to protect confidential information and is overly broad, additional lawsuits are expected to follow. Given the high stakes, it seems likely that we can expect appeals and a lengthy battle before any definitive resolution.

State and Local Law; Other Guidance

Employers are cautioned to review state and local laws regarding bans and partial bans of employee noncompetes which are currently in effect.

Additionally, employers should consider whether the noncompete policies of other government agencies may apply. For example, in connection with bank merger transactions, the Federal Deposit Insurance Corporation recently issued a policy statement providing that it would require the seller not to enter into or enforce any noncompetes with its employees. Likewise, the National Labor Relations Board’s general counsel advised regional officials in a written memo that employee noncompetes could violate the National Labor Relations Act (the “NLRA”). The NLRA generally protects employees’ rights to organize for collective bargaining, but it does apply to employers without unionized workforces as well.

For more information on the topic discussed, contact:

• Jason B. Klimpl  |  klimpl@thsh.com  |  212-508-7529
• Randi B. May  |  may@thsh.com  |  212-702-3167
• Elizabeth E. Schlissel  |  schlissel@thsh.com  |  212-508-6714
• Andrew W. Singer  |  singer@thsh.com  |  212-508-6723
• Stacey A. Usiak  |  usiak@thsh.com  |  212-702-3158
• Andrew P. Yacyshyn  |  yacyshyn@thsh.com  |  212-508-6792