The National Ban on Post-Employment Noncompete Clauses – What To Do Now?

The National Ban on Post-Employment Noncompete Clauses – What To Do Now?

6.4.2024

By Sheryl B. Galler

“Noncompete clauses are now banned in the United States.”

“Noncompete clauses aren’t going away anytime soon.”

I have heard both of these statements in the weeks since April 23, 2024, when the Federal Trade Commission announced that it was issuing its final noncompete clause rule.[1] For the moment, neither statement is true . . . and neither one is false. So, what’s the story?

First, some background on the rule and the FTC.

Noncompete clauses, generally speaking, are terms or conditions of employment that restrict workers from working for or operating a business that competes with their current or former employers.

The FTC is an independent federal agency that has statutory authority to investigate and enforce compliance with antitrust and consumer protection laws.

A few years ago, the FTC took an interest in non-complete clauses and their effect on the formation of new business and fostering innovation. After its initial hearings, the FTC opened an investigation into noncompete clauses in 2021. The FTC concluded that noncompete clauses are unfair methods of competition under Section 5 of the Federal Trade Commission Act.

In January 2023, the FTC published a notice of proposed rulemaking concerning noncompetes. The proposed rule would have invalidated all existing noncompetes and barred employers from entering into noncompetes with any workers.[2] The FTC received over 26,000 public comments in response to the notice.[3]

The FTC revised its proposed rule and, in April 2024, issued its final rule on noncompetes. The rule will:

• Prohibit employers from entering into any noncompete clauses (as defined by the rule) as of the rule’s effective date.
• Prohibit employers from enforcing or attempting to enforce existing noncompete clauses as of the effective date, except those with “senior executives” (as discussed below).
• Prohibit employers from enforcing or attempting to enforce any noncompete clauses entered into after the rule’s effective date.
• Require employers, by the effective date, and on paper, by mail, by email or by text, to notify all employees with existing noncompete restrictions that such clauses are unenforceable. The FTC published a sample notice in multiple languages that employers may use.[4]

The effective date of the rule will be Sept. 4, 2024, unless the rule is delayed or blocked by legal challenges that have been filed against it.

Now to the details.

For the purposes of the new rule, a “noncompete clause” means:

• A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

          (a.) 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

         (b.)  operating a business in the United States after the conclusion of the employment that includes the term or condition.

2. For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.[5]

There is a lot to unpack in this definition.

First, the definition limits the ban to restrictions that apply only “after the conclusion of the employment.” It does not include restrictions on current employees. As such, employers will be allowed to continue to restrict current employees from engaging in activity that is competitive with the employer. To the extent that an employer offers an employee “garden leave,” during which the worker remains employed by and paid by the employer but might be relieved of all duties, the employer likely will be permitted to restrict the employee from seeking or accepting work from a competitor of the employer during the garden leave period.

Second, the definition limits the ban to restrictions on work or business in the United States. So, the rule does not prohibit post-employment restrictions on work or business outside the United States.

Third, the rule uses the word “worker,” which it defines to include “an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person” and “a natural person who works for a franchisee or franchisor” but not “a franchisee in the context of a franchisee-franchisor relationship.”[6] Thus, the rule prohibits employers from entering into or enforcing noncompete clauses with many types of workers, not only employees.

Fourth, the rule prohibits any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” competing. This language seems to prohibit not only noncompete clauses that are part of employment or separation agreements, but any clause or agreement that would or could prevent the worker from competing. This may include overly onerous non-solicitation clauses or training-repayment agreement provisions that prevent a worker from obtaining another job in the employee’s field, and this “functions to prevent a worker from” competing. It also could include “forfeiture for competition” clauses, which may appear in agreements such as deferred compensation and equity agreements and which impose a penalty (the forfeiture of the deferred compensation or equity) on employees who choose to compete post-employment.

It is important to note that the rule not only broadly bans future noncompete agreements, but it also has a retroactive effect. The rule prohibits employers from enforcing noncompete clauses that exist as of the effective date, except for agreements with “senior executives.”

The rule defines a senior executive as a worker who (1) was in a “policy-making position” and (2) received from the employer total annual compensation of at least $151,164 in the preceding year (or annualized for the preceding year). The rule defines “policy-making position” as a business entity’s (i) president, chief executive officer or the equivalent or (ii) any other officer or natural person who has policy-making authority over the business entity (but not merely a subsidiary or affiliate of the business entity).[7] Employers may enforce noncompete agreements against senior executives if there is a clause in effect as of the rule’s effective date, but may not enter into a noncompete agreements with senior executives after the rule’s effective date.

Almost all other noncompete clauses are not enforceable, whether they date from before or after the rule’s effective date. However, the rule has three other narrow exceptions to this ban. One, parties may enforce a noncompete clause that is part of an agreement with a business owner for the “bona fide 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.”[8] In other words, a person selling their business may be restricted from competing with the business being sold.

Two, the rule “does not apply where a cause of action related to a noncompete clause accrued prior to the effective date.”[9]

Three, the rule includes a good faith exception, which provides that it is not a violation to enforce or attempt to enforce a noncompete clause where a person has a good-faith basis to believe that” the rule is inapplicable.[10]

The rule does not supersede state laws on noncompete clauses, unless those laws would permit the type of noncompete clause that is deemed unfair method of competition under Section 910.2(a) of the rule or unless those laws conflict with the notice requirement in Section 910.2(b).

Finally, the rule is severable if any part is held to be invalid or unenforceable or is stayed pending further action by the FTC.

Almost immediately after the FTC announced that it was issuing the rule, businesses and business groups filed lawsuits in federal court in Texas and Pennsylvania seeking to challenge and block the rule. Ryan, LLC filed first, on the day of the announcement, in the Northern District of Texas.[11] The U.S. Chamber of Commerce and other business associations filed the next day in the Eastern District of Texas.[12] On April 25, 2024, ATS Tree Services sued the FTC in the Eastern District of Pennsylvania.[13] The three cases argue that the rule exceeds the FTC’s rule-making authority and the rule is arbitrary and capricious.

The Texas courts are moving forward with the Ryan case as the one first filed. The Ryan court set a briefing schedule and announced that it will issue a decision on the merits of Ryan’s motion by July 3, 2024.

Meanwhile, the lawsuits do not automatically stay the effective date of the rule, which is, for now, Sept. 4.

While we wait for a ruling by the Texas federal court, the rule is like Schrödinger’s cat: it is neither alive nor dead. It is neither in effect nor should it be ignored. So, what steps, if any, should employers and employees take in response to the FTC Rule?

1. Consider whether the FTC covers your business entity. The FTC’s authority to investigate and enforce applicable law extends to almost all natural persons and entities “engaged in or whose business affects commerce” except private banks, insurance companies, non-profits, transportation and communications common carriers and air carriers.

Non-profit entities should not automatically assume that the rule will not apply to them. The FTC has signaled that an entity’s tax-exempt status as a non-profit may not be enough to avoid its jurisdiction; rather, the FTC will consider both the source of the non-profit’s income and whether the entity was really organized for its members’ profit.

Lawyers should not ignore the rule either when they consider their own career moves. Rule 5.6 of the New York Rules of Professional Conduct already prohibits lawyers from entering into noncompete agreements that restrict their post-employment right to practice law or that impose financial penalties (such as withholding of earned revenues) on attorneys who chose to compete post-employment, with limited exceptions. New York permits noncompetes in connection with the sale of a practice, which would also be permitted under the FTC’s rule. However, Rule 5.6 does not necessarily protect in-house counsel, who provide both legal and non-legal services, from post-employment restrictions on their non-legal services. Rule 5.6 also permits law firms to offer retirement benefits to attorneys who are close to retirement and meet a formula for age and years worked in exchange for limited restrictions on their post-employment practice of law. And Rule 5.6 does not necessarily apply to paralegals, administrators, assistants and other staff. If the FTC’s rule goes into effect, it would prohibit noncompetes for in-house counsel and legal department employees at entities under the FTC’s jurisdiction and prohibit noncompetes for non-attorney law firm employees. It may also eliminate the retirement benefit exception to Rule 5.6.

2. Employers should determine which workers, if any, past and current, have noncompete clauses. If the rule goes into effect, employers will be required to notify employees with noncompete restrictions that the restrictions are no longer enforceable. The FTC rule does not specify how far back employers should go in their files and whether to include workers who may have already received payments and/or equity for abiding by their noncompete restrictions. This is one of several open questions that the FTC will need to address.
3. Review alternatives to noncompete clause, such as confidentiality agreements, non-disclosure agreements, non-solicitation agreements and any other restrictions in place, to determine what provisions the business entity may have or need to protect its proprietary information, trade secrets and any information or relationships that the entity sought to protect by using noncompete clauses.
4. Review any applicable state and local laws on noncompetes. At this point, four states have completely banned noncompete clauses, and other states have limits or restrictions on their use. In New York State, the Legislature passed a ban on noncompetes, but the governor vetoed it. Meanwhile, a bill to ban noncompete clauses was introduced into the New York City Council but did not get through the process.
5. Last, but not least, speak to your employment lawyer. They can help guide you through the federal, state and local rules, and advise you about any new developments.

---

Sheryl B. Galler is a partner at Book Law, an employment firm in New York City. She is immediate past chair of NYSBA’s Labor and Employment Law Section and past chair of NYSBA’s Women in Law Section.

 [1] The rule was published in the Federal Register on May 7, 2024 (89 Fed. Reg. 38342) and will create a new subchapter J, Part 910 of Title 16 of the Code of Federal Regulations. https://www.federalregister.gov/documents/2024/05/07/2024-09171/noncompete-clause-rule.

[2] https://www.federalregister.gov/d/2024-09171/p-68.

[3] https://www.federalregister.gov/d/2024-09171/p-71.

[4] 16 CFR § 910.2.

[5] 16 CFR § 910.1.

[6] Id.

[7] 16 CFR § 910.1.

[8] 16 CFR § 910.3.

[9] Id.

[10] Id.

[11] Ryan, LLC v. Fed. Trade Comm’n, Case No. 3:24-cv-00986-E (N.D. Tex. Apr. 23, 2024).

[12] U.S. Chamber of Commerce v. Fed. Trade Comm’n, Case No. 6:24-cv-00148 (E.D. Tex. Apr. 24, 2024).

[13] ATS Tree Servs, LLC v. Fed. Trade Comm’n, Case No. 2:24-cv-01743 (E.D. Pa. Apr. 25, 2024).