Federal Trade Commission bans most noncompete clauses 

Beginning 120 days after the rule is published in the Federal Register (the “effective date”), employers may not enter into new noncompetes or enforce existing noncompetes, except for agreements with “senior executives” that were in place before the effective date. The rule covers most public and private employers, excluding certain organizations that aren’t regulated by the FTC, such as banks, insurance companies, and nonprofits. It also covers virtually all paid and unpaid workers and independent contractors. Employers must notify workers by the effective date that their noncompetes are unenforceable.

Given the rule is already facing legal challenges that could delay or invalidate it, employers may want to wait to make significant changes to noncompete practices. But they should take this time to determine which individuals qualify for the senior executive exception; review existing nondisclosure and nonsolicitation agreements with all workers to ensure they are broad enough to give the company sufficient protection but not so broad that they would be considered noncompete agreements; explore alternatives to noncompetes; and consider whether to use the window before the effective date to enter into new noncompetes with senior executives. 

According to the FTC’s release, noncompete provisions are an unfair method of competition under Section 5 of the Federal Trade Commission Act.

The rule defines a noncompete clause as a term or condition of employment that prohibits a worker from, or penalizes a worker for, either of the following: (i) seeking or accepting work in the US with a different person where the work would begin after employment ends, or (ii) operating a business in the US after employment ends. This means the following provisions are prohibited:

• An affirmative obligation not to seek or accept other work or start a business after employment ends.
• A “forfeiture-for-competition” clause that imposes adverse financial consequences if a former worker seeks or accepts other work or starts a business.
• An offer of consideration for a noncompete, whether via an up-front payment or severance that’s paid only if a former worker refrains from competing.
• A nondisclosure or nonsolicitation clause that is so broad that it prevents a worker from accepting new employment or operating a business. 

Disputes over what constitutes a noncompete, including whether nondisclosure and nonsolicitation clauses are too broad, are likely to arise. 

The rule covers most public and private companies but doesn’t apply to employers that aren’t regulated by the FTC, including banks, insurance companies, nonprofits, transportation and communications common carriers, and air carriers. With respect to the exception for nonprofits, the release states that, even if an entity is a registered nonprofit for tax purposes (e.g., a healthcare company), it may still be subject to the rule if it’s a profit-making enterprise or organized for the profit of its members. This is likely to raise interpretive issues.

The definition of workers covered by the rule is also very broad. It includes employees, independent contractors, externs, interns, volunteers, apprentices or sole proprietors, whether paid or unpaid. 

Employers may continue to enforce noncompetes with “senior executives” that were entered into before the effective date of the rule. This provides a short window for employers to enter into new enforceable noncompetes with their senior executives before the effective date. 

The rule includes the following definitions:

• Senior executives: Workers who earned more than $151,164 (including salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation) in the preceding 52-week period and who are in a “policy-making position.” The preceding 52-week period is the employer’s choice of the most recent calendar year, fiscal year or anniversary of hire year.
• Policy-making positions: Any officer of a business entity who has “policy-making authority,” such as an entity’s president, chief executive officer or equivalent, including officers of a subsidiary or affiliate of a business entity that is part of a “common enterprise” who has policy-making authority for the common enterprise.
• Policy-making authority: Final authority to make policy decisions that control significant aspects of a business entity or a “common enterprise,” but not authority limited to advising or exerting influence over policy decisions or having final authority to make policy decisions for only a subsidiary or affiliate of a common enterprise.
• Common enterprise: Affiliated companies that have one or more of the following characteristics: maintain officers, directors, and workers in common; operate under common control; share offices; commingle funds; or share advertising and marketing.

The rule doesn’t apply to the following:

• Noncompetes that apply to periods before employment ends
• Noncompetes between the seller and buyer of a business
• Existing causes of action under noncompetes that accrued before the release of the final rule
• Contracts between franchisees and franchisors (but it does cover individuals working for a franchisee or franchisor)

The FTC offers a few alternatives to noncompetes that aren’t categorically banned, including:

• Narrow nondisclosure and nonsolicitation clauses. Nondisclosure and nonsolicitation clauses aren’t specifically covered by the rule. But they could be considered noncompete clauses if they are so broad that they prevent workers from accepting new employment or operating a business after employment ends. These clauses are still subject to state laws and antitrust considerations.
• “Garden leave” arrangements. Arrangements where the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis wouldn’t be noncompete clauses because they aren’t post-employment restrictions. This would be the case even if the worker’s job duties or access to colleagues or the workplace are significantly or entirely curtailed, or a worker isn’t paid an expected aspect of their compensation (e.g., a bonus) because a condition to earn the bonus wasn’t met. 

Employers have until the effective date to notify affected workers that their noncompetes won’t be enforced. The rule includes a model notice with safe harbor language that doesn’t require employers to identify recipients as actually being subject to a noncompete. Instead, they can send a mass communication on paper, by mail, by email or by text to all current and former workers.

The rule preempts state laws “inconsistent with” the final rule, but doesn’t preempt state laws that offer greater protection to workers than the final rule. 

The FTC can seek an injunction in federal court against employers that have entered into noncompetes or otherwise engaged in an unfair method of competition and can obtain civil penalties in court if an employer is ordered to cease and desist from a violation and fails to do so. Complaints regarding suspected violations may be sent to the agency by email or mail.

Opponents of the ban argue that the final rule exceeds the FTC’s authority, is arbitrary and capricious in violation of the Administrative Procedure Act, violates constitutional law, and ignores potential pro-competitive benefits of noncompetes. Significant opposition that could delay or invalidate the rule is expected. For example, the US Chamber of Commerce has already filed a lawsuit to prevent implementation. 

Given the pending and expected legal challenges, employers should wait to make significant changes to noncompete practices, but a few steps employers can take to prepare include:

• Reviewing and/or entering into noncompete agreements with senior executives. Employers should determine which individuals would be considered “senior executives” under the rule, review current noncompete agreements and consider whether to enter into new noncompetes with senior executives before the effective date. These agreements would still be subject to applicable state laws and other antitrust considerations.
• Reviewing and/or adopting nondisclosure and nonsolicitation agreements. Employers should review existing nondisclosure and nonsolicitation agreements to ensure they are broad enough to give the company sufficient protection but not so broad that they would be considered noncompete agreements. Employers that currently have noncompete agreements, but not separate nondisclosure and nonsolicitation agreements, may want to enter into these separate agreements to ensure maximum protection without running afoul of the new rule. As with noncompetes, such agreements would still be subject to applicable state laws and other antitrust considerations.
• Considering garden leave arrangements. Employers should consider garden leave arrangements as an alternative to other types of severance arrangements.
• Drafting notices for non-executives. Employers should be prepared to issue notices to workers (other than senior executives) that their noncompetes will no longer be in effect or enforced as of the effective date.