Today, the Federal Trade Commission (FTC) voted 3-2 to issue its final rule on noncompetes, imposing a near-total ban on all employer-employee noncompetes in the US. Barring challenges (which are expected), the rule would become effective 120 days from publication.
The rule will be a game-changer for companies operating in the US if it takes effect as issued. Here’s what you need to know now.
What does the rule do?
With only a few exceptions, the FTC’s now-final rule declares employer-employee noncompete clauses an “unfair method of competition,” and a violation of Section 5 of the FTC Act. The rule targets both formal noncompete clauses and “de facto” noncompete clauses that have “the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.” This can include broad nondisclosure agreements that have the effect of precluding workers from seeking employment opportunities in the same field.
Who does the rule apply to?
The rule applies to a “worker” who is defined as a natural person who works or previously worked for a person, paid or unpaid, without regard to the worker’s title or status under other state or federal laws. “Worker” includes an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. A “worker” includes a person working for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.
- The final rule bans new noncompetes with all workers, prohibiting employers from entering into noncompete clauses with workers on or after the final rule’s effective date.
- The final rule also bans existing noncompetes with most workers. Existing noncompetes with senior executives (workers earning more than $151,164 annually who are in a “policy-making position”), are spared and remain enforceable–though new noncompetes with senior executives are banned.
When is compliance required?
The final rule will become effective 120 days after publication in the Federal Register, but we expect legal challenges and, therefore, delays. The US Chamber of Commerce vowed to challenge the rule in court, and several other third-party organizations are also preparing to sue. This litigation could impact the new rule’s effective date because courts will consider whether to stay the rule while challenges are pending.
Which noncompetes are covered by the rule?
The rule applies to noncompetes that prohibit, penalize, or functionally prevent workers from:
- Seeking or accepting work in the US 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 US after the conclusion of the employment that includes the term or condition.
Are any noncompetes exempt from the new rule?
Yes.
- As mentioned above, existing noncompetes with senior executives as defined in the rule, are exempt.
- Noncompetes between franchisors and franchisees in franchise agreements are excluded from the rule’s prohibitions (but noncompete agreements between franchisors or franchisees and their respective workers are still covered).
- The rule does not apply to noncompetes with employees who work outside of the US.
- The rule does not apply to noncompetes entered into by a person pursuant to a “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.
- Importantly, the rule no longer includes a requirement that the restricted party be a substantial owner of, or substantial member or substantial partner in, the acquired business entity.
- If this exception remains, there will likely be increased use of partnership structures in certain types of business in order to continue using noncompetes.
How does this rule fit with existing state laws on noncompetes?
Where state laws conflict with the rule, the rule preempts them. But if there is no conflict, the rule does not otherwise limit or affect enforcement of state laws that restrict noncompetes.
What’s next, and what do companies need to do to comply?
Although the expected legal challenges may delay implementation of the rule, employers should start to prepare a compliance strategy.
- Know what you have. Companies should inventory all noncompetes, if they have not done so already.
- Check offer letters, employment agreements, proprietary information and invention assignment agreements (PIIAs), stock option and award agreements, and other compensation-related agreements.
- Companies should carefully review all employment documentation (including things like employment agreements, PIIAs and equity awards) for language that may have the effect of a noncompete to determine whether the noncompetes will be prohibited when the rule takes effect, and whether form agreements must be modified to remove noncompete clauses.
- Prepare to give notice. Companies that have existing noncompetes with workers who are not “senior executives” must provide such workers with notice that their noncompetes are no longer enforceable as of the rule’s effective date. (This differs from the proposed rule, which would have required employers to formally rescind noncompetes.)
- The FTC provides model notices (in several languages) on its Noncompete Rule webpage. Notice can be delivered by email, text message, or a paper notice by hand or mail–and if the employer has no contact information for the former worker, no notice is required.
- We have experience with helping clients craft a plan to notify current and former employees that their noncompete clauses are void (see our blog on California’s AB 1076). Contact a member of our team for assistance.
- Know the details. The FTC has provided some resources, including a Fact Sheet on the FTC’s Noncompete Rule and the FTC’s Noncompete Rule webpage, that may be helpful to review.
Special thanks to Mark Hamer, Creighton Macy, Arvind Miriyala, and William Rowe.
