Neal F. Perryman, Chair of the Litigation Department

A new final rule issued by the FTC this week (the “New Rule”) declares almost all non-compete clauses—including clauses in existing agreements with present or past employees—to be “unfair methods of competition” and therefore unenforceable. The New Rule represents a sea change in the ability for employers to protect their legitimate business interests through non-compete agreements. Although the New Rule may ultimately be invalidated by a court, an increasing number of states are banning or placing restrictions on non-compete agreements. In light of this trend, employers should take this opportunity to consider additional or alternative means of protecting their legitimate business interests, including trade secrets and customer goodwill. Some questions about the effect and scope of the New Rule are addressed in this Alert.

Since 1914, Section 5 of the Federal Trade Commission Act has allowed the FTC to declare unlawful any "unfair methods of competition in or affecting commerce.” For over one hundred years, that statute has co-existed with court decisions and statutes in nearly all fifty states that permit, to a lesser or greater extent, employers to require employees to agree to non-competition clauses that govern post-employment conduct. The New Rule would declare many non-compete agreements “unfair methods of competition." 

What Does the New Rule Prohibit?

The New Rule declares that it is an unfair method of competition to (1) enter into or attempt to enter into, (2) enforce or attempt to enforce, or (3) represent that a worker is subject to, a non-compete clause.

The phrase “non-compete clause” is defined broadly and includes any term or condition of employment that prohibits or penalizes a worker for, or functions to prevent a worker from, seeking or accepting work in the United States, or from operating a business in the United States, at the conclusion of the worker’s employment.

Further, the term “worker” broadly includes any person who works or used to work for any other person or company—regardless of whether the person was an employee, independent contractor, intern, or unpaid volunteer.

How Does the New Rule Affect Other, Related Agreements that Protect Employers’ Business Interests?

The New Rule adopts a functional test to identify a prohibited non-compete clause, which means any term or condition that restricts a worker’s post-employment conduct must be evaluated to determine whether it has the practical effect of preventing the worker from seeking employment in the same field after the end of his or her employment.

In its explanation of the New Rule, the FTC identified non-disclosure agreements, training-repayment agreements, and non-solicitation clauses as examples of agreements that may impermissibly function as non-compete clauses. Although the New Rule does not categorically prohibit these agreements, it does require a case-by-case inquiry to determine whether any term or condition of employment functions to prevent a worker from accepting an offer of employment or starting a business.

Does the New Rule Have Any Exceptions?

Yes. The first exception allows non-compete clauses entered into before the New Rule’s effective date to remain in effect, so long as the subject of the noncompete is a “senior executive.” A senior executive is an employee, irrespective of title, who (1) is in a “policy-making position” and (2) earns a total annualized compensation of at least $151,164. Non-compete agreements with senior executives are invalid if entered into after the New Rule’s effective date.

Another exception permits a non-compete clause that a person enters pursuant to a bona fide sale of a business entity, of the person’s ownership of a business entity, or of substantially all of the business entity’s operating assets.

Finally, the New Rule includes a good-faith exception that protects employers who, on the basis of a good-faith belief that a particular non-compete clause does not violate the New Rule, enforces or attempts to enforce it.

How Does the New Rule Apply to Employers with Nonprofit Status?

This question will be decided on a case-by-case basis. The FTC’s statutory jurisdiction extends over only those entities that are organized to carry on business for their own profit or that of their members. Many employers, such as hospitals, are 501(c)(3) tax-exempt nonprofit organizations. However, the FTC has argued, and some courts have agreed, that its jurisdiction extends over certain 501(c)(3) organizations that operate as though they are for-profit entities—businesses whose revenue derives from commercial activities and who seek to maximize profit. This analysis is a case-specific inquiry, although the FTC’s commentary on the New Rule indicates that it believes some nonprofit hospitals will be subject to the New Rule’s restrictions.

What Does the New Rule Mean for Existing Non-Compete Agreements?

Subject to the exceptions above, the New Rule declares that all currently existing non-compete agreements are invalid. Employers are prohibited from enforcing them or attempting to enforce them.

Additionally, employers must provide “clear and conspicuous” notice to current and former employees who are currently subject to prohibited non-compete clauses that such clauses “will not be, and cannot legally be, enforced against the worker.”

What Does the Rule Mean for Future Non-Compete Agreements?

Except for non-compete agreements entered into in connection with the bona fide sale of a business, the New Rule would prohibit any new non-compete agreements, anywhere in the United States. The exception for existing non-compete agreements with senior executives does not permit new non-compete agreements with senior executives in the future.

Does the New Rule Affect Attempts to Enforce Non-Compete Agreements That Have Already Been Filed or Are About to Be Filed?

No. The New Rule does not apply to any causes of action that accrue prior to the New Rule’s effective date. If the New Rule becomes effective, it will not extinguish any pending lawsuits related to non-competes and will not prohibit lawsuits based on a cause of action related to a non-compete, if the cause of action accrued prior to the New Rule’s effective date.

When Does the New Rule Go Into Effect?

The New Rule will go into effect 120 days after its publication in the Federal Register, which is anticipated to occur in late April, unless a court issues an order that prevents it from being enforced.

Are There Any Legal Challenges to the New Rule Currently Pending?

Yes. On April 23, 2024, the U.S. Chamber of Commerce filed a lawsuit in federal court seeking an injunction that would prevent the New Rule from ever going into effect. Though this lawsuit is still in its early stages, Lewis Rice will monitor its status and provide updated client guidance based on new significant developments.

If you have questions about the effect of the New Rule, or if you are seeking guidance about the validity of non-compete agreements, please contact one of the authors listed above.