Federal Trade Commission Issues Sweeping Non-Compete Ban

On April 23, 2024, the U.S. Federal Trade Commission (“FTC”) issued a proposed final rule that would ban most post-employment non-competition agreements—deeming them an “unfair method of competition” under Section 5 of the FTC Act. The final rule is sweeping in its application, covering most clauses that would effectively restrict workers’ post-termination employment opportunities. Certain notable issues, such as its application to equity awards and partnership agreements, are not squarely addressed in the final rule, creating lingering uncertainty and room for interpretation and disputes.

The rule will become effective 120 days after its announcement and publication in the Federal Register (on or around August 21, 2024), but it is already subject to legal challenge, including lawsuits seeking to enjoin the rule from taking effect while courts consider whether the issuance of the rule was within the scope of the FTC’s authority and otherwise comports with constitutional and administrative law.

Summary of Material Provisions

For “senior executives”—those earning at least $151,164 in total annual compensation and who hold a “policy-making position”—non-compete provisions entered into before the final rule goes into effect will remain enforceable, but employers are prohibited from entering into any new non-competes with “senior executive” employees after the rule takes effect.

For all other workers, all non-compete provisions—including those already in place—will be deemed “an unfair method of competition” and therefore prohibited once the rule becomes effective. Employers will be required to notify employees and other workers subject to unlawful non-competes that such provisions cannot be enforced against them.

The final rule does not apply to non-competes entered into in connection with a bona fide sale of a business entity, of a person’s ownership interests in an entity, or of all or substantially all of an entity’s operating assets. In its commentary, the FTC noted that the “bona fide” qualifier was included to make clear that sales falling within the exception are those made at arms’ length, and in which the seller “has a reasonable opportunity to negotiate the terms of the sale.” The FTC also clarified that the exception does not cover non-compete clauses arising out of repurchase rights and mandatory stock redemption programs because, according to the FTC, the worker has no knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting. Further, the FTC stated in its commentary that the exception does not cover so-called “springing non-competes”—those that become effective upon the breach of a contractual obligation or other duty.

The rule does not purport to make unlawful any restrictive covenants other than non-competes (e.g., non-solicits, non-disclosure agreements). However, to the extent that such provisions “penalize” or “function to prevent” a worker from seeking or accepting work or operating a business after their employment ends, such provisions would be impermissible under the final rule.

Analysis & Practical Implications

As an initial matter, it may be far longer than 120 days before the rule actually takes effect, as a result of an inevitable wave of legal challenges. Within hours of the rule’s issuance, a global tax services firm and software provider, Ryan, LLC, filed suit in the United States District Court for the Northern District of Texas seeking to challenge the rule, asserting that the Commission does not have statutory authority to promulgate such a rule, and even if it did have such authority, it would be an unconstitutional delegation of legislative power. The U.S. Chamber of Commerce separately filed its own lawsuit in the U.S. District Court for the Eastern District of Texas, seeking to enjoin the rule from taking effect, emphasizing that the rule would force businesses to suffer immediate costs associated with overhauling their compliance practices, and “deprive [them] of the opportunity to protect their investments [and] promote specialized workforce training.”

Other challenges are sure to follow, likely resulting in delays in implementation. Until these challenges are resolved and the rule takes effect, employers may continue to enter into and enforce valid non-competition agreements, and their enforceability remains primarily a matter of state law.

An area that remains unclear in the final rule is its application to non-competition agreements entered into in connection with sophisticated incentive compensation or profit-sharing plans, including carried interest plans in which the carry vehicle entity (typically an LLC or partnership) is not the employer, and the individual is a member of or partner in the carry vehicle entity, not an employee or independent contractor. The rule applies to any such agreements entered into with a “worker” performing services for a “person.” The definition of “worker” notably omits “partners” and “members,” while the definition of “person” includes any corporation, partnership, LLC, or other legal entity. The Commission’s summary of the rule suggests that it intentionally used broad language “designed to capture indirect employment relationships as a general matter without regard to the label used,” and “regardless of whether an employment relationship exists under another law, such as a Federal or State labor law.” Nevertheless, the lack of clarity will likely invite litigation over differing interpretations of the rule’s applicability.

The rule also takes aim at forfeiture-for-competition provisions, including those requiring or permitting the forfeiture or repurchase of equity interests or the clawback of severance or equity proceeds, in a stark departure from the Delaware Supreme Court’s decision in Cantor Fitzgerald, L.P. v. Ainslie earlier this year. In Cantor, the Delaware Supreme Court took pains to distinguish forfeiture provisions from traditional non-competes and held that the former do not function as a penalty and therefore should not be subject to the same level of scrutiny as non-competes. The Commission has taken the opposite approach, describing forfeiture provisions as unfairly punitive without attempting to reconcile—and without even acknowledging—the recent Delaware ruling.

The Commission’s commentary around “de facto” non-competes also leaves much to interpretation. The final rule does not specifically address non-solicits or non-disclosure agreements, and the Commission appears to be content to allow agency enforcement practice and/or litigation determine when the enforcement of such provisions crosses the line and “functions to prevent” employment opportunities, on a case-by-case basis.

One notable change from the initial January 2023 proposed rule (as summarized here) to the final rule is that the FTC eliminated the previous 25% ownership threshold for invoking the sale-of-business exemption. Under the final rule, employers can invoke the exception regardless of the level of equity ownership held by the employee, subject to a “totality of the circumstances” review of whether there was a bona fide sale of a business’s goodwill.

Go-Forward Recommendations

As we continue to monitor the fallout from the FTC’s final rule, we recognize that many clients will want to take preemptive steps.

Employers should ensure that employees whose non-competition agreements would be voided by the rule are bound by robust—yet reasonably tailored—customer and employee non-solicitation clauses. Employers may also wish to consider using the 120-day period to roll out new benefit and incentive plans that incorporate non-competition covenants to senior executives not previously bound by non-competition agreements before the rule takes effect.

In addition, given the continued uncertainty and pending legal challenges, employers may consider whether to retain certain provisions for deterrent effect until the landscape comes into clearer focus.

Please contact any member of Ropes & Gray’s employment or antitrust teams for further guidance on the FTC’s final rule.