The Non-Compete Rule¹

On April 23, 2024, the Federal Trade Commission (FTC) voted 3-to-2 to enact a final rule preventing most employers from enforcing non-compete agreements against their employees, affecting nearly 30 million workers across the United States.² The rule defines non-competes broadly as any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” either “seeking or accepting work in the United States with a different person,” or “operating a business in the United States after the conclusion of the [worker’s] employment.”³

Under this rule, it is now illegal for employers to:

• Enter into or attempt to enter into a non-compete agreement with a worker;
  
  
• Enforce or attempt to enforce a current non-compete agreement, except as to current non-compete agreements of “senior executives;”⁴ or
  
  
• Represent to a worker under certain circumstances that they are subject to a non-compete agreement.

This rule applies to both paid and unpaid employees as well as independent contractors across all sectors of the economy. Additionally, it extends to non-disclosure agreements, non-solicitation agreements or other agreements if they function as de facto non-compete agreements. 

The rule carves out a few narrow exceptions, however. It does not apply to non-compete agreements that are part of the bona fide sale of a business. It also does not apply to workers for nonprofit entities, which are not subject to FTC’s jurisdiction, or causes of action that accrue prior to the effective date of the rule, 120 days after its publication in the Federal Register. Finally, it “does not include a franchisee in the context of a franchisee-franchisor relationship.”⁵

Unless enjoined in court, businesses will have a 120-day grace period to come into compliance and provide notice of non-enforceability to individual current and former employees.

Note that the final rule preempts state laws and local regulations that would otherwise allow companies to use non-compete agreements. More stringent state laws that provide greater worker protections, are unaffected. 

The rule raises significant questions regarding the scope and constitutionality of the FTC’s claimed statutory rulemaking authority, including under the Supreme Court’s recently expanded “major questions doctrine,” which featured prominently in the dissenting commissioners’ comments before their “no” votes on the Non-Compete Rule. Under that doctrine, courts are hesitant to find a delegation of decision-making power to administrative agencies on issues of major economic or political significance, particularly where a statute is ambiguous. Preemptively defending the Rule, Chair Lina Khan took the position that the “most straightforward reading” of the FTC Act allowed for unfair competition rulemaking. The U.S. Chamber of Commerce filed suit along with Business Roundtable and two Texas business associations in the Eastern District of Texas to block the Rule on April 24, 2024, calling it an “astounding assertion of power [that] breaks with centuries of state and federal law.”⁶ As litigation unfolds, a court may issue a temporary restraining order or a preliminary injunction, which would suspend the rule while the legal challenge moves through the courts. 

Takeaways

• Compliance. Companies should prepare for unenforceability of their current employment agreements (except for those of “senior executives” in effect as of the effective date of the rule) and to reform their future employment agreements to comply with the new rule and provide the required notice to current and former employees over the next four months.   
  
  
• Risk Evaluation. Companies should consider whether other restrictive covenants used to protect their business may violate the Non-Compete Rule. Potential examples include non-disclosure agreements, client or customer non-solicitation agreements, no-business agreements, no-recruit agreements, liquidated damages provisions, training-repayment agreements, no-poach agreements, or wage-fixing agreements. Under the Rule, such agreements are not subject to a blanket prohibition but rather are only prohibited if they prevent workers from taking employment at (or starting) a new company. 
  
  
• Litigation. Companies relying on non-competes to protect significant business interests may consider joining potential declaratory judgment suits to delay enforcement of the FTC rule.
  
  
• M&A Planning. Non-compete agreements pursuant to the “bona fide sale of a business entity” are exempted from the rule’s general prohibition but remain subject to pre-existing state and federal antitrust laws, and state non-compete laws. To qualify for this exception, the non-compete must be negotiated between two independent parties at arm’s length and when the seller has a reasonable opportunity to negotiate the terms of the sale. In addition, current non-competes of “senior executives” may continue to be valuable as a Code Section 280G mitigation technique; however, under the final rule, non-compete agreements entered into after the effective date of the rule may not be utilized even for “senior executives,” which would seemingly limit the ability to utilize this very common Code Section 280G mitigation strategy for “senior executives” who enter into non-compete agreements after the effective date of the rule.
  
  
• Senior Executives. Companies should assess, and consider entering into, non-compete agreements with their “senior executives” prior to the effectiveness of the rule. Under long-standing principles, such non-compete covenants would need to be compliant with applicable state law, including being supported by adequate consideration. 

• Trade Secrets. As has been the case in California for many years, having solid enforceable non-disclosure agreements that protect confidential information and other protections of trade secrets will be increasingly important as the focus shifts from non-compete provisions to protection of trade secrets and other confidential information known to departing employees.

The FTC’s Non-Compete Rule is a significant development as it overturns numerous long-standing state statutory and common laws. This rule affects companies in all fields, but we expect that it will have an outsized impact on sectors and businesses that have traditionally placed greater reliance on non-competes, such as medicine, manufacturing, technology, finance, private equity, and acquisitive companies. Baker Botts attorneys can help you navigate the new landscape across compliance, risk evaluation, litigation and M&A planning.

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