On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule (the “Rule”) banning noncompete clauses between workers and employers, deeming them “unfair method[s] of competition” under Section 5 of the FTC Act. The Rule was passed by a 3-2 vote split along party lines.

The Rule comes into effect 120 days after its publication in the Federal Register, leading to an anticipated late August / early September 2024 effective date (the FTC anticipates it to be September 4th). However, the Rule has already been challenged by the U.S. Chamber of Commerce and other groups. See Chamber of Commerce v. FTC, No. 6:24-CV-148 (JCB) (E.D. Tex. April 23, 2024) and Ryan, LLC v. FTC, No. 3:24-CV-986-E (AB) (N.D. Tex. April 23, 2024). These challenges, in short, allege that the FTC lacks authority to enact the Rule and that the Rule is contrary to the FTC Act, is arbitrary and capricious and violates the Fifth Amendment due to its retroactive nature.

On a granular level, the main concerns with the Rule are the breadth of its scope and its limited exceptions.

Scope.
Who it Covers. The Rule defines “worker” as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” So, anyone providing services, such as independent contractors, are prohibited from being locked up via noncompete agreements; not just employees.

What it Covers. Outside a “pure” noncompete (you can’t work with someone who competes with the service recipient), the scope of the prohibitions is not clear. The biggest question is the Rule’s application to non-solicitation clauses. While “non-solicitation” clauses are stated to be “outside” the Rule, they become “inside” (covered) by it if they have the effect of being a
“non-compete clause.”

The Rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

So, it becomes a functional test – does the non-solicitation clause act as a noncompete? Well, if a person can’t solicit a client, that would certainly seem to fall within item (1) above; the person would be prohibited from “seeking or accepting work” – that constitutes a “non-compete clause.” It’s a mess, that only fosters uncertainty as to the enforceability of non-solicitation clauses.

Exceptions:
Coverage: The FTC has no authority over “unfair methods of competition” when done by certain banks, nonprofits, common carriers, or persons subject to the Packers and Stockyards Act of 1921. The coverage exceptions are not much use to most businesses.

Sale of Business: The Rule does not apply to a non-compete clause in connection with 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.” Again, unless you are buying a business, the sale of business exception is useless.

Senior Executives. The Rule does not disturb noncompete agreements made before the Rule’s effective date for those workers whom the FTC defines as “senior executives.” A “senior executive” is defined as a worker who earns at least $151,164 per year and serves in a “policy-making position” (which is narrowly defined) with the organization. For workers who are not “senior executives,” however, pre-existing non-competes will no longer be enforceable after the Rule’s effective date. Just to clarify, while pre-existing agreements with “senior executives” will remain enforceable after the Rule’s effective date, employers will not be able to enter into new non-competes with “senior executives” after said date.

Existing Employees. The Noncompete Rule only applies to agreements that restrict workers from taking work with another employer “after the conclusion” of their employment. Therefore, subject to state law, an employer would still remain able to prohibit current employees from working for a competitor. So, if you want to keep a service provider from competing, you have to keep them on the payroll / vendor list and compensate them; thanks, but no thanks.

What to Do.
Because of the risk of the Rule coming into effect when scheduled (late August / early September), there are a few things that you can do now.

1. If there are any “senior executives” who have not been locked up with non-competes, etc., they should be locked up ASAP. State law would determine if continued employment / engagements constitute sufficient consideration to lock up existing “senior executives.”

2. All personnel who should be locked up, should be required to enter into non-disclosure / confidentiality agreements. State law would determine if continued employment / engagements constitute sufficient consideration to lock up existing personnel.

3. Even though non-solicitation clauses could be deemed to be prohibited “non-compete” agreements, all personnel who should be locked up should be required to enter into tailored non-solicitation clauses. These could be limited to customers / clients who they served, who they pitched business to and/or received confidential information about to enhance their enforceability. This may be the best line of defense. State law would determine if continued employment / engagements constitute sufficient consideration to lock up existing personnel.

4. The Rule requires that personnel bound by non-compete clauses have to be notified that their non-competes will no longer be enforced; the FTC has prepared a model notice. This notice would not go out to existing “senior executives” who have non-competes. Consideration should be given to make the notices conditioned upon the Rule’s effectiveness.

The Bottom Line: Anyone concerned with governmental overreach and its interference with the right of private parties to contract between themselves as they deem fit should be troubled by the Rule. I must have missed the constitutional law class that explained why the Federal Government has the power to dictate the enforcement of noncompete agreements between private parties. Last time I checked, the 10th Amendment (stating that any powers that aren’t mentioned in the Constitution as expressly belonging to the federal government belong to the states themselves) has not been repealed. It has been in effect since its ratification on December 15, 1791, but has certainly taken some body blows over the years. If the states want to govern noncompete agreements, as many have, let them do so. We don’t need Big Brother expanding its control in yet another aspect of life.