CLIENT ALERT: What you need to know about the FTC’s Historic Ban on Non-competes
Highlights:
- For-profit, public and non-public employers, existing non-competes with senior executives remain enforceable. Employers must notify all other employees that existing non-competes are unenforceable by the effective date.
- Employers are prohibited from entering into new non-competes with all employees, including senior executives, after the effective date.
- The Final Rule becomes effective 120 days after publication in the Federal Register.
Background:
On April 23, 2024, the Federal Trade Commission (“FTC”) issued its Final Rule banning retroactively almost all non-competes nationwide, across all business sectors, most business entity forms and for both public and non-public companies. Acting on an Executive Order issued by the Biden Administration in July 2021, the FTC was tasked to “exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” The Final Rule will not take legal effect until 120 days from its publication in the Federal Register (“Effective Date”). Consequently, the Final Rule has no current legal effect on existing non-competes until the Effective Date.
With respect to existing non-competes in contracts, the Final Rules takes two different approaches for “senior executives” and all other employees. Existing non-competes with senior executives remain effective and enforceable. As to all other employees, the Final Rule provides that existing non-competes promote an “unfair method of competition” and are no longer unenforceable. As to the latter, absent good faith, it would be a violation of the Final Rule “to enter into or attempt to enter into a non-compete clause; to enforce or attempt to enforce a non-compete clause; or to represent that the worker is subject to a non-compete clause.”
The Final Rule also provides that, with respect to “senior executives” who enter into contracts containing a non-compete term or clause after the Effective Date, it would also be a violation of the Final Rule to “to enter into or attempt to enter into a non-compete clause; to enforce or attempt to enforce a non-compete clause; or to represent that the worker is subject to a non-compete clause.” The Final Rule prohibits all other employees from entering into non-competes after the Effective Date.
The scope of the Final Rule is unprecedented, but still requires a fact-intensive review for both employers and employees to determine who may or may not be covered by the Final Rule once effective.
The Final Rules defines a “senior executive” to be a worker who:
- “was in a policy-making position (for any part of the preceding year); and
- received from a person for the employment:
- total annual compensation of at least $151,164 in the preceding year[1]; or
- total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or
- total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.”
The Final Rules defines a “policy-making position” as follows:
[A] business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. The definition of ‘policy-making position’ further states that an officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position for the business entity for purposes of this paragraph.As used in the definition of “policy-making position,” an “officer” is a “president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any natural person routinely performing corresponding functions with respect to any business entity whether incorporated or unincorporated.” Further, “[t]o account for differences in the way business entities may use and define job titles, the definition includes workers in equivalent roles. By incorporating this definition of ‘officer,’ ‘senior executive’ applies to workers at the highest levels of a business entity.”
Of note, the Final Rule’s “officer” definition is nearly identical to the Securities and Exchange Commission’s definition of “officer” as set forth in its Rule 3b-7.[2]” There are some noteworthy differences. First, the Final Rule’s term “chief executive officer or the equivalent” is intended to be given an expansive (not limiting) interpretation to “to reflect the wider range of businesses with various structures that are subject to the final rule.” Thus, the FTC favors a focus on anticompetitive effects over business formation types. Second, the Final Rule extends to non-public companies, whereas SEC Rule 3b-7 does not. Third, unlike SEC Rule 3b-7, the Final’s Rule’s definition of “policy-making position” does not include the phrase “any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration or finance)” in the definition of “executive officer.” The FTC’s removal of employees who hold the title of vice president from the definition of “executive officer” is intentional. The FTC takes the position that there is a “broader array” of non-public business entity forms that employ “workers who, despite their titles, are among those who are likely to be coerced or exploited by non-competes.” More specifically, “the only group of workers that is likely to have bargained for meaningful compensation in exchange for their non-compete is senior executives who are both highly paid and, as a functional matter, exercise the highest levels of authority in an organization.”
The Final Rule also speaks to employees who may hold a “senior executive” position in a subsidiary or affiliate business that is part of larger “common enterprise.” The Final Rule excludes from the definition of “senior executive” an employee with “policy-making authority over only a subsidiary or affiliate of a common enterprise who do not have policy-making authority over the common enterprise.” In other words, if the employee does not have “policy-making authority with respect to the common enterprise as a whole, not just a segment of it,” the employee will not be treated as a “senior executive” as to whom the Final Rule does not apply. The FTC reasons as follows:
Workers who head a subsidiary or affiliate of a common enterprise are similar to department heads; the senior executives controlling the entire common enterprise control those individual subsidiaries and affiliates. As the Commission has explained, the Commission finds that department heads and other highly paid non-senior executives do not have sufficient bargaining power to avoid exploitation and coercion and are unlikely to have bargained in connection with non-competes.[3]
The Final Rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity.
In addition, the Final Rule does not apply where a cause of action related to a breach of a non-compete accrued prior to the Effective Date. Thus, it does not apply where an employer commences an action for violation of a non-compete if the alleged breach occurred prior to the Effective Date.
Again, the Final Rule will not take legal effect until 120 days from the publication of the Final Rule in the Federal Register. Consequently, the Final Rule has no current legal effect on existing non-competes until the Effective Date. Once effective, however, employers must provide employees with existing non-competes notice that they are no longer enforceable. The Final Rule includes proposed, model notice language that may be provided to employees on paper, by mail, by email, or by text.
Once the Final Rule is effective, employers or employees may report information on a suspected violation of the Final Rule to the Bureau of Competition. The Final Rule, however, does not itself create a private right of action. Likewise, it does not preempt State statutes, regulations, orders or interpretations thereof, including with respect to State antitrust, consumer protection and common law. The FTC’s position is that States may continue to enforce their own laws so long as such activities do not conflict with the Final Rule (even if the State statutes, regulations, orders or interpretations thereto, are narrower than the scope of the Final Rule).
On April 24, 2024, the United States Chamber of Commerce, together with a coalition of other interests, filed a lawsuit captioned, Chamber of Commerce of the United States of America v. Federal Trade Commission, Case No. 6:24-cv-00148, in the United States District Court for the Eastern District of Texas, Tyler Division. The lawsuit seeks both declaratory and injunctive relief challenging the Final Rule, including the FTC’s position that “individual noncompete agreements [are] ‘unfair methods of competition’ under the FTC Act” and the position that the FTC Act grants the FTC broad rulemaking authority for “unfair methods of competition.”
According to the lawsuit, “Congress has never empowered the Commission with general rulemaking authority regarding matters under its jurisdiction.” The lawsuit also challenges the retroactive rulemaking effect or result of the Final Rule, as not authorized under the FTC Act.
In anticipation of a legal challenge to the Final Rule, the Final Rule also articulates the position of the FTC that, absent a “judicial ruling on the validity” of the Final Rule, compliance is mandatory upon the Effective Date.
Takeaways
For-profit, public and non-public employers covered by the Final Rule should immediately start to review their own hiring and retention policies and procedures, employee handbooks and manuals, contracts and offers in anticipation of a potentially unprecedented change in the employer-employee landscape across all sectors and wherever employers and employees work. Without regard to any delay in the implementation of the Final Rule, in whole or in part, employers and employees should begin preparing for the possibility that non-competes may be prohibited across the United States for all but a small percentage of senior executives.
For more information and guidance on the FTC’s Final Rule relating to non-competes, and its potential impact on your business or your employment, contact Daniel Scott Furst or another member of Sichenzia Ross Ference Carmel’s Business Litigation & Arbitration, Broker-Dealer Regulation and Compliance Groups.
About The Author
Scott Furst is a member of Sichenzia Ross Ference Carmel’s Business Litigation & Arbitration, Broker-Dealer Regulation and Compliance Groups. He has extensive civil litigation, regulatory action, investigations and enforcement defense experience with a specialization in securities, business, complex commercial litigation and employment matters involving senior executives, including with regard to contract disputes, investor, shareholder and member disputes, covenants litigation and statutory discrimination claims, in state and federal courts, before the Securities and Exchange Commission, Financial Industry Regulatory Authority, American Arbitration Association, and JAMS. Mr. Furst also routinely advises, negotiates and drafts employment and transactional agreements for senior executives across all business sectors, including officers and investors in the fund structure and formation space for private equity funds, hedge funds, real estate funds and hybrid vehicles for alternative investments.
[1] “Total annual compensation” is defined to include “salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during that 52-week period. Total annual compensation does not include board, lodging and other facilities as defined in 29 CFR 541.606, and does not include payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other similar fringe benefits.”
[2] 17 CFR 240.3b-7 (“The term executive officer, when used with reference to a registrant, means its president, any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions for the registrant. Executive officers of subsidiaries may be deemed executive officers of the registrant if they perform such policy making functions for the registrant.”)
[3] The Final Rule provides that, “[t]o be considered a ‘common enterprise’ for the purposes of defining policy-making authority and policy-making position, the Commission looks beyond legal corporate entities to whether there is a common enterprise of ‘integrated business entities.’ This means that the various components of the common enterprise have, for example, one or more of the following characteristics: maintain officers, directors, and workers in common; operate under common control; share offices; commingle funds; and share advertising and marketing.”
