FTC Issues New Rule—But Not the Final Chapter—on Non-Competes: What Employers Need to Know

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On April 22, the Federal Trade Commission issued its final “Non-Compete Clause Rule” which bans most non-competes in the United States. It will become effective 120 days after it is published in the Federal Register.

If it becomes effective—which is far from certain—the Rule will have a sweeping impact on the U.S. economy and employers’ hiring and compensation practices. The FTC estimates that 30 million employees in the U.S. are subject to non-competes.

Planning for this possibility is clearly important for U.S. businesses that utilize non-competes. However, it is also important to emphasize that the Rule is not yet in effect and may never be. There are already at least two lawsuits filed to halt implementation of the Rule, including a suit by the U.S. Chamber of Commerce. The lawsuits seek to block the Rule on several grounds, including its Constitutionality and the FTC’s authority to issue the Rule in the first place. While the FTC lays out its counterarguments in the explanation of the Rule, it is possible that one of the courts may issue a stay of the Rule while the suits progress in order to keep the Rule from being enforced.

If implemented, the Rule effectively will ban future non-competes and invalidate those in place for all employees who are not “senior executives,” which the Commission calls “Workers.” “Senior Executive” is defined based on an earnings test and a job duties test. In general, the term “Senior Executives” refers to workers earning more than $151,164 who are in a “policy-making position.” Employers must inform Workers that existing non-competes are unenforceable, though they need not retract them, as was contemplated in the Proposed Rule. For Senior Executives, non-competes currently in place may remain, but new ones are prohibited. Note that the Rule will apply to all workplace policies, whether oral or written, including manuals, not just written contracts. The Rule also will apply nationwide, as the FTC claims the Rule pre-empts conflicting state laws.

There are certain limitations to the Rule that are worth noting. First, the Rule does not apply to franchisees or to non-competes arising in the sale of a business. Second, the Rule only applies within the United States. Employers can prohibit taking a job or starting a business outside the U.S., which is another difference from the Proposed Rule. 

Moreover, it is important to keep in mind that the Rule prohibits “non-competes” where a worker is prohibited from, penalized for, or prevented 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. It also does not prevent agreements that restrict competition during employment – only post-employment non-compete are prohibited. 

So, as recognized in the FTC’s comments, the Rule “does not categorially prohibit” covenants that prohibit non-solicitation of customers or employees. But the FTC cautions against any non-solicitation restriction “that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends,” which will be deemed to be a non-compete prohibited under the Rule.

Notwithstanding the FTC’s action, appropriately drafted and targeted confidentiality provisions with employees and non-disclosure agreements (NDAs) should remain fully enforceable (and, should the Rule survive the legal challenges, likely will be even more important). State and federal statutes protecting trade secrets are still effective, including state versions of the Uniform Trade Secrets Act and the federal Defend Trade Secrets Act. In fact, the Commission argues that that “employers have adequate alternatives to non-competes to protect these interests, including trade secret law and NDAs, and that these alternatives do not impose the same burden on competition as non-competes.” But again, the Rule does not categorically approve NDAs, and leaves open that overly broad NDAs risks having the same “functional effect” as a non-compete and, thus, also indirectly may be barred by the Rule.

Nevertheless, as businesses that have attempted to stop unfair competition can attest, while well drafted NDAs and trade secret laws are important tools to protect assets, they are not always perfect solutions. Generally, businesses have limited visibility into whether a former employer working for a competitor is using confidential information to their detriment. So, while confidentiality agreements can be helpful, enforcing them means one has to know about and then establish the violation in court, which can be particularly challenging when the former employee claims to be using general knowledge and skills developed over the course of the career. Similarly, suing for misappropriation of trade secrets can help protect businesses and their intellectual property, but again, one must prove that what was taken and used is a “trade secret” as defined in the law, and not all business information is a “trade secret,” such as customer sales relationships, which standing alone, are not. 

In sum, the Rule, if it goes into effect, will change dramatically how businesses hire, compensate, train, and seek to retain employees, and will require all businesses to reconsider their agreements with employees and how best to protect trade secrets and customer relationships. There are over 500 pages of commentary addressing multiple comments, objections, and changes from the Notice of Proposed Rule Making (NPRM), which may provide guidance on specific questions about the Rule’s application. In the near term, businesses should continue to track the progress of the legal challenges to the Rule, including whether it is struck down or its enforcement delayed, and begin planning for what steps to take if the Rule ultimately is upheld.