Nah, Nah, Nah, Nah, Hey, Hey, Hey, GOODBYE...Non-Competes
Let the countdown begin.
Last Tuesday, the Federal Trade Commission (FTC) published its final rule prohibiting non-compete agreements in nearly all employment contexts. When the rule becomes effective on September 4, 2024, most existing non-competes will be invalidated, and new non-competes will be prohibited nationwide.
Whether you praise the FTC's decision or curse it, the near-total ban on non-competes will profoundly impact businesses and workers alike. You can read (all 165 pages of) the final rule here: https://www.govinfo.gov/content/pkg/FR-2024-05-07/pdf/2024-09171.pdf.
THE BACKSTORY: HOW DID WE GET HERE?
Once upon a time, the 2020 Democratic presidential candidate campaigned on broadly eliminating non-compete agreements. That candidate became President and made good on his promise. In July 2021, President Biden issued an Executive Order (EO) on Promoting Competition in the American Economy, which encouraged the FTC 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 FTC took its directive seriously. In January 2023, the FTC proposed a rule prohibiting employers from entering into non-compete agreements with employees and invalidating all existing non-compete agreements nationwide. You might have heard the uproar.
But the presidential candidate and the FTC weren't acting on a whim. The widespread (and often abusive) use of non-compete agreements has been under fire for years. Several states severely restrict the use of non-compete agreements, and a few states, like California, Nebraska, North Dakota, and Oklahoma, have near-total bans on non-compete agreements. What makes the FTC rule so polarizing is its sheer scope (and perhaps the FTC's audacity). The rule is a sledgehammer. I'm willing to bet no one, including President Biden, expected the FTC to ban all non-competes.
In support of its rule, The FTC determined that the use of non-compete agreements is an unfair method of competition under section 5 of the Federal Trade Commission Act (FTC Act). The FTC says a nationwide non-compete ban is necessary to "promote competition, protect[] the fundamental freedom of workers to change jobs, increas[e] innovation, and foster[] new business formation." Laudable goals. The problem is that the FTC probably didn't have the authority to enact the ban in the first place, and how this will eventually play out is a mystery.
In the meantime, let's talk about preparing for the ban if it becomes effective on September 4, 2024.
WHO DOES THE BAN APPLY TO?
The FTC's ban is sweeping. When clients ask me who the ban applies to, I half-jokingly respond, everyone. Let's unpack it, starting with the key defined terms.
Definition of "Worker." The rule defines a "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."
I couldn't come up with a broader definition if I tried. Two key takeaways: (1) it does not matter if a worker is paid or unpaid, and (2) the term "worker" encompasses nearly every employment context you can think of.
Definition of "Non-Compete." The final rule defines a non-compete agreement/provision/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." "Term or condition of employment" is defined as "a contractual term or workplace policy, whether written or oral." Finally, "employment" is defined incredibly broadly as: "work for a person."
Yikes! Let's simplify the legal mumbo jumbo. Here's what you can't do after September 4, 2024:
Enter into (or attempt to enter into) a non-compete agreement with a worker (e.g., employees, independent contractors, volunteers).
Adopt or enforce policies that punish workers for seeking or accepting a new job or starting a business.
Enforce a non-compete against a worker.
Represent to or tell a worker that they are subject to a non-compete.
EXCEPTIONS TO EVERY RULE
As with every rule, there are exceptions to the FTC’s non-compete ban. The ban does not apply to:
Non-profit organizations, including health industry organizations that operate as true non-profits.
Existing non-competes with senior executives. The rule defines "senior executives" as employees earning more than $151,164 in annual compensation who perform a policy-making function for the company.
Sale of a business entity. Non-competes entered into in connection with the bona fide sale of a business, of a person's ownership interest in a business, or of all or substantially all the operating assets of a business are exempt from the FTC ban.
Claims occurring before September 4, 2024. The FTC rule does not prevent employers from enforcing a non-compete agreement where the employer's claim related to the non-compete happened before the rule’s effective date (September 4, 2024).
Good faith basis. The rule also does not prevent employers from enforcing or trying to enforce non-compete agreements where the employer has a good faith basis to believe the FTC's non-compete rule does not apply. This exception is as vague as they come. I will be following for how it plays out.
Note of caution re: exceptions: Businesses and workers in states with near-total or total non-compete bans, must consider the implications of your state's law relative to the FTC ban. For example, while a non-profit or other type of entity is exempt from the FTC non-compete rule, your state's law may not have a similar exemption.
WHAT IF MY STATE LAW/POLICY ALLOWS NON-COMPETES?
The FTC's non-compete rule overrides state law and policy. What that means is it doesn't matter if your state allows non-competes. The FTC ban will apply, and you cannot use, enforce, or attempt to enforce non-competes after September 4, 2024.
HOW DO I COMPLY WITH THE BAN?
For existing non-competes (not covered by an exception), employers must notify, in writing, any workers subject to a non-compete agreement that the non-compete is no longer enforceable. The notices must be delivered on or before September 4, 2024.
The FTC provides sample notices in several languages, which you can access on the FTC website under the heading "Model Notices": https://www.ftc.gov/legal-library/browse/rules/noncompete-rule.
Because we don't know if a court will stop the FTC from enforcing the non-compete ban, businesses should begin the process of identifying current and former employees, independent contractors, and other persons who qualify as "workers" under the rule (who are not senior executives) who are currently bound by a non-compete agreement/provision, so that they (and their legal teams) can prepare the required notice ahead of the September 4, 2024 notification date.
Proactive businesses will also want to review their form employment agreements (including independent contractor agreements) for non-solicitation and confidentiality/non-disclosure clauses to determine whether those clauses qualify as prohibited non-competes.
Pro Tip: Although there is no express penalty for failing to provide the required notice, the FTC may (and likely will) use section 5 of the FTC Act to enforce compliance.
CONSEQUENCES OF NON-COMPLIANCE
The FTC has signaled its determination to enforce the ban, and businesses are wise to take the FTC at its word. Workers can report companies (or individuals) who don't comply with the ban to the FTC, which can result in an FTC investigation. Following an investigation, the FTC may issue a cease-and-desist order through its internal processes or seek an injunction in federal court to stop a company from continuing to use or enforce non-compete agreements. The FTC cannot obtain civil penalties or other monetary relief against companies or individuals for using, enforcing, or attempting to enforce non-competes. However, it can obtain civil penalties in court if a company or individual is ordered to cease and desist from a violation and does not do so.
WHY DO I HAVE TO MAKE CHANGES NOW IF THE BAN MIGHT NOT BE ENFORCEABLE?
When it comes to government regulations, we are firmly on team "better safe than sorry." It is true that the FTC's ban is already being challenged. Two lawsuits seeking to stop the FTC from enforcing the ban were filed in Texas mere hours after the FTC announced the ban. However, it is too early in these lawsuits to predict what will happen next, including if the court will stop the ban from going into effect. Until we know more, we are working with our clients to take proactive steps to comply with the rule before September 4, 2024.
HOW DO I PROTECT MY BUSINESS WITHOUT NON-COMPETES?
Understandably, the primary concern for many companies, regardless of size or industry, is how to safeguard their businesses and intellectual property without non-compete agreements. The good news is there are workable alternatives to non-competes, including confidentiality or non-disclosure agreements (NDAs) and non-solicitation agreements. The FTC rule does not bar these types of agreements, but it does fire a warning shot: confidentiality and non-solicitation agreements that read or function like a non-compete are illegal. Going forward, it will be critical to draft those agreements/clauses with that warning in mind. (As we noted above, we also encourage our clients to review any non-solicitation and confidentiality provisions in their form employment agreements to ensure compliance with the FTC rule.)
Businesses actively taking steps to protect their confidential and proprietary information (i.e., trade secrets) will have the advantage when September 4 rolls around. Trade secrets are protected under both federal and state law. Trade secrets are typically defined as information (e.g., formula, pattern, compilation, program, device, method, technique, or process) that is (1) valuable because it is not known to others (i.e., a secret) and (2) protected because the business (or individual) takes steps to maintain its secrecy. Businesses can take various steps to protect their confidential or trade secret information, including:
Implementing clear and comprehensive policies and training regarding using and disclosing the company's confidential information and intellectual property, including to third parties.
Limiting disclosure of confidential information and trade secrets to only those who need the information to do their job and consistently reminding those persons of the confidential or trade secret nature of the information and their obligation to maintain its secrecy. Ask yourself, who has a legitimate need to know this information?
Consistently labeling confidential or trade secret information as "confidential and proprietary to [insert the company name]" and taking steps to limit who (including third parties) has access to the information. Pro tip: labeling information "confidential" is not enough. You must also make reasonable efforts to maintain its secrecy.
Implementing security measures like (1) password protection for confidential or trade secret information that is stored electronically and limiting access to only those who are authorized to know the information, (2) firewalls, encryption, anti-hacker and anti-virus initiatives and programs, and multi-factor authentication (3) maintaining non-electronically stored information in secure areas like a locked cabinet/room, (4) restrict USB ports and portable drives on company computers, and (5) prohibiting employees from removing confidential or trade secret information from the company's physical premises or downloading/accessing confidential information to/from personal devices.
Consistently using NDAs for third parties and key employees with access to confidential or trade secret information.
Implementing exit procedures for departing employees who have access to confidential or trade secret information, such as (1) providing departing employees with a copy of any NDAs they signed, reminding them of their obligations under the agreement, and asking them to sign an acknowledgment of their continuing confidentiality obligations (2) using exit interviews to determine the employee's future career plans, (3) turning off access to company computers and files immediately, (4) reviewing the departing employee's activity before termination (e-mail, downloads, hard drives, and communication records) for any signs of misappropriation, (5) taking steps to ensure the departing employee has returned all company documents (including electronic) and files and consider asking the employee to sign an acknowledgment, and (6) changing passwords as necessary.
Adopting a protocol for addressing any accidental disclosure of confidential or trade secret information to limit the spread of disclosed information, including developing a plan for contacting individuals who received the accidental disclosure to return or destroy the information, and training employees on the company's unintentional disclosure protocol.
Routinely auditing your company's confidential information and trade secrets to ensure procedures are in place to protect the company's interests and are followed consistently.
Monitoring and responding to suspected misappropriation.
WE CAN HELP!
As always, we’re here to help! If the FTC non-compete rule has you confused (and maybe a little frustrated), reach out and schedule a call with us to discuss your options. Click this link to schedule a free 20-minute call.