The Federal Government continues to impose its heavy hand on trade and commerce in the United States. On April 23, 2024, the Federal Trade Commission announced its Final Non-Compete Clause Rule (“Final Rule”), which bans post-employment non-compete clauses between employers and their workers. The Final Rule becomes effective 120 days after being published in the Federal Register. As of this date, the Final Rule has not been published in the Federal Register, so stay tuned.
While this will have little impact on Condominium Associations, the rule does not apply to non-profit organizations or corporations, it will certainly have a significant impact on their vendors. Property Management companies will be affected, as they often have non-compete and non-solicitation clauses with their employees. This new rule might even dictate how property management companies structure employment relationships with managers going forward, i.e. should they be employees of the condominium association, which is a non-profit and not governed by the FTC Rule.
Key Provisions
Scope:
- The final rule broadly bans all true non-compete clauses. A non-compete clause is not just a contractual term but can include any workplace policy, whether oral or written. Section 910.1 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” either seeking or accepting work after the conclusion of employment, or operating a business after the conclusion of employment.
- As indicated in the 560 pages of “Supplementary Information” accompanying the final rule, it is possible that non-disclosure agreements, training repayment agreement provisions, and non-solicitation agreements that are overbroad and “function to prevent” a worker from seeking or accepting other work or starting a new business after employment ends could be barred by the final rule, depending on the precise language of the agreements and the surrounding facts and circumstances.
- Significantly, garden variety non-solicitation clauses are not covered by the final rule. The reality for many employers is that the issue is not competing it is client solicitation that is more concerning as is taking and using trade secrets or other proprietary information.
- The Final Rule prohibits an employer from entering into, or attempting to enter into, a non-compete clause with a “worker” (including, e.g., employees and independent contractors) or representing that a worker is subject to a non-compete clause. The Final Rule allows employers to maintain existing non-compete agreements with “senior executives,” (those with over $151,164 annual compensation and in a policy making position for the business) but bars an employer from entering into, or attempting to enter into, a non-compete clause with a senior executive after the Effective Date of the Final Rule.
- The Final Rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity.
- The Final Rule does not prohibit employers from enforcing non-compete clauses where the cause of action related to the non-compete clause accrued prior to the Effective Date of the Final Rule.
- The Final Rule further provides that it is not an unfair method of competition to enforce or attempt to enforce a non-compete or to make representations about a non-compete where a person has a good-faith basis to believe that the final rule is inapplicable.
- The Final Rule supersedes all state laws to the extent, and only to the extent, that a state’s laws permit or authorize conduct prohibited under the Final Rule or conflict with the Final Rule’s notice requirements.
Notice of Non-Enforcement:
- The Final Rule requires an employer to provide clear and conspicuous notice to workers subject to a prohibited non-compete, in an individualized communication, that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.
- The employer must provide notice by the Final Rule’s Effective Date by hand-delivery, by mail at the worker’s last known street address, by email, or by text message.
Analysis
The Final Rule bans almost all non-competes between employers and workers, but does not explicitly ban non-disclosure agreements, customer non-solicitation agreements, or employee non-solicit agreements.
Nevertheless, the Final Rule makes clear that it bans these other forms of restrictive covenants when they have the same functional effects as non-compete clauses, so non-solicitation agreements may be scrutinized depending on the facts and circumstances and nature of the employment relationship. The Final Rule provides that a non-disclosure clause operates as a non-compete, for example, “where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.” Such non-disclosure agreements are so broadly written, the FTC states, that for practical purposes, “they function to prevent a worker from working for another employer in the same field and are therefore non-competes under [the Final Rule.]”[13] Similarly, non-solicitation agreements can satisfy the definition of non-compete clause “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”
The Final Rule becomes effective 120 days after being published in the Federal Register. During that time, we expect trade associations and businesses across the country to legally challenge the Final Rule. In fact, two lawsuits have already been filed. The challenges are and will be constitutionally based.
Below are some answers to some frequently asked questions about the FTC Final Rule.
Frequently Asked Questions
What happened?
The FTC voted 3-2 to ban most non-competes for U.S. workers. The final rule and discussion is over 500 pages long, but it is intentionally broad and captures most non-competes for both employees and independent contractors.
Are non-compete agreements void right now?
No. The rule, assuming it is not enjoined, is not effective until 120 days from publication in the Federal Register (which as of April 24thhas not happened, but will happen soon). The rule also does not apply to breach of contract actions where the action accrues before the effective date.
Why did the FTC do this?
The FTC concluded that non-competes unlawfully stifle competition and depress wages for U.S. workers, and that banning them would encourage competition, innovation, and increased wages. More to the point, the current administration issued an executive order in 2021 directing the FTC to curtail non-competes in some fashion, so this rule was long in the making.
What does the ban cover?
The ban covers all non-competes for U.S. workers (including employees and independent contractors) with limited carve-outs, and is subject to certain exceptions based on the FTC’s statutory authority. For example, the rule notes that the FTC has no authority over not-for-profit enterprises, so those entities are not subject to the new rule. There are exceptions for existing agreements with “senior executives” (discussed below) and for non-competes entered into as part of the bona fide sale of a business.
Is the rule retroactive?
In most instances, yes – the rule bans new non-competes after the effective date, but also invalidates existing non-competes subject to few exceptions.
Does it only apply to non-competes?
On its face, the rule only applies to non-competes and does not ban other restrictions like confidentiality or non-solicitation provisions. The rule makes clear that it bans these other forms of restrictive covenants when they have the same functional effects as non-compete clauses. The rule provides that a non-disclosure clause operates as a non-compete, for example, “where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.” Such non-disclosure agreements are so broadly written, the FTC states, that for practical purposes, “they function to prevent a worker from working for another employer in the same field and are therefore non-competes under [the Final Rule.]” Similarly, non-solicitation agreements can satisfy the definition of non-compete clauses “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”
How is non-compete defined?
The final 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.” Again, those terms should be construed broadly.
What are the exceptions?
There are industry-specific exceptions based on certain industries excepted from the Federal Trade Commission Act (“the FTC Act”). Specifically, the rule does not apply to banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act. Outside of those industries, the major exceptions include (1) existing agreements for “senior executives” (defined below), (2) non-competes entered into in connection with the bona fide sale of a business, and (3) non-competes enforced where the cause of action accrued prior to the rule’s effective date.
Who are qualified senior executives under the exception?
The rule largely adopts the SEC’s existing definitions for “executive officers”, but also includes an income threshold of $151,164 in the preceding year. Put differently, a “senior executive” includes someone making in excess of that threshold who also meets a “job duties test” set forth in the rule. Who falls under that exception leaves room for interpretation, but it is intended to be narrow and requires the individual to have “policy-making” authority for the entire organization, and would closely align with the SEC’s definition of an executive officer. Again, this exception only allows for existing non-competes prior to the effective date. It does not allow for new non-competes with senior executives that are entered into after the effective date.
Does this rule replace state laws regarding non-competes?
The rule preempts state laws only where they conflict with the final rule. Put differently, the rule allows for customer non-solicits, but California state law does not. If the rule remains in place, customer non-solicits will continue to be void in California. The patchwork of state-level income and notice requirements for non-competes would also remain in effect.
Are non-profits covered by the ban?
No. By statute, the FTC only has authority over for-profit enterprises, so the rule does not apply to those organizations. This is in addition to the industries noted above, which are specifically excluded from the FTC’s purview by statute: banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act.
Will the ban affect current rights to severance pay?
Generally, no. The ban does not become effective until 120 days after the rules are published in the Federal Register. For any severance payments scheduled to be paid after that date, which are conditioned on compliance with specific restrictive covenants, the ban only affects restrictive covenants relating to non-competition (as discussed above) and the payee may still be required to comply with any remaining valid restrictive covenants such as protection of trade secrets.
What type of notice do employers need to provide to employees under the rule?
Prior to the effective date of the Rule, employers will need to provide notice to each worker who is subject to a non-compete in violation of the Rule so long as the employer has either a mailing address, email address, or cell phone number for the affected worker. The notice must: (i) identify the person who entered into the non-compete clause with the worker; (ii) be provided via mail, email or text message to the worker.
What about non-solicit, non-disclosure, and training repayment provisions?
They are covered by the ban only if they are “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, such a term is a non-compete clause under the final rule.”
The FTC references nondisclosure agreements (NDAs), training repayment agreements, non-solicitation agreements, no-hire agreements, and “no-business” agreements as examples to evaluate whether the functional effect is applicable, that is “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”
What should employers do in the meantime?
Carefully follow whether the Rule is enjoined and the deadline for compliance should the rule remain intact. It may also be prudent to prepare to send notices should the rule become effective by compiling a list of impacted current and former employees with relevant contact information. Determine whether any of the impacted employees qualify for the “senior executive” exception described above. Evaluate whether there are “senior executives” who should sign non-competes prior to the Rule’s effective date. Model notice language is included in the Rule and can be delivered by email or text message, or by delivering a paper notice by hand or mail. The notices must be sent before the effective date of the rule. DO NOT send notices right away; monitor the progress of the legal challenges.
We will continue to enhance and expand our FAQ section as new developments arise.
Finally, noncompete agreements are still banned in law firms as they have been for decades, but if noncompete agreements were not banned in law firms for other reasons, they would be now by the FTC action.
Written by
Ed Allcock
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