The Federal Trade Commission (FTC) on Tuesday, in a 3-2 vote, approved a final rule banning non-competes in almost all employment contexts. This sweeping rule, while not unexpected, has caused quite a stir among employers and workers alike. Here is what employers need to know.

Background

The rule, which was first proposed in January, comes on the heels of the Biden administration’s 2021 executive order designed to “promote competition in the American economy, which will lower prices for families, increase wages for workers, and promote innovation and even faster economic growth.”

Key Provisions of Final Rule

The FTC based its rulemaking authority to ban non-competes on the premise that they are an inherently unfair method of competition and, therefore, a violation of Section 5 of the Federal Trade Commission Act.

Definition of a Non-Compete. Under the rule, a non-compete clause is defined as a term or condition of employment that prohibits a worker from, penalizes a worker for or functions to prevent a worker from:

• 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
• operating a business in the United States after the conclusion of the employment that includes the term or condition.

Non-Solicitation Agreements and Non-Disclosure Agreements (NDAs) Are Not Banned.The FTC noted that NDAs and non-solicitation agreements will not generally be barred under this new rule but that such provisions, if drafted too broadly, could constitute a non-compete provision under the “functions to prevent” prong in the rule’s definition of non-competes. For example, an NDA would violate the rule if it prevented an employee from using all information used in their prior job when working for a subsequent employer or starting a business, even if such information was publicly available.

Broader Than Contracts. Notably, the rule is drafted broadly not just to cover standalone non-compete agreements and non-compete provisions in broader employment agreements, but also any term or condition of employment creating such a restriction. This broader language intentionally covers non-competes that fall outside of written, legally enforceable contracts, such as those found in employee handbooks, company policies or even oral employer instructions. The FTC stated that this was designed to stop employers that have previously used these informal methods to prevent workers from seeking or accepting other employment or starting a new business. The rule notes that concurrent employment restrictions and contracts setting a duration of promised employment are not expressly covered by this rule but could still be found to violate it if such provisions functionally prevent a worker from seeking alternative work or starting a new business.

Required Notice. The final rule also requires employers to notify workers whose non-competes are no longer enforceable that their non-competes are no longer in effect and will not be enforced. The FTC provided model language that employers can use to notify employees.

Exemptions

The final rule also contains a few important exemptions:

• Nonprofits. Because the FTC's authority only extends to for-profit businesses, the rule will not affect employment agreements entered into by workers employed by nonprofit organizations. Many health care entities and schools are nonprofits.
• Franchise relationships. The rule also permits limited use of non-compete agreements between franchisees and franchisors.
• Bona fide business sale. The proposed rule also does not apply to non-competition agreements entered into by a person during the "bona fide sale of a business," of the person's ownership interest in a business entity or of all or substantially all of a business's operating assets.
• Senior executives. Employers may continue to enforce existing non-competes with senior executives, who are defined as employees earning more than $151,164 annually and serving in policy-making positions.

The new rule is expected to become effective by late August, 120 days after the FTC publishes it in the Federal Register.

Modifications to January’s Proposed Rule

Since this rule was first proposed in January 2023, the FTC received tens of thousands of comments, most of which lauded the potential rule as a welcome measure to allow employees to more freely change positions and create greater mobility in the labor market. Some noted criticisms of the rule, however, did result in the FTC making three important concessions from its originally proposed rule:

• No need to formally rescind existing non-competes. Employers do not need to formally rescind non-compete provisions in existing agreements. While the initial proposal would have required this, the FTC noted that doing so would have caused too great of an administrative burden for employers. But the rule as finalized still bars enforcing existing non-competes and, as discussed above, still requires employers to undertake providing notice to all employees with such agreements that they are now unenforceable and no longer in effect.
• Expanded business sale exemption. As discussed below, the FTC expanded the originally proposed business sale exemption. The original rule only permitted the application of this exception for persons selling a minimum of 25% ownership interest in a business.
• Senior executives. As discussed above, the FTC did carve out existing agreements with senior executives from this ban on non-competes, which was not the case in the originally proposed rule.

Existing State Laws that Bar or Restricts Non-Competes

While the impact of the FTC’s new rule banning non-competes is undeniable, it is important to note that many states have already taken steps to restrict or outright ban these provisions. Four states have an outright ban on noncompetes: California, Oklahoma, Minnesota, and North Dakota. Other states have not entirely banned noncompetes, but have restricted them in various ways, including limiting them in certain sectors and to ban their use with workers that earn below specified thresholds. These states include:

• Colorado
• Washington, DC
• Idaho
• Illinois
• Maryland
• Maine
• Massachusetts
• Nevada
• New Hampshire
• Oregon
• Rhode Island
• Washington
• Virginia

Other states have proposed bills or are ready to enact a ban or severely limit noncompetes. Finally, not to be left out of the conversation, the National Labor Relations Board has also targeted noncompetes, finding that they block access to new or different employment opportunities and thus could hinder an employee’s right to exercise rights under Section 7 of the National Labor Relations Act.

Employer Takeaways

The United States Chamber of Commerce has already filed a lawsuit in Texas challenging the rule and seeking to enjoin the rule from taking effect, the first of what could be many legal challenges. Employers, however, should not wait to take steps to plan for the rule going into effect. They should prepare for the finalized rule by proactively gathering information about their use of various noncompetes, and similar restrictions used in policy or practice. Employers should also explore, with the help of counsel, alternative methods available to protect a company’s competitive position when key employees leave to join competitors.

Employers should be prepared to notify all other workers that existing non-competes are unenforceable by the effective date. Moving forward, employers may look to employment agreements used in states such as California, where non-competes have already become unenforceable, for guidance on restructuring their employment agreements to comply with the new rule.

Miles and Stockbridge’s labor and employment lawyers will be monitoring developments related to the new rule. Stay tuned for future blog posts with updates on when (and whether) the new rule will go into effect and its impact on specialized industries, including technology companies, government contractors and the health care industry.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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