(908)402-4770On April 23, 2024, the Federal Trade Commission (FTC) voted 3-2 to approve the Non-Compete Clause Rule in its final form. The rule, first proposed in January 2023, was passed pursuant to President Biden’s 2021 “Executive Order on Promoting Competition in the American Economy,” effectively prohibits the use of almost all non-compete clauses across the country.
The rule will supersede any state rules or regulations to the contrary.
According to the FTC, a “non-compete” is “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” A “worker” is defined as anyone from the CEO of a company to its mail room clerks, and the term includes independent contractors.
The new FTC rule allows an exception for a bona fide sale of a business and eliminates the 25% ownership threshold (i.e., the defecting employee had to own 25% or more of the company for the non-compete clause to be effective) that appeared in the proposed rule.
This means employers will have to notify existing employees who may have previously signed non-compete agreements that those agreements are no longer enforceable.
However, existing agreements with senior executives are not affected by the new rule (senior executives are those with policy-making power who are paid over $151,164 annually). Still, companies may not enter new non-competes with those senior executives after the effective date of the rule.
When Is the Rule Effective?
Employers will have 120 days from the FTC’s publication of the final rule to comply with it. The rule is currently scheduled to be published in the Federal Register on May 7, 2024. The rule would become effective on September 4, 2024 (120 days later).
However, enforcement of the rule could be delayed—or barred completely—by legal challenges. The U.S. Chamber of Commerce sued in the Eastern District of Texas on April 25th challenging the new rule.
The New Definition of Non-Competes
Employers and their attorneys should note that the new rule applies not only to non-competes but terms that function as non-competes. This means that any contract that “has the effect of prohibiting the worker from seeking or accepting employment” is prohibited.
For example, the FTC identifies as problematic (1) a nondisclosure provision that is “written so broadly that it effectively precludes the worker” from working in the same position for a new employer and (2) a provision that requires a worker to repay training costs where the repayment is not reasonably related to the costs of the training.
What Happens if an Employer Violates the New Rule?
The rule provides that the use of non-competes in violation of the rule is an “unfair method of competition” that violates Section 5 of the FTC Act. Therefore, the rule does not merely render covered employer-employee agreements unenforceable; it establishes that an agreement that violates the rule is an unlawful act itself. Such violations of the FTC Act can lead to fines, penalties, and other injunctive relief.
Can the FTC Do This?
Well …. that remains to be seen.
The two dissenting commissioners, Melissa Holyoak and Andrew N. Ferguson, expressed concerns that the FTC lacks authority to promulgate this rule. Likewise, several commentators have mentioned that the powers vested in the FTC by the rule are “vague” and “very broad.”
The FTC has concluded that non-competes are an “unfair method of competition.” By using this characterization of all non-competes, it purports to expand its own jurisdiction. Remember, non-compete clauses are basic contracts. Therefore, they have traditionally been governed by state—not federal—law.
Federal regulation by the FTC of non-compete clauses is therefore unprecedented.
Moreover, if the FTC may regulate any activity it declares to be an “unfair method of competition” this would constitute a significant expansion of its power. The Constitution grants Congress the authority to regulate matters that affect interstate commerce; there is no such grant of authority to the executive branch.
And the FTC is part of the executive branch.
Whether the FTC has the power to decide a “major question” that may be within congressional authority, rather than executive branch authority, is a question that will not be resolved quickly.
Schiller, Pittenger & Galvin. P.C., Attorneys Can Help Employers Affected by the FTC Proposal to Ban Non-Compete Agreements
Given the likely legal challenges to the FTC’s proposed ban on non-compete agreements, it is unclear when and in what form the FTC’s final rule will become effective. Nevertheless, if the federal government does not ban non-competes, New Jersey may join the half-dozen states that have done so (the Assembly has passed a bill restricting non-competes but the bill has not yet passed the full Legislature).
Consequently, businesses that extensively use non-competes should have experienced New Jersey employment and commercial lawyers review their agreements (as well as any other restrictive covenants they use) to see if they comport with the new FTC rule.
If interested, please call us at our Scotch Plains office at 908 490 0444. You can also email us here.