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After first publishing a proposed rule in January 2023 and after receiving over 26,000 comments on the proposed rule, the Federal Trade Commission voted in late April to issue a final rule banning noncompete agreements for the majority of workers.
The rule passed via a 3-2 vote along party lines. In issuing the rule, the FTC determined that entering noncompetes and enforcing certain noncompetes was an unfair method of competition.
According to the FTC, an estimated 18% of workers in the U.S. are subject to a noncompete. The FTC’s announcement of the rule claimed that the ban will “generate over 8,500 new businesses each year, raise worker wages, lower health care costs, and boost innovation.”
It remains unclear, however, whether and when the rule will go into effect, as lawsuits have already been filed challenging the FTC’s authority to issue the rule and the rule itself.
Overview of the rule
The final rule bans all noncompete agreements with all workers, including senior executives, after the rule’s effective date. The rule also makes existing noncompetes, except those for “senior executives” (defined below), no longer enforceable after the rule’s effective date. Under the rule, employers are required to provide notice to workers with existing noncompete agreements that those agreements are no longer enforceable.
The final rule provides some limited exceptions to this blanket ban.
Existing noncompetes for “senior executives” can remain in force. “Senior executives” are employees “in a policy-making position” who earned at least $151,164 in the preceding year (or when annualized based on employment or departure date).
Noncompetes in other specific circumstances are also not affected by the rule, specifically noncompetes (1) in franchisee-franchisor relationships (although the rule applies to employees who work at franchises); (2) with certain nonprofit organizations who are not subject to the FTC’s jurisdiction; or (3) in connection with the sale of a business entity (regardless of ownership percentage).
Despite these limited exceptions, the rule would likely affect the vast majority of noncompetes, both past and future, nationwide. Companies in violation of the rule who are ordered to cease and desist but fail to do so may be subject to civil penalties.
When the rule might take effect
While the rule is scheduled to go into effect 120 days after it is published in the Federal Register, it is far from certain that the FTC’s final rule will become the law of the land. Multiple lawsuits challenging the rule were filed within days of its adoption.
The lawsuits raise a host of legal arguments regarding the enforceability of the final rule.
Fundamentally, the plaintiffs argue that the FTC lacks the rulemaking authority to issue regulations proscribing unfair methods of competition.
Second, even if the FTC had such authority, the plaintiffs argue it is improper to deem noncompetes categorically unfair. Plaintiffs point to the widespread use of noncompete agreements and their regulation and enforcement under state law as indicia that a broad federal ban is an overreach by the FTC.
Third, plaintiffs attack the FTC rule as impermissibly retroactive, arguing that it will inappropriately disrupt existing contracts in a manner that the Constitution prohibits.
Finally, the plaintiffs argue that banning nearly all forms of noncompetes is arbitrary and capricious given the FTC’s refusal to entertain a more targeted approach.
Briefing on a motion for preliminary injunction in one of the lawsuits is scheduled to conclude by the end of May, with a ruling anticipated in June. If the rule is enjoined at the trial-court level, it is a near certainty appeals will follow.
What the rule means for business
Where does this leave employers now?
Most noncompetes are banned—maybe, depending on how the courts rule.
Non-solicitation agreements are still permitted—maybe, so long as they are not so broad as to be an end-run around the rule.
All sorts of ancillary questions remain as well. What must the notice say? How will this development impact ongoing litigation premised on existing agreements? Will a senior executive continue to be exempt if the company updates the employment agreement to change only other terms?
Answers to each of these questions and myriad others are beyond the scope of this article but deserve careful consideration by any business that utilizes restrictive covenants. This body of law is going to be in a state of flux for the foreseeable future. Even if the rule survives the current challenges, follow-up litigation over the interpretation of the ban will likely take years.
What is clear, however, is that there is a loud drumbeat sounding against the enforceability of noncompete agreements. The number of states with complete bans (like California) or partial bans (like Illinois) is on the rise.
In most situations, these statutes cannot be wired around through choice of law clauses. The trend in the common law is also to scrutinize noncompetes more critically. In Delaware, for example, a series of recent decisions from the Court of Chancery held several noncompete agreements unenforceable, with the Court unwilling to blue pencil.
Businesses are not without tools, however. Narrowly tailored non-disclosure agreements and trade secret protection plans are both more likely to withstand scrutiny under the new regime.
Indeed, the FTC expressly called these out as viable alternatives. Through focused NDAs and trade secret law, businesses can protect their most valuable information, such as customer lists, manufacturing processes, software, algorithms, business strategies, financial information, R&D information, and the like.
Employers would be wise to consider shifting to use these tools to decrease their exposure under this trend of increased scrutiny on noncompetes generally and to avoid the risk that comes with uncertainty as it relates to the FTC’s ban.•
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Harmony Mappes, Ryan Hurley and Matthew Burkhart are litigation partners at Faegre Drinker in Indianapolis. Harmony co-leads Faegre Drinker’s trade secret and noncompete practice, and Ryan is a deputy practice group leader for the business litigation group. Matt, Ryan, and Harmony focus their practice on trade secret and restrictive covenant litigation and counseling.
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