KHVPF Insight
FTC Bans Non-Competes
On April 23, the Federal Trade Commission (FTC), by a 3-2 vote, issued its final rule banning nearly all non-competes. The FTC asserted, for the first time in the over 10 year history of the Federal Trade Act, that non-competes are an “unfair method of competition” under the Act. Thus, noncompetes are unlawful as a “general matter.”
The scope of the FTC’s new rule is expansive. It applies beyond low-wage employees, who proponents of a non-compete ban usually claim require protection. Instead, it applies to any “employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” Prohibited is any contractual “term or condition that prohibits a worker for, or functions to prevent workers from” seeking or accepting other work, or operating a business after their employment ends. This ban, according to the Rule’s commentary, includes provisions that impose “liquidated damage or other forfeiture-for- competition,” clauses that “impose adverse financial consequences on a former employee expressly conditioned on the employee seeking or accepting other work or starting a business,” and “severance arrangement[s] in which the worker is paid only if they refrain from competing.” And the ban is retroactive, prohibiting enforcement of existing non-competes.
The FTC’s commentary also specifies that the ban may apply to functional non-competes, that could include non-disclosure agreements and other restrictive covenants, training re-payment programs, non- solicitation agreements, and no re-hire agreements. The ban on these types of functional restrictions occurs where they restrain “such a large scope of activity that they function to prevent a worker from seeking or accepting other work or starting a new business after their employment ends.” Such covenants will be subject to a case-by-case adjudication for whether they constitute an unfair method of competition. If implemented, the FTC’s rule could upend long-standing Michigan law, even outside the general non-compete context. For instance, in Follmer, Rudzewicz & Co v Kosco, an accounting firm required its employees to agree to a contract term providing that if the employee left the company and provided services to a firm client thereafter, a former employee would be required to pay those fees to the employer. The Michigan Supreme Court held that this was an enforceable agreement and recognized that it served to discourage a departing employee from poaching his employer’s clients. But that ruling may now be in jeopardy. Under the FTC’s new rule, such a provision could be seen as a “functional” non-compete.
There are only two exceptions to the ban. First, existing non-competition agreements between an employer and its senior executives are not abrogated (although future non-competes with senior executives will not be allowed). A senior executive is defined as an officer with “final authority” to make policy decisions that control significant aspects of a business. They must also have annual compensation of at least $151,164 in the preceding year. The Rule specifies that the exception does not include workers with policy making authority over only a subsidiary or affiliate of a common enterprise where the employee does not have authority over the common enterprise. Second, the Rule permits non-competes related to the bona fide sale of a business entity.
The Rule also requires employers to notify workers (including former workers) with existing non-compete agreements that the non-compete provision is not enforceable and will not be enforced. This notice must be in writing, identify the company who entered into the non-compete with the worker, and be delivered by hand, mail, email, or text to the workers by the Rule’s Effective Date. The Rule provides a model notice that can be used as a “safe harbor.” This notice requirement does not apply to senior executives and employers are exempt from this notice requirement where it does not have a record of the worker’s contact information.
It is unclear whether the FTC ban will go into effect. At least three court cases challenging the rules have been filed, with Plaintiffs claiming that the FTC has no authority to issue regulations prohibiting “unfair methods of competition,” and that Congress did not explicitly delegate the FTC the power to make the sweeping rule change it announced. Plaintiffs also argue that the FTC has not demonstrated that non-competes do more harm than good and that the FTC’s authority under the Act does not authorize retroactive invalidation of millions of existing contracts. On July 3, a Texas federal court issued a preliminary injunction in one of these cases, staying enforcement of the FTC’s ban. However, that decision is limited to the plaintiffs in that action, including the Chamber of Commerce, but not individual members of the Chamber of Commerce. This ruling thus does not impact most employers, and unless another court issues a broader injunction, the FTC ban will go into effect for other employers on September 4, 2024.
Employers should keep a close eye on other legal challenges, but in the meantime should prepare for the possibility of the FTC ban taking effect as scheduled. Employers should review confidentiality agreements, non-disclosure covenants, training agreements, and agreements restricting solicitation of employees and customers to determine if they can protect their competitive interests in other ways.