April 26, 2024
On April 23, 2024, the employment industry was rocked by the Federal Trade Commission’s (“FTC”) announcement of a rule called the “Non-Compete Clause Rule.” With some important exceptions, the impact of this rule is to prohibit U.S. employers from including non-compete clauses in employment agreements. Below we will discuss the basic parameters of the rule, its potential impact on California employers, and potential barriers to its enactment.
What is A Non-Compete Provision?
Non-compete provisions (sometimes called “non-compete clauses”) are typically provisions in employment agreements that prohibit – or even function to prevent – an employee from performing specified work after leaving their employer. Generally, non-compete clauses contain language such as: “Employee shall refrain from working for a company providing similar services as Employer for a period of ___ years after separation from Employer.” Sometimes, non-compete provisions also contain a geographic restriction (e.g., “Employee may not work for an employer providing similar services within a 50-mile radius from Employer’s main headquarters for ___ years after separation from Employer”).
Non-compete provisions commonly appear in employment contracts in the United States. It is estimated that approximately 1 in 5 working adults, or approximately 30 million people in the United States, are currently subject to non-compete provisions. When the rule was initially proposed by the FTC, it solicited public comment. It received more than 26,000 responses, and more than 25,000 of those were in favor of banning non-compete provisions.
What is the New Rule?
Simply, the rule adopted by the FTC states that as of the “effective date” it shall be an unfair method of competition for a U.S. employer to do any of the following:
- Enter into a non-compete agreement with workers;
- Attempt to enforce a non-compete agreement against workers; or
- Represent that the worker is subject to a non-compete clause.
A key thing to note is that the rule is not effective until the “effective date,” which the rule defines as “120 days after the rule is reported in the Federal Register.” This has not yet happened as of the time of this publication, but can be as soon as days after the rule is announced. However, if the final rule is deemed “significant” due to its economic impact or important policy implications, it undergoes a presidential-level review before being published in the Federal Register. Further, Congress and the Government Accountability Office will have an opportunity to review it before it takes effect. If both the House and Senate pass a resolution of disapproval and the President signs it, or if both houses override a presidential veto, the rule is void and cannot be reinstated in the same form without Congressional approval.
If it becomes effective, the rule will preempt current State laws that permit non-compete provisions or otherwise conflict with the rule.
In addition to setting new rules, the FTC rule includes provisions regarding the enforceability of existing non-compete provisions. For the most part, non-compete clauses are unenforceable by employers immediately after the effective date. (It is important to note that non-compete agreements are already expressly forbidden in several states, including California. The information below regarding the FTC’s handling of “existing” non-compete provisions applies only to agreements in States that currently permit them.)
There are a few exceptions to this rule. First, existing non-compete provisions in the contracts of “senior executives” (defined as individuals making over $151,164 who are in a “policy-making position”) remain enforceable, to the extent permitted by their State law. Also, the rule does not apply to non-compete agreements entered into by a person in connection with a bona fide sale of a business entity. Additionally, adoption of the rule does not invalidate an employer’s otherwise viable claims under a non-compete clause where the cause of action accrued prior to the effective date (i.e., the rule is not retroactive). Finally, non-profit entities — including non-profit health systems and universities — are generally exempt from coverage under the Federal Trade Commission Act, and thus the rule will not apply to many non-profit organizations, to the extent their State’s law permits non-compete provisions.
What is the Impact on California Employers?
If you are in California, you may be wondering about the impact of the FTC’s rule here. After all, non-compete provisions have been void in California as against public policy for over 100 years. In 2024, the California legislature further strengthened California’s strong public policy against non-compete provisions by adopting laws (1) prohibiting enforcement of non-compete agreements even if they were signed outside of California, and (2) imposing penalties on employers who attempt to enforce non-compete provisions, including awards of attorney’s fees to employees who go to court to have such provisions declared invalid.
As a result of California’s existing stance on non-compete provisions, the FTC rule is not quite as impactful on California employers as it will be on employers elsewhere in the United States. In fact, the FTC repeatedly uses California as an example in its lengthy defense of the rule. In the 570-page information sheet published by the FTC in connection with the new rule, the FTC echoed long-held California positions about how and why non-compete provisions hinder both competition and innovation, and how they negatively impact the economy. Because California employers do not presently impose non-compete provisions, their employment agreements will not have to change.
In practice, the FTC’s rule is positioned to help California employers. After the effective date, California employers should be able to hire new employees (other than senior executives) without having to be concerned with the potential legal fallout of out-of-state non-compete provisions on their business or on their new employees.
Potential Hurdles to Enforcement of the FTC Rule
Almost immediately after the FTC announced the rule, lawsuits commenced to challenge it. On the same day as the announcement, Ryan, LLC (a Dallas-based tax firm), filed a lawsuit in the U.S. District Court for the Northern District of Texas seeking to set aside the final rule, contending that: (a) the FTC does not have the authority to issue the rule, and (b) the rule itself is unconstitutional. The next day, the U.S. Chamber of Commerce (a business association advocacy group and the largest lobbying group in the United States) filed a federal lawsuit in the U.S. District Court for the Eastern District of Texas, Tyler Division, seeking an injunction on enforcement of the FTC’s final rule, which would prevent enforcement of the final rule and (at a minimum) extend the effective date of enforcement.
This story will continue to develop, and the next several months will tell whether the nationwide ban on non-compete agreements will stand. If you have additional questions about the FTC rule or its impact on your business or otherwise, we would be happy to provide additional information and advice.
DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Ferber Law is available to help answer questions relating to the Corporate Transparency Act.