The Federal Trade Commission Issues Rule Invalidating Covenants Not To Compete

On April 23, 2024, the Federal Trade Commission (FTC) announced a final rule (FTC Rule) invalidating covenants not to compete. The FTC Rule, which is set to take effect on September 4, 2024, significantly impacts the employment relationship by broadly prohibiting non-compete clauses for the vast majority of workers in the United States.

What is a Non-Compete Clause?

The FTC Rule defines a “non-compete clause” as any term or condition of employment that prevents a worker from seeking or accepting work with a different employer or operating a business after the conclusion of their current employment. This prohibition applies both prospectively and retrospectively, meaning it invalidates existing non-compete agreements with current and former workers, as well as prevents new agreements from being formed. The FTC Rule applies to contractors as well as employees in for-profit organizations. Specifically excluded from the FTC Rule are banks, savings and loan institutions, federal credit unions, and non-profit organizations. The only exceptions are for senior executives who possess policy-making authority for the entire organization and who earn an annual compensation of at least $151,164, and in the context of the sale of a business, provided the agreements predate the FTC Rule.

This Rule represents a significant departure from previous legal standards, which typically evaluated non-compete agreements based on their reasonableness in duration, geographic scope, and demonstrated need to protect the employer’s legitimate business interests. Historically, courts have enforced covenants not to compete if they were deemed reasonable and necessary to protect an employer’s interest without being overly burdensome to the employee or harmful to the public. The FTC Rule, however, categorically bans these agreements, reflecting a shift towards prioritizing worker mobility and competition over employer protections.

This Rule has faced legal challenges, including a recently filed lawsuit in which the United States District Court for the Northern District of Texas enjoined the FTC from enforcing the Rule against the plaintiffs prosecuting that lawsuit. This ruling, however, does not affect the FTC Rule’s applicability to other employers, and the Rule’s nationwide implementation remains uncertain due to ongoing judicial scrutiny and potential further legal challenges. It appears likely that the FTC Rule will ultimately be successfully challenged as an impermissible delegation of legislative authority as the Chevron doctrine, which formerly required federal courts to defer to an agency’s reasonable interpretations of ambiguities in statutes they implement, has recently been overruled.

Impact on Employment Law

1. Notice Requirements: On or before September 4, 2024, employers must notify employees and former employees bound by existing non-competes that these agreements will no longer be enforced. Such notification must be in writing and must be delivered via hand delivery, by mail or email to the worker’s last known address, or by text message to a mobile telephone number belonging to the worker. The FTC has provided model language at the website referenced below and the FTC has indicated it will grant a compliance safe harbor if the model notice is used.

• Increased Job Mobility: The rule is expected to significantly enhance workers’ freedom to change jobs, start new businesses, or bring new ideas to market without the fear of legal repercussions from former employers. Once the FTC Rule is effective, the FTC has provided resources for reporting suspected violations of the law.

• Alternatives to Non-Competes: Employers may need to rely more heavily on other legal mechanisms to protect their interests, such as non-disclosure agreements (NDAs) and trade secret laws. The FTC has noted that these alternatives can effectively safeguard proprietary information without restricting workers’ employment opportunities.

• Market Dynamics: The rule aims to reduce market concentration and lower prices for consumers by promoting competition.

Considerations for Employers

1. Contract Revisions: Employers should review and revise their employment contracts to remove covenants not to compete in order to ensure compliance with the FTC Rule. While the ban does not explicitly include NDAs and covenants not to solicit employees or customers, employers should also consider narrowing the scope of non-disclosure and non-solicitation provisions and other restrictive covenants in order to avoid their potential interpretation as de facto covenants not to compete. The FTC Rule provides that such provisions operate as a non-compete “where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.” If such provisions “function to prevent a worker from working for another employer in the same field” they will be deemed a prohibited covenant not to compete.

• Strategic Planning: Employers may need to adopt new strategies to retain employees, such as improving wages, benefits, and working conditions.

• Monitoring Legal Developments: Due to the ongoing legal challenges, employers should stay informed about the status of the rule and be prepared for potential changes in its implementation.  It is recommended that the required notice to impacted workers be delayed until the end of August as the possibility exists that a nationwide injunction will impact the anticipated enforcement of the FTC Rule.

The FTC Rule, including model language for notification to workers of the invalidation of existing covenants not to compete, is available for review on the FTC’s website: https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf.

If you have questions about this topic or any other employment-related matter, please contact Connie Carrigan at (919) 250-2119 or email her at ccarrigan@smithdebnamlaw.com.

Co-written with Kaylyn Chatman – 2024 Smith Debnam Summer Associate

A 2024 Smith Debnam Summer Associate, Kaylyn Chatman comes to Smith Debnam after recently completing her second year of law school at North Carolina Central University. She earned a Bachelor of Arts in Criminal Justice from Livingstone College and a Master of Arts in Human Service Consulting from Liberty University. Before enrolling in law school, Kaylyn worked as a police officer for ten years.