Non-Competes Now a Nonstarter

This is really big news!

Businesses that have entered into non-compete agreements with current or recently departed employees will need to come up with other ways of achieving the investment-protecting goals those non-competes were designed to accomplish. That’s because the Federal Trade Commission has issued a final rule, which will take after 120 days after publication in the Federal Register, that invalidates current non-competes for most workers and bans new ones for all employees.

The FTC determined, by a 3-2 vote, that the Non-Compete Clause Rule (16 CFR Part 910) was necessary “because it is an unfair method of competition—and therefore a violation of section 5 [of the Federal Trade Commission Act]—for persons to, among other things, enter into non-compete clauses with workers.” The rule requires that in cases of existing agreements, the business must inform the individual that the non-compete is no longer in effect, and the FTC has provided model language to this effect.

Executives Still Subject—for Now

The one exception to that: The final rule allows existing non-competes with senior executives—defined as those earning more than $151,164 and in policy-making positions, about 0.75% of workers—to continue. The FTC says it made this decision “because this subset of workers is less likely to be subject to the kind of acute, ongoing harms currently being suffered by other workers subject to existing non-competes and because commenters raised credible concerns about the practical impacts of extinguishing existing non-competes for senior executives.”

The FTC issued the proposed rule in January 2023 and took comments for 90 days, reporting that of more than 26,000 received, more than 25,000 supported the rule. In making its determination, the commission found non-competes prevent efficient matching of workers and employers, making labor market conditions less competitive; and that they inhibit new business formation and innovation by negatively impacting product and service market competition.”

The final rule defines the term “non-compete clause” as a term or condition of employment that either prohibits, penalizes or otherwise functions to prevent a worker from “(1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

The Particulars

The FTC’s rule does not apply in cases where the person has entered into a non-compete related to a bona fide sale of a business entity, nor will it retroactively apply to any situation where a cause of action occurred prior to the effective date of the agreement. And the rule says that in cases “where a person has a good-faith basis to believe that the final rule is inapplicable,” they cannot be found to have engaged in “an unfair method of competition,” even if they turn out to be incorrect.

The rule specifies that it preempts state laws that allow non-competes, although it does not invalidate any state laws that restrict non-competes in ways that do not contradict the FTC’s dictates. In addition, the rule contains a severability clause so that if any reviewing court finds any provisions of the rule invalid or unenforceable, the remainder of the rule remains in effect.

The FTC suggests that employers can still protect their investments through trade secret laws and non-disclosure agreements (NDAs), noting research that has estimated 95% of workers with a non-compete also have an NDA. The Commission also points out that “instead of using non-competes to lock in workers, employers that wish to retain employees can compete on the merits for the worker’s labor services by improving wages and working conditions.”

The Benefits, Per the Commission

In announcing the new rule, the FTC estimated that:

• about 30 million Americans—one in five workers—are currently subject to a non-compete agreement;
• an additional 8,500 new businesses—representing 2.7% annual growth—will be created each year;
• the average worker will earn an extra $524 per year;
• health care costs will be lowered by up to $194 billion over the next decade; and,
• there will be an average annual increase of 17,000 to 29,000 new patents.

“Non-competes are a widespread and often exploitative practice imposing contractual conditions that prevent workers from taking a new job or starting a new business,” the FTC asserts. “Non-competes often force workers to either in a job they want to leave or bear other significant harms and costs, such as being forced to switch to a lower-paying field, being forced to relocate, being forced to leave the workforce altogether, or being forced to defend against expensive litigation.”

Of course small business owners have a different view.  Employees are trained and given access to customers, and there is very real threat that the employee will quit and either take that knowledge and the customer to a competitor or start their own business.   However, there are still ways employees can protect their business by taking advantage of the Trade Secret Laws or non-disclosure agreements (NDA’s).   It is highly recommended that your employment agreements be reviewed with counsel to find alternatives to protecting your business assets.