On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule largely banning noncompete agreements nationwide. Unless overruled the ban would become effective on September 4, 2024 - 120 days after publication in the Federal Register.

WHAT DOES THE FTC RULING ENCOMPASS?

The Commission determined that noncompetes are an unfair method of competition that violates Section 5 of the FTC Act. Should this ruling come into effect in its current form, in-force noncompetes for the vast majority of employees would no longer be enforceable after the rule’s effective date. Existing noncompete agreements for senior executives, representing less than 0.75% of all workers, would remain in force under the FTC’s final rule, but employers would be banned from entering into or enforcing any new noncompetes, even those involving senior executives. The FTC defines senior executives as those workers earning more than $151,164 annually that are in policy-making positions. Employers would also be required to notify workers other than senior executives bound by an existing noncompete that their noncompete agreements will not be enforced.¹

WHY DID THE FTC MAKE THIS RULING?

The FTC found that noncompetes tend to negatively impact labor market competition by inhibiting efficient matching between employers and workers. The Commission also determined that noncompete agreements tend to have a negative effect on competition in product and service markets, impeding innovation and new business development. In addition, evidence suggests that noncompetes may lead to increased market concentration and higher consumer prices.¹

ARE THERE EXCEPTIONS TO THE RULING? 

The ruling does note a few exceptions. For example, franchisees would still be subject to noncompete restrictions. This gives a franchise business assurance that a franchisee won’t change restaurant chains spontaneously. Additionally, noncompete covenants would still be legal and applicable for those selling a business, their business’s property, or who maintain a substantial ownership stake in a business.⁴ There is also some gray area when it comes to nonprofits. The FTC Act specifically applies to people, partnerships, or corporations that conduct business for their own profit or the profit of their members. However, the FTC has indicated that claiming 501c3 status is not dispositive. Judicial decisions and commission precedent both recognize that not every entity claiming tax exemption falls outside FTC jurisdiction. Applicability would likely be dependent on whether or not the organization is actually devoted to public rather than private interests or a charitable cause.

ARE THERE ALTERNATIVES TO NONCOMPETE AGREEMENTS?

Employers do have several alternatives to noncompete agreements that still enable companies to protect their investments and goodwill. Non-disclosure agreements (NDAs) and trade secret laws both provide employers with well-established avenues to protect sensitive or proprietary information. The ability to leverage retention/training repayment agreements as well as customer and employee non-solicitation agreements or term agreements offer additional avenues of protection for employers. However, it’s worth noting that training repayment agreement provisions are also under scrutiny by the National Labor Review Board (NLRB).

Rather than leveraging noncompetes, the FTC also suggests striving to retain employees by improving wages and working conditions.¹ There are also less sweeping changes that could be made at the individual state level should the final rule be deemed unenforceable. For example, Texas limits noncompete agreements in geography, time, and scope. Several other states include wage thresholds for noncompete agreements.

WHAT ARE THE POTENTIAL IMPACTS OF THE BAN?

The intent of the ban is to promote fair commerce and empower employees to move jobs, which is consistent with the intent of the National Labor Relations Act. However, if noncompetes are widely banned, there will likely be a spike in trade secret misappropriation litigation, which is often intertwined with noncompete lawsuits. This is due to the likelihood that employees would take client information, proprietary information, and cost/margin data with them to a competitor. Facilitating competition is one thing but allowing the transfer of trade secrets and/or confidential information would be a different matter.

Some suggest the ban could actually have a reverse effect that keeps wages low because employers may decide it’s not worth paying higher wages if employees are going to leave more frequently. Employees that are subject to noncompete agreements typically benefit from bonuses, incentives, and higher compensation, which may not be offered in an environment free of noncompetes.

DO EMPLOYERS NEED TO TAKE ACTION IMMEDIATELY?

At this point, immediate action in response to the ban is not required. The ruling has 120 days before it takes effect and multiple challenges have already been filed with additional challenges expected. For example, the Chamber of Commerce of the United States of America filed suit against the FTC in the Eastern District of Texas citing, among other things, the FTC's lack of substantive rulemaking authority.² There is a strong constitutional argument being made that the FTC does not have the authority to make this ruling and that the federal government cannot override state legislative powers.

In recent years, the NLRB has also been very active and increasing scrutiny regarding unfair labor practices such as requiring long notice periods and repayment of exorbitant training costs. The combined scrutiny of the NLRB and FTC means that it would be wise for employers to become familiar with the FTC ruling and what it does and does not impact. It is also important to review current employment practices to ensure compliance with applicable state laws as well as the National Labor Relations Act.

BOTTOM LINE

It’s unclear if the FTC ruling will stand as passed due to significant legal challenges. It’s anticipated that additional briefs will be filed around the country. Once a district court decision is made, appeals will follow. A Supreme Court stay decision is likely before the September 2024 effective date. Regardless of the final decision, the FTC has investigative authority and will continue to investigate the conduct of companies regarding noncompete agreements. Increased scrutiny of noncompetes during and arising out of transactions is also likely. Should the FTC ruling be enacted in its current form, it’s likely that breach of contract claims would ensue along with trade secret misappropriation claims. If litigation does ensue between employees and employers, it is expected that insurance policies like Directors & Officers Liability (D&O) and Employment Practices Liability would potentially be impacted.

A wait-and-see approach that avoids making any sweeping changes is best at this time. Instead, monitor the legal challenges and make sure client noncompete agreements comport with state law as there is renewed scrutiny in this area. It is clear that there will be some sort of law change moving forward, which may result in greater regulation to confirm employers are complying with applicable state law, a change in noncompete guidelines at the state level, or ultimately an amended version of the current FTC ruling. Collaborating with a trusted wholesale partner can make a difference when navigating coverage needs within the changing legal landscape. Reach out to your CRC Group producer today for assistance.

GUEST CONTRIBUTOR

Kunal Shah is a Partner with the national law firm of Spencer Fane out of its Dallas office. With clients ranging from corporations to businesses of all sizes and C-suite individuals, Kunal brings specific industry experience in construction, health care, IT, food service, and retail with a curated track record in successfully resolving disputes involving trade secret misappropriation, breach of restrictive covenants, hacking, fraud, breach of contract, discrimination, and retaliation.

In addition to litigation, Kunal brings significant experience in labor and employment. He regularly makes presentations and provides critical guidance to management on claims identification, mitigation, and prevention, along with the creation and implementation of effective best practices and policies geared toward claims avoidance. He holds a J.D. from Rutgers Law School and is admitted to the bar in New Jersey, New York, and Texas.

END NOTES

1. FTC Announces Rule Banning Noncompetes
2. Lawsuits Filed Challenging the FTC’s Final Rule Banning Non-Competes
3. The NLRB 2022 Year in Review, McNees
4. Potential Impacts of FTC’s Near-Blanket Ban on Noncompetes