Legal Alert: Understanding the FTC’s New Rule on Non-Compete Agreements

In a landmark decision, the Federal Trade Commission (FTC) voted (3-2) to adopt a Final Rule that significantly alters the landscape of non-compete clauses in employment contracts across the United States. This ruling represents a pivotal change in federal employment law, aimed at enhancing labor mobility and curbing practices that are seen as limiting competition and innovation within the workforce. Litigation challenging the FTC’s authority to implement this ban through rule-making is likely underway. In the meantime, unless and until the Final Rule is stayed, here's what employers need to know about the new regulations concerning non-compete agreements:

Background

For years, non-compete clauses have been a staple in employment contracts, intended to protect businesses by restricting the ability of employees to enter into competition against their employers post-employment. However, these clauses have increasingly been criticized for stifling workers' ability to move freely between job opportunities and for depressing wages and innovation. In response, the FTC proposed a rule to eliminate non-compete clauses, prompting more than 26,000 public comments, largely in support of the change. After thorough review, the FTC moved to formally ban these agreements with certain nuanced considerations for existing contracts and specific worker categories.

Details of the FTC’s Final Rule

Existing Non-Compete Agreements

• Senior Executives: Non-compete agreements currently in place for senior executives will remain enforceable. This exception acknowledges the unique negotiations and compensations typically involved in the contracts of high-level executives.
• Other Workers: For all other non-executive employees, the enforcement of existing non-compete agreements will cease. Employers are required to notify these employees of the change, reflecting the FTC’s stance that these workers often do not have significant bargaining power in their contractual relationships.

Prohibition of New Non-Competes

• Effective 120 days after its publication in the Federal Register, the creation of new non-compete agreements will be prohibited for all workers, including senior executives. This decisive move is aimed at fostering a more dynamic labor market and is supported by FTC research suggesting significant potential for economic improvement through enhanced worker mobility and business innovation.

Exclusions for Non-Profits

• The Final Rule does not apply to non-profit organizations that fall outside the FTC’s jurisdiction. Consequently, many healthcare entities and other non-profits may continue to implement reasonable non-compete clauses in accordance with their specific regulatory frameworks.

Strategic Implications for Businesses

Businesses must now reassess their employment strategies and prepare for adjustments in how they manage human resources, protect business secrets, and comply with the new regulations. Organizations should:

• Review and Revise HR Policies: Align internal policies and employment contracts with the new legal landscape. Focus on enhancing retention strategies and employer attractiveness without relying on non-competes.
• Strengthen Alternative Safeguards: Adopt other legal mechanisms, such as confidentiality agreements and non-disclosure agreements, to safeguard proprietary information and maintain competitive advantages.
• Ensure Compliance and Communication: Clear and timely communication with affected employees about the changes is essential. Updates to HR systems and training for HR managers will be necessary to navigate the new rules effectively.

Legal Challenges

Within a few hours of the Final Rule's passage, it was challenged in Federal Court (Ryan, LLC v. Federal Trade Commission). Ryan, LLC has filed a lawsuit in the Northern District of Texas challenging the Federal Trade Commission's (FTC) recently finalized rule that prohibits nearly all non-compete agreements across the United States. The complaint, filed on April 23, 2024, argues that the FTC has overstepped its statutory authority and violated constitutional limits by issuing a rule that effectively invalidates 30 million employment contracts and overrides the regulatory regimes of at least 46 states.

Key Points from the Lawsuit:

• Statutory Authority: Ryan LLC contests that the FTC lacks the statutory authority to promulgate such a sweeping rule under the Federal Trade Commission Act, which it claims only allows for procedural regulations, not substantive prohibitions like those imposed on non-compete agreements.
• Constitutional Issues: The lawsuit raises constitutional concerns, suggesting that the FTC’s rule is a broad, unauthorized exercise of power that lacks an "intelligible principle" required for delegation of legislative authority. Additionally, it challenges the constitutionality of the FTC’s structure, arguing it improperly insulates commissioners from executive oversight.
• Economic and Social Impact: Ryan, LLC emphasizes that non-compete agreements have historically been used to protect business interests and encourage investment in employee training and innovation. The complaint argues that the FTC’s rule disregards these benefits and will disrupt existing economic relationships and business models.

Significance of This Lawsuit: This legal challenge is significant as it tests the boundaries of the FTC’s rule-making authority and raises fundamental questions about the balance of federal regulatory power and state-level contract law. A decision in this case could have wide-reaching implications for employment law and corporate governance across the country.

Businesses should closely monitor the progress of this case, as its outcome could impact the enforceability of non-compete agreements and potentially reshape the regulatory landscape for employment contracts nationwide.

Conclusion

The FTC’s Final Rule on non-compete agreements marks a significant shift in how employers and employees will approach employment contracts and mobility. This change underscores the importance of innovation and competition in the labor market. As always, our firm is here to help navigate these changes with strategic advice and comprehensive compliance support.

Please contact us to discuss how this new ruling may impact your business and to update your employment practices accordingly.