The Federal Trade Commission recently issued a final rule largely banning the use of non-compete agreements nationwide.  The stated purpose of the rule is to address the substantially increased harm non-compete agreements have caused to fair competition in recent years.  While several states, including California, already have similar bans in place, the FTC determined that a nationwide rule was necessary as the state-by-state approach did not adequately address the issue.

The FTC estimates that approximately 30 million workers are currently covered by non-competes.  By wiping out these agreements, the FTC expects that the final rule will result in reduced health care costs, new business formation, a rise in innovation, and higher worker earnings.  For purposes of the rule, a noncompete is defined as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or 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.” (internal quotation omitted). Under the final rule, employers will no longer be permitted to require workers to enter into such an agreement.

Moreover, the final rule not only bans use of non-compete agreements going forward, but it also invalidates almost all existing non-compete agreements.  The one category of worker against whom existing non-competes may still be enforced are senior executives, who are defined as workers earning more than $151,164 a year and who are in a “policy-making position.”  Estimated to make up less than 1% of workers, senior executives are exempted as they are “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.”  For all other workers, a non-compete agreement will no longer be enforceable. Indeed, the final rule states that it is a form of unfair competition to: (i) enter into or attempt to enter into a non-compete clause; (ii) enforce or attempt to enforce a non-compete clause; or (iii) represent that the worker is subject to a non-compete clause (in the case senior executives, after the effective date of the rule). 

Importantly, employers are required to proactively inform employees and former employees that their existing non-competes are no longer enforceable before the effective date of the final rule, which will be 120 days after it is published in the Federal Register; as the rule is scheduled to be published in the Federal Register on May 7, 2024, the effective date of the rule should be September 4, 2024.  Model language for such a notice is included in the final rule (page 566).  The notice must be written and delivered by hand to the employee or former employee, or by mail to the person’s last known personal street address, or by email at an email address belonging to the person, including a current work email address or last known personal email address, or by text message to a mobile telephone number belonging to the worker or former worker.

The FTC provides very few exceptions to the application of the ban on non-competes.  Specifically, the ban will not apply to a noncompete clause that is entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.  The ban also will not apply to existing causes of action where the cause of action related to a non-compete clause accrued prior to the effective date. In addition, the rule includes a good faith exception that states that it is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a noncompete clause where a person has a good-faith basis to believe that the ban is inapplicable.

The final rule largely reflects the current state of non-competes in California.  For years now, California has implemented a broad ban on the use of noncompete agreements and restrictive covenants with very limited exceptions, including in connection with the sale of a business.  In fact, California required that employers send notice of the invalidity of a non-compete agreement illegal under California law earlier this year.  The primary difference between the FTC’s new rule and current California law is that, in California, a prior non-compete agreement with a senior executive would not be enforceable.  Regardless, the FTC rule makes clear that state law pertaining to non-competes will not be annulled by the FTC ban except to the extent that such laws would otherwise permit or authorize a person to engage in conduct that is an unfair method of competition under the FTC rule, or conflict with the FTC’s notice requirements.

Given California’s existing comprehensive ban on non-competes, the FTC’s final rule likely will not have much of an impact for employers operating in California.  Further, various business groups have already indicated that they will initiate legal action to stop the rule from taking effect. Nevertheless, unless and until that happens, employers should review their existing agreements and policies to ensure they are compliant with the final rule. If any non-competes are in place with employees or former employees that would not be considered senior executives, employers will need to make sure to provide sufficient written notice to those persons by the effective date that the non-compete will not be enforced.