If implemented the new federal rule would mark a stark change in how employers and employees can contract to prepare for an employee’s separation.
Today, the Federal Trade Commission released the long-awaited rule prohibiting most employers from enforcing or entering into noncompetition agreements with workers, including independent contractors. Historically, legislation around noncompetes has been left up to individual states. This new federal rule, if implemented, would mark a stark change in how employers and employees can contract to prepare for an employee’s separation.
Background
Noncompetition agreements, or noncompetes, are agreements entered into between an employee and an employer that block employees from competing against their former employer after their employment ends. Noncompetes have been a hot topic of legislation in recent years, with many states limiting or outright banning their use.
The final FTC rule upends individual states’ noncompete rules and for the first time, regulates them on the federal level. As justification for this new rule, the FTC states that noncompetes encumber individual employees by reducing their wages and coercing them into staying in jobs that they would rather leave. It also states that noncompetes hinder innovation by stifling new businesses and new ideas from coming to market.
Key Provisions of the FTC Rule
The new FTC rule, which is over 500 pages, significantly shifts the usage and enforceability of noncompetition agreements across the United States. We will follow up with more details about the new law, but as it stands, the rule will affect businesses in many ways. Most importantly, it:
- Declares that noncompetition agreements are an “unfair method of competition” which makes them unlawful under the FTC Act. This would prohibit employers from entering into a noncompete with a worker, maintaining a noncompete, or representing to a worker that they are subject to a noncompete. The rule goes into effect 120 days from today, on August 21, 2024, and it applies retroactively to all current noncompetition agreements.
- Applies to a broad definition of “workers” including any employee, independent contractor, extern, intern, volunteer, apprentice, or sole proprietor.
- Requires employers to rescind any existing noncompete and provide notice to the worker that the noncompete is no longer in effect. The rule also provides a model notice that employers may send to workers.
- Includes a safe harbor provision whereby the employer satisfies the requirement to rescind if the employer provides notice to the worker that their noncompete is no longer valid within 45 days of rescinding. The employer must notify current workers and former workers, if the employer has the contact information readily available.
- Includes a limited exception where the rule does not apply to a noncompete entered into by a person pursuant to the bona fide sale of a business entity, the person’s ownership interest in a business entity, or all or substantially all of a business entity’s operating assets.
- Applies to people, not businesses, so it would not apply to noncompetes between corporate entities.
How the FTC Rule Impacts Other Employee Restrictions
The final rule does not prohibit employers from entering into and enforcing other restrictive agreements with workers. For example, employers may still enforce nonsolicitation agreements and nondisclosure agreements. However, such agreements may be interpreted as noncompetes (and therefore prohibited under the rule) if they include terms that function to prevent a worker from working for another, or starting their own, business after leaving a job.
The line between a noncompetition agreement and an enforceable restrictive agreement is currently unclear. The determination, and therefore enforceability, will depend on the specific terms of the agreement and how the FTC rule is interpreted upon enactment. Employers should consider reviewing all restrictive agreements to avoid unintended noncompete liability.
What Employers Should Do Now
The final rule will not go into effect until 120 days from April 21, 2024. Experts predict that the FTC rule will be challenged in federal courts across the country and stayed as a result.
Given this uncertainty, employers should continue to follow state law regarding entering into or enforcing noncompetes. However, the FTC rule is part of a trend against these types of agreements. As such, employers should carefully evaluate the benefits and risks of the usage of noncompetes, in addition to the cost of enforcing them.
Employers that have existing noncompetes or that anticipate entering into them should track the FTC rule closely. We will continue to monitor and update clients on the status and implications of the rule, anticipated court challenges, and revisions to state law.
This update is prepared for the general information of our clients and friends. It should not be regarded as legal advice. If you have questions about the issues raised here, please contact any of the attorneys in our Labor & Employment Practice Group, or the attorney with whom you normally consult.
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