On April 23, 2024, the Federal Trade Commission issued its final rule prohibiting new non-compete agreements for all workers and declaring them an unfair method of competition.
WHAT ARE NON-COMPETE CLAUSES AND WHAT IS THE PROBLEM?
The rule defines a “non-compete clause” as a term or condition of employment that prohibits, penalizes, or functions to prevent a worker from seeking or accepting work or operating a business in the U.S. after the conclusion of the employment that includes the term or condition. The rule also applies to terms and conditions that require a worker to pay a penalty for seeking or accepting other work or starting a business after their employment ends. One example of such a term is a term providing that, for two years after the worker’s employment ends, the worker may not engage in any business within a certain geographic area that competes with the employer unless the worker pays the employer liquidated damages of $50,000. An additional example of a term that “penalizes” a worker is a severance arrangement in which the worker is paid only if they refrain from competing.
Basically, if an agreement restricts who a worker can work for or their ability to start a business after they leave their job, it is a non-compete clause. The rule also prohibits employers from requiring workers to sign any new agreements.
In creating the rule, the FTC found that the use of non-competes is restrictive and exclusionary conduct and exploitative and coercive conduct that tends to negatively affect competitive conditions in labor markets and product and service markets. The Commission estimates that approximately one in five American workers—or approximately 30 million workers—is subject to a non-compete.
If you think these clauses are negotiated or at least known, think again. Many people who commented on the rule said that the non-compete clauses were not disclosed to them until they started their jobs. Some workers reported that the clauses were slipped into stacks of paperwork signed at the beginning of employment. Even if they knew about the clause, the FTC found a lack of ability to negotiate given the unequal bargaining power between employers and workers.
Non-compete clauses are not only used to prevent executives from competing with a former employer but also to stop regular employees from competing. A salesperson in an asphalt company was prevented from working for a competitor within a 50-mile radius of the business for 2 years. A barber could not work anywhere for a competitor for 6 months and a power washer could not work for 5 years. A bartender working for $10 an hour who quit a job because of sexual harassment was sued for $30,000 for working as a bartender elsewhere because of a 2-year non-compete clause. Even a national sandwich shop chain bound its workers to a non-compete clause prohibiting them from working for another sandwich shop within 3 miles of any of the chain’s locations for two years after leaving the job.
A laid off worker lost an offer for a new job because of a non-compete clause. Physicians could not take care of patients. Workers have been forced to move, forced into long commutes, or even forced into leaving their fields because of non-compete clauses. Some workers were forced to hire a lawyer or abandon their fields entirely because of the chilling effect of litigation.
Employers have used non-compete clauses to prevent workers from pursuing new ideas, even ideas that the employer had no intent of pursuing. A survey by the Authors Guild finds that 19.2% of respondents reported that non-competes prevented them from publishing a similar or competing book.
Does it matter if you live in a state that will not enforce a non-compete clause either because the state already prohibits such clauses, or the clause contains acceptable time or geographic limits? Until a court determines that the clause is unenforceable, a worker has the threat of enforcement to worry about. Future employers do not want to buy litigation, so they are unlikely to hire someone subject to a non-compete clause regardless of whether it is enforceable. The risk is not worth it.
HOW PERVASIVE ARE THESE CLAUSES?
A 2014 study found that 18% of respondents were working under a non-compete and 38% of respondents worked under one at some point in their lives. Among workers without a bachelor’s degree, 14% of respondents reported working under a non-compete at the time surveyed and 35% reported having worked under one at some point in their lives. For workers earning less than $40,000 per year, 13% of respondents were working under a non-compete and 33% worked under one at some point in their lives. 53% of workers covered by non-competes were hourly workers. The study even found non-competes used in states that do not enforce them.
A 2017 study found the use of non-competes growing with 24.2% of workers subject to a non-compete. A 2017 survey of business establishments with 50 or more employees estimated that 49% of such establishments use non-competes for at least some of their employees, and 32% of such establishments use non-competes for all of their employees.
The results were consistent in a 2022 study in which 18% of workers were found to be subject to non-competes.
ARE THEY LIMITED BY INDUSTRY OR JOB?
The short answer is no. A survey of independent hair salon owners finds that 30% of hair stylists worked under a non-compete in 2015. A survey of electrical and electronic engineers finds that 43% of respondents signed a noncompete. A 2007 study found that 45% of physicians worked under a non-compete.
The industries where non-compete clauses were used varied from Agriculture and Hunting (9% in 2014); to Arts, Entertainment, and Recreation (12%); to Professional, Scientific, and Technical (30%). The occupations varied as well from Community and Social Services (8%); to Computer and Mathematical (32%); practitioners in the applied behavioral analysis field (33%); cardiologists (68%); colorectal surgeons (42%); and hip and knee surgeons (72%). Trade Associations report a diverse group of their members being affected as well: National Association of Wholesaler-Distributors (80%); Independent Lubricant Manufacturing Association (69%); Gas and Welding Distributors Association (80%); and National Association of Manufacturers (70%.). One industry organization said its survey found that 57% of respondents require workers earning over $150,000 to sign non-competes.
THE RULE DOES NOT BAN ALL NON-COMPETE CLAUSES
Existing non-competes with senior executives can remain in force; however, for workers who are not senior executives, existing agreements are no longer enforceable once the rule goes into effect. Employers must inform workers that non-compete agreements are no longer enforceable.
With respect to all workers, it is an unfair method of competition for a person to enter into or attempt to enter into a non-compete clause; to enforce or attempt to enforce a non-compete clause; or to represent that the worker is subject to a non-compete clause. For existing non-competes, the ban applies to all workers except for “senior executives.” Existing non-compete clauses with “senior executives” remain in force.
According to the rule, a “senior executive” is a worker who makes more than $151,164 and is in a “policy-making position.” A “policy-making position” is a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority. The important part here is that the name of the office does not determine whether the individual is in a policy-making position. The exception is meant to apply to workers at the highest levels of a business entity.
“Policy-making authority” means having the final authority to make policy decisions that control significant aspects of a business entity or a common enterprise; it is based on the business as a whole and not a particular office or department. The Commission found that department heads and other highly paid non-senior executives do not have sufficient bargaining power to avoid exploitation and coercion and are unlikely to have bargained in connection with non-competes.
The rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity. A bona fide sale is one made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.
The rule also does not apply if a cause of action related to a non-compete provision accrued prior to the effective date.
SO, WHAT DOES THIS MEAN FOR YOU?
The end of non-compete clauses does not leave employers without the means to protect confidential information. The FTC recognized that trade secret laws and non-disclosure agreements (NDAs) both provide employers with well-established means to protect proprietary and other sensitive information. However, if those agreements are used to prevent a worker from working for another employer or starting a business after the end of employment, those agreements also will be prohibited.
Don’t try to use non-solicitation agreements to get around the rule. While they are generally not non-compete clauses because they do not prevent a worker from seeking or accepting other work or starting a business, they can satisfy the definition of non-compete clause where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.
WHEN WILL THE RULE BECOME EFFECTIVE?
That answer is anyone’s guess. The final rule is set to become effective 120 days after publication in the Federal Register, but it has already been challenged in court by the U.S. Chamber of Commerce. The legal challenges could delay its implementation, limit its impact, or render it invalid.
Judge Ada Brown of the U.S. District Court for the Northern District of Texas granted a preliminary injunction requested by several plaintiffs, including the U.S. Chamber of Commerce. Judge Brown said the F.T.C. lacked “substantive rule-making authority” with respect to unfair methods of competition and that the plaintiffs were “likely to succeed on the merits” of their challenge. The preliminary injunction remains in effect until the court rules on the merits — which the court stated it intends to do by August 30, 2024.
In another case, Judge Kelley Brisbon Hodge of the U.S. District Court for the Eastern District of Pennsylvania, however, ruled that the plaintiff did not prove that it would suffer irreparable harm from the rule. Denying the company’s motion for a preliminary injunction, she said the lawsuit was unlikely to ultimately prevail on the merits.
The cases will likely end up in the Circuit Courts of Appeals and ultimately at the U.S. Supreme Court.
In the meantime, if you use noncompete agreements, make sure that they are limited in time, scope, and geography and be prepared to get rid of them if the rule goes into effect or your state invalidates them.
If you have questions about this article or about other employment issues, please contact Mitchell Goldstein (mgoldstein@setlifflaw.com) at (804) 377-1269, or Steve Setliff (ssetliff@setlifflaw.com) at (804) 377-1261.
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