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A condensed version of this article, authored by WLJ attorneys Daveante Jones and Cole Henderson, appeared in the June 3, 2024, issue of Arkansas Business.
The Federal Trade Commission’s (FTC) Non-Compete Clause Rule (the Rule) was published in the Federal Register on May 7, 2024. That means, beginning September 4, 2024 (the Effective Date), employers will no longer be able to enter into non-competition agreements with workers and the majority of existing non-competition agreements will be invalidated. Facing great uncertainty, the following questions provide a good starting point.
What does the Rule ban?
The Rule’s definition of a non-competition agreement includes any clause that has a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
Beginning on the Effective Date, employers will be prohibited from entering into non-competition agreements with any “workers.” Workers include full-time and part-time employees, independent contractors, interns, externs, volunteers, and apprentices. Additionally, employers will be prohibited from enforcing existing non-competition agreements with workers other than senior executives.
What is not impacted by the Rule’s ban?
The Rule does not impact non-competition agreements entered into by a person pursuant to a bona fide sale of a business entity and does not impact customer and employee non-solicitation agreements. The Rule also does not prohibit confidentiality and non-disclosure agreements to the extent they do not span such a large scope of information that the agreements effectively function to prevent workers from seeking or accepting other work or starting a business after they leave their job. Training repayment agreements are not prohibited so long as the required payment is reasonably related to the costs the employer incurred to train the worker.
Existing non-competition agreements entered into with “senior executives” will remain valid. Senior executives include those who earn more than $151,164 in compensation in a year and are in a “policy-making” position. Policy-making positions include the president, CEO, or someone else with authority to make policy decisions for the entire company. Any causes of action related to a non-competition agreement accrued prior to the Effective Date will remain valid as well.
Does the Rule apply to all industries?
There are questions that remain as to the industries that will be impacted. For instance, the FTC generally does not have jurisdiction over banks (as defined in the FTC Act), savings and loan institutions or Federal credit unions. So, most would think the Rule will likely not apply to those institutions. The Rule may, however, still apply to bank holding companies.
In response to comments expressing concern that the Federal Deposit Insurance Corporation (FDIC) could apply the Rule to banks, the FTC noted that whether other agencies apply the Rule to entities under their own jurisdiction “is a question for those agencies.” The FDIC recently published proposed revisions to its Statement of Policy on Bank Merger Transactions, which included a restriction on the use of non-competition agreements in connection with mergers. Although focused on the review of bank mergers, the proposed revisions signal the FDIC’s interest in scrutinizing the use of non-competition agreements. While the Rule’s application to entities within the banking sector remains unclear at this stage, decision-makers within those entities should strongly consider planning for its potential application.
Organizations not organized to carry on business for their own profit or that of their members are also exempt from FTC jurisdiction and thus likely exempt from the Rule. This does not, however, mean that all entities claiming tax-exempt status are outside the FTC’s jurisdiction or the reach of the Rule. According to FTC Commissioner Rebecca Kelly Slaughter, entities that claim non-profit tax status but are really organized for the profit of their members are within the FTC’s jurisdiction and covered by the Rule. The Rule, echoing the Commissioner’s sentiments, cites prior examples of FTC enforcement against tax-exempt entities. In light of these comments, tax-exempt organizations should not assume that they are exempt from the Rule simply by virtue of tax-exempt status.
What about the legal challenges to the Rule?
A number of legal challenges have been made to the Rule and will likely continue to be made. The first lawsuit was filed by a tax-service firm in the Northern District of Texas on April 23rd, hours after the vote approving the Rule for publication. The presiding judge expects to issue a decision by early-July as to whether the Rule should be halted from taking effect in September as scheduled.
The U.S. Chamber of Commerce and several other business organizations have also filed a lawsuit in the Eastern District of Texas seeking, among other relief, a declaratory judgment finding the Rule to be unlawful, an order vacating and setting the Rule aside, and an injunction prohibiting the FTC from enforcing the Rule. That case has been stayed to allow the above lawsuit to proceed first.
A third lawsuit challenging the Rule is pending in the Eastern District of Pennsylvania.
It is also worth noting that Congress could override the Rule. Under the Congressional Review Act, Congress has 60 days from the date the Rule was published (May 7, 2024) to override it.
While any of these legal challenges could delay the Rule’s implementation, employers should go ahead and start preparing their plans for how to comply.
How do employers prepare for a potential world without Non-Competition Agreements?
First, do not panic. A major change is on the horizon, but the sky is not falling.
Second, it is critical for employers to be aware of and to comply with the Rule’s notice requirement. Specifically, employers must provide “clear and conspicuous notice” to all workers (other than senior executives) with existing non-competition agreements by the Effective Date, notifying the workers that the non-competition agreements will not be and cannot be legally enforced against the worker. The FTC has released a model notice for employers to use, which can be found here.
Third, remember there are other ways to protect those invaluable business interests. For instance, there are state and federal laws in place to protect intellectual property and trade secrets, and employers still have the ability to enter into narrowly-tailored confidentiality and non-disclosure agreements with workers. In addition, client relationships and the company’s workforce may be protected through the use of narrowly-tailored non-solicitation agreements. And, in certain circumstances, employers can mitigate the risk of losing the value of special training offered to employees through a training repayment agreement requiring reimbursement if the employee leaves too quickly.
Finally, consider this as an opportunity for some introspection and self-improvement, starting with these preliminary questions:
- Does the company have the proper safeguards in place to protect trade secrets and intellectual property? Is the company restricting access on a need-to-know basis, storing them on a secure server—especially in the age of remote work?
- Does the company have a plan in place to promptly collect devices and terminate access to company data once an employee is furloughed, laid off or terminated?
- Is the company focused on maintaining and improving customer retention strategies? What is being done to strengthen those customer relationships that may lessen the impact of losing an employee and avoiding a mass exodus of customers leaving?
- What is the company doing to develop and maintain culture to aid in avoiding employee retention issues?
Conclusion
Employers should carefully consider the Rule’s impact on their organizational practices and policies. A proactive action plan to bolster employee retention and safeguard business interests through alternative methods could significantly soften the Rule’s ultimate impact upon implementation.