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The FTC’s New Rule on Non-Competes and its Impact on Employers and Employees

FIRST SEEN IN BPN MAGAZINE | On April 23, 2024, the Federal Trade Commission (“FTC”) announced a new rule (“Final Rule”) that, once in effect, would effectively prohibit employers from entering into new non-compete agreements with workers and invalidate most existing non-compete agreements nationwide. The Final Rule was scheduled to go into effect 120 days after being published in the Federal Register, or September 4, 2024 (the “Effective Date”). However, on August 20, 2024, a Texas federal district court ruled that the FTC exceeded its authority in issuing the Final Rule and effectively blocked its enforcement nationwide (the “Texas court suspension”). The FTC has sixty (60) days, or until October 19, 2024, to appeal the decision. While the FTC may not win this battle on non-competes, the Final Rule has brought up the issue of non-competes on a national level, and many state legislatures have either passed or are introducing legislation banning non-compete agreements in their states. Unless the U.S. Court of Appeals for the Fifth Circuit reverses the decision of the district court, the Final Rule will remain unenforceable during the appeal process. There are other cases to be decided in other district courts regarding the Final Rule, and a split in the circuits’ decisions could lead the Supreme Court to weigh in on the Final Rule. However, based on recent rulings by both the U.S. Appeals Court for the Fifth Circuit and the Supreme Court, the FTC’s success on appeal seems doubtful.

This article will provide an overview of the Final Rule, the reasoning behind the Final Rule, its implications for employees and employers, and what employers can do to minimize its impact should the Final Rule be upheld.

In announcing the Final Rule, the FTC chair, Lina M. Khan, stated, “Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned. The FTC’s Final Rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” Once the Final Rule goes into effect, it will supersede state laws on noncompetes if a state law permits or authorizes conduct that conflicts with the Final Rule. If an employer tries to enforce a noncompete after the Effective Date, it will be considered an “unfair method of competition” and a violation of Section 5 of the FTC Act, which may result in penalties or injunctive relief. In cases of non-compliance, the FTC cannot fine a company directly. Still, it can issue an enforcement action to order compliance, requiring the employer to provide notice to employees in an individual manner that their noncompete cannot be enforced. If the order is not acted on, the FTC can file an action in court seeking an order to enforce the compliance order. Failure to follow the compliance order could result in fines of up to $51,744 for each violation.

For the delivered fuels industry, the Final Rule will impact almost all workers, which, under the Final Rule, includes employees and independent contractors. After the Effective Date, existing non-competes will no longer be enforceable and new non-competes will not be allowed to be entered into with employees. The Final Rule makes it easier for employees to leave their current employer and work for a competitor or start a new business without the fear of legal action being taken against them for violating a non-compete agreement. Indeed, providing workers with the freedom to change jobs, which could lead to more innovation and to more new companies being formed, was part of the rationale for the Final Rule. The FTC believes that wages for employees will increase as employers will need to offer competitive compensation to hire and retain employees. It is important to note that a breach or violation of an existing non-compete agreement that was in place prior to the Effective Date may be enforced if the action related to the non-compete violation occurred prior to the Effective Date.

However, the Final Rule does not prohibit non-compete agreements in all situations. Exceptions exist for senior executives and business owners. Under the Final Rule, a senior executive is defined as an employee earning over $151,164 in the prior year and in a policy-making position in the business. While non-compete agreements with senior executives are permitted and are enforceable by an employer after the Effective Date, employers may not enter or attempt to enter into such agreements after the Effective Date. The Final Rule also does not apply to owners who enter into a non-compete agreement in relation to a bona-fide sale of their business, regardless of their ownership percentage, and such non-compete agreements are enforceable after the Effective Date.

A key aspect of the Final Rule may have an immediate impact on businesses. Prior to the Effective Date, which was to be September 4, 2024, employers are required to inform employees in writing, except for senior executives, that their non-competes are no longer enforceable. This notice must be clearly communicated if the employer has either a mailing address, email address, or cell phone number of the affected employee. The Final Rule provides model language for such notice. In the meantime, though, due to the Texas court suspension, employers are not required to discontinue non-competes or issue notices to employees with non-compete agreements as previously mandated by the Final Rule.

 

Updating Agreements

Although the Final Rule provides more freedom for employees, there are certain steps that employers can take to protect their business. One way to mitigate the impact is through restrictive covenants with employees and independent contractors. Non-disclosure agreements are used to protect trade secrets, and non-solicitation agreements for customers and employees are used to prevent former employees from poaching customers and employees of the employer. Employers should carefully review, with the assistance of legal counsel, the current restrictive covenant agreements they have with their employees. Such reviews should be done so that any changes made to the agreements are enforceable and do not violate the requirements of the Final Rule. Although the Final Rule does not prohibit the use of the restrictive covenant agreements mentioned above, it does establish that such agreements need to be narrowly tailored so that they do not have the same effect as a non-compete agreement.

For non-disclosure agreements, the Final Rule provides that non-disclosure agreements can function as non-compete agreements when they “span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.” The FTC states that such agreements “prevent a worker from working for another employer in the same field and are therefore non-competes under the Final Rule.”

The FTC has used the same line of reasoning for non-solicitation agreements for customers and employees. A non-solicitation agreement of customers will be considered to function as a non-compete if it imposes undue restrictions on an employee’s ability to find future employment. For instance, if the employee’s non-solicitation agreement for customers extended to all the company’s customers and not only the customers whom the employee had relationships with, this agreement would violate the Final Rule as it does not allow the employee to work in the same industry, thus acting as a non-compete.

 

Using Diverse Retention Tools

Other practices can help companies mitigate the effects of the Final Rule. Besides updating existing non-disclosure and non-solicitation agreements, companies can use different tools to help hire and retain employees. Employees will be more inclined to stay with their current employer if retention tools such as bonuses, deferred compensation plans that require continued employment to receive payouts, and equity rewards that vest over lengthy periods are in place. Companies may consider which senior executives do not have non-competes and enter into a non-compete agreement before the Effective Date. Companies may also invest in internal training and development so that the required skills needed to replace a departed employee are acquired by current in-house employees, and outside employees from competitors who may bring in non-compete issues do not need to be hired. Another suggestion is to invest in and maintain customer relationships so that the relationship is independent of individual employees.

In conclusion, the FTC’s Final Rule introduces a major change by banning most non-compete agreements nationwide. While this increases employee freedom, it presents a challenge to employers who rely on non-competes to help protect their business interests. Although a Texas court currently blocks the Final Rule’s implementation, employers should still prepare by reassessing their restrictive covenants with legal counsel and adopting alternative strategies, including increased use of restrictive covenants and retention tools and investing in training and customer relationships to adapt to the new regulatory landscape. Employers or their legal counsel should carefully follow the Final Rule as it moves through the appeals process, which could take up to eighteen months. Companies, in the meantime, should identify which employees and former employees have active non-compete agreements in place and be prepared to notify them, if the Final Rule is upheld, that their non-compete agreements are no longer enforceable by the company. With proper planning, businesses can navigate these changes and remain competitive.

Fred Lord

Director, Cetane Associates

January 2025

 

Sources

FTC Announces Rule Banning Noncompetes | Federal Trade Commission

Noncompete Rule | Federal Trade Commission (ftc.gov)

FTC Non-Compete Ban: What You Need to Know (UPDATED) | Seyfarth Shaw LLP – JDSupra

Life After the FTC Non-Compete Ban: What Companies Should Know (orrick.com)

Don’t Fret (Yet): Trade Secrets, NDAs and Non-Solicits After the FTC Non-Compete Rule | Insights | Holland & Knight (hklaw.com)

FTC’s Final Rule Banning Non-Competes: What Is It and How “Final” Is It? | Locke Lord LLP – JDSupra

Two Exceptions to FTC’s Non-Compete Ban | ThinkAdvisor

Gibson Dunn: FTC Issues Final Rule Barring Employee Non-Compete Agreements

What Employers Need to Know About the FTC’s Ban of Non-Competition Agreements | Lippes Mathias LLP – JDSupra

Battle Over/War Isn’t: Employer Considerations Now That FTC Non-Compete Ban Is Set Aside – Jackson Lewis

 

This article was first published in Oil & Energy , October 2024 Issue.

 

About Cetane Associates

Cetane is a leading provider of financial advisory services to business owners in the propane, heating oil, pest control, lawn care, landscaping, and HVAC & plumbing industries. Clients engage Cetane to advise on sales, spin-offs, and acquisitions, as well as to perform valuation and ad hoc corporate finance assignments. For more information, please visit www.cetane.com.


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