By one estimate, every fifth American worker has a “noncompete agreement” with a current or former employer. Such agreements typically prohibit the worker from competing with the employer, such as by going to work for a competitor or starting a competing business, for a certain period of time after leaving the employer.[1]
But a new rule announced by the Federal Trade Commission (FTC) on April 23, 2024, promises to ban the great majority of noncompete agreements should it take effect. The rule creates exceptions only for (1) existing noncompete agreements with “senior executives,” defined as workers who occupied a “policy-making position” and made at least $151,164 in the past year, and (2) noncompete agreements entered into as part of a “bona fide sale of [a] business.”[2] The rule will take effect in early September of this year at the earliest. But legal challenges threaten to delay the effective date of the rule—if not completely prevent the rule from taking effect.
By the FTC’s own calculations, the rule would protect more than 100 million workers across the country, including about 2.3 million in Colorado,[3] and affect the great majority of the country’s large businesses as well as almost 2.6 million of the country’s small businesses.[4]
What does the FTC’s action mean for workers and businesses? This Client Alert provides a summary of the rule and, at the end, suggested next steps.
What would the rule do?
The rule would, with only limited exceptions, make it illegal for a business to (1) enter into new noncompete agreements with workers, (2) enforce existing noncompete agreements against workers, and (3) tell others that workers have existing noncompete agreements.[5] The rule would, in other words, not only prohibit future noncompete agreements but also make existing noncompete agreements unenforceable.
That said, the rule would only make existing noncompete agreements unenforceable from the effective date of the rule, meaning that a business could still sue a worker for violating a noncompete agreement after the rule’s effective date as long as the worker’s conduct took place before the rule’s effective date.[6]
The rule would also require any business that previously entered into a newly prohibited noncompete agreement with a worker to provide the worker notice that the business will not and cannot enforce the noncompete agreement against the worker.[7]
What “workers” would the rule protect?
The rule would protect essentially anyone that qualifies as a “worker,” including both paid and unpaid employees, independent contractors, apprentices, externs, interns, volunteers, and certain sole proprietors.[8]
But the rule creates a small exception for “senior executives,” allowing a business to continue to enforce existing noncompete agreements against senior executives.[9] The rule still prohibits new noncompete agreements with senior executives.[10] A worker qualifies as a “senior executive” if the worker (1) occupied a “policy-making position” and (2) made at least $151,164 in “total annual compensation” the “preceding year.”[11] The term “policy-making position” refers to a businesses’ president, chief executive officer, and any other position endowed with “final authority to make policy decisions that control significant aspects” of the business.[12] The FTC appears to suggest that at least a business’s vice-president(s), secretary, treasurer/chief financial officer, and comptroller/principal accounting officer have such authority and, by extension, occupy a policy-making position.[13] The term “total annual compensation” includes “salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation” but does not include employer-provided benefits (e.g., medical and life insurance), contributions to retirement plans, board, or lodging.[14] The term “preceding year” means the business’s choice among “the most recent fifty-two-week year, the most recent calendar year, the most recent fiscal year, or the most recent anniversary of hire year.”[15]
In addition, the rule would not apply to a “franchisee in the context of a franchisee-franchisor relationship,” meaning that a franchisor like McDonalds may enter into a noncompete agreement with a franchisee who owns and operates one of its restaurants.[16] That said, the FTC takes pains to clarify that the rule would protect workers who work for either franchisors or franchisees, just not the franchisee itself.[17]
Finally, the rule would not protect workers in certain industries, activities, or entities over which the FTC does not have jurisdiction.[18]
This includes, for example, workers for banks; savings and loans institutions; credit unions; “common carriers” (airlines, railroads, bus lines, taxi companies, phone companies, internet service providers, cruise lines, trucking companies, etc.); meatpacking companies; and livestock dealers.[19]
This also includes workers for entities “not organized to carry on business for [their] own profit or that of [their] members.”[20] While this might seem, at first blush, to mean that the rule would not protect workers for nonprofits, the FTC emphasizes that the fact that an entity claims nonprofit status does not mean that the entity actually operates as a nonprofit, and to the extent that an entity does not actually operate as a nonprofit, the rule would protect its workers.[21] This presents one of the bigger open questions concerning the rule: Does the rule protect workers—doctors, nurses, and staff—for “nonprofit” hospitals and healthcare organizations?[22] This will probably require case-by-case determination by the FTC, Internal Revenue Service, or courts, though the FTC already concedes that “not all entities in the healthcare industry fall under its jurisdiction.”[23]
What “noncompete agreements” would the rule cover?
The rule would cover essentially anything that even plausibly qualifies as a “noncompete agreement,” including any “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 another business where that work would begin after leaving the employer or (2) “operating a business in the United States” after leaving the employer.[24] Such a “term or condition of employment” may appear in a contract or workplace policy (e.g., employee manual), or the employer could even convey it orally.[25]
With “penalizes a worker,” the FTC intends to prohibit any term that requires a worker to pay a monetary “penalty” or imposes other “adverse financial consequences,” such as forfeiting compensation under a severance agreement, in return for allowing the worker to compete.[26]
With “functions to prevent,” the FTC intends to prohibit any term “so broad or onerous that it has the same functional effect” as a noncompete agreement.[27] Examples of such terms include overbroad nondisclosure agreements that bar workers from “disclosing any information or knowledge . . . obtain[ed] during their employment whatsoever, including publicly available information.”[28] The “functions to prevent” language would presumably also prohibit overbroad nonsolicitation agreements, training repayment agreements, or various other kinds of agreements. This will require a case-by-case determination based on the language of the agreement at issue and surrounding circumstances.
In general, nonsolicitation agreements prove less extensive than noncompetition agreements because they typically only prohibit workers from soliciting an employer’s customers or employees, not competing with the employer in the industry at large. But if, for example, an employer does business with essentially everyone in an industry such that a nonsolicitation agreement effectively prohibits workers from competing in the industry because there exist no potential customers that they could solicit for a competitor or a new competing business, the rule could prohibit the nonsolicitation agreement because it has the same functional effect as a noncompetition agreement. That said, most nonsolicitation agreements will probably survive under the rule.
The rule creates a small exception for “bona fide sales of business,” allowing parties to a bona fide sale of a business entity, ownership interest in a business entity, or substantially all operating assets of a business entity to enter into a noncompete agreement as part of the transaction.[29]
The rule would not apply to terms or conditions of employment that prohibit a worker from competing with the employer while working for the employer, only ones that prohibit a worker from competing with the employer for a certain period of time after leaving the employer.[30]
How does the rule affect existing state laws concerning noncompete agreements?
The rule allows states to continue enforcing state laws that restrict noncompete agreements and do not conflict with the rule.[31] Critically, states “may . . . continue to pursue enforcement actions under their laws prohibiting non-competes even if the State law prohibits a narrower subset of non-competes than [the rule] prohibits.”[32]
Thus, for example, the rule would preempt the provisions of Colorado state law that allow noncompetition agreements for highly-compensated workers intended to protect trade secrets, but the provisions of Colorado state law that prohibit other noncompetition agreements would remain enforceable.[33]
When might the rule take effect?
The rule should, theoretically, take effect 120 days after the FTC publishes it in the Federal Register, the official journal of the United States federal government.[34] According to a compliance guide posted to its website, the FTC intends to publish the rule in time for it to take effect in early September of this year.[35]
But multiple organizations, including the U.S. Chamber of Commerce, have already sued to block the rule, asking courts to issue an injunction that would prevent the rule from taking effect for at least as long as it takes courts to sort through the various arguments, if not permanently.[36] The arguments advanced by these organizations include that the FTC lacks the power to issue the rule.[37] Given the nature of the arguments and the scope of the rule, the United States Supreme Court may have the final say.
What should workers do now?
Workers should take a wait-and-see approach.
Because courts may prevent the rule from taking effect and, regardless, the rule would not take effect until at least early September of this year, workers should not rely on the rule to make any employment-related decisions at this point. In fact, workers should not rely on the rule until the FTC provides final confirmation that the rule has taken effect. (But in the meantime, workers might find success using the rule as leverage to eliminate noncompete clauses and obtain other concessions in negotiations with employers.) Instead, workers should rely on existing state law.
In Colorado, for example, state law prohibits noncompetition agreements entered into after August 10, 2022, with only limited exceptions.[38] The most prominent exception allows noncompetition agreements for “highly compensated workers” intended to protect trade secrets.[39] The term “highly compensated workers” means workers with annual compensation exceeding $123,750 in 2024, with lower thresholds for preceding years.[40] A worker qualifies as a “highly compensated worker” if the worker’s compensation exceeded the applicable threshold at the time that the worker entered into the noncompetition agreement.
Two points of caution: First, many terms and conditions of employment include “choice of law” clauses that specify that a certain state’s law applies. For example, a Colorado worker for an Illinois company may have a choice of law clause in his employment agreement that specifies that Illinois state law applies; Illinois and Colorado take different approaches to noncompete agreements. (But under certain circumstances too complicated to discuss here, courts may decide not to enforce choice of law clauses and may, instead, apply the law of the state where the worker lives.) Thus, workers should determine which state’s law applies to their particular situations. Second, in Colorado, additional exceptions apply to noncompetition agreements entered into before August 10, 2022.
Regardless, before making any employment-related decisions that might run afoul of a noncompetition agreement, workers should thoroughly inform themselves of the restrictions on noncompete agreements applicable to their particular situations and, if necessary, contact an attorney for guidance.
What should businesses do now?
Businesses should take a wait-and-see approach but, sooner rather than later, begin preparing for the possibility that the rule will take effect.
Because courts may prevent the rule from taking effect and, regardless, the rule would not take effect until at least early September of this year, businesses need not follow the rule in making employment-related decisions at this point. But businesses must, as before, comply with existing state law.
To prepare for the possibility that the rule will take effect, businesses should do the following:
- Monitor developments regarding the rule. The status of the rule, whether tied up in courts or on the path to taking effect, will determine the timeline for completing these steps.
- Determine whether the rule will apply to their workers and, if so, which ones. See “What ‘workers’ would the rule protect?” section, above.
- Consider whether to enter into new noncompetition agreements with “senior executives” before the rule takes effect. If desired, do so before the rule takes effect. The rule would allow a business to continue to enforce existing noncompete agreements against senior executives after the rule takes effect, though still prohibiting future noncompete agreements with senior executives. See “What ‘workers’ would the rule protect?” section, above.
- Consider whether entering into other agreements with workers or taking other action not prohibited by the rule would, together, replace some of the protection of noncompetition agreements. If so, prepare a plan to implement such agreements and actions if and when the rule takes effect. With respect to protecting trade secrets and other confidential information, the FTC suggests that businesses pursue enforcement of intellectual property rights under trade secret and patent laws, enter into nondisclosure agreements with workers, or enter into invention assignment agreements with workers.[41] With respect to protecting investments in worker training, the FTC suggests that businesses enter into fixed duration employment contracts and, regardless, ensure that their worker compensation and working conditions prove competitive.[42] See “What ‘noncompete agreements’ would the rule cover?” section, above.
- Prepare a notice to any worker with whom they previously entered into a newly prohibited noncompete agreement to inform the worker that they will not and cannot enforce the noncompete agreement against the worker. Businesses need only send such notice if and when the rule takes effect and may do so with an “all-staff” email.[43] The FTC has provided model language for such notice here: https://www.ftc.gov/system/files/ftc_gov/documents/English.docx. Businesses need not send such notice to “senior executives” because the rule allows them to continue to enforce existing noncompete agreements against senior executives. See “What ‘workers’ would the rule protect?” section, above.
- Prepare revised versions of terms and conditions of employment, including form contracts and workplace policies, that comply with the rule to implement if and when the rule takes effect. See “What ‘noncompete agreements’ would the rule cover?” section, above.
- Ensure that human resources and other relevant departments have the information needed to comply with the rule if and when it takes effect. See “What ‘noncompete agreements’ would the rule cover?” section, above.
Finally, businesses should expect that, regardless of whether the rule takes effect or not, as a result of the news generated by the FTC’s announcement, workers may have a newfound awareness of and sensitivity toward noncompetition agreements.
BHGR attorneys will gladly discuss the rule and provide guidance regarding the rule’s impact on particular workers or businesses. Please contact Josh Marks, Kathleen Alt, Rudy Verner, or Andrew Fischer.
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[1] See Fed. Trade Comm’n, Non-Compete Clause Rule (April 23, 2024) (to be codified at 16 C.F.R. pt. 910), https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (“Final Rule”), at 14.
[2] See Press Release, Fed. Trade Comm’n, FTC Announces Rule Banning Noncompetes (April 23, 2024), https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes.
[3] Final Rule App’x Table A.1.
[4] See Final Rule 540.
[5] See Final Rule 564, § 910.2(a)(1). The rule itself makes it illegal for “any natural person, partnership corporation, association, or other legal entity . . . , including any person acting under color or authority of State law” to engage in this conduct. See Final Rule 561–64, §§ 910.1 (definition of “person”), 910.2(a)(1) (prohibition). This Client Alert uses “business” as shorthand.
[6] See Final Rule 567, § 910(3)(b).
[7] Final Rule 564–67, § 910.2(b).
[8] See Final Rule 563–64, §§ 910.1 (definition of “worker”), 910.2(a)(1) (prohibition).
[9] Final Rule 564, § 910.2(a)(2).
[10] Final Rule 564, § 910.2(a)(2).
[11] Final Rule 563, § 910.1 (definition of “senior executive”). To the extent that a worker left the employer partway through a year, the worker qualifies as a “senior executive” if the worker (1) occupied a “policy-making position” and (2) made at least $151,164 in “total annual compensation” that year when annualized. Final Rule 563, § 910.1 (definition of “senior executive”).
[12] See Final Rule 562–63, § 910.1 (definitions of “policy-making position” and “policy-making authority”).
[13] See Final Rule 562–63, § 910.1 (definitions of “policy-making position” and “officer”).
[14] Final Rule 563, § 910.1 (definition of “total annual compensation”).
[15] Final Rule 563, § 910.1 (definition of “preceding year”).
[16] See Final Rule 563, § 910.1 (definition of “worker”).
[17] Final Rule 563, § 910.1 (definition of “worker”).
[18] See Final Rule 33 (“The final rule will apply only to the extent that the Commission has jurisdiction under the FTC Act.”), 47–48.
[19] See Final Rule 47–48; 15 U.S.C. § 45(a)(2).
[20] See 15 U.S.C. §§ 44 (definition of “corporation”), 45(a)(2).
[21] Final Rule 51–54.
[22] See Final Rule 380–381.
[23] See Final Rule 374, 380–381.
[24] Final Rule 561–64, §§ 910.1 (definition of “non-compete clause”) (emphasis added), 910.2(a)(1) (prohibition). Thus, the rule would not cover noncompete agreements that only prohibit seeking or accepting work or operating a business outside the United States, though foreign jurisdictions may impose their own regulations. Final Rule 87–88.
[25] Final Rule 561–62, § 910.1 (definition of “non-compete clause”).
[26] Final Rule 76–77.
[27] Final Rule 77–78.
[28] Final Rule 80–81.
[29] Final Rule 567, § 910.3(a).
[30] See Final Rule 561, § 910.1 (definition of “non-compete clause”).
[31] Final Rule 567, § 910.4.
[32] Final Rule 395.
[33] See Final Rule 567, § 910.4; Colo. Rev. Stat. § 8-2-113(2).
[34] Final Rule 1.
[35] Fed. Trade Comm’n, Noncompete Clause Rule: A Guide for Businesses and Small Entity Compliance Guide (April 23, 2024), https://www.ftc.gov/system/files/ftc_gov/pdf/Business-and-Small-Entity-Compliance-Guide-updated.pdf, at 2.
[36] See, e.g., Jeanne Sahadi, FTC is sued by business groups over its ban on noncompete agreements, which may delay enforcement (updated April 26, 2024, 9:45 AM), https://www.cnn.com/2024/04/25/success/ftc-noncompete-ban-lawsuit.
[37] See, e.g., Jeanne Sahadi, FTC is sued by business groups over its ban on noncompete agreements, which may delay enforcement (updated April 26, 2024, 9:45 AM), https://www.cnn.com/2024/04/25/success/ftc-noncompete-ban-lawsuit.
[38] See Colo. Rev. Stat. § 8-2-113(2).
[39] Colo. Rev. Stat. § 8-2-113(2).
[40] Colo. Rev. Stat. § 8-2-113(2); 7 Colo. Code Regs. § 1103-14:1.
[41] Final Rule 290.
[42] Final Rule 290.
[43] Fed. Trade Comm’n, Noncompete Clause Rule: A Guide for Businesses and Small Entity Compliance Guide (April 23, 2024), https://www.ftc.gov/system/files/ftc_gov/pdf/Business-and-Small-Entity-Compliance-Guide-updated.pdf, at 3.