It all depends on who the parties are, the purpose or circumstances of the clause, and the outcome of pending legal challenges to the FTC’s final rule.
Since April 23, when the Federal Trade Commission (FTC) announced its final rule regarding noncompete clauses, I have received numerous calls and emails asking if such clauses are no longer binding and effective.
As explained below, my general response to these inquiries has been a “definite maybe,” for it all depends on who the parties are, the purpose or circumstances of the clause, and the outcome of pending legal challenges to the final rule.
Why Did the FTC Take This Action?
The starting point for understanding the final rule is not the rule itself but, instead, examining why the FTC decided to tackle this issue. Through its final rule, the FTC seeks to curb what it sees as abuses in using such restrictive covenants in commerce, which it estimates to affect 18 percent of the American workforce.
Rather than using noncompete clauses to prevent a former employee from engaging in unfair competition by using the former employer’s proprietary information, employers often use noncompete clauses indiscriminately to stifle employee mobility or new competition.
For instance, a well-known national fast-food restaurant used noncompete clauses to prevent its counter and service personnel from working at other sandwich shops that sell “submarine, hero-type, deli-style, pita and/or wrap or rolled sandwiches” within several miles of any of the employer’s many locations throughout the entire United States — as if there is some special way to make a turkey sandwich.
However, such overreach in the use of noncompete clauses is not limited to such unskilled positions or clerical staff; it also extends to tech and other industries where highly skilled and educated employees are routinely subjected to noncompete clauses that prevent them from working for competitors or creating their own competing businesses.
Although such abuses and overreach have been dealt with through litigation and by some state statutes, such as the California statute that essentially proscribes the use of noncompete clauses in commerce, the FTC clearly felt there was a need to address the issue on a national level. With its final rule, it has done so, at least in some instances.
Specifically, the final rule prohibits the use of noncompete clauses in most, but not all, employment or independent contracting relationships.
In pertinent part, the final rule provides that:
“… it is an unfair method of competition for a person:
“(i) To enter into or attempt to enter into a noncompete clause;
“(ii) To enforce or attempt to enforce a noncompete clause; or
“(iii) To represent that the worker is subject to a noncompete clause.”
What Exactly Is a Noncompete Clause?
As defined by the FTC, a noncompete clause means:
“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.”
Who and What Does the Final Rule Cover?
The final rule defines “worker” as being a natural person (an individual, as opposed to a company),
“… who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State both Federal laws, including, but not limited to, whether a worker is an employee, independent contractor, extern, intern, volunteer or sole proprietor who provides a service to a person.”
Thus, the final rule does not apply to noncompete clauses between business entities. However, the prohibition against noncompete clauses under the final rule applies to independent contractors, such as independent sales representatives and sub-representatives, who are sole proprietors, as opposed to those who provide their services through a corporation or limited liability company.
The final rule also includes an exception that permits the enforcement of noncompete clauses entered before the final rule’s effective date (Sept. 4, 2024) between an employer and its senior executives. The final rule defines senior executives as workers in a policy-making position and earning at least $151,164 in the preceding year (or the equivalent annualized for partial-year employment).
The final rule further defines a policy-making position as a business entity’s president, CEO or equivalent, and other officers with policy-making authority. The final rule also provides an exception for the continuation of pre-existing litigation relating to the enforcement or actions for breach of noncompete clauses.
After the final rule becomes effective, new litigation cannot be filed, except with respect to noncompete clauses involving senior executives. The final rule also provides an exception for noncompete clauses ancillary to the sale of a business or an owner’s interest in a business.
Of course, to the extent that the continued use of noncompete clauses is not barred by the final rule — such as with senior executives or between businesses — the clause still must comply with all applicable state laws, which typically will enforce noncompete clauses that are narrowly drafted in scope as to duration and geography or accounts and are intended to protect an employer’s legitimate business interest.
So, What Should I Do Now?
The final rule requires all employers with noncompete clauses in place with their workers (including employees and independent contractors), other than exempted senior executives, to provide each affected worker with a “clear and inconspicuous notice” by Sept. 4, 2024, that the “worker’s noncompete clause will not legally be enforced against a worker.” The final rule requires that the notice:
“(i) Identify the person who entered into the noncompete clause with the worker;
“(ii) Be on paper delivered by hand to the worker, or by mail at the worker’s last-known personal street address, or by email at an email address belonging to the worker, including the worker’s current work email address or last-known personal email address, or by text message at a mobile telephone number belonging to the worker.”
The final rule also provides model language that can be used for such notice, as follows:
“A new rule enforced by the Federal Trade Commission makes it unlawful for us to enforce a noncompete clause. As of [date employer chooses but no later than the effective date of the final rule], [employer name] will not enforce any noncompete clause against you. This means that as of [date employer chooses but no later than the effective date of the final rule]:
“• You may seek or accept a job with any company or any person — even if they compete with [employer name].
“• You may run your own business — even if it competes with [employer name].
“• You may compete with [employer name] following your employment with [employer name].
“The FTC’s new rule does not affect any other terms or conditions of your employment. For more information about the rule, visit ftc.gov/noncompetes. Complete and accurate notice translations in certain languages other than English, including Spanish, Chinese, Arabic, Vietnamese, Tagalog and Korean, are available at ftc.gov/noncompetes.”
Although such notices must be issued to all affected workers by Sept. 4, 2024, companies may wish to delay compliance until the end of August to see if courts enjoin this procedure or other parts of the final rule.
What About Nonsolicitation and Nondisclosure Agreements?
Although the final rule does not specifically address the viability of nonsolicitation and nondisclosure agreements, it does prohibit using a term, condition or contract that “functions to prevent the worker” from engaging in competitive activity. Thus, it is an issue of substance over form.
Nonsolicitation agreements or provisions that restrict former employees from soliciting specific customers and accounts, such as those customers and accounts that were serviced or called on by the employee.
The more a nonsolicitation provision is narrowly tailored to an employer’s legitimate protectable interest, the more likely it will be found to be enforceable. However, if it functions to prevent a former employee from engaging in competitive employment or starting a business, a nonsolicitation agreement will be subject to the final rule and held unenforceable.
Nondisclosure (confidentiality) agreements also need to be reviewed and, if necessary, revised to make them more focused on protecting the proprietary or confidential information of the employer, as opposed to being so broad in scope that it serves as a back-door method to prevent an employee from engaging in competitive activity.
The final rule already is the subject of ongoing litigation challenging the FTC’s authority to issue it and seeking to stay its enforcement. While I don’t have a crystal ball and cannot predict the future, my sense is that the Supreme Court likely will find that all or some of the final rule is unconstitutional. Stay tuned.
Please contact Dan Beederman with any questions at (312) 648-2300 or e-mail at [email protected].
