by Nelson O. Fitts, Michael J. Schobel, and Emily E. Samra
Left to right: Nelson O. Fitts, Michael J. Schobel, and Emily E. Samra (photos courtesy of Wachtell, Lipton, Rosen & Katz)
In a recent public meeting, a divided Federal Trade Commission voted along party lines to issue a final rule prohibiting non-compete clauses for nearly all U.S. workers. The FTC previously published the proposed ban in January 2023, drawing thousands of public comments. The final rule hews closely to the initial proposal, but with slightly broader exceptions.
Non-compete clauses prevent an employee or other individual service provider from working for a competitor or starting a competing business of her own for a defined time period after she leaves her job. The FTC’s new rule prohibits such clauses as “unfair methods of competition” in violation of Section 5 of the Federal Trade Commission Act. The rule also prohibits provisions that “penalize” an individual for working for a competitor, such as through the forfeiture or clawback of compensation or liquidated damages. The Commission did clarify that an arrangement in which a worker is on leave (sometimes referred to as “garden leave”) but still employed and receiving total compensation and benefits on a pro rata basis would not be considered a non-compete clause under the rule.
The final rule ⸺ which will take effect 120 days after publication in the Federal Register ⸺ will invalidate existing non-compete clauses for nearly 30 million workers nationwide. The rule obligates companies to notify impacted workers prior to the effective date that their non-competes are no longer enforceable. Assuming the ban withstands legal challenges, employers can no longer use non-competes as a tool to protect investments in research and development or to promote training. Employers may want to consider alternative arrangements to achieve these goals, including, for example, confidentiality and trade secret covenants and custom-tailored non-solicitation covenants, which the FTC noted are not prohibited by the rule, provided that they do not function to prevent a worker from seeking or accepting other work or starting a business. In addition, employers should consider compensatory arrangements that promote continued service, such as retention awards with longer vesting periods.
The rule includes two limited exceptions: First, companies may continue to enforce an existing non-compete with a “senior executive,” defined as an officer with “policy-making authority” who earns total annual compensation in excess of $151,164. This “senior executive” exception will not be available for non-compete clauses entered into after the rule’s effective date. Second, the rule permits individuals to enter into non-competes pursuant to a “bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.” This bona fide sale exemption, which is broader than in the FTC’s initial proposed rule, will allow transacting parties to continue to use non-compete agreements in the sale of a business, which is often a key aspect of a sale transaction. These exceptions also make it possible for transacting parties to continue to use non-competes as a tool to mitigate the impact of Section 280G of the Internal Revenue Code.
This sweeping order is the FTC’s first attempt in decades to regulate unfair methods of competition by rule. The Commission is relying on an untested interpretation of its rulemaking authority under the FTC Act to justify the new approach. In their verbal dissents, both newly confirmed Republican Commissioners asserted that the ban appropriates legislative authority and exceeds the FTC’s rulemaking power. The U.S. Chamber of Commerce and other business groups today filed a lawsuit in the Eastern District of Texas challenging the new rule on these and other grounds. This lawsuit will be an important test of the FTC’s power to regulate methods of unfair competition, as the agency seeks to expand its Section 5 authority.
Even if the courts delay or ultimately block implementation of the new rule, we expect the FTC will continue to use its investigatory powers under the federal antitrust laws to curtail non-competes. Companies and transacting parties should expect non-compete clauses to remain an enforcement priority focus of the antitrust agencies.
Nelson O. Fitts and Michael J. Schobel are Partners and Emily E. Samra is an Associate at Wachtell, Lipton, Rosen & Katz. This post first appeared as a client alert.
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