LEGAL UPDATE: FTC Ban on Noncompete Provisions
by Michelle Bomberger | May 3, 2024In recent years, it’s become increasingly common for states to limit the use of noncompete agreements by employers. With Washington’s recent amendment and further restrictions on the use of such provisions this year (see our blog) Washington Further Limits the Use of Noncompetition and Nonsolicitation Provisions, and California essentially eliminating them (see California Senate Bill 699), additional movement in this arena should not be a surprise. In January 2023, the Federal Trade Commission (FTC) proposed a Rule (Noncompete Rule) that would largely prohibit the use of noncompetes, much to the disappointment of many business leaders. This proposal sparked a comment period that garnered over 26,000 public responses.
On April 23, 2024, the FTC voted to adopt the Rule. Legal challenges were swiftly initiated in an attempt to prevent the Rule’s implementation. If these legal challenges do not overturn the Rule, it will become effective 120 days after its publication in the Federal Register. Based on current projections, the effective date will be in early September 2024.
Key Provisions:
- The Rule generally states that it is an “unfair method of competition” for an employer to enter into, enforce, or claim that a worker is subject to a noncompete clause. The FTC asserts that allowing future noncompetes after the Rule’s implementation constitutes unfair competition.
- The Rule defines a “noncompete” as a term or condition of employment that restricts a worker from seeking or accepting work with a different employer or operating a business in the United States after their current employment ends. The Rule clarifies that if the agreement does not restrict where the worker can work post-employment, it is not a noncompete. The Rule defines a “worker” broadly and includes independent contractors, interns, volunteers, apprentices, and sole proprietors providing services.
- Noncompete provisions will still be enforceable if they are already in existence as of the Rule’s effective date and the party is a senior executive, or if they are entered into by a person as part of a bona fide sale of a business entity. A “senior executive” is defined as an employee who earned over $151,164 in the previous year, has policy-making authority (such as a company President, CEO, or equivalent role), and represents less than 1% of the company’s workforce. New noncompetes with all other workers, including senior executives, will be prohibited after the Rule’s effective date.
- The Rule does not apply to most not-for-profit entities and certain financial institutions, as these entities fall outside the FTC’s jurisdiction.
- The Rule permits noncompete provisions during a “garden leave” arrangement, where an employee remains on the payroll with the same salary and benefits after leaving a job voluntarily or involuntarily, as these are not post-employment restrictions.
- While nonsolicitation, non-disclosure, no-business, and training repayment provisions are permitted, the Rule also restricts any provision that is so broad or burdensome that it effectively replicates the effects of a noncompete, even if it is not labeled as such.
- For noncompete clauses that existed prior to the Rule, employers are required to inform affected workers within 60 days of the Rule’s effective date that their existing noncompete restrictions will no longer be enforced. The Rule includes a model notice language that can be delivered via email, text message, or paper notice by hand or mail. These notices must be dispatched before the Rule’s effective date.
- While the Rule does permit an employee to take legal action against their employer for violations, the FTC has also established a mechanism for workers to report violations directly to them.
Where does this leave state laws?
The Rule only supersedes state laws when there is a conflict. While the Rule’s provisions would largely replace Washington State’s law if enacted, Washington’s definition of a noncompete provision is more extensive than the FTC’s. Under the Rule, a noncompete clause is one that “prohibits,” “penalizes,” or “functions to prevent” a worker from seeking employment elsewhere or operating a business. In contrast, Washington’s definition is more detailed and could apply to broad agreements not to solicit former customers. There are also differences between the Rule and Washington’s law regarding the exemption for the sale of a business, particularly where Washington’s 1% sale threshold differs from the Rule’s “bona fide sale” exception.
What Employers Should Know
Now is the time to review your employment documents and identify any provisions that may be classified as noncompete provisions that will contravene the new Washington law and the federal Rule. Assess the potential risks these changes pose to your business and consider alternative risk management tools to safeguard your business interests. Make necessary changes to documents and processes to ensure compliance with Washington’s law. Compile a list of current and former employees impacted by the new federal Rule and be prepared to modify your documents again to comply with the Rule, should it come into effect.