The Long-Anticipated Decision.

April 23, in a 3-2 decision, the Federal Trade Commission (FTC) narrowly approved the issuance of a revised final rule (“Rule”) that prohibits most post-employment noncompete agreements nationwide. In doing so, the FTC determined that noncompetes are an unfair method of competition and violate Section 5 of the Federal Trade Commission Act. While this action was immediately met with cheers by most employees and jeers by most employers, its immediate, short-term impact may be overstated.

When Does the Rule Become Effective?

The Rule was codified on May 7, and is scheduled to go into effect 120 days later on Sept. 4.¹ Employers have already filed lawsuits seeking to overturn the Rule. The Rule may be enjoined by a court, further delaying its effective date. Until then, we expect that many workers who are subject to noncompetes will monitor the effective date and plan their exit strategies accordingly.

What Does the Rule Do?

The Rule does not invalidate every noncompete in every context. Instead, the Rule states (1) that employers cannot enforce existing noncompetes against workers unless they are senior executives; and (2) that employers may not enter into new noncompetes with any workers (including senior executives).² In other words, even after the Rule goes into effect, employers will still be able to enforce existing post-employment noncompetes against senior executives. If the Rule is ultimately enforced, employers should consider having their senior executives bound by noncompetes before the effective date. After that, it would be too late.

Who are Senior Executives?

“Senior Executives” are defined as workers earning more than $151,164 annually who are in a “policy-making position.”³ The Rule defines a “policy-making position” as “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity.”⁴ In turn, “policy-making authority” describes only the “final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.”⁵

Based on this definition, the “senior executive” exclusion applies to a relatively limited class of workers. Based on data from the American Community Survey, the FTC has estimated that senior executives comprise only 0.75% of all workers, which means that the Rule would still apply to approximately 99.25% of all post-employment noncompetes.⁶

What Does the Rule Not Do?

As noted above, the Rule does not affect existing noncompetes of senior executives.⁷  It also does not affect the following types of noncompete relationships:

Relationships the Commission Lacks Control Over. 15 U.S.C. § 45(a)(2) empowers and directs the Commission to prevent the use of unfair methods of competition, but that same language limits the Commission’s control over certain entities.⁸ These entities include banks, savings and loan institutions, federal credit unions, common carriers subject to the acts to regulate commerce,⁹  air carriers, and businesses subject to the Packers and Stockyards Act.¹⁰

In-Term Noncompetes. The Rule does not affect noncompetes that prevent a worker from competing while still employed; in other words, the Rule applies only to post-termination noncompetes.¹¹ Contracts that prevent an employee from working multiple jobs or working for two competitors simultaneously should not be affected.

Pending Noncompete Litigation. Under § 910.3(b), the Rule does not apply “where a cause of action related to a noncompete clause accrued prior to the effective date.”¹² It is unclear, however, whether that means that an employer may sue for violations of preexisting noncompetes after the Rule’s effective date so long as the violation occurred before then or whether it means that any enforcement action related to an existing noncompete must be filed before the Rule becomes effective.¹³ For employers to stay out of the grey, this exclusion will likely lead many employers to commence noncompete-related litigation against certain former workers before the Rule becomes effective to ensure they come within this exception.

Certain Nonprofit Employees. The Rule does not extend to certain non-profit workers because the FTC lacks jurisdiction over entities not organized to carry on business for their own profit or that of their members.¹⁴ However, the FTC has cautioned that not all entities claiming tax-exempt status, such as healthcare organizations, fall outside its jurisdiction.¹⁵ If an entity is organized for its members’ profit, those entities fall under the FTC’s jurisdiction, and the Rule applies to them.

Sale of a Business. A person who sells a business to a purchaser can still be bound by a noncompete as part of the sale transaction — provided that the sale is a bona fide sale and not a sham transaction.16 Noncompetes associated with the sale of a business are commonplace in Tennessee and often looked at less harshly than noncompetes against employees. After all, the purchaser of a business arguably has a solid and legitimate business interest in keeping the seller from immediately starting a competing business down the street. Notably, this exception is also a change from the FTC’s proposed rule, which would have required a 25% equity threshold before the owner could be restricted.

Franchisees in a Franchisor-Franchisee Relationship. Similarly, although the Rule defines the term “worker” to include individuals who work for a franchisee or franchisor, the Rule does not include the franchisee in the context of a franchisee-franchisor relationship.¹⁷ The FTC considers the relationship between a franchisor and a franchisee to, in some cases, be “more analogous to the relationship between two businesses than the relationship between an employer and a worker.”¹⁸

What Is Considered a Noncompete Under the Rule?

“Noncompete clause” is defined in the Rule as:

“A 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 a different person where such work would begin after the conclusion of the employment that includes the term or condition, or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”¹⁹

The FTC knows that employment lawyers can be a clever lot, so it does not only restrict traditional noncompetes that prohibit workers from working for a competitor. This “functional noncompete” test also restricts the use of agreements that “penalize” or restrain such a large scope of activity that they “function to prevent” workers from working elsewhere after their employment ends.²⁰ This includes any agreement requiring a worker to forfeit compensation, bonuses, equity awards, deferred compensation, etc., in the event of a breach. While not categorically prohibited, even agreements that require nondisclosure, nonsolicitation or reimbursement of training expenses may also be considered “functional noncompetes” if they are so broad that they have the same functional effect as a traditional noncompete.

Does the Rule Only Apply to Employees?

No. The Rule defines “worker” as “a natural person 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 or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice or a sole proprietor who provides a service to a person.”²¹ In other words, the Rule applies to employees and contractors.

What Must Employers Do Regarding Workers with Noncompetes That This Rule Invalidates?

Once (and if) it goes into effect, the Rule will require employers to notify any workers whose noncompetes are no longer enforceable that they are no longer in effect and will not be enforced.²² The FTC provided model language for giving notice that noncompetes will not be enforceable or enforced, which is effectively the same as requiring a notice of rescission under the former proposed rule.²³ Importantly, however, these notices are not required until after the Rule’s effective date.²⁴

How Will the Rule Be Enforced?

Once the Rule is effective, workers can send information regarding suspected Rule violations to an FTC-provided email address: noncompete@ftc.gov. However, the Rule does not create a private right of action in its current form,²⁵ so it would affect only actions by the FTC seeking injunctive relief under Section 5 of the Act, which does not authorize the FTC to seek damages or other forms of monetary relief.²⁶ As such, monetary sanctions would be available only if a party violated a prior FTC cease and desist order banning conduct related to noncompetes — or, hypothetically, if an employer subject to a prevailing party fee provision improperly seeks to enforce a non-compete in court after the Rule goes into effect.

How Is the Business Community Likely to Respond to the Rule?

The business community will challenge both the Rule and the FTC’s authority to issue it — and efforts to do so have already begun. Two lawsuits were filed the day after the FTC approved the Rule, including one by the U.S. Chamber of Commerce in Tyler, Texas.²⁷ The U.S. District Court for the Eastern District of Texas stayed the proceedings in Chamber of Commerce v. FTC by granting the FTC’s request to apply the first-to-file doctrine in favor of the pending, first-filed action, Ryan LLC v. FTC, which was filed in the Northern District of Texas.²⁸ The chamber then moved to intervene in the Ryan LLC case, which was granted.²⁹ Ryan LLC moved to stay the FTC noncompete ban and issue a preliminary injunction.³⁰

Based on the current briefing schedule, it appears that the court will issue its decision on July 3, after this issue has gone to press.*³¹A third lawsuit was filed against the FTC by ATS Tree Services in the Eastern District of Pennsylvania,³² and that court has indicated that it will rule on the motion to stay the effective date of the non-compete rule by July 23.³³ Based on these filings, it appears that one or more courts will have decided whether to stay enforcement of the Rule before the end of July and well in advance of the Sept. 4, effective date, and the courts’ rulings could set up a circuit split that could accelerate the review of the Rule by the United States Supreme Court.

Whether the FTC has the authority to promulgate the Rule is almost certain to end up before the U.S. Supreme Court. While I certainly don’t have a crystal ball — and I would dramatically increase my rates if I did — many employment attorneys (myself included) believe that the FTC will likely lose that battle. The arguments against enforcement of the Rule are very similar across the numerous pending lawsuits against the FTC. Employers assert that the FTC lacks authority to issue the Rule under the Major Questions Doctrine, which is a rule of constitutional interpretation that generally holds that Congress must provide clear authority when delegating rulemaking authority to agencies on questions of significant economic and political significance.³⁴ They argue that even if Congress had given the FTC authority to issue a rule on noncompetes, under Article I of the Constitution, that would be an impermissible delegation of authority under the Non-Delegation Doctrine, because Congress cannot transfer powers that are exclusively legislative.³⁵ The employers argue further that even if it was not an impermissible delegation, the Rule is arbitrary and capricious.³⁶

Between now and the resolution of these questions — which could take years as the Rule faces various legal challenges and winds its way through the court system — it is anticipated that an injunction will be entered enjoining the enforcement of the Rule. If enjoined, the Rule could be paused and not go into effect until the courts decide its enforceability. It is also possible that the Rule is only enjoined in particular cases or jurisdictions or that only parts of it are enforced. The Rule attempts to address this possibility by including language limiting any holding of invalidity to the particular persons or circumstance and includes severability language.³⁷ In any event, employers may obtain some clarity depending on the outcome of the pending cases in July of this year.

What Should Employers Do While the Rule Is Being Challenged in the Courts?

Generally, drastic changes to employers’ current practices should be avoided:

First, the Rule most likely will never go into effect, at least not in its current form. Its enforcement will probably be enjoined and the U.S. Supreme Court will ultimately reject it because the FTC did not have the authority to issue the Rule.

Second, even if it does, the enforcement risk is low, and as noted above, the FTC has limited enforcement mechanisms. However, employers could potentially risk state law claims for attempting to enforce now-unenforceable noncompete clauses, including claims for tortiously interfering with the employees’ relationships.

Third, without aiming to bring politics into this, it is not a coincidence that the FTC is seeks to expand its jurisdiction during President Biden’s term, just as the NLRB did. As a reminder, the Rule passed 3-2, which is also not a coincidence because no more than three commissioners can be of the same political party.³⁸ Depending on the outcome of this year’s election and other factors, there is a chance that a new administration would appoint one or more new commissioners who would vote to rescind the Rule, either before or after it goes into effect.

Fourth, there is uncertainty around how this will ultimately play out in the court system. For consistency, employers may want to continue having new employees sign noncompetes during this transitional period. Otherwise, if the Rule is overturned, not every new hire will have a noncompete, and the ones who do will argue that you can’t enforce it against them because you didn’t enforce it against the others.

With that said, employers should:

1. Audit their current and past workers and determine which noncompetes (and other agreements that could be considered a “functional noncompete” under the Rule) are arguably still in effect so they can determine which are excluded from the Rule and which the Rule renders unenforceable; and Prepare a list of workers who they may need to notify that their noncompetes will not be enforced once the Rule goes into effect.
2. Employers should also use this transitional time to review their methods of protecting confidential, proprietary and trade secret information and to restrict unfair competition. Employers don’t want to be caught unprepared if the U.S. Supreme Court upholds the Rule, so they need to look at alternatives they can use to accomplish the same tasks. Some alternatives are discussed in more detail below.
3. Finally, employers must weigh whether it is worth enforcing a noncompete agreement against a nonsenior executive during this interim period if the Rule has yet to be enjoined. Trial courts and arbitrators will be aware of the Rule, and some courts may — rightly or wrongly — be less likely to enforce post-employment noncompetes until it is clear whether the Rule will go into effect. It is also expected that employees will attempt to argue that the Rule demonstrates a growing public policy against noncompetes — though it is debatable whether three FTC commissioners necessarily reflect national public policy.

What Can Employers Do to Protect Themselves If This New Rule Is Upheld?

Despite the enactment of the Rule, employers still have numerous weapons in their arsenal to limit various types of unfair competition:

• Employers can still have workers sign confidentiality or nondisclosure agreements. According to the FTC, over 95% of workers with noncompetes already had an NDA.³⁹
• Employers can still use non-solicitation and non-interference restrictions to protect their businesses from losing clients, having their employees poached, or former employees using improper methods to compete with them unfairly, provided that they do not prohibit, penalize, or function to prevent a worker from switching jobs or starting a new business and thereby become the functional equivalent of a noncompete under the Rule.
• Employers can rely on state and federal trade secret laws to protect their trade secrets, which do not require an agreement (although the use of a non-disclosure or confidentiality agreement helps to demonstrate that the employer took reasonable steps to protect their trade secrets, which is part of the analysis of whether something is a trade secret).⁴⁰
• Employees are still bound by their common law duty of loyalty to their employers, which prevent them from competing with their employers while still employed or taking other actions to usurp opportunities from their employers.
• Employers can use “garden leave” provisions under which a worker remains employed and receives regular compensation during a mandatory notice period (as contrasted with paid noncompete periods, which are not allowed).⁴¹
• Finally, the FTC encourages employers to make “human capital investments,” such as entering into employment agreements and increasing pay and benefits to improve retention. In other words, employers can lock employees into long-term employment agreements and pay them more to prevent them from leaving and competing with them.⁴²

Conclusion

This is a confusing time for both employers and employees. Some employees may believe they’ve been handed a “get out of jail free” card, and some employers feel like they just lost their ability to prevent unfair competition. As with most issues, the truth is probably somewhere in the middle.

The Rule has not yet gone into effect, and it’s likely to be enjoined while the Rule is litigated nationally at all levels. Until then, employers can evaluate whether to continue to use and enforce post-employment restrictions when appropriate, but they should also take steps to prepare for the possibility that the U.S. Supreme Court may find that the FTC did have the authority to issue the Rule.|||

*On July 3, the U.S. District Court for the Northern District of Texas in Ryan LLC, et al. v. Federal Trade Commission, issued a Memorandum Opinion and Order that granted the plaintiffs’ and plaintiff-intervenors’ Motions for Stay of Effective Date and Preliminary Injunction regarding the enactment of the FTC Rule, but only with respect to those parties. The court did not enter a nationwide injunction regarding the FTC’s Rule as employers hoped. However, the court indicated that it intends to enter a “merits disposition” by Aug. 30, so it is possible that it could expand the relief provided. Until then, the Eastern District of Pennsylvania is still expected to issue its ruling in July. The takeaway is that the FTC Rule is still set to take effect on Sept. 4, but it is looking more likely that its enforcement will be enjoined before then.

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THOMAS W. SHUMATE IV is the founder and managing member of Meridian Law PLLC in Brentwood. He is a graduate of Vanderbilt University and Notre Dame Law School; his practice includes business and employment litigation and noncompete disputes. He hopes his predictions in this article are correct so he can remain gainfully employed until his children graduate from college. Shumate thanks the following team members for assisting with this article: Eric C. Lyons, Kealy K. Welage, Colton L. Adams and Joshua T. Swafford.

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NOTES

1. 16 C.F.R. § 910.6 (2024).
2. See, e.g., Fact Sheet on the FTC’s Noncompete Rule, www.ftc.gov/system/files/ftc_gov/pdf/Non-Compete-Fact-Sheet.pdf (last visited May 6, 2024).
3. 16 C.F.R. § 910.1 (2024).
4. Id.
5. Id. (emphasis added).
6. Non-Compete Clause Final Rule, FTC, pt. X.F.11, at 510–17, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
7. 16 C.F.R. § 910.2(a)(2)(iii) (2024).
8. 15 U.S.C. § 45(a)(1).
9. “Since passage of the FTC Act over a century ago, Congress has never defined [(1)] ‘common carrier’ or explained the meaning of the phrase [(2)] ‘subject to[.]’” Fed. Trade Comm'n v. AT&T Mobility LLC, 883 F.3d 848, 855 (9th Cir. 2018). The phrase (3) “[a]cts to regulate commerce” is a term of art that has been defined to encompasses “subtitle IV of Title 49 and the Communications Act of 1934 and all Acts amendatory thereof and supplementary thereto.” 15 U.S.C. § 44. Therefore, the logical conclusion is any carrier subject to “subtitle IV of Title 49 …, the Communications Act of 1934 …, [or any] Acts amendatory thereof and supplementary thereto” is a common carrier. Id.
10. Persons subject to the Packers and Stockyards Act include “any packer or swine contractor with respect to livestock, meats, meat food products, or livestock products in unmanufactured form, or for any live poultry dealer.” 7 USC § 192; see also Frequently Asked Questions About Regulated Entities, USDA, https://bit.ly/4aWB1oY (last visited May 10, 2024) (“Who is subject to the Act? Those engaged in the business of marketing livestock, meat, and poultry in commerce are subject to the Act and regulations. Regulated entities include stockyard owners, market agencies, dealers, packers, swine contractors and live poultry dealers.”).
11. 16 C.F.R. § 910.1 (2024).
12. 16 C.F.R. § 910.3(b) (2024).
13. Eron Reid & Jesse M. Coleman, Cutting Off Claims – When Does the FTC Non-Compete Ban Allow for Accrued Actions?, Seyfarth (May 17, 2024), www.tradesecretslaw.com/2024/05/articles/ftcs-crackdown-on-non-competes/cutting-off-claims-when-does-the-ftc-noncompete-ban-allow-for-accrued-actions/.
14. F.T.C. v. Univ. Health Inc., 938 F.2d 1206, 1214 (11th Cir. 1991) (“the FTC has no jurisdiction to regulate nonprofit, charitable enterprises”).
15. Redlands Surgical Servs. v. Comm’r, 242 F.3d 904, 904–05 (9th Cir. 2001); St. David’s Health Care Sys. v. United States, 349 F.3d 232, 239 (5th Cir. 2003); In the Matter of Preferred Health Servs. Inc., No. 041-0099, 2005 WL 593181, at *1 (F.T.C. Mar. 2, 2005).
16. 16 C.F.R. § 910.3(a) (2024).
17. 16 C.F.R. § 910.1 (2024).
18. Non-Compete Clause Final Rule, FTC, pt.V.D.6.a., at 385, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
19.16 C.F.R. § 910.1 (2024).
20. Non-Compete Clause Final Rule, FTC, pt.III.D.2.b., at 77–80, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
21. 16 C.F.R. § 910.1 (2024) (emphasis added).
22. See, e.g., Fact Sheet on the FTC’s Noncompete Rule, www.ftc.gov/system/files/ftc_gov/pdf/Non-Compete-Fact-Sheet.pdf (last visited May 6, 2024).
23. 16 C.F.R. § 910.2(b)(4) (2024).
24. 16 C.F.R. § 910.2(b)(1) (2024).
25. See 15 U.S.C. § 45(b); 15 U.S.C. § 53(b).
26. See, e.g., Holloway v. Bristol-Myers Corp., 485 F.2d 986, 988–89 (D.C. Cir. 1973); Liu v. Amerco, 677 F.3d 489, 492 (1st Cir. 2012).
27. Roy Maurer, U.S. Chamber of Commerce Sues to Block FTC Ban on Noncompetes, SHRM (Apr. 24,2024), www.shrm.org/topics-tools/employment-law-compliance/us-chamber-commerce-sues-block-ftc-ban-noncompetes.
28. Jesse M. Coleman et al, FTC Non-Compete Ban Lawsuits Update: Eastern District of Texas Stays Chamber of Commerce Suit in Favor of Ryan LLC as First-to-File, Seyfarth (May 4, 2024), www.tradesecretslaw.com/2024/05/articles/ftcs-crackdown-on-non-competes/ftc-non-compete-ban-lawsuits-update-eastern-district-of-texas-stays-chamber-of-commerce-suit-in-favor-of-ryan-llc-as-first-to-file/.
29. Jesse M. Coleman et al, Federal District Court to Rule on Plaintiffs’ Motion for Stay of FTC Non-Compete Ban and Preliminary Injunction Most Likely by July 3rd, Seyfarth (May 9, 2024), www.tradesecretslaw.com/2024/05/articles/ftcs-crackdown-on-non-competes/federal-district-court-to-rule-on-plaintiffs-motion-for-stay-of-ftc-non-compete-ban-and-preliminary-injunction-by-july-3rd/.
30. Id.
31. Id.
32. Small business owner fights FTC’s lawless non-compete ban, Pacific Legal Foundation, https://pacificlegal.org/case/ats-ftc-non-compete-delegation/ (last visited June 13, 2024).
33. Robert B. Milligan & Jesse M. Coleman, Pennsylvania Federal Court to Issue Decision on FTC Non-Compete Ban Challenge by July 23, Seyfarth (May 22, 2024), www.tradesecretslaw.com/2024/05/articles/noncompete-enforceability/pennsylvania-federal-court-to-issue-decision-on-ftc-non-compete-ban-challenge-by-july-23/.
34. See West Virginia v. Environmental Protection Agency, 142 S. Ct. 2587, 2622 (2022) (striking down the EPA’s Affordable Clean Energy rules); National Federation of Independent Business v. Department of Labor, Occupational Safety and Health Administration, 142 S. Ct. 661, 669 (2022) (striking down OSHA’s emergency temporary standard mandating COVID-19 vaccine for private sector workers).
35. See Gundy v. United States, 139 S.Ct. 2116, 2123 (2019) (“Congress does not usually ‘hide elephants in mouseholes.’”)
36. See The Federal Trade Commission’s Non-Compete Rule, Congressional Research Service (May 3, 2024), https://bit.ly/4eyPtq8.
37. Section 910.5 of the Rule states that if any provision of the final rule is held to be invalid or unenforceable, such invalidity shall not affect the application of the provision to other persons or circumstances. 16 C.F.R. § 910.5 (2024). It further includes severability of any provision held to be invalid, so that other provisions of the Rule will continue to be enforceable. 16 C.F.R. § 910.5 (2024).
38. 15 U.S.C. 41.
39. FTC Announces Rule Banning Noncompetes, Federal Trade Commission (April 23, 2024), www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes; see Non-Compete Clause Final Rule, FTC, p. 294–96, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
40. See Non-Compete Clause Final Rule, FTC, p. 292–94, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
41. See Non-Compete Clause Final Rule, FTC, p. 83, www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).
42. See Non-Compete Clause Final Rule, FTC, p. 308–14 www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf (last visited May 6, 2024).