On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule banning most noncompete agreements in employment contracts across all sectors. This new regulation exempts only executives earning over $151,164 annually and holding policy-making positions.
The new rule, set to take effect 120 days after official publication in the Federal Register, faces potential challenges as several business groups have expressed their intent to sue over the sweeping regulation.
What are Noncompete Agreements?
Noncompete agreements, often found within employment contracts, restrict employees from entering into competition with their employer during or after their employment period. These clauses typically prevent employees from starting a similar business or working for a competitor within a particular geographic area and for a specified period.
Businesses use noncompete agreements primarily to protect their proprietary information, trade secrets, and investment in employee training. Through these clauses, companies aim to prevent the risk of former employees using specialized knowledge or skills acquired during their tenure to benefit competitors or compete directly against their former employer.
They also tend to contribute to more controlled turnover in critical positions, allowing companies more time to find suitable replacements without the immediate threat of competition from former employees.
What is the Rationale Behind the New Rule?
The FTC has determined that noncompetes hinder competition within the labor market. These agreements currently affect an estimated 18% of U.S. workers, or about 30 million people. The FTC argues that a noncompete agreement limits an individual’s ability to seek better employment opportunities, negotiate for higher wages, or move to areas with more favorable job markets.
The decision to prohibit most noncompete agreements stems from the FTC’s conclusion that such clauses are an unfair method of competition that suppresses innovation, keeps wages artificially low, and impedes labor market efficiency.
The Commission also claims that the ban will promote competition, foster new business formation, and potentially reduce prices for consumers.
Who Does this Affect?
Once the rule takes effect, existing noncompete agreements will become unenforceable for the vast majority of employees. However, existing noncompete clauses for senior executives who are in policy-making positions and earn over $151,164 annually can remain in effect.
Moving forward, the creation of any new noncompete agreements, including those for senior executives, is strictly prohibited. This means that existing contracts for specific high-level employees can be maintained, but no new noncompete agreements can be established for any employees, regardless of their position or salary. Attempts to enforce newly created noncompete agreements will be considered unlawful.
Although the FTC’s jurisdiction does not extend to nonprofits, the commission reserved the right to evaluate an entity’s nonprofit status to determine whether it truly operates as a nonprofit. This means some tax-exempt nonprofits could be subject to the rule. The implication is that merely having tax-exempt status will not automatically exempt an organization from the rule if the FTC suspects it operates more like a for-profit entity.
What’s Next?
As the new rule on noncompete clauses approaches its effective date, employers should prepare for changes in how they manage noncompete agreements. Notably, there is no requirement that employers change existing employment contracts. Employers will be required to notify all workers, except the exempted senior executives, that existing noncompete clauses will not be enforced against them. This notification does not necessitate any modifications to existing employment agreements, nor does it affect the enforceability of other provisions within those contracts.
In response to business concerns about protecting sensitive information, the FTC emphasizes that employers still have other options. Non-disclosure agreements (NDAs) and trade secret laws remain effective tools for safeguarding proprietary information. These alternatives may prevent the unauthorized sharing of critical business information without unduly restricting workers’ employment opportunities.
Despite the FTC’s final decision, the rule faces potential legal challenges from various business trade groups who argue that the ban could have unintended negative impacts on businesses. The rule’s impact on the U.S. economy will undoubtedly be closely watched by all stakeholders in the coming months.
This article is merely an overview of the FTC’s final rule on noncompete agreements to date and could be subject to future changes. Businesses seeking more detailed guidance or advice specific to their circumstances should consider speaking with a legal expert or business advisor.