The FTC’s Final Rule – A Sweeping Ban on Noncompetes

The Federal Trade Commission yesterday held an open meeting at which it voted to finalize and promulgate its long-anticipated rule that effectively bans noncompetes nationwide subject to only a few exceptions. The rule will be effective 120 days after Federal Register publication.

Rationale for the Rule and Anticipated Impact

 In describing its rationale for the rule, the Commission stated that:

  • Noncompete clauses significantly reduce workers’ wages;
  • Noncompete clauses stifle new businesses and new ideas;
  • Noncompete clauses can exploit workers and hinder economic liberty; and
  • Employers have other ways to protect trade secrets and other valuable investments that are significantly less harmful to workers and consumers.

In issuing the rule, the Commission estimated that banning noncompetes will result in:

  • Reduced health care costs: $74-$194 billion in reduced spending on physician services over the next decade.
  • New business formation: 2.7% increase in the rate of new firm formation, resulting in over 8,500 additional new businesses created each year.
  • Rise in innovation: an average of 17,000-29,000 more patents each year for the next ten years.
  • Higher worker earnings: $400-$488 billion in increased wages for workers over the next decade. The average worker’s earnings will rise an estimated extra $524 per year.

The Basic Rule

Pursuant to the rule, which was adopted by a 3-to-2 vote of the FTC’s commissioners and which will become effective 120 days after Federal Register publication (not yesterday’s public announcement), except in the case of a senior executive (as defined below), or where an exception applies (as discussed below), it is an unfair method of competition in violation of Section 5 of the FTC Act for a person (typically an employer) to:

  • enter into or attempt to enter into a noncompete clause;
  • enforce or attempt to enforce a noncompete clause; or
  • represent that the worker is subject to a noncompete clause.

The practical effect is that on or after the effective date new noncompete agreements are banned and existing noncompete agreements can no longer be enforced.

With respect to senior executives, the rule is basically the same, i.e., noncompetes can neither be entered into nor enforced nor represented as being in effect after the effective date except in the case of a noncompete entered into before the effective date. In other words, for senior executives, existing noncompetes can remain in force.

In addition, under the rule, there is a notice requirement pursuant to which the person who entered into the noncompete clause with the worker must provide clear and conspicuous notice to the worker by the effective date that the worker’s noncompete clause will not be, and cannot legally be, enforced against the worker. The rule provides details as to the required form.

Who Is a Senior Executive?

A senior executive is a worker who was in a “policy-making position” and received total annual compensation of at least $151,164 in the preceding year; or when annualized under certain circumstances.

A “policy-making position” means “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 similar to an officer with policy-making authority. An officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position.”

What is a Noncompete Clause?

A noncompete clause is defined to include any term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

  • 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
  • operating a business in the United States after the conclusion of the employment that includes the term or condition.

Entities Outside of the FTC’s Jurisdiction

Certain entities that would otherwise be subject to the final rule fall outside the FTC’s jurisdiction under the FTC Act, which grants the Commission enforcement jurisdiction over “persons, partnerships or corporations.”

Significantly, the Act excludes from its definition of “corporation” any entity that is not “organized to carry on business for its own profit or that of its members.”

This is obviously of great significance in the context of the health care industry where many employers, who have obtained Section 501(c)(3) status for federal income tax purposes, have and will continue to put in place noncompete agreements with their employees.

In the commentary to the final rule (570 pages in length), the FTC states that Section 501(c)( 3) organizations are not categorically beyond the Commission’s jurisdiction and “[t]o dispel this misunderstanding,” the Commission summarizes the existing law pertaining to its jurisdiction over nonprofits.

According to the FTC, the not-for-profit jurisdictional exemption under Section 4 of the Act requires both that there be an adequate nexus between an organization’s activities and its alleged public purposes and that its net proceeds be properly devoted to recognized public, rather than private, interests.

Alternatively stated, the FTC looks to both “the source of the income, i.e., to whether the corporation is organized for and actually engaged in business for only charitable purposes, and to the destination of the income, i.e., to whether either the corporation or its members derive a profit.”

That said, the final rule leaves open the question as to how this standard will ultimately be applied in connection with the specific activities and operation of Section 501(c)(3) health care organizations including nonprofit providers of health care.

Exceptions to the Rule

There are certain exceptions to the final rule’s prohibition on noncompetes. For example:

  • The rule does not apply to a noncompete clause that is entered into by a person 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;
  • The rule does not apply where a cause of action related to a noncompete accrued prior to the effective date; and
  • It is not an unfair method of competition to enforce or attempt to enforce a noncompete or to make representations about a noncompete where a person has a good faith basis to believe that the final rule is inapplicable.
  • The rule does apply to employees working for a franchisor or franchisee. It does not, however, apply to franchisor-franchisee agreements.

Upcoming Challenges to the Rule

The final rule will be subject to challenge on various grounds, most notably: (i) a claim that the FTC Act does not grant the Commission authority to promulgate the rule; (ii) that the validity of noncompetes is a “major question” that Congress has not given the Commission the authority to address (West Virginia v. EPA, 597 U.S. 697, 721 (2022)); and (iii) if Congress did delegate authority to the FTC, that was an impermissible delegation.

In voting against the final rule, Commissioners Melissa Holyoak and Andrew N. Ferguson asserted, among other things, that the Commission lacked the authority to the issue the rule.

Immediately following issuance of the rule, the U.S. Chamber of Commerce issued a press release in which it stated that the FTC has never been granted statutory authority to promulgate the rule and announced that it will sue the FTC to block the rule.