FTC Bans Non-Competes, Setting Up Courtroom Showdown

The Federal Trade Commission (FTC) has finalized a rule that broadly bans most non-compete agreements — but a courtroom challenge to the rule’s validity has already been filed, with more looming.

The FTC said non-compete agreements violate Section 5 of the Federal Trade Commission Act, which generally bans “unfair or deceptive acts or practices.” The agency said in its summary of the rule that it is an “unfair method of competition” for employers to enter into non-compete clauses with employees.

Legal challenges to the rule will test whether the ban on non-competes stretches the relevant statutory language too far.

Assuming that intervening litigation does not place implementation of the ban on hold, the new rule will take effect 120 days after the final rule is published in the Federal Register.

Let’s take a closer look at what the final rule says.

What the new FTC rule says

Under the new rule, most existing non-compete agreements would become unenforceable. An exception applies to senior executives, who are defined as workers in policy-making positions who earn at least $151,164 annually. The FTC says fewer than 1% of workers meet this definition. Existing non-competes entered into with those workers would remain enforceable.

It is important to note that an “existing” non-compete agreement means one that is in place before the final rule’s effective date. This means that employers still have time to lock senior executives into a binding non-compete agreement despite the rule’s broad ban on them. They just need to get it done before the rule’s effective date.

Under the final rule, employers would not be able to enter into new non-compete agreements with any employee once the rule’s effective date arrives.

The rule also obligates employers to notify non-senior executive employees who are bound by existing non-compete agreements that the agreements will not be enforced.

The rule provides model language with respect to the provision of the required notice, which may be provided via hand delivery, mail, email or text message.

Why did the FTC ban non-competes?

The FTC says empirical research supports the conclusion that non-compete agreements hurt competition in the labor, product and service markets. It adds that about 1 in 5 workers – a total of about 30 million – are subject to non-compete agreements.

Banning non-competes will lead to the creation of more new businesses, the agency adds, and will increase average earnings by $524 annually. The ban would also reduce healthcare costs and drive innovation, it said.

Litigation may delay implementation

Ryan LLC, a tax services and software provider, wasted no time in presenting a legal challenge to the rule. The firm has already filed a lawsuit in Texas to block the rule, saying it has “history, logic, law and the Constitution on [its] side.”

On the same day that the agency announced the final rule’s publication, the U.S. Chamber of Commerce announced that it will also sue to block it, calling the rule “unnecessary and unlawful.”

The gist of the argument against the rule: The FTC lacked the authority to promulgate it.

Obviously, the agency disagrees with that position. In fact, its announcement of the final rule includes more than seven pages dedicated solely to explaining why it has the authority to put the rule in place. It says that the plain text of the Federal Trade Commission Act gives it the authority to “promulgate rules for the purpose of preventing unfair methods of competition” – and that non-compete agreements fall into that bucket.

5 key points for HR

Here are five key takeaways for HR pros.

1. Don’t do away with existing agreements. Though the final rule says it will take effect 120 after its publication in the Federal Register, court challenges may delay that date. In other words, the 120-day post-publication date may not remain a hard compliance deadline. Rather, a court may issue a restraining order or injunction to block implementation. This means employers should not tear up existing non-compete agreements just yet.
2. There is still time to lock in senior executives. Even if the rule takes effect as quickly as the FTC would like it to, existing agreements with senior executives will remain enforceable after that time. And because an “existing” agreement is one that exists when the law takes effect, employers have between now and then to enter into valid and enforceable non-compete agreements with senior executive employees.
3. Prepare to provide notice. The rule itself provides model language that can be cut and pasted into a notice to provide to non-senior executive employees who have a non-compete agreement. Be ready to distribute this notice if and when the rule takes effect. To see the model language, scroll down to page 566 of the final rule.
4. Monitor ongoing litigation. Stay on top of litigation that may delay implementation. To paraphrase Yogi Berra (sort of), the law doesn’t take effect until it takes effect. That date is not set in stone.
5. Know your state law. Minnesota, California, Oklahoma and North Dakota ban non-compete agreements, while several others place restrictions on their use. The FTC rule preempts state laws only if they are in conflict with it.