In a highly anticipated decision, the Federal Trade Commission (“FTC”) voted April 23, 2024 to finalize a rule (the “Rule”) banning non-compete agreements for most workers. The Rule is scheduled to become effective 120 days after its publication in the Federal Register, though we expect legal challenges to the Rule in the coming days.

Employers should start analyzing how the Rule may affect their businesses. This update summarizes the Rule’s key prohibitions and employer obligations, highlights certain exceptions, and discusses potential next steps that employers should consider.

Key Prohibitions, Definitions, and Obligations

• General Prohibition: The Rule declares it an “unfair method of competition” to (1) enter into or attempt to enter into a non-compete clause; (2) enforce or attempt to enforce a non-compete clause barred by the Rule; or (3) represent that a worker is subject to a non-compete clause barred by the Rule.

• Once effective, the Rule will bar new non-compete clauses for all workers, including top executives. It also will nullify existing non-compete agreements for all workers except for “senior executives” (discussed below).

• Functional Definition of “Non-Compete Clause”: The Rule provides a functional definition of “non-compete clause.” In particular (and with our emphasis), the Rule defines “non-compete clause” to mean any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

• If the Rule becomes effective, whether a clause “penalizes” or “functions to prevent” a worker from seeking different employment will likely be a hotly disputed issue. The FTC has indicated, however, that it believes a forfeiture-for-competition clause, where an employee is subject to an adverse financial consequence if he or she changes employers, “penalizes” a worker and thus would run afoul of the Rule.

• Broad Definition of “Worker”: The Rule defines “worker” to include an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor. Notably, however, because it focuses on worker relationships, the Rule does not restrict non-compete agreements entered into “pursuant to a bona fide sale of a business entity.”

• Notices: By the effective date of the Rule, employers must notify, in writing, workers whose non-compete clauses are no longer enforceable that their non-compete clauses will not be enforced. The FTC provides model language for such notices.

• Senior Executives: For “senior executives,” the Rule permits enforcement of non-compete agreements entered into before the Rule’s effective date. The Rule defines “senior executive” to mean a worker in a “policy-making position” who received annualized compensation of at least $151,164 in the preceding year.

• Good-Faith Exception: Under the Rule, it is not an unfair method of competition to enforce or attempt to enforce a non-compete clause where the employer has a “good-faith basis” to believe that the Rule does not apply. The Rule does not define “good-faith basis.”

• No Private Right of Action: The Rule does not provide a private right of action for workers.

• State and Other Laws: State laws regulating non-compete clauses that do not conflict with the Rule will remain in effect even after the Rule’s effective date. Many states have such laws, including Illinois. At least for now, employers should continue to comply with state and local restrictions, including, for Illinois employers, the Illinois Freedom to Work Act. Employers should also be mindful that the National Labor Relations Board, a separate federal agency from the FTC, has also expressed hostility to certain restrictive covenants.

• Effective Date and Court Challenges: As noted, the Rule becomes effective 120 days after it is published in the Federal Register, which will likely happen in the coming days. We expect one or more immediate court challenges to the Rule, and those legal challenges may delay (possibly indefinitely) the implementation of the Rule. Stay tuned for updates on this front.

• Grandfathering Senior Executives: The Rule bars companies from entering into non-compete clauses with senior executives only after the effective date. Accordingly, before the Rule becomes effective, employers should consider creating or updating non-compete clauses for their employees who qualify as senior executives.

• Compliance Plan: Although the Rule will not become effective for several months at the earliest, employers should promptly evaluate their options and compliance obligations. As part of that analysis, employers should consider which employees do not require notices because they qualify as “senior executives” under the Rule.

• Alternatives to Non-Competes: Even if the Rule is struck down, and especially in light of continued scrutiny of non-competes by state and federal regulators, employers should consider alternative approaches to protect their legitimate business interests. Non-disclosure agreements, non-solicitation agreements, and garden-leave provisions, for example, can sometimes provide employers similar protections and are generally subject to less regulatory scrutiny.

The FTC’s Rule is a milestone that warrants immediate attention. Fox Swibel will continue monitoring developments regarding this Rule and can advise companies on strategies for using non-compete, non-solicitation, and non-disclosure agreements. Please contact Steve Brenneman, Kelly Smith-Haley, David Levine, Anna Boshardy, or the Fox Swibel attorney with whom you regularly work to discuss these issues.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.