FTC Bans Non-Compete Agreements: Litigation is Anticipated

This was not a surprise. The Federal Trade Commission’s (FTC[1]) publication of the final rule[2] banning most non-compete clauses in employer-employee contracts has been anticipated since the FTC proposed the rule[3] in January 2023. The 90-day public comment period yielded more than 26,000 comments, with over 25,000 of these comments supporting the new rule.

The final rule, announced on April 23, 2024, will take effect 120 days after its publication unless those who are opposed to it secure a court order to block it.

New Restrictions

The final rule hasn’t changed much since the proposed rule was first announced over a year ago. The FTC fact sheet[4], published in January 2023 and updated on April 23, 2024, provides an overview of the final rule, which will definitely face court challenges for allegedly exceeding the FTC’s legal authority.

Here are the highlights:

• The final rule bans non-compete agreements with any worker, including senior executives, after the effective date. It specifically states that non-compete agreements are an unfair form of competition and a violation of Section 5 of the FTC Act[5].

• Workers are employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person or entity.

• Existing non-competes for senior executives can remain in force. Existing noncompetes with workers other than senior executives are not enforceable after the effective date. The final rule differs from the original rule by defining the exception for existing non-compete agreements with some senior executives. The exception applies to individuals who earn more than $151,164 annually and are in “policymaking positions.” The FTC believes fewer than 1 percent of all workers would qualify for this exemption.

• The new rule does not prohibit contractual terms that prevent workers from working for two firms simultaneously. It also does not prohibit non-compete clauses when selling a business. The final version of the rule has eliminated the 25 percent ownership threshold in the proposed rule.

• The new rule requires employers to rescind existing non-competes and actively inform workers that these agreements are no longer in effect. The FTC also states that “other types” of employment restrictions could be subject to the new rule if the FTC determines that they are so broad in scope that they function as non-competes.

State Laws

The final rule preempts state laws that currently allow non-compete agreements. However, it does not preclude enforcement at the state level of state laws consistent with the new rule. Employers should be aware that even if anticipated litigation results in a complete or partial invalidation of the FTC’s new rule, enforcement of state noncompete restrictions will continue.

Historically, non-competes have been evaluated on a case-by-case basis under state law. Many states have restricted non-competes to prevent abuse and to define the conditions under which they will be enforced. In New Hampshire, where Orr & Reno is located, the courts evaluate non-compete contracts on a case-by-case basis, with some exceptions as described below. They are enforceable only if the agreement is reasonable in scope and tailored to “protect the employer’s legitimate business interests.”

Generally, protecting “legitimate business interests” in a non-compete agreement means describing activities an employee must avoid after leaving the employer and guarding the employer’s interests in its customer goodwill and its confidential and proprietary information. Non-compete agreements also often provide for a specific period and a geographic area where the agreement is effective. In some cases, these restrictive covenants will prohibit an employee from soliciting employees or customers away from the employer and include clauses that specifically protect the employer’s confidential and proprietary information.

New Hampshire legislation enacted in 2014 requires employers wishing to execute a non-compete agreement as a condition of employment to disclose that information before the employee accepts an offer of employment (RSA 275:70[6]). Exemptions include physicians, nurses, and podiatrists. In 2019, related legislation (RSA 275:70-a[7]) prohibited non-compete agreements with “low-wage” employees that would restrict a low-wage employee from performing work for another employer. The legislation defines “low-wage” employees as those earning less than or equal to 200 percent of the federal minimum wage.

The Economic Impact 

The FTC estimates that banning non-competes will result in:

• Reduced health care costs: The FTC estimates $74-$194 billion in reduced spending on physician services over the next decade.
• New business formation: The FTC predicts a 2.7 percent increase in the rate of new firm formation, resulting in over 8,500 additional new businesses created each year.
• Rise in innovation: There will be an average of 17,000-29,000 more patents each year for the next ten years. This reflects an estimated increase of about 3,000 to 5,000 new patents in the first year non-competes are banned, rising to about 30,000-53,000 in the tenth year. This represents an estimated 11-19 percent increase annually over ten years. Higher worker earnings: The FTC estimates $400-$488 billion in increased worker wages over the next decade. The average worker’s earnings will rise an estimated extra $524 per year.

Legal Challenges

The FTC is preparing for significant opposition from the business community regarding the new rule’s sweeping scope. Pending litigation will raise many thought-provoking constitutional, statutory, and administrative law issues.

One of the main grounds for challenging the rule will be the major questions doctrine[8], a concept developed over time by the United States Supreme Court that requires explicit Congressional authorization before an administrative agency can exercise its power to decide major policy questions. In defending the rule, the FTC will likely base its authority on a 1973 decision[9] of the D.C. Circuit Court of Appeals, which held that the FTC has the authority to implement “substantive” rules about what constitutes unfair methods of competition.

These court challenges could lead to significant confusion. Different courts may likely decide cases in inconsistent ways, resulting in different applications of the rule in various parts of the country.

Preparation and Planning

There is a high probability that the new rule will ultimately be struck down, but should it survive initial court challenges and take effect at the end of August, employers must move quickly to comply. Employers should be prepared to distribute the required notices to inform employees about the new rule and review existing non-competes with senior executives to ensure that the language used is narrowly tailored enough to protect legitimate business interests while being otherwise compliant. The new rule has a catchall provision prohibiting using terms in any restrictive covenant that “functions to prevent” an employee from working for a different company.

Some employers are also advised to prepare for potential trade secret litigation — as competitors entice employees away — and budget for possible data and forensic expenses associated with confidentiality and trade secret litigation.

If you have any questions or concerns about the new non-compete rule — or wish to explore how the pending non-compete ban could change your recruitment and innovation strategies — don’t hesitate to contact Orr & Reno for assistance.

Steven L. Winer[10] and Lindsay E. Nadeau[11]