Legal Alert: FTC Ban on Non-Compete Clauses

Legal Alert: FTC Ban on Non-Compete Clauses

By Harvey R. Linder, Partner, Culhane PLLC.

On April 23, 2024, the Federal Trade Commission (“FTC”) issued a final rule banning non-compete clauses nationwide.  (California already has a similar ban in place.)  The FTC contends that this protects the fundamental freedom of workers to change jobs, increases innovation, and fosters new business formation.  An estimated 30 million U.S. workers are subject to some form of non-compete.

“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once non-competes are banned,” said FTC Chair Lina M. Khan. “The FTC’s final rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

Without providing any empirical evidence, the FTC opined that banning non-competes will lead to new business formation growing by 2.7% per year, resulting in more than 8,500 additional new businesses being created each year.  The ban is expected to result in higher earnings for workers, with estimated earnings increasing for the average worker by an additional $524 per year.  And oddly, the FTC expects the ban to lower health care costs by up to $194 billion over the next decade.  In addition, the ban is expected to help drive innovation, leading to an estimated average increase of 17,000 to 29,000 more patents each year for the next ten years under the final rule.

The FTC complains that non-competes provide companies with contractual conditions that prevent workers from taking a new job or starting a new business.  In an over-arching statement, the FTC stated that non-competes often force workers to either stay in a job they want to leave, or bear other considerable harms and costs, such as being forced to switch to a lower-paying field, being forced to relocate, being forced to leave the workforce altogether, or being forced to defend against expensive litigation.

Under the FTC’s new rule, existing non-competes for the vast majority of workers will no longer be enforceable after the rule’s effective date.  Existing non-competes for senior executives (who represent less than 0.75% of workers) will be “grandfathered” and can remain in force under the FTC’s final rule.  (Senior executives are defined as workers earning more than $151,164 annually and who are in policy-making positions).  Employers, however, are banned from entering into or attempting to enforce any new non-competes, even if they involve senior executives.  Employers will be required to provide notice to workers other than senior executives who are bound by an existing non-compete that they will not be enforcing any non-competes against them.

The FTC determined that it is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for employers to enter into non-competes with workers and to enforce certain non-competes.  It is fully expected that there will be numerous legal challenges to the ban, as well as to the FTC’s authority to promulgate such a broad policy.

The FTC contends that employers have several potential alternatives to non-competes that still enable firms to protect their investments without having to enforce a non-compete.  According to the FTC, trade secret laws and non-disclosure agreements (“NDA’s”) both provide employers with well-established means to protect proprietary and other sensitive information.  As nice as that sounds, it still leaves employers quite vulnerable to having their employees leave after they have spent a great deal of time, money, and effort formally training them to do certain important and specific skills.

The FTC also argues that instead of using non-competes to lock in workers, employers who wish to retain employees can compete on the merits for the worker’s labor services by improving wages and working conditions.  This theory conveniently avoids the stark reality of employers being forced into a costly scenario that can only negatively affect financial viability.

Under the final rule, employers will have to provide notice to workers bound by an existing non-compete that the non-compete agreement will not be enforced against them in the future. To assist employers’ compliance with this requirement, the FTC has included model language in the final rule that employers can use to communicate appropriately to workers.

The final rule will become effective 120 days after publication in the Federal Register.

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