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For the first time in its history, the US Federal Trade Commission issued a final rule governing unfair methods of competition. In line with its ambitious approach towards its Section 5 enforcement, the FTC will ban almost all non-compete agreements between employers and employees—if the rule survives legal challenge. We discuss what dealmakers need to know about this new rule and how non-competes are treated around the world.
With very limited exceptions, the final rule invalidates existing non-competes and prohibits employers from entering into new non-competes with employees for all businesses under the FTC’s jurisdiction. The key exception for dealmakers is the bona fide sale of a business exception.
The FTC released the final rule on April 23, 2024, marking the culmination of a rulemaking that began in January 2023 and garnered significant criticism from business groups in over 26,000 submitted public comments. Despite the criticism, the final rule largely maintains the broad sweep of the original proposal. The rule will become effective September 4, 2024. However, numerous legal challenges are expected to delay the effective date and could block the rule entirely.
The rule defines “non-compete clause” broadly to cover provisions that prohibit a worker from seeking or accepting work from another person or operating a business after the conclusion of employment. The rule applies to paid and unpaid workers, including volunteers, independent contractors, and apprentices, though it does not apply to franchisees in the context of a franchisee-franchisor relationship. The ban applies regardless of the form of the non-compete, so restrictions in workplace policies, employee handbooks, and informal contracts are also prohibited. As is currently the case, states will continue to be able to enact more stringent prohibitions on non-competes.
Subject to some limitations (see below), existing non-competes will only remain enforceable against senior executives. New non-competes will only be permitted under limited exceptions, including in the context of M&A under the bona fide sale exception.
The bona fide sale of a business exception permits new non-competes to be entered into pursuant to a bona fide sale of (i) a business entity, (ii) the person’s ownership interest in a business entity, or (iii) all or substantially all of a business entity’s operating assets. The Final Rule discards the 25% minimum ownership threshold from the proposed rule. The FTC describes “bona fide” sales as being between two independent parties at arm’s length, in which the seller has a reasonable opportunity to negotiate the terms of the sale. During a workshop held this week, the FTC also stated that the exception is applicable only between the buyer and seller individually, and not to the workers in the business being sold.
Check out our Employment team’s alert for detail on the other exceptions.
Limits to rule’s application
The non-compete prohibition is limited geographically and does not apply to non-compete clauses that restrict activities only outside the United States. Even in the US, some entities fall outside the FTC’s jurisdiction and may not subject to the non-compete ban, such as most non-profit entities, certain financial institutions, certain common carriers, and most businesses subject to the Packers and Stockyards Act of 1921.
The rule does not categorically ban other restrictive agreements, like non-disclosure agreements, training-repayment agreements or non-solicitation agreements. However, consistent with the rule’s focus on substance over form, these alternatives may be banned if they “function” to prevent competition. The FTC indicates that some broad non-disclosure agreements or non-solicitation agreements may be forbidden under the new rule, but that “garden-variety” non-disclosures covering confidential information would not. The FTC has also identified forfeiture-for-competition clauses and severance arrangements which pay only if an employee refrains from competing as examples of other potential non-competes. Regarding investments in training, the FTC noted that a provision requiring the repayment of a bonus based upon a worker’s early departure is permissible, if the repayment is not greater than the bonus amount and not tied to subsequent employment or operation of a business. The FTC also suggested that employers provide fixed-term employment appropriate to the training.
Several challenges have already been filed seeking to invalidate the rule, including two lawsuits filed in Texas federal courts, and we expect further legal challenges in the coming days and weeks. In their dissent, Republican Commissioners Holyoak and Ferguson questioned the FTC’s authority to issue the non-compete ban since the proposal was published, echoing a common criticism in the public comments. In addition to the challenges to the FTC’s rulemaking authority, some public comments suggested constitutional grounds for blocking the rule based on retroactivity, the Takings Clause, and the Due Process Clause.
The FTC asserts that these arguments are inapplicable, but perhaps in anticipation of litigation, the FTC includes a discussion of its rulemaking authority in its commentary to the final rule, and the rule itself includes a severability clause to address invalidation of part of the rule.
Non-competes have been a concern elsewhere too. In the UK, the government announced plans last year to limit the length of non-complete restrictions to three months, in a bid to boost competition and innovation by giving individuals greater freedom to move jobs. But despite concerns raised in the CMA’s recent report, legislative reforms are not likely to be introduced this year.
The proposed UK approach is significantly stricter than EU competition laws. In a recent policy brief, the EU Commission stated that non-compete clauses are outside the scope of Article 101 and noted that non-competes which comply with national labor laws are considered to be less restrictive alternatives to no-poach agreements. Limitations on duration in individual Member States range from six months to five years. Some countries, like Germany, France and Italy also require mandatory compensation where non-competes are used, in order to compensate employees for the duration of the clause.
In the employment context, APAC antitrust regulators are generally focused on no-poach agreements, with varying degrees of attention to the enforcement of non-compete clauses. China has recently taken a more active stance on no-poach agreements, with SAMR expressing concern in 2023 about a no-poach agreement, later withdrawn, between the four largest pig breeders in China. This marked the first time SAMR has publicly condemned potentially anticompetitive practices in the human resources sector.
Some other APAC antitrust regulators have started to spotlight the issue of non-compete restrictions. The Hong Kong, Japanese and Australian antitrust authorities have started to outline limited guidance on non-compete clauses, though there has been no enforcement to date. Notably, Australia's "Competition Review Taskforce" has released a consultation paper seeking submissions on non-competes from 4 April 2024 to 31 May 2024. On the other hand, the antitrust authorities in countries such as China, Singapore, South Korea, Thailand, and Vietnam have not issued similar guidance on nor engaged in the enforcement of non-compete clauses.
Given the current and anticipated litigation related to the final rule, companies should look out for updates on when the final rule will become effective. It is likely that a federal court could enjoin the final rule’s implementation pending judicial review, further delaying implementation.
In light of the potentially tight timeframes in the absence of an injunction, employers may want to consider taking the following steps in preparation for any effective date of final rule: