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FTC Seeks To Ban Noncompete Agreements Nationwide, But Legal Challenges Await

In a bold move for workers, the Federal Trade Commission (the “FTC” or the “Commission”) is seeking to extinguish, on a nationwide basis, the common yet controversial practice of post-employment noncompete agreements.

In January 2023, the Commission published a notice of proposed rulemaking to institute a broad ban on noncompete agreements. Last month, by a 3-2 vote along political party lines, the five-person Commission issued its final non-compete clause rule (the “Final Rule”), prohibiting employers from entering into new noncompete agreements and rendering most existing noncompete agreements unenforceable after the Final Rule’s effective date – 120 days after its publication in the Federal Register (which likely will not happen before September).

This action stands to reshape the employment landscape across the United States. Yet the future of the nationwide ban is uncertain, even with the prospective effective date fast approaching. Employers and business advocacy groups are already challenging the new rule in court, with claims that the Commission is stepping into a sphere of lawmaking that should be the exclusive jurisdiction of the legislative branch.

Furthermore, the Supreme Court has signaled in decisions over the last few years that it is increasingly willing to limit agency authority, especially when agency rules have broad economic or political implications. Indeed, an upcoming Supreme Court decision concerning how much deference courts generally should give to an agency’s interpretation of a statute may suggest that the Final Rule is likely to be invalidated or significantly limited.

The New Rule

What Is A Noncompete Agreement?

Noncompete agreements, also known as restrictive covenants, are stand-alone agreements or clauses in employment contracts that restrict employees from engaging in certain professional activities after the employment period ends. Typically, noncompetes specify a length of time over which the employee is barred from working for a competitor, and they often prohibit competing employment within a certain geographic area. A noncompete may also prohibit the employee from using or disclosing the employer’s confidential business information, such as trade secrets.

The FTC’s Purpose In Enacting The Final Rule

Although a growing number of states have banned or substantially restricted noncompetes, they continue to be prevalent in the United States, due in part to the interstate nature of the modern work force and employers’ use of choice-of-law provisions in these agreements. The Commission estimates that approximately one in five American workers – or nearly 30 million workers – is subject to a noncompete.

The Final Rule is driven by the FTC’s concerns about workers’ autonomy and economic fairness. Citing, in part, the negative impact of noncompetes on workers’ careers and finances, especially for middle and low-income workers, the Commission stated that a complete ban is intended to alleviate the difficulties workers face in understanding and enforcing their rights.

Details Of The Final Rule

The Final Rule will ban most noncompete clauses as an unfair method of competition. For employees other than senior executives, the Final Rule will make it an unfair method of competition for a business to enter into, enforce, or represent that a worker is subject to a noncompete clause. The FTC defines a “noncompete clause” as a “term or condition of employment that prohibits or penalizes a worker from seeking or accepting work with a different employer or operating a business after the conclusion of employment.”

Furthermore, the Final Rule defines “term or condition of employment” broadly, to include both written and oral contracts, as well as workplace policies. Thus, the Final Rule also bans any other form of a restrictive covenant, including non-disclosure and non-solicitation clauses, if the provision is so broad or onerous that it functions to prevent a worker from seeking or accepting other work, from working for another employer in the same field, or from starting a business after leaving a job. Such clauses would be considered prohibited noncompetes under the Final Rule.

The Final Rule, once in effect, will be retroactive, extinguishing all existing noncompetes other than for senior executives. Employers will be required to provide notice to workers with existing noncompetes that they are no longer valid.

A narrow exception will remain for existing agreements with senior executives, whose noncompete agreements will remain enforceable, though the Final Rule will prohibit future noncompetes for this group. Specifically, the Final Rule defines the term “senior executive” as an employee earning more than $151,164 annually who is in a “policy-making position.” Fewer than 1% of workers are estimated to be senior executives under the Final Rule. In explaining the rationale for this exception, the Commission observed that “this subset of workers is less likely to be subject to the kind of acute ongoing harms currently being suffered by other workers,” and that commenters had raised credible concerns about the practical impacts of extinguishing existing noncompetes for senior executives.

The Final Rule carves out a few other limited exceptions, including noncompete agreements executed as part of a bona fide sale of a business entity, as well as legal claims arising under existing noncompetes prior to the effective date of the Final Rule.

Separately, the Final Rule contains an express “preemption clause” whereby the rule will not limit or affect enforcement of state laws that restrict non-competes, but only insofar as state laws do not conflict with the rule.

Legal Authority And Challenges To The Rule

The FTC’s Stated Legal Authority

The Commission asserts that it is empowered to institute a rule banning noncompetes nationwide pursuant to its authority under sections 5 and 6(g) of the FTC Act. Section 5 of the FTC Act declares that “unfair methods of competition in or affecting commerce” are “unlawful” and that the Commission is “empowered and directed to prevent” entities subject to its jurisdiction from “using” such unfair methods of competition.

Section 6(g) of the Act authorizes the Commission to “make rules and regulations for the purpose of carrying out the provisions of” the FTC Act. Although Section 6(g) had historically been understood to permit the FTC to enact certain procedural rules, the Commission’s current position is that these two sections, read together, authorize it to impose major legislative rules defining and banning certain conduct – i.e., asking employees to enter into non-compete agreements – as an unfair method of competition.

Employer Pushback

Outcry against the Final Rule has been swift. Multiple lawsuits have been filed, notably by the tax services firm Ryan, the U.S. Chamber of Commerce, and the Business Roundtable, arguing that the Commission has grossly overreached. Challengers argue, in part, that the Commission has the power to make determinations regarding unfair methods of competition, such as those in a noncompete clause, only on a case-by-case basis, through an enforcement action, rather than through broad rulemaking. Opponents of the rule also contend that the FTC exceeded its authority by failing to consider narrower limits on noncompetes.

Lawsuits challenging the Final Rule are pending in Texas and Pennsylvania, and more are expected. Opponents are pressing for a stay or preliminary injunction to freeze the Final Rule’s rollout while the legal battles work their way through the courts, possibly up to the Supreme Court. Court rulings are expected by July on whether to postpone the rule’s effective date. If a stay is granted, the Final Rule may not take effect for years, if ever.

Is The Final Rule Likely To Be Upheld?

While the Supreme Court has upheld many delegations of authority to Executive Branch agencies, that willingness may be waning. In 2022, in West Virginia v. EPA, the Supreme Court significantly limited the scope of the Environmental Protection Agency’s (“EPA”) powers to regulate emissions, a major economic and political issue, through the Clean Air Act, stating that Congress must provide specific direction to the EPA as part of its delegation of authority for the agency to broadly regulate greenhouse gas emissions. Last year, the Court similarly ruled that the U.S. Department of Education did not have the statutory authority to forgive roughly $430 billion in student loan debt under the national emergencies provisions of the Higher Education Relief Opportunities for Students Act of 2003.

In addition, the Supreme Court is expected to issue a decision this week on two consolidated cases, individually titled Relentless, Inc. v. Department of Commerce and Loper Bright Enterprises v. Raimondo. This decision may abrogate or significantly limit the principle colloquially known as the Chevron doctrine, based on the landmark 1984 case Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., which sets forth the current legal test for when federal courts must defer to a government agency’s interpretation of a law. Under Chevron, courts have given broad deference to an agency’s interpretation of a statute that Congress delegated authority to an agency to administer, as long as Congress has not explicitly spoken on the issue at hand. The Chevron doctrine is based on the general theory that agencies have more expertise in their designated areas than the courts.

The Final Rule on noncompetes will likely be affected by the Supreme Court’s ruling, with regard to the FTC’s ability to argue that courts should defer to its interpretation of the FTC Act both procedurally (making rules regarding unfair competition) and substantively (interpreting “unfair competition” to include all noncompete agreements with employees). If the Supreme Court overturns or significantly narrows the Chevron holding, this could invalidate the Final Rule entirely and could even lead a court to decide that the Commission may not issue any noncompete-related rules at all.

Industry Repercussions

Pending these court rulings, the corporate sector remains in limbo with regard to the enforceability of existing and future noncompetes. If courts do not issue a stay or injunction, the noncompete landscape will transform dramatically.

Conversely, if the effective date of the Final Rule is put on hold pending the outcome of the legal challenges, the rule will not become effective until all the legal challenges play out, which could take several years. A change in administrations following this fall’s presidential election could also result in the FTC’s withdrawing the Final Rule.

Given this uncertainty, employers may want to take a wait-and-see approach before giving notice to employees that past noncompetes are unenforceable. At the same time, employers should be aware of the Final Rule when entering into any new noncompete agreements with employees.

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SHPC will continue to monitor developments with the FTC’s Final Rule and provide updates as they occur. In the meantime, please feel free to contact one of our experienced employment attorneys with any questions.