By Brandon Winchester and Fraser Holmes
On April 23, 2024, the Federal Trade Commission (FTC) announced its final Rule (16 CFR Part 910) that bans non-compete clauses for most workers as unfair competition under federal law, specifically Section 5 of the FTC Act (15 U.S.C. § 41, et seq.). The FTC is authorized to regulate and prohibit “unfair methods of competition” in or affecting commerce, and it has sought to use that power in its rulemaking on non-compete agreements.
This final Rule has already been challenged in two district courts in Texas. But even if it does not go into force across the entire country, individual states may decide to follow suit, becoming less hospitable to non-compete clauses currently held to be enforceable under state law.
Businesses should preemptively consider ways to alleviate any adverse consequences that would result from a more restrictive regime. Below, we outline several considerations and potential solutions.
Key Provisions
In announcing the Rule, the chair of the FTC said that eliminating the practice will “ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” Specifically, the FTC estimates that it will lead to a growth in new business formation of 2.7% more per year, an estimated average increase of 17,000 to 29,000 more patents each year, and a decrease in health care costs by up to $194 billion over the next decade.
The final Rule bans non-compete clauses by making them a form of “unfair competition” under federal law. Under the Rule, companies will be prohibited, after the effective date September 4, 2024, from (1) entering into or attempting to enter into a non-compete clause, (2) enforcing or attempting to enforce a non-compete clause, or (3) representing that the worker is subject to a non-compete clause. 16 CFR § 910.2(a)(1). The Rule defines “non-compete clause” as a term or condition that prohibits or penalizes workers or “functions to prevent a worker from” seeking or accepting work or operating a business in the United States following employment with the contracting employer. 16 CFR § 910.1(1). Notably, a “term or condition of employment” is not necessarily confined to written or oral contractual terms or workplace policies.
The Rule allows for three substantive exceptions. First, and perhaps most prominently, the Rule does not apply to so-called “senior executives” whose current contracts include a non-compete clause. Senior executives are workers that meet both a minimum annual salary threshold—$151,164—and serve in a “policy-making position.” 16 CFR § 910.2(a)(1). Policy-making positions, in turn, are generally defined as C-suite executives or equivalent positions that “make policy decisions that control significant aspects of a business entity or common enterprise.” 16 CFR § 910.1. While the FTC reasoned that senior executives are “most likely to have bargaining power and a bespoke, negotiated agreement,” it nevertheless prohibited the use of non-competes even in such “bespoke, negotiated agreements” after the effective date. In short, employers are banned from entering into or attempting to enforce any new non-competes, even if they involve senior executives. There is no retroactive effect for these senior executives.
Second, the Rule does not apply in the bona fide sale of a business entity, a person’s interest in a business entity, or all or substantially all of a business entity’s operating expenses. 16 CFR § 910.3(a).
Third, the Rule does not apply “where a cause of action related to a non-compete clause accrued prior to the effective date.” 16 CFR § 910.3(b).
Additionally, employers are 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. However, employers do not have to formally rescind those non-compete agreements, which will substantially reduce compliance costs.
Legal Challenges to the Rule
As mentioned above, there are already two challenges to the Rule filed in Texas federal courts. Ryan LLC has sued the FTC in the United States District Court for the Northern District of Texas, Case No. 3:24-cv-000986. Notably, the U.S. Chamber of Commerce, Business Roundtable, and Texas Association of Business have all intervened as additional plaintiffs. In its complaint, Ryan LLC challenges the final rule under the Administrative Procedure Act. It seeks a declaration under the Federal Declaratory Judgment Act and a stay of the Rule’s effective date and a preliminary injunction barring the FTC from enforcing the Rule. The U.S. Chamber of Commerce, Business Roundtable, and Texas Association of Business also filed suit in the Eastern District of Texas, Case No. 6:24-cv-00148, on similar grounds. They seek declaratory judgment that the Rule is arbitrary and capricious, a vacation of the Rule, and an injunction barring the FTC from enforcing the Rule. The Eastern District subsequently stayed its case under the first-to-file rule given the possibility of inconsistent judgments; it will allow that case to proceed. The fate of the Ryan LLC case in the Northern District of Texas may affect the Rule’s ultimate application.
Potential Pitfalls and Solutions
Texas, like many states, has long recognized that non-compete clauses are unenforceable unless “the limitations of time, geographical area, and scope of activity are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interests of the [company].” Tex. Bus. Com. Code Ann. S. 15.50. While such “other business interests” are open to broad interpretation, the state’s statutory authority and case law support a well-established presumption against the enforceability of non-compete clauses. Consequently, employers in Texas have access to solutions that the Rule would not eliminate.
First, the Rule is not generally intended to preclude what the FTC terms “garden-variety” non-disclosure agreements. Instead, non-disclosure agreements are only prohibited to the extent they would “function[] to prevent a worker from” seeking or accepting other work or leaving to start their own business. There is an obvious tension between the FTC’s preservation of “garden-variety” non-disclosure agreements and its prohibition on non-disclosure agreements that would “function to prevent a worker from” obtaining other employment. What about those employees whose potential future value is dependent upon access to, or knowledge of, information that would be considered confidential in any “garden-variety” non-disclosure agreement? Courts will undoubtedly be forced to consider the sensitivity of the confidential information and the extent to which the non-disclosure agreement effectively precludes the employee from other employment, as well as those varied and competing interests based on different factual scenarios. In order to successfully navigate these circumstances, companies must engage legal counsel who can seamlessly integrate facts into a quickly developing area of the law.
Second, companies can still utilize the existing trade secret protections available under both federal and state law. Much like non-disclosure agreements, companies will be increasingly encouraged to draft more expansive NDAs to protect their sensitive assets, including their personnel, without falling afoul of legal prohibitions. Companies and their counsel must draft contractual provisions with a full understanding of the legal regime—including the litigation around the key terms and provisions—to ensure compliance in this landscape.
Finally, the terms of the Rule itself—and any state-based initiatives that might follow in its wake—allow ample space for creatively structuring contracts. In addition to the existing body of case law on non-compete clauses in Texas and across the country, the Rule itself has already generated hundreds of pages of commentary and analysis. Companies will benefit from counsel with the skills to persuasively apply long-standing legal principles, as well as those who can develop creative, novel strategies to succeed in this “new normal.”
Brandon Winchester is senior counsel and Fraser Holmes is an associate at Hicks Johnson PLLC, a Houston-based trial law firm.