On April 23, 2024, the Federal Trade Commission (FTC) approved a new rule banning non-compete agreements in the United States. Previously, jurisdiction over the enforceability of non-compete agreements were the sole purview of the individual states. However, once the final rule goes into effect, existing noncompete agreements for the vast majority of workers will no longer be enforceable.
Non-Compete Agreements
A non-compete clause is often included in employment agreements to protect employers from the risk of an employee or a consultant starting a business that competes with the business of the employer, or of going to work for a competitor of the employer. Of course, the fear is that, armed with insider information gained during their period of employment, an employee who starts a competing business or goes to work for an existing competitor can use that information as an advantage over his or her former employer.
The validity and enforceability of non-compete agreements vary by jurisdiction, and they are subject to a heightened level of scrutiny by courts when their validity is challenged. Many state courts refuse to enforce noncompete clauses if they are too expansive in breadth or in scope.
For example, if the owner of a French restaurant asks its head chef to sign a non-compete agreement prohibiting the chef from working in any another restaurant in the state for five years after leaving the restaurant, most states would likely refuse to enforce that agreement, as it places unfair restrictions on the chef’s ability to earn a living. However, if the same agreement only restricted the chef from working for any other French restaurant located within a 30-mile radius of his current employer for a period of one year after leaving his current job, such a restriction would likely have been upheld in most state courts.
However, the FTC viewed this attempt to limit an employee’s right to work in a competing business as an unfair method of competition. This view goes as far back as 1711 and the landmark case of Mitchel v. Reynolds, which established the principle that reasonable restraints of trade are permissible and enforceable, while unreasonable restraints are not. In Mitchel, the court highlighted the vulnerability of workers to exploitation through agreements that threatened their ability to practice their trade and earn a livelihood. These concerns raised the 18th century still resonate today.
In the press release announcing the new rule, FTC Chair Lina M. Khan stated that “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 noncompetes are banned. The FTC’s final rule… will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”
Agreements Covered by the Rule
When it comes to existing non-compete agreements—those entered into before the effective date of the final rule—the rule’s application depends upon whether an agreement is with a senior executive or a lower-level employee. Here's a breakdown of the approach:
- For Senior Executives: Existing non-compete agreements can remain in force; the final rule doesn't address these agreements, but employers are prohibited from entering into or enforcing any new noncompete agreements with senior executives. According to the FTC, senior executives' non-compete agreements can persist because such high-level employees are less likely to experience the immediate and ongoing negative effects seen in other employees with existing non-competes.
- For Non-Executive Workers: Existing non-compete agreements will no longer be enforceable after the final rule takes effect. Employers who had lower-level employees sign agreements with non-compete clauses must inform those workers that their existing non-compete agreements are no longer enforceable. The final rule provides model language to help employers meet this notice requirement efficiently, aiming to reduce the burden of compliance.
Alternatives to a Non-Compete Agreement
As the FTC pointed out in its announcement, even after the new rule takes effect, employers can benefit from several alternative legal solutions that will enable them to protect their businesses short of a noncompete agreement, such as non-disclosure agreements (NDAs) and trade secret laws.
Predicted Outcomes
The FTC predicts that the new rule will result in substantial savings in healthcare costs, ranging from $74 to $194 billion over a decade, primarily attributable to reductions in physician expenses. The FTC also anticipates that the new rule will lead to a notable uptick in entrepreneurial activity, with a projected 2.7% increase in new firm formation, equating to over 8,500 additional businesses established annually, as well as a surge of 17,000 to 29,000 new patents over the next decade.
The FTC also believes the new rule will lead to a boost in worker earnings, with aggregate wages projected to rise by $400 to $488 billion over the next decade, translating to an average annual increase of $524 per worker.
Effective Dates
The final rule will take effect 120 days after its publication in the Federal Register. However transformative the new rule may or may not be, it is anticipated to face substantial legal challenges and may not live to see the light of day.
