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Is It Too Soon For Executives (and Partners) to be Celebrating Their Release from US Non-Competition Restrictions?

On 23 April 2024, the US Federal Trade Commission (FTC) announced its final rule banning non-compete clauses across the United States of America (Final Rule). In a 3-2 decision, the FTC determined that non-compete clauses are an unfair method of competition and so violate s 5 of the Federal Trade Commission Act (FTC Act). This is a major ruling for a country where nearly one in five workers is subject to a non-compete. 

Our colleagues Liz Pearson and David Fisher, together with US employment attorney Mark Risk, consider below the changes, potential exemptions and what this means for UK and multinational companies, while noting the need to keep abreast of developments. For example, on 24 April 2024, the US Chamber of Commerce sued the FTC for what it views as the agency exceeding its administrative authority. 

The Bottom Line: it is too soon for executives and partners to be celebrating their release from non-competition restrictions.

Background

On 19 January 2023, the FTC proposed the Final Rule pursuant to sections 5 and 6(g) of the FTC Act (which empowers and directs the FTC to prevent most entities ‘from using unfair methods of competition in or affecting commerce and unfair or deceptive acts or practices in or affecting commerce’). 

This proposal followed increased concern around the use of non-competes and greater involvement from the FTC, including public hearings from 2018 and investigations from 2021. 

The FTC considered its own expertise and the ‘entire rulemaking record’, including empirical research on how non-competes affect competition and over 26,000 public comments (25,000 of which supported the ban). 

The Changes

(First, note that key industries such as banks – see definitions at the end of this article – are excluded from the FTC Act and therefore excluded from these changes.)

Workers (other than senior executives)

Existing non-competes are no longer enforceable from the Effective Date (120 days after publication in the Federal Register) and employers must provide workers with notice that they are no longer enforceable. 

No new non-competes can be made because they will violate s 5 of the FTC Act, as an unfair method of competition to:

  • Enter into or attempt to enter into a non-compete clause; 
  • Enforce or attempt to enforce a non-compete clause; or 
  • Represent that the worker is subject to a non-compete clause.

Partners

The broad definition of workers (see definitions at the end of this article) could include LLP partners, members and shareholder members of an LLP agreement. The FTC explicitly declined to specify ‘that a “worker” includes an owner who provides services to or for the benefit of their business because the definition already encompasses the same’ (emphasis added).  

Note also that partners are likely to be senior executives, as defined below.

Senior Executives

In general, the term “senior executives” refers to workers earning more than $151,164 who are in a “policy-making position” (see definitions at the end of this article). 

Existing non-competes remain enforceable, but as per workers, there can be no new non-competes from the Effective date. 

The FTC did not find that non-competes with senior executives were exploitative or coercive (senior executives are most likely to have genuinely bargained for the non-compete), but did find they were unfair methods of competition.  

Non-Competition

The FTC provides a broad definition of non-compete clauses – (in summary) a term or condition of employment (including, but not limited to, a contractual term or policy) that prohibits, penalises, or functions to prevent a worker from operating a business or seeking or accepting different work after the conclusion of employment. 

Notably, there is no distinction between non-competes in employment agreements, separation agreements (though note the sale of business exception below), or elsewhere, and no distinction based on the employee receiving consideration. 

The Final Rule does not deal with confidentiality and trade secrets provisions or provisions prohibiting solicitation of clients or employees. The proposed rule of January 2023 suggested that such clauses were not affected unless they were so broad as to function like non-competition clauses. For example:

  • A requirement that employee not solicit any potential customer within 1,000 miles is in substance a non-compete;
     
  • A non-disclosure agreement that prevents disclosure of ‘any information that is “usable in” or “relates to” the industry in which they work’ or ‘any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information’. 

Share and Equity Agreements

The FTC’s broad definition would seemingly capture non-competes in an equity agreement, given the common approach is to create financial penalties for workers who compete (such as a clawback or a non-issue of equity). 

Indeed, the FTC notes:

  • ‘Another example of a term that “penalizes” a worker, under § 910.1, is an agreement that extinguishes a person’s obligation to provide promised compensation or to pay benefits as a result of a worker seeking or accepting other work or starting a business after they leave their job. One example of such an agreement is a forfeiture-for-competition clause, which, similar to the agreement with liquidated damages described previously, imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee seeking or accepting other work or starting a business after their employment ends.’ and
     
  • ‘An additional example of a term that “penalizes” a worker under § 910.1 is a severance arrangement in which the worker is paid only if they refrain from competing.’ 

While this appears clear-cut, one commentator posits a potential workaround – ‘Perhaps an employment contract that says “we will take back all your deferred compensation if you leave for any reason,” combined with a winking understanding that actually you can keep it as long as you don’t leave for a competitor’. 

Another reminder to executives: the Final Rule only covers competition – it does not nullify other obligations such as non-solicitation, or ongoing obligations such as confidentiality. 

What about Garden leave?

Garden leave clauses are seemingly beyond the scope of the Final Rule. This is because the employee remains employed by the employer, such that any restriction on their activity during the garden leave period is, strictly speaking, not a restriction on post-employment activity. 

The FTC notes: 

  • ‘An agreement whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis would not be a non-compete clause under the definition, because such an agreement is not a post-employment restriction. Instead, the worker continues to be employed, even though the worker’s job duties or access to colleagues or the workplace may be significantly or entirely curtailed’. 
     
  • ‘Furthermore, where a worker does not meet a condition to earn a particular aspect of their expected compensation, like a prerequisite for a bonus, the Commission would still consider the arrangement “garden leave” that is not a non-compete clause under this final rule even if the employer did not pay the bonus or other expected compensation’.

We anticipate this would be tested in future litigation.

Exception for Sale of a Business

The Final Rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets. (Note business entity means a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.)

The FTC commentary states that ‘partners would also likely fall under the sale of business exception in § 910.3 if the partner leaves the practice and sells their shares of the practice’. Further, the FTC rejected proposals to exempt certain types of workers, noting ‘partners, shareholders, and similar groups are likely covered by the sale of business exception if they sell their share of the business upon leaving’.  

We note that many partners in professional service firms do not receive a specific payment upon exit, but instead transfer their partnership interest to existing or new partners upon their departure. It remains open whether such a transfer would constitute a bona fide sale and, if not, whether a nominal payment would constitute a bona fide sale. 

Pending these considerations, this exemption could be a crucial mechanism to enable the ongoing use of new non-competes. 

Alternatives to Non-Competes

According to the FTC,  firms can:

  • Utilise trade secret laws and non-disclosure agreements to protect proprietary and sensitive information; and
     
  • ‘Compete on the merits for the worker’s labor services by improving wages and working conditions’.

As above, firms could also consider the sale of business exception, garden leave and other restraints.

What Next – For the Final Rule

We anticipate employees (and their counsel) arguing that their non-competes should be stricken as “offensive to public policy” citing the FTC Rule – but it is far from clear that those arguments will be successful. We also note the FTC Act, which provides the basis for the Rule, has no private right of action, so only the FTC (and not employees or workers) can sue to enforce the FTC Act.

We anticipate employers will challenge the Final Rule (as above), with some seeking to obtain court orders temporarily pausing the FTC requirement that they notify their employees that existing non-competes are null and void.

In the current US judicial climate, employer arguments could potentially succeed. 

  • A confident new US Supreme Court majority is highly sceptical of the “administrative state” (agencies in the government bureaucracy advancing new policies), which the Court believes is the duty of the legislative branch of the government. 
     
  • The Court has already enunciated a “Major Questions Doctrine” in which it is presumed that Congress has not delegated authority to an agency to address a question of significant importance unless the delegation is made explicitly. 
     
  • Since the making of restrictive covenant jurisprudence has been the job of state courts, it is possible that the Supreme Court will view the Final Rule as relating to a “major question”. 

Even if the Final Rule were to survive “major question” scrutiny, the Supreme Court could still conclude that it constitutes an unconstitutional delegation by Congress of its legislative authority to the FTC.

Though the future of the Final Rule is far from certain, it still represents a major milestone, taking account the FTC’s extensive findings that non-competes inhibit fair competition in labour markets and inhibit new firms from entering new markets.

Lawyers for workers and executives argue that in some states, insufficiently rigorous judicial scrutiny of non-competes has provided employers with a work-around to the “employment at-will” rule by making it impossible for people to continue their careers without leaving their chosen field, and in that way locking them into their current employment. 

State legislatures (and for that matter, the Conservative government in the UK, which has proposed to limit non-competes to 3 months in employment and worker contracts) have come to recognize this. 

The FTC Rule will be a shot in the arm for legislators, judges, and lawyers who are aware that this area of law needs significant reform.

What Next for UK and International Employers & Executives Concerned About the FTC Rule?

As the FTC notes, the definition of “non-compete clause” is expressly limited to terms or conditions that prevent workers from seeking or accepting work in the US or operating a business in the US  The FTC revised the Final Rule to ‘clarif[y] for stakeholders the scope of the Final Rule and confirm it does not prohibit employers from using non-competes that restrict work outside the US, in compliance with those jurisdictions’ own laws’. Further, the FTC notes that the Final Rule ‘would not invalidate non-competes entered into by foreign companies with foreign workers unless they restrict a worker’s ability to work or start a business inside the US’

Global employers with workers in the U.S or operating a business in the US will need to keep a keen eye on the progress of the Final Rule and be ready to localise their policies and procedures accordingly. American parent companies with US global incentive plans can take comfort that their international staff can still be subjected to non-competes in their own jurisdictions, subject to local law and public policy. 

The Final Rule has significant implications for the global war on talent. Faced with candidates from e.g. the UK, Australia and the US, a hiring committee may favour the one from the US who can quickly and cheaply join the firm (e.g. with no need to “buy-out” the non-compete from the former employer).

International senior executives may push back against non-competes, pointing to this market shift as evidence that a 12 or 24 month non-compete is no longer reasonable. 

The FTC directly challenged employers to consider whether they can attract and retain workers without resorting to non-competes. We wait to see whether the Final Rule spurs innovations, or innovative workarounds.  

Join in the discussion on the FTC decision and the enforceability of non-competes around the world at the IFSEA annual senior executive and founder conference on Tuesday 25 June in London; the panel will be chaired by Mark Risk. You can download the programme here and register here

If you have any questions or would like specific advice in relation to the FTC ban, please contact Partner David Fisher or Associate Liz Pearson at CM Murray LLP in London who specialise in employment and partnership law, or US employment law attorney Mark Risk at Mark Risk, PC in New York.

 

Key definitions

(re non-competes)

“non-compete clause”
(1) a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

(i) seeking or accepting work in the United States with a different person where such
work would begin after the conclusion of the employment that includes the term or condition; or

(ii) operating a business in the United States after the conclusion of the employment that
includes the term or condition.

(2) For the purposes of this part 910, term or condition of employment includes, but is not
limited to, a contractual term or workplace policy, whether written or oral.

“term or condition of employment” – includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

“employment” – work for a person.

“person” – any natural person, partnership, corporation, association, or other legal entity within the Commission’s jurisdiction, including any person acting under color or authority of State law

“worker” – natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. The term worker includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.

“senior executives” means a worker who:
(1) Was in a policy-making position; and

(2) Received from a person for the employment:

(i) Total annual compensation of at least $151,164 in the preceding year; or

(ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or

(iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.

“policy-making position” – a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. An officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position for purposes of this paragraph. A natural person who does not have policy-making authority over a common enterprise may not be deemed to have a policy-making position even if the person has policy-making authority over a subsidiary or affiliate of a business entity that is part of the common enterprise.

“officer” president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any natural person routinely performing corresponding functions with respect to any business entity whether incorporated or unincorporated.

“policy-making authority” – final authority to make policy decisions that control significant aspects of a business entity or a common enterprise. The definition further states that policy-making authority does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.

“business entity” – a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.

(re excluded industries)
 
“bank” means—
(A) national banks and Federal branches and Federal agencies of foreign banks;
 
(B) member banks of the Federal Reserve System (other than national banks), branches and agencies of foreign banks (other than Federal branches, Federal agencies, and insured State branches of foreign banks), commercial lending companies owned or controlled by foreign banks, and organizations operating under section 25 or 25A of the Federal Reserve Act [12 U.S.C. 601 et seq., 611 et seq.]; and
 
(C) banks insured by the Federal Deposit Insurance Corporation (other than banks referred to in subparagraph (A) or (B)) and insured State branches of foreign banks.