Update on August 20, 2024: A federal judge has issued an injuction to block the enforcement of this ban. According to the judge, the noncompete ban is too broad and in excess of the FTC’s authority.
What does this mean? For the foreseeable future, employers are not required to notify employees (current and former) that any noncompetes are unenforceable.
The litigation over this will very probably continue, so stay tuned to learn how this plays out, and read on to learn about the FTC ban on noncompetes.
In April of 2024, the Federal Trade Commission (FTC), the agency charged with protecting consumers and promoting competition, released a new final rule that could affect up to 30 million U.S. employees and their employers. The rule imposes a comprehensive ban on new noncompete agreements with all workers, including “senior executives.” The sweeping final rule could also apply to nondisclosure agreements (NDAs) and other restrictive covenants. But it’s already facing some legal challenges.
Read on for the answers to some of the most common questions about the final rule and its implications for employers.
What does the new rule prohibit?
Under the new rule, existing noncompete agreements for most workers won’t be enforceable. Existing noncompete agreements for senior executives (see below) can remain in force.Still, employers are prohibited from entering new noncompetes with any employee.
What is a noncompete agreement for purposes of the new rule?
The final rule generally defines a noncompete agreement as a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:
- Seeking or accepting work in the United States with a different employer when the work would begin after the employee leaves the business, or
- Operating a business in the United States after the employee leaves.
It’s important to note that the three prongs of the definition—prohibits, penalizes, or functions to prevent—can cast a wider net than you might expect. They could ensnare agreements that aren’t specifically labeled or even intended as noncompete agreements but that have the effect of penalizing or preventing a worker from seeking other employment or starting a business (see below for examples).
Why did the FTC approve this final rule?
The FTC approved the new rule by a 3-2 vote along party lines. The majority determined that noncompete agreements are unfair methods of competition under the FTC Act because they hurt competition and stifle innovation.
The FTC says that the ban will facilitate the creation of more than 8,500 new startups per year, representing a 2.7 percent growth per year in new business formation (for more information on the current state of entrepreneurship, check out Gusto’s “2024 New Business Formation Report”).
The FTC also claims that the final rule will result in an average of 17,000-29,000 more patents each year for the next ten years. This would work out to an estimated increase of 11 to 19 percent annually over ten-years.
The FTC estimates that the average worker’s earnings will rise an estimated extra $524 per year. This, of course, has budgetary and payroll tax repercussions for employers, among other consequences.
Note: The FTC issued a proposed rule in January 2023 with a 90-day public comment period. According to the agency, it received more than 26,000 comments on the proposed rule—with more than 25,000 comments voicing support for the proposed ban on noncompetes.
Does the rule apply to all workers?
Just about. The final rule defines “worker” as a natural person who works or previously worked, whether paid or unpaid, without regard to the worker’s title or status. That means it can encompass individuals working as employees, independent contractors, interns, externs, volunteers, or sole proprietors who provide a service to a person.
The rule does include an exception for existing noncompete agreements with “senior executives,” though.
Who is a “senior executive”?
The final rule defines “senior executives” as workers who 1) earn total annual compensation of at least $151,164 and 2) hold policy-making positions. The FTC says senior executives make up less than 0.75 percent of workers in the United States.
Total annual compensation is based on the worker’s earnings over the preceding year. It includes salary, commissions, nondiscretionary bonuses, and other nondiscretionary compensation earned during that 52-week period. It doesn’t, however, include board, lodging, and other facilities. It also doesn’t include payments for medical insurance, payments for life insurance, contributions to retirement plans, or the cost of other similar fringe benefits.
Policy-making positions include a business’s:
- President,
- Chief executive officer or the equivalent,
- Any other officer of a business entity who has policy-making authority, and
- Any other natural person with policy-making authority for the business similar to an officer with policy-making authority.
An officer of a subsidiary or affiliate that’s part of a common enterprise and who has policy-making authority for the common enterprise may also be deemed to have a policy-making position.
Are employers required to formally rescind existing noncompete agreements with non-senior executives?
No, which is good news for employers. The earlier version of the rule included language that did require formal rescission.
The final rule instead requires only that employers provide notice to workers who are subject to an existing noncompete agreement (other than senior executives) that they won’t be enforcing any noncompetes against them. The final rule includes model language that will satisfy the requirement.
The model language states, in part, that “[EMPLOYER NAME] will not enforce any noncompete clause against you.” Because this language doesn’t identify the recipient as having a noncompete, employers don’t need to determine which of their workers have noncompete agreements. They can send a mass communication—on paper, by mail, by email, or by text—to current and former workers. Employers are exempt from the notice requirement if they don’t have a street address, email address, or mobile telephone number for a worker.
Does the final rule apply to noncompetes that are part of the sale of a business?
The new rule doesn’t apply to a noncompete clause that’s entered as part of a “bona fide sale” of a business, of the person’s ownership interest in a business, or of all or substantially all of a business’s operating assets.
However, these noncompete agreements will still be governed by applicable state laws, which generally require a noncompete to be necessary to protect the value of the business being sold. They’ll also be subject to federal antitrust law.
Does the rule ban nondisclosure agreements?
The final rule doesn’t apply to what the FTC describes as a “garden-variety NDA,” where the worker agrees not to disclose certain confidential information to a competitor. The agency reasons that these agreements aren’t noncompetes because they don’t prevent the worker from seeking or accepting employment with a competitor after leaving their job.
An NDA could be banned, though, if it prohibits disclosure of information that:
- Arises from the worker’s general training, knowledge, skill, or experience, whether gained on the job or otherwise, or
- Is readily ascertainable by other employers or the general public.
An NDA could fall under the “functions to prevent” prong of the final rule’s definition of noncompete agreements if it covers such a large swath of information that it functions to prevent workers from seeking or accepting other employment or starting a business after leaving their jobs.
For example, an NDA shouldn’t bar a worker from disclosing any information that is “usable in” or “relates to” the industry in which they work. The ban would also apply to an NDA that bars disclosure of any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information.
What about nonsolicitation agreements (NSAs)?
NSAs—also known as no-hire or no-business agreements—generally aren’t considered noncompete agreements. Some might be, though, if they function to prevent a worker from taking another job or starting a new business. The final rule calls for a fact-specific inquiry to determine whether an NSA is in fact a prohibited noncompete agreement.
Are training repayment agreements (TRAPs) prohibited?
TRAPs could be treated as noncompete agreements under the final rule, depending on facts and circumstances. The rule cites two examples of TRAPs that may be functional noncompete agreements because they could force workers to stay in their current jobs or face significant out-of-pocket costs to leave:
- A TRAP that required entry-level workers at an IT staffing agency who were earning minimum wage or nothing during their training periods to pay more than $20,000 if they failed to complete a certain number of billable hours.
- A TRAP that required nurses to work for three years or repay all they’ve earned, plus paying the employer’s “future profits,” attorneys’ fees, and arbitration costs.
Can employers still require repayment of a bonus when a worker leaves?
Clauses that require repayment of a bonus when a worker leaves their job generally aren’t noncompete agreements. An employer can require a worker to repay a bonus if they leave before a certain period of time, as long as the repayment amount isn’t more than the amount received. Similarly, an employer can have a policy that says a worker forfeits accrued sick leave when they leave.
Are “garden leave” agreements still allowed?
“Garden leave” generally refers to a kind of grace period before an employee’s termination—leave for the employee to tend their garden or engage in other non-work-related activities. The employee remains employed and on the payroll and continues to receive benefits, but the employer isn’t required to assign any work to the employee and the employee can’t work for a competitor.
The FTC considered whether several types of garden leave agreements were actually noncompete agreements. It determined that the following weren’t noncompetes and therefore are allowed:
- An agreement where the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis,
- An agreement where the worker doesn’t receive part of their expected compensation if they don’t meet a condition to earn it (for example, if the employee fails to meet sales goal to earn a bonus), and
- A severance agreement with no restrictions on where the worker can subsequently work.
Does the new rule replace state laws regarding noncompetes?
The final rule “preempts” state laws only where they conflict with it. In other words, it bans noncompete agreements that would be legal under state law.
When does the new rule take effect?
The final rule is scheduled to take effect on Sept. 4, 2024. However, at least two legal challenges to the final rule have already been filed, including one brought by the U.S. Chamber of Commerce. The lawsuits could delay or eventually block the rule from taking effect.
Note: Even if the federal rule is struck down, several states have laws that prohibit or limit the use of noncompete agreements. For example, California, Minnesota, North Dakota, and Oklahoma fully prohibit noncompetes, and similar legislation is pending in other states. Some states limit the agreements based on the employee’s income. In Maryland, for example, noncompetes generally aren’t allowed for an employee who earns equal to or less than 150 percent of the state minimum wage rate.
How should employers prepare for the noncompete ban?
Employers with existing noncompete agreements in place should prepare to provide the requisite notice to covered current or former workers who aren’t senior executives. As noted above, a mass email with the model language should do the trick.
Employers that want to enter new noncompetes in the hope that the new rule will be permanently blocked should tailor such agreements narrowly to accomplish legitimate business purposes (for example, protecting trade secrets or confidential information) and impose reasonable restrictions in terms of duration and geography. They should also avoid using noncompete agreements with lower-paid employees.
Note: Employers should always consult with an attorney before implementing any restrictive covenants.
Employers can also consider legally permissible alternatives to protect proprietary and other sensitive information, such as trade secret laws and NDAs. The FTC says that more than 95 percent of workers with noncompete agreements are also subject to NDAs. And, of course, higher wages and favorable work conditions are yet another way to retain valuable employees.
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Protecting confidential information and trade secrets from competitors is just one of the many challenges on small business owners’ plates. Gusto’s payroll service can ease some of the burden by making it easier to pay employees and automatically file payroll taxes.
