May 21, 2024

FTC Rule Banning Most Non-Competes Would Outlaw Forfeiture Provisions

The Federal Trade Commission (“FTC”) recently issued a Final Rule (the “FTC Rule”) that, unless invalidated by the courts, will soon prohibit most non-compete provisions.  In its current form, the FTC Rule will cover not only covenants that prohibit working for a competitor but also provisions that call for the forfeiture of compensation, severance or benefits if a former worker competes.

What Does the FTC Rule Provide?

General; Effective Date.  On April 23, 2024, the FTC issued a Final Rule banning most non-compete provisions between workers (e.g., employees, independent contractors, interns and volunteers) and employers, as an “unfair method of competition” under Section 5 of the FTC Act.  The Final Rule was published in the Federal Register on May 7, 2024, and is scheduled to become effective on September 4, 2024 (the “Effective Date”).

Non-Compete Provisions Banned.  The FTC Rule bans business entities subject to the FTC’s jurisdiction from:

  • Entering into or attempting to enter into a non-compete provision;
  • Enforcing or attempting to enforce a non-compete provision; or
  • Representing that a worker is subject to a non-compete provision.

The FTC Rule does not rescind existing non-compete provisions.  Instead, the Rule prohibits employers from enforcing most non-compete provisions that are in effect on or after the Effective Date.

Notice Requirements.  Employers have an affirmative duty to notify current and former workers that the non-competes in effect on the Effective Date will not be enforced.  The FTC has issued a sample notice for this purpose, although an employer is not required to use that specific language.

Impact on State Non-Compete Laws.  The FTC Rule preempts state laws that are more lenient in permitting non-compete provisions but would allow states to enforce their laws that are more restrictive.

Non-Compete Provisions Exempt from the Ban.  The FTC Rule does not apply to non-compete provisions that are in effect before the Effective Date and that apply to senior executives.  However, new non-competes may not be entered into after the Effective Date, even for senior executives.

  • For this purpose, a “senior executive” is a worker who earns more than $151,164 annually and who is in a policy-making position for the parent company and its affiliates.
  • A “policy-making position” means a business entity’s president, chief executive officer or any other officer who has policy-making authority over the overall company and its affiliates (and not just over a subsidiary company).
  • “Policy-making authority” means the authority to make policy decisions that control significant aspects of a company or the company and its subsidiaries. The authority to advise or influence policy decisions will not be sufficient.

Non-compete provisions entered into between a buyer and a seller in a transaction for the sale of a business, the seller’s ownership interest in the business or substantially all of the assets of a business are also exempt.

What is a Non-Compete under the FTC Rule?

The FTC Rule defines “non-compete” very broadly, as:

(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) …. term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

What Restrictive Covenants are Not Covered by the FTC Rule?  Other types of restrictive covenants generally are not banned by the FTC Rule.  For example, non-solicitation and nondisclosure provisions generally are still permitted.  However, if a non-solicitation or nondisclosure provision is drafted so broadly that it functions “to prevent a worker from seeking or accepting other work or starting a business after their employment ends,” the non-solicitation or nondisclosure provision could be classified as a banned non-compete.

What are the Legal Challenges to the FTC Rule?  To date, at least three lawsuits have been filed asking federal courts to invalidate the FTC Rule and, in the meantime, to stay its Effective Date.  Claims include (among others) that the FTC does not have substantive rulemaking authority, banning all non-compete provisions exceeds the FTC’s authority, and Congress has not delegated this type of rulemaking authority such that the FTC Rule violates the “major questions doctrine”.  Although it is impossible to predict how federal courts will rule, the challenges to the FTC Rule appear to have merit.

How Does the FTC Rule Impact Forfeiture Provisions?  Forfeiture provisions – which do not actually prohibit a worker from competing but result in the forfeiture of compensation, severance or other benefits – are quite common.  For example, these types of provisions are frequently incorporated into nonqualified retirement plans, in which case those provisions can be broader than allowed by state law due to the application of ERISA preemption.  Forfeiture provisions are also widely used in severance agreements, such that, if a former employee goes to work for a competitor, his/her severance payments will stop.

Under the definition of “non-compete”, in addition to non-compete provisions that prohibit a worker from employment with a competitor, the FTC Rule would ban provisions that penalize a former worker if he/she competes with the company.  The preamble to the FTC Rule clarifies that a forfeiture of compensation, severance or benefits due to a former worker’s competition with the employer would be considered such a penalty.

How Will the FTC Rule Apply to Forfeiture Provisions?  If a company has a forfeiture provision that applies to a former worker in an employment agreement, a severance agreement, a nonqualified deferred compensation plan or an equity arrangement, and if the former worker was not a senior executive, the company will be required to notify the former worker before the Effective Date that the forfeiture provision will not be enforced.  In addition, if any severance, nonqualified or equity plan includes a forfeiture for competition provision that would apply to workers who become participants after the Effective Date, these plans may need to be amended before the Effective Date to remove the forfeiture provision with respect to future participants.

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