July 17, 2024

Obligate Law

Professional Law Makers

Most Noncompete Agreements Could Be Banned After FTC Vote, Lawsuits Likely

5 min read
Most Noncompete Agreements Could Be Banned After FTC Vote, Lawsuits Likely

This is a developing story and will be updated.

The Federal Trade Commission voted Tuesday to approve a final rule that would ban most new noncompete agreements, effectively barring their use except in limited cases and setting the stage for legal fights between business groups that oppose the rule and its supporters, which include the Biden administration.

Shortly after the rule was released, the Chamber of Commerce said in a statement that it plans to challenge the ruling in court. “The Chamber will sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked,” the organization’s president and CEO, Suzanne Clark, said in a press release.

In key changes announced Tuesday to the proposed rule, the agency said existing noncompete agreements may remain in effect for senior executives, which the FTC defines as those earning more than $151,163 annually who are in “policy-making positions,” but would be unenforceable for all other employees. It also doubled the transition time period for when the rule will come into effect, to 120 days. Newly established noncompetes would be banned for all employees following that date.

While the Republican commissioners argued that the FTC did not have congressional authority to pass the rule, the commission’s Democratic chair, Lina Khan, argued “the FTC Act clearly gives the agency the authority to address unfair methods of competition. To my mind, arguing that the FTC lacks the authority requires ignoring the straightforward reading” of the act’s text, she said.

The vote on the final rule, which fell along party lines, with three Democratic commissioners voting in favor and the agency’s two Republicans voting against, caps a more than year-long process. Once effective, the new rule would become the first at the federal level to restrict noncompete agreements for most workers nationwide.

Noncompete agreements prohibit workers who sign them from working for a direct competitor, or creating their own, after leaving an employer. The new rule will apply to employees, as well as independent contractors, interns, volunteers and others who work for companies that fall under the FTC’s regulatory authority.

The FTC said Tuesday that existing noncompete agreements for workers who don’t meet the definition of “senior executive” would not have to be rescinded, but also won’t be enforceable. It explained that those who make “policy-making decisions” are executives who have the “final authority to make policy decisions that control significant aspects of a business entity,” and account for less than 1% of workers.

While that may leave room for some interpretation, “the initial view is that it will be a limited set of employees, which is consistent with what the FTC is trying to do here,” says Robert Milligan, Los Angeles-based partner at Seyfarth Shaw.

The FTC introduced its proposed rule in January 2023 following a 2021 executive order from President Joe Biden. It argued that noncompete agreements hurt workers by lowering wages and stifling innovation if workers can’t start companies that compete with their former employers. According to the commission, banning noncompete agreements would free 30 million people in the United States from their current noncompetes and increase earnings between $400 billion and $488 billion per year.

Yet the proposed rule was met with heavy criticism. Nearly 27,000 comment letters were submitted to the FTC in the year since the submission period opened, drawing ire from industry associations including the U.S. Chamber of Commerce; an intellectual property group headed by executives from companies such as Apple, Dell, Nike and Google; the National Small Business Association and the Securities Industry and Financial Markets Association, which argued that a noncompete ban would actually stifle innovation.

In its statement Tuesday, the Chamber of Commerce said “the Federal Trade Commission’s decision to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive.”

With so much pushback, lawyers have been expecting legal challenges. “Someone or multiple groups will file a lawsuit attempting to obtain an injunction to prevent the law from taking effect,” says Chris Marquardt, an Atlanta-based partner at Alston & Bird.

The FTC’s rule will supersede any state regulation. Several states, including California and Colorado, already ban or restrict noncompete agreements for all or some employees, such as those earning above a certain income level or working in certain industries. A group of attorneys general from 17 states and Washington D.C. wrote a letter last spring in support of a federal rule, arguing that it will “clarify the law and yield predictable outcomes for workers and employers” across multiple states. More than 25,000 of the letters received by the FTC were in support of the proposed ban, the FTC said in Tuesday’s meeting. Among them were Democratic senators, as well as several labor organizations including the AFL-CIO and the Service Employees International Union.

But another group of state attorney generals, including those from West Virginia, Utah and Texas, criticized the draft rule as an overreach, arguing the decision should be left to the states. “Noncompetes are not an issue a top-down categorical ban can solve,” they argued in a letter to the FTC. “State flexibility matters, especially in an area where tailored solutions can better reflect difficult-to-balance policy needs.”

There are a few groups and types of employees who will be exempt from the noncompete rule. In addition to senior executives with existing agreements, they include franchise owners, who are considered business owners rather than employees, as well as people who are owners of more than 25% of a company that is sold to another entity. Employees of banks and nonprofit organizations are also exempt because they largely do not fall under the FTC’s regulatory authority, says Marquardt.

The rule on noncompetes will not impact nondisclosure or nonsolicitation agreements, which prohibit workers from poaching a company’s clients or contacts upon leaving, lawyers say, unless they are deemed as being a substitute for noncompetes. Companies could still pursue prosecution of former or current employees regarding more specific allegations, such as sharing trade secrets.

“When there is a lawsuit over a noncompete, there is almost always a group of claims done at the same time,” says Marquardt, such as allegations of giving confidential information to a competitor. The new rule, he says, if approved, “is not going to end litigation between companies and individuals when you have the scenario of someone going to work for a direct competitor.”

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