By now you’ve probably heard that the Federal Trade Commission (“FTC”) adopted a new rule severely restricting the use of non-compete agreements in the United States. You also might have heard that a number of organizations, including the U.S. Chamber of Commerce have already challenged this rule in court. Below is a Client Alert written by several of my colleagues (Robert C. Nagle, Brian A. Berkley, or Josephine H. Wenson) respecting the details of the new rule and a recent court challenge.

The TL:DR for the franchise industry is that the FTC carved out non-compete clauses between franchisors and franchisees from the nationwide ban. This means our industry can relax, right? Well, not really. The ban still applies to non-compete agreements between franchisors and their employees and franchisees and their employees. This means franchisors will need to think carefully about how to protect their brands and especially their trade secrets.

In this regard, I expect we will see a proliferation of nondisclosure agreements and other less orthodox ways of protecting the brand. For example, I spoke at the 2022 American Bar Association Forum on Franchising on the topic of “Bringing a Knife to a Gun Fight? Preventing or Limiting Post-Termination Competition without a Non-Compete”. Many options are available, but most all of them take more thought and careful planning to use successfully.

Further, while the carve out for non-competes between franchisors and franchisees is a relief (particularly as compared to the nationwide ban other industries face), the devil is going to be in the details. The general hostility to non-competes will likely mean courts will apply stricter and stricter scrutiny to such agreements. One of my questions is to whom the non-compete can apply going forward. Some of the owners of the franchisee? All of the owners? Even if they are minority owners? And what about spouses?

Obviously, no ban is better than a complete ban. But, whether or not the Final FTC Rule sticks, a lot of analysis will still need to be done.

Client Alert

On April 23, 2024, in a rare public meeting, the FTC voted 3-2 to approve a final regulatory rule (“Final Rule”) which bans virtually all preexisting and future non-compete agreements with very few exceptions.

The Final Rule is substantially the same as the initially proposed rule. The Final Rule applies to essentially all businesses, regardless of size, and all employees, with a partial exception for “senior executives.”  Key Elements of the Final Rule include:

  • The Ban: Regarding workers who are not “senior executives,” it is unlawful for a person to (1) enter or attempt to enter into a non-compete clause; (2) enforce or attempt to enforce a non-compete clause; or (3) represent to any worker that the worker is subject to a non-compete clause. The Final Rule applies to non-compete agreements not just with employees, but with workers classified as independent contractors as well.
  • Senior Executives: The Final Rule “grandfathers” existing non-compete agreements applicable to “senior executives,” but employers may not require senior executives to enter into a non-compete clause after the effective date of the rule.  “Senior executives” are those employees who (1) are employed in a policy-making position; and (2) received at least $151,164 in annual compensation the prior year.   Employees who make policy only with regard to a specific department or division of a business will not be considered “Senior Executive” under the Final Rule.
  • Franchises: The Final Rule does not apply to franchisee/franchisor contracts. However, it does apply to employees working for a franchisee or franchisor.
  • Existing Non-Competes: The Final Rule does not call for the formal recission of existing non-compete agreements; however, prior to the effective date, notice must be provided to employees whose post-employment non-compete agreements are no longer enforceable.
  • Effective Date: The Final Rule will be effective 120 days after publication in the Federal Register.

Types of Contracts Covered by the Final Rule:

The Final Rule defines “non-compete clause” extremely broadly. According to the Final Rule, a “non-compete clause” includes any written or oral contractual term or condition of employment that (a) prohibits a worker from, (b) penalizes a worker for, or (c) functions to prevent a worker from: (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.

Notably, the final rule does not specifically apply to customer and employee non-solicitation agreements or confidentiality/non-disclosure agreements. However, in its comments, the FTC stated that “whether a specific clause falls within the scope of the final rule will necessarily depend on the precise language of the agreement at issue.” Therefore, customer and employee non-solicitation agreements and confidentiality/non-disclosure agreements apparently are permissible to the extent that they are not so broad as to “function to prevent” a worker from working for another employer.

Exceptions to the Final Rule:

Although broad, the Final Rule laid out the following exceptions:

  • The Final Rule does not apply to a person or entity outside of the FTC’s jurisdiction. This includes individuals acting under the authority of state law or non-profit corporations.
  • The Final Rule does not apply to a cause of action related to a non-compete clause that accrued prior to the effective date.
  • The Final Rule does not apply to a noncompete clause that is 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.

Notice Requirements to Workers Subject to Preexisting Non-Compete Clauses:

Prior to the effective date, an employer who entered into an agreement including a non-compete clause with a worker (not a senior executive) must provide “clear and conspicuous notice” to the worker “that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.” Model language for the required notice is included in the Final Rule.

Legal Challenges to the Final Rule:

The U.S. Chamber of Commerce and other business groups have already challenged the Final Rule in the United States District Court for the Eastern District of Texas. In the complaint, the U.S. Chamber of Commerce argued that noncompete clauses “benefit employers and workers alike—the employer protects its workforce investments and sensitive information, and the worker benefits from increased training, access to more information, and an opportunity to bargain for higher pay.” It is to be expected that other parties will follow suit and file similar challenges to the Final Rule.   

Employers’ Next Steps:

Although the Final Rule may yet be enjoined by the courts, employers are advised to take the following steps immediately:

  • Reach out to counsel to discuss which current and former workers fall within the Final Rule and require Notice.
  • Reach out to counsel to discuss review of your Trade Secret policies and protections as Trade Secret Laws may accomplish similar protections for which employers were relying on Non-Compete Agreements. [NRC1] 

For More Information: If you have any questions about the FTC’s Final Rule on non-compete agreements, please contact any member of our franchising and distribution law team.

 [NRC1]Brian, feel free to revise this.