The US Federal Trade Commission voted on Tuesday 23 April 2024 to ban nearly all worker non-compete provisions. This Final Rule will take effect 120 days from publication in the Federal Register, expected to take place soon, however enforcement may be delayed or even barred by numerous legal challenges.
Key points
Provisions of the Final Rule
The Final Rule bans any provision which functions to prevent a worker from seeking or accepting work, or operating a business, in the USA, after their employment end. Existing non-competes will not be enforceable, and new non-competes cannot be entered into. It will be a violation to attempt to enforce or enter into a non-compete clause, or to represent that a worker is subject to a non-compete clause.
Employers are required to provide “clear and conspicuous notice” to the worker by the effective date that the any existing non-compete clause will not be, and cannot legally be, enforced against the worker.
Worker is broadly defined as “a person who works for an employer”. This is explicitly intended to cover independent contractors, apprentices and unpaid workers.
What is left?
Existing non-competes for senior executives are excluded from the ban. Senior executives are workers earning over $151,000 and who have a “policy making position”. However, the Final Rule bans new non-competes for senior executives. The requirement of a policy making position means that many high-earning roles do not qualify for the exemption, for example workers in the financial sector such as brokers.
An employer is still entitled to take action in relation to existing non-competes, where the breach takes place before the ban comes into effect.
The Final Rule applies to all provisions which have the effect of a non-compete obligation. Garden leave and other pre-termination provisions remain valid. Post termination restraints such as non-solicitation and non-dealing covenants will remain unaffected, unless they are “so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.”.
The Final Rule will not apply in the context of a franchisor-franchisee relationship and also exempts non-competes as part of the sale of a business.
Background to the Final Rule
Non-competes have been void in California, Oklahoma and North Dakota since the 19th century. Recent years have seen an increasing number of states legislate to regulate the use and scope of non-competes, for example in 2022 Washington DC made non-competes valid only for employees earning over $150,000 or $250,000 for medical specialists. Currently 17 states are introducing legislation to regulate non-competes.
The FTC has investigated and consulted for many years on the economic and competitive impact of non-competes on labour flexibility, wage growth and new business formation. In the FTC’s view, the prevalence of non-competes “suggests that employers may believe workers are unaware of their legal rights; that employers may be seeking to take advantage of workers’ lack of knowledge of their legal rights; or that workers are unable to enforce their rights through case- by-case litigation”.
Much of the FTC’s justification refers to the impact on workers earning below the $151,000 threshold. The FTC estimates that 30 million American workers, some 20% of the workforce, are affected by non-competes, which are widely used in low-wage positions and insecure hourly work. Bartenders, seasonal warehouse packers and fastfood servers were some of the roles identified. Its research found multiple examples of abusive practices with onerous restraints purporting to extend for several years or even indefinitely, sometimes included in paperwork which workers were not given time to read much less get advice on, imposed on entry-level workers and enforced against employees made redundant.
A second area of the FTC’s focus is the healthcare sector. The FTC found evidence that the nono-competes were widely used, for example 68% of cardiologists are restricted. It estimates that the ban will reduce healthcare costs by $74-194 billion over the next decade.
On the other hand, the FTC considered that employers already had ample protection for trade secrets by way of confidentiality provisions or NDAs. Further, confidentiality provisions and NDAs are more widely enforced by US employers. The protection of confidential information is reinforced by the status of theft of trade secrets as a federal crime.
The FTC did not find that non-competes with Senior Executives were exploitative or coercive, although it did find that they are anti-competitive and unfair. The FTC decided to permit existing non-competes for Senior Executives to remain in effect because “credible concerns” were raised about the impacts of removing them, in particular the consideration often offered for non-competes including LTIPs, stock options and bonuses.
Legal Challenge
Enforcement of the rule may be delayed or barred by legal challenges.
A coalition of the US Chamber of Commerce and other trade groups have filed a lawsuit in the federal court in Texas, asking the court to declare the ruling void and unenforceable. The coalition argues that the ruling is constitutional and statutory overreach, and regulation should be left in the hands of individual states. The US Chamber of Commerce regards the ruling as “aggressive regulatory proliferation” and that non-competes serve procompetitive functions and protect investment in R&D and workforce training.
Impact for UK employers and advisers
Employers will wish to consider the impact on non-compete clauses which purport to restrict competition within the USA, as well as any potential jeopardy arising from the threat of legal proceedings in relation to work to be performed in the USA.
The FTC’s ruling is anticipated to give impetus to the UK Government’s varying proposals to limit non-competes, the most recent of which is the suggestion to limit the restricted period to three months. However, the rationale for the Final Rule may not directly translate to the UK.
As the FTC’s report reveals, the US labour market bears features unique to America. The impact of non-competes on the cost of healthcare was a major driver for the proposal. By contrast, there was virtually no discussion of the impact on the financial industry, a sector which has been so important to the development of English law of business protection: concerns raised by the financial sector were addressed in less than three pages of the 570 page report.
There are material differences which may enhance the oppressive effect of non-competes in the US compared to the UK, in particular the limited healthcare available to the unemployed, the limited nature of maternity and other forms of leave, and limited access to justice for the enforcement of employment rights. The US context of ubiquitous and coercive use of non-competes is very different to the UK landscape. The FTC’s evidence showed non-competes which ran for time periods that UK employers can only dream of, often for several years. Numerous examples suggested that employers regarded such non-competes as likely to be enforced and so were discouraged from hiring those restricted workers. The FTC cited widespread evidence that non-competes are used to compel workers to endure poor working conditions or low pay.
Whatever may be the challenges to the Final Rule, it is beyond doubt that the battlelines are now drawn. The growing global trend to “disfavour” non-competes has been given a significant boon not only by the detailed evidence in the FTC’s report, but also in its decisive action.
