Are Noncompetes No Longer Allowed? An Update for Employers

JULY 24, 2024 UPDATE:

In a 39-page decision issued yesterday afternoon (July 23), the Eastern District of Pennsylvania denied a request from Plaintiff ATS Tree Services (ATS) that asked the Court to block the FTC’s Final Rule from going into effect. This decision means that, at least until further developments, the FTC’s Final Rule will be allowed to go into effect on September 4, 2024. This is the opposite result of the earlier decision from the Northern District of Texas in the Ryan litigation dated the July 3, 2024. In Ryan, the Court did grant a preliminary injunction, blocking the FTC’s Final Rule from going into effect for the plaintiffs in that case.

The new decision from Judge Kelley Hodge focuses on the element of “irreparable harm” necessary to obtain injunctive relief blocking the FTC’s Final Rule from going into effect, and concludes that ATS had not made the necessary showing.

ATS had argued that it would incur harm because of the time and costs associated with notifying its employees about the FTC’s Final Rule, as required under the new regulation. But the Court noted that ATS has just 12 employees subject to noncompetes, and the cost of compliance is minimal.

ATS had also argued that it is harmed by the loss of contractual rights it had validly secured. Its employees had agreed to ATS’s noncompete, and the FTC’s Final Rule would invalidate those contracts, allowing ATS’s employees to join a direct competitor. The Court rejected this argument, as well, finding that potentially losing employees in the future was a speculative harm—not an immediate one that warranted immediate relief from the Court.

Notably, in considering whether ATS’s challenge to the FTC’s Final Rule is likely to succeed on the merits, Judge Hodge’s decision signals that the FTC likely acted within its authority by passing a regulation banning all noncompetes. This conclusion is contrary to the earlier decision from the Court’s July 3 opinion in the Ryan case, which signaled that the FTC likely exceeded its authority by passing the Final Rule.

This decision from the Eastern District of Pennsylvania means that one federal court has blocked the FTC’s Final Rule, and one federal court has declined to block it. However, we can expect further developments. The Ryan Court has already indicated that it plans to issue another decision by the end of August 2024, shortly before the effective date of the Final Rule. In addition, regardless of which side initially prevails at the district court level, the parties may appeal to the federal court of appeals, and ultimately, this issue  is extremely likely to end up before the U.S. Supreme Court. 

Main Article

In recent months, there has been a lot of buzz about the future of noncompetition agreements (noncompetes). We have heard everything from “noncompetes are completely done—employers need to scrap all noncompete agreements right away,” to “employers don’t need to change a thing.”

The reality is that there have been significant developments on noncompetes recently, stemming from a Final Rule passed by the Federal Trade Commission (FTC) on April 23, 2024. The FTC’s Final Rule broadly prohibits noncompetes at the federal level across the U.S., with certain exceptions.

This new Final Rule by the FTC impacts a large number of workers and employers. In fact, at least 2.3 million workers in Wisconsin are subject to noncompetes, according to the FTC. Noncompetes are common nationwide, as well, with 18% of the U.S. workforce estimated to work under a noncompete.[1]

However, litigation challenging the FTC’s Final Rule is already well underway, with new developments coming all the time. Therefore, it is important for employers to stay up-to-date on the latest developments before deciding how to react to the FTC’s Final Rule.

This article will provide you with updated information on: (1) what is in the substance of the FTC’s Final Rule prohibiting certain noncompete clauses, including which types of noncompete clauses are exempt and still permissible; (2) the status of court challenges to the FTC Rule and the likelihood that the Rule will actually go into effect; and (3) recommendations for employers in the interim.

1. What are the basics of the FTC’s Final Rule?

At a broad level, the FTC’s Final Rule prohibits an employer from entering into a “noncompete clause” with any “worker,” unless an exception applies. The FTC’s Final Rule also prohibits an employer from attempting to enforce a “noncompete clause” against a “worker” and from representing that the worker is subject to a noncompete clause.

A. Text of FTC Final Rule.

Specifically, the FTC’s Final Rule provides that it is an unfair method of competition for a person:

(i) To enter into or attempt to enter into a noncompete clause;

(ii) To enforce or attempt to enforce a noncompete clause; or

(iii) To represent that the worker is subject to a noncompete clause.

Each of the bolded terms are very broadly defined, as set forth below.

Noncompete clause means: (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) For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

16 C.F.R. § 910.1. This language would not only block written noncompete agreements, but would also prohibit other “terms or conditions of employment,” including verbal statements, that functionally prevent a worker from leaving one employer and working for another.

Worker means a natural person who works or who previously worked, whether paid or 563 unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. The term worker includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.

16 C.F.R. § 910.1. Again, this language is extremely broad. Notably, it includes former employees or former workers. This means that, even if a business had an employee who left employment a year ago and who was subject to a 2-year noncompete provision, meaning the noncompetition period would normally be valid for another 1 year, that employer cannot seek to enforce the provision.

B. Requirement for Employers to Notify Workers In Writing by Sept. 4, 2024.

One of the main provisions in the FTC’s Final Rule that has caused alarm is a provision that would require employers to notify all workers (including former employees or former workers) in writing that their noncompete agreements are no longer valid and cannot be enforced. 16 C.F.R. § 910.2. The written notification must:

(i) Identify the person who entered into the noncompete clause with the worker;

(ii) Be on paper delivered by hand to the worker, or by mail at the worker’s last known personal street address, or by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address, or by text message at a mobile telephone number belonging to the worker.

As drafted, this requirement could pose substantial risks and headaches for employers. This is especially true given the Court challenges to the FTC’s Final Rule that call into doubt whether the rule will actually go into effect for some or all employers. (See Section II below).

Consider an employer that issues the written notice to its workers, only for a court to later determine that the FTC’s Final Rule is invalid. You can imagine a scenario where, even though the employer issued the formerly-required notice, the employer still wants to enforce its noncompete provision, if possible. The potential risk is that, by issuing the notice contemplated by the FTC’s Final Rule, that employer has opened itself up to an argument that it has waived or significantly limited its ability to enforce the noncompete.

Given the high potential for disruption involved with issuing the written notice, paired with the low risk of penalties and the likelihood that the current ongoing litigation will block the FTC’s Final Rule from going into effect, many employers may determine that they are better served by declining to issue a written notice, at least until litigation challenging the Final Rule comes to a conclusion.

C. Exceptions to FTC Rule Banning Noncompetes.

While the FTC Rule takes a broad approach largely banning noncompete clauses, it does provide certain exceptions:

Business-to-Business Noncompetes are permitted: The Final rule does not apply to noncompete agreements that are part of business-to-business arrangements, such as joint ventures or other collaborative business activities, where participants agree to certain restrictions on business conduct to protect the joint enterprise's interests. However, even these business-to-business noncompetes must comply with existing antitrust laws.

Noncompetes with certain “Senior Executives” are permitted: “Senior executive” means any worker who “was in a policy-making position” and received at least “$151,164 in total annual compensation in the preceding year,” when annualized (if the worker only worked for part of the year). 16 C.F.R. § 910.1. The FTC commentary suggests that less than 1% of U.S. workers are expected to fall under this provision, signaling that this is intended to be a rather narrow exception. [2]

Noncompetes in conjunction with the bona fide Sale of Business are permitted: Noncompetes as part of the sale of a business entity, ownership interest, or substantial operating assets are allowed.

Noncompetes between a franchisor and franchisee are permitted: Noncompetes between franchisors and franchisees are not banned, but those between a franchisor or franchisee and its workers are banned.

Noncompetes in the context of the sale of a business are common and for good reason. For example, a purchaser of a business wants to protect the value of their purchase by blocking the seller from turning around and starting a competing company.

This is a meaningful carveout from the FTC’s Final Rule. Notably, the earlier, proposed version of the rule would have imposed a 25% ownership interest threshold. That is, a seller could only include noncompete clauses as part of the sale of its ownership interest if it was selling 25% or more in terms of ownership in the business. The FTC’s Final Rule, however, eliminated that requirement. As such, non-compete clauses should remain available from any owner who is selling his/her company, his/her ownership interest in a business, or all of his/her company’s operating assets.

D. What about State Laws on Noncompetes and Restrictive Covenants?

The FTC’s Final Rule purports to supersede any inconsistent state statute, regulation, order, or interpretation, except that, if the protection that any such state law affords any worker is greater than the protection provided under the Final Rule, then the state law would continue to apply. 16 C.F.R. § 910.4. For example, California has a state law that prohibits non-compete clauses, but also prohibits customer non-solicitation clauses. That second prohibition would not be superseded by the Final Rule.

2. Have The Court Challenges Blocked The FTC Final Rule From Going Into Effect?

The short answer is yes, at least one federal court thus far has issued a preliminary injunction blocking the rule from going into effect, but only for the named plaintiffs in that case.  However, no nationwide injunction has been issued at this time.

Thus far, there have been at least three court challenges to the FTC Final Rule in federal court. The timeline of pertinent events with respect to the FTC’s Final Rule and the relevant court actions are as follows, thus far:

• January 8, 2023: The Commission published the initial version of the Noncompete Clause Rule.
• Jan. 8 – April 19, 2023: The FTC received over 26,000 public comments during the comment period, and made several revisions to the proposed rule.
• April 23, 2024: The FTC voted 3-2 in favor of passing the Final Rule. See FTC, Non-compete Clause Rule, RIN3084-AB74 (Apr. 23, 2024). The full text of the FTC’s Final Rule is available online.
• April 23, 2024: A food distribution company (Ryan LLC) filed a lawsuit in the Northern District of Texas challenging the FTC’s Final Rule and seeking an immediate stay and injunction preventing the Final Rule from going into effect. See Ryan LLC v. Fed. Trade Comm'n, No. 3:24-CV-00986-E, 2024 WL 3297524 (N. Dist. Tex.) (filed April 23, 2024). Several additional parties intervened as intervenor-plaintiffs in this action, including the U.S. Chamber of Commerce and the Texas Association of Business.
• April 24, 2024: The U.S. Chamber of Commerce filed a substantially similar lawsuit as the Ryan case, this time in the Eastern District of Texas. See Chamber of Commerce v. Fed. Trade Comm’n, No. 6:24-cv-00148-JCB (E.D. Tex.) (filed April 24, 2024). In a decision dated May 3, 2024, since the U.S. Chamber of Commerce had intervened in the Ryan case, the Eastern District of Texas dismissed this lawsuit under the “first-to-file doctrine,” and finding that the plaintiffs in this case could join the Ryan litigation.
• April 25, 2024: A tree care and tree cutting company in Pennsylvania called ATS Tree Services filed a similar lawsuit against the FTC, also challenging the Final Rule and seeking an injunction blocking it from going into effect. See ATS Tree Services, LLC v. Fed. Trade Comm’n, No 2:24-cv-01743-KBH (E. Dist. Penn.) (filed April 25, 2024).
• July 3, 2024: The Court in the Ryan case issued a decision granting the plaintiffs’ request for a preliminary injunction, blocking the FTC’s Final Rule from going into effect for the plaintiffs in that case. See Ryan LLC v. Fed. Trade Comm'n, No. 3:24-CV-00986-E, 2024 WL 3297524, at *2 (N.D. Tex. July 3, 2024). Since the Court’s decision is in the context of deciding a preliminary injunction, meaning it’s not a full adjudication on the merits, the decision strongly signals that the FTC’s Final Rule is unlikely to go into effect. Specifically, the Court determined, at least at this initial stage, that the FTC likely exceeded its authority under its enabling statute enacted by Congress by passing this substantive Final Rule, and that the FTC’s Final Rule is likely arbitrary and capricious under the APA, including because it appears to be more restrictive than any operative state law on the books.
• July 23, 2024: The Eastern District of Pennsylvania has indicated that it will issue a decision on ATS Tree Services’ request for a preliminary injunction by this date.
• August 30, 2024: The Ryan Court has confirmed it intends to issue a full merits decision on whether it will grant an injunction on a go-forward basis.
• September 4, 2024: this is the date that the FTC’s Final Rule is scheduled to go into effect, and the date by which employers must issue written notices, unless the FTC’s Final Rule is blocked.

3. CONSIDERATIONS FOR EMPLOYERS IN DETERMINING HOW TO PROCEED.

Given the uncertainty of the Court challenges to the FTC’s Final Rule, employers should keep the following in mind:

A. More developments will come between now and September 4, 2024. Both Courts involved in active litigation over the FTC’s Final Rule have confirmed that they plan to issue decisions before September 4. The Courts could issue an order that applies nationwide, or only block the FTC’s Final Rule from going into effect for the named parties, or decline to issue a permanent injunction, allowing the Final Rule to technically go into effect.

Based on the case trajectories thus far, including the Ryan Court’s July 3 decision, and other recent Supreme Coury precedent (Loper Bright Enterprises v. Raimondo), it appears likely that one or both Courts will issue some relief preventing the FTC’s Final Rule from going into effect. Specifically, a decision dated June 28, 2024, from the U.S. Supreme Court overturned prior precedent and reduced the power of federal agencies, including the FTC. See Loper Bright Enter’s v. Raimondo, No. 22-451, 603 U.S. ___ (June 28, 2024).

In short, this decision means that, in litigation challenging the FTC’s Final Rule, reviewing Courts are not required to defer to the FTC’s interpretation of the law, including whether the FTC acted within its authority. The parties in the Ryan and ATS Tree cases have already cited the Loper Bright decision heavily in arguing that the FTC’s Final Rule should not go into effect.

It is worth nothing that, even if a federal district court issues a decision on the merits, the litigating parties may appeal to the federal appeals court, and possible to the U.S. Supreme Court. This process will take a significant amount of time. And an injunction could stay in place while the appellate review process moves forward.

Thus, while employers should be on the lookout for developments in the coming weeks, we may not have a final resolution from the Courts for weeks or months or even years. This is a consideration that weighs against taking immediate action regarding issuing a letter to employees and former employees at this time.

B. The risk of enforcement actions from the FTC is low. The bottom line is that, even if Courts decline to enter permanent injunctions and the FTC’s Final Rule does go into effect (on a temporary or permanent basis), non-compliant employers do not have significant exposure. The FTC’s Final Rule does not contemplate monetary penalties, and the FTC’s enforcement mechanisms are limited.

Congress has never established a private right of action under section 5 of the FTC Act, and Congress has not authorized the FTC to recover civil penalties or other monetary relief from parties who engage in unfair methods of competition. See, e.g., Holloway v. Bristol-Myers Corp., 485 F.2d 986, 988-89 (D.C. Cir. 1973); Liu v. Amerco, 677 F.3d 489, 492 (1st Cir. 2012).

Instead, the FTC may either pursue an adjudication under section 5(b) or seek an injunction in Federal court under section 13(b) against a party that has engaged in an unfair method of competition. Neither option is a major risk for employers.

First, Section 5(b) of the FTC Act authorizes the FTC to issue cease-and-desist orders in response to the use of any “unfair method of competition,” but only after completion of internal adjudicative proceedings. A cease-and-desist order would simply require compliance with the FTC’s Final Rule. If the order becomes “final” and the employer violates it, only then could civil penalties be on the table, and only for violations on a going-forward basis—not for conduct that came before the order became final.

Second, an injunction under Section 13(b) of the FTC Act, if successful, would likely be limited to an order that would require an employer to comply with the FTC Act by issuing the notices and refraining from enforcing non-compete clauses.

C. The potential downsides of issuing the purportedly required written notice are high.

As outlined above, given the uncertainty of Court decisions at the present moment, affirmatively issuing the notices contemplated under the FTC’s Final Rule right now is risky. This could cause confusion to employees and former employees, who may be contacted now before September 4^th that their non-competes are not in effect, but later may need to be contacted again about their non-competes actually being effective if a Court issues a nationwide injunction that then withstands appeals. 

D. Some employers may want to do the legwork of compiling names and drafting the written notice, just to have it ready.

While the risks of noncompliance are low, some employers may want to get ahead of the game by taking two preliminary steps at this time: 1) compiling names of all current and former employees who would need to receive the letter (make sure to exclude the Senior Executives as noted above); and 2) preparing written notices now. That may be a worthwhile step, especially if Courts later either do not issue a nationwide injunction or reverse a decision issuing a nationwide injunction.

E. There are many alternatives to noncompete clauses that are available and not in dispute.

The FTC’s Final Rules does not preclude employers from using other contractual protections including the following:

(a) Non-solicitation clauses, such as clauses preventing former employees from contacting customers with whom they worked closely during their former employment, or clauses blocking former employees from poaching other employees from their former employer;

(b) nondisclosure agreements and confidentiality provisions, prohibiting employees and former employees from sharing sensitive information;

(c) compliance with state and federal trade secret statutes, and taking steps to affirmatively designate certain materials as “trade secrets,” where appropriate; and

(d) garden leave provisions and notice periods before an employee can separate.

Employers may also incentivize employees not to leave for a competitor through compensation, vesting schedules, bonuses with time-based contingencies and other retention tools, though the rule does not permit forfeiture-for-competition clauses. 

Finally, if your business uses non-compete agreements, make sure to continue to follow reports concerning the status of the FTC’s Final Rule and the court decisions referenced in this posting.  

If you would like more information or have any questions, please reach out to Kai Hovden at ckh@dewittllp.com or Stephen DiTullio at sad@dewittllp.com.