Non-Competes Now Unenforceable? Breaking Down the New FTC Rule

In a significant move to address the controversial practice of non-compete clauses in employment contracts, the Federal Trade Commission (FTC) has issued its final rule on the use of these restrictive covenants. The rule, titled “The Use of Non-Compete Clauses in Employment Contracts,” aims to protect workers and promote competition by setting new guidelines for the use of non-compete clauses in the workplace.

A non-compete clause is defined, for the purposes of the rule, as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or 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 that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

Prior to the implementation of this rule, Michigan and most other states did not prohibit employees from entering into non-compete agreements. However, certain non-compete agreements, namely those affecting employees (but not independent contractors), when challenged, were reviewed by courts to determine if the clauses were narrowly drawn to prohibit only those activities necessary to protect the employers “reasonable competitive business interests” and were reasonable as to their duration, geographical area, and type of employment or line of business prohibited. As can be imagined, this standard led to a great deal of uncertainty as to whether a given non-compete clause would be enforced as written, would be rendered unenforceable, or if it would be essentially re-written by the courts to narrow its scope or duration.

In a drastic departure from existing law, the new FTC rule contains a sweeping prohibition on the use of non-compete clauses in most employment agreements as a form of unfair competition. The rule is slated to take effect 120 days from the date the rule is published in the Federal Register (likely to occur in the next few days) and contains slightly different treatment for existing non-competes (i.e. those contained in agreements effective before the August 22, 2024 effective date of the rule). Most of these existing non-competes are unenforceable as of the effective date; however, there is an exception of those affecting “senior executives.” The rule defines “senior executives” as someone who earned at least $151,164 in the year preceding the rule publication and who was in a policy-making position. According to the rule’s definitions, a “policy-making position” includes a business entity’s president, chief executive officer or equivalent, or any other officer in the business with policy making authority. For this small group of employees, existing non-complete clauses can remain in force. The FTC justified this carve-out for existing non-complete agreements with senior executives on the basis that this subset of workers are “less likely to be subject to the kind of acute, ongoing harms currently being suffered by other workers subject to existing non-competes.”

In addition, the FTC places an obligation on employers to provide workers subject to existing non-competes with notice that they are no longer enforceable. Further, the rule takes a very broad view of who constitutes a “worker” in the context of the non-compete ban. It includes any person who performs work in any capacity for another, whether paid or unpaid, an includes categories persons previously excluded from Michigan’s non-compete “reasonableness” limitation on non-compete clauses, including independent contractors and sole proprietors “who provide a service to a person.” However, the rule excludes from the ban non-compete clauses or agreements in the context of a franchisee-franchisor relationship or those entered into by persons pursuant to a bona fide sale of a business entity.

This new rule will likely be the subject of legal challenge at some point in the future, simply by virtue of the drastic and sweeping change it represents to the current legal landscape. However, at this point, the rule is set to take effect on August 22, 2024 and employers with existing non-compete clauses must evaluate their potential obligations to provide notice to employees that they are no longer effective. Further, employers who depend on non-compete clauses to protect proprietary intellectual property and trade secrets should consider having their employment agreements reviewed to determine what, if any, protective provisions survive the ban and what alternatives to non-compete clauses are available to continue to provide necessary protection of this vital information.

If you wish to learn more about the new FTC rule and how it could affect your business practices or employment agreements, please contact Jennifer L. Gross at [email protected] or any of the business and employment attorneys at Cooper & Riesterer, PLC.

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