CHARLES C. SHULMAN, ESQ.
212-380-3834 / 201-357-0577
cshulman@ebeclaw.com
cshulman@yahoo.com
www.ebeclaw.com (blog)
FTC and Other Bans on Noncompete Clauses -
and Pending Litigation Regarding Potential Stay of FTC Rule
Introduction - On May 7, 2024, the FTC published a final rule banning all noncompete clauses as an unfair method of competition, effective September 4, 2024. This rule will prohibit employers from entering into noncompete agreements and other clauses with all employees or service providers. The rule will also prohibit enforcement of existing noncompete clauses against all workers, with the exception of grandfathered agreements in effect on Sept. 4, 2024, which can continue to be enforced for senior executives. Since 2021, 14 states have banned some or all types of noncompete provisions. Two cases are pending in Federal district court challenging the FTC noncompete ban and seeking a stay on enforcement. Decisions are expected shortly.
Points to Consider re FTC Final Rule – Could noncompetes be replaced with nonsolicitation and nondisclosure provisions? Will district court in Pennsylvania stay the rule? When does the grandfather for senior management apply? Notice required before effective date (after litigation?). Garden leave is not banned. FTC enforcement is limited. Modification treatment for grandfathered senior management arrangements is unclear.
See full memo at https://ebeclaw.blogspot.com/2024/06/ftc-and-other-bans-on-noncompete.html
I. FTC
Noncompete Clause Ban
A. Final
FTC Rules Banning Practically All Noncompete Provisions – Effective Sept. 4,
2024 – On May 7, 2024, the Federal Trade Commission (FTC) published
a new rule in final form, banning all noncompete clauses as an unfair method of
competition, and therefore violating Section 5 of the FTC Act. [1]
The
effective date of the new noncompete ban is 120 days after publication, i.e.,
September 4, 2024, pending any judicial efforts to stay the rule.
This
rule: (i) will prohibit employers from entering into noncompete agreements and
other clauses with all employees or service providers ("workers");
and (ii) will prohibit enforcement of existing noncompete clauses against all workers
(with the exception of grandfathered agreements in effect on Sept. 4, 2024,
which can continue to be enforced for senior executives).
These
FTC rules were designed to protect the fundamental freedom of workers to change
jobs, increase innovation, and foster new business formation.
B. Key
Points in Final FTC Rule – The following are the key provisions in the FTC
ban:
1.
Ban on Noncompete Clauses – Under the FTC rule, it is an unfair method
of competition for a person (including an employee or independent contractor):
(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. [2]
2.
Senior Executives Exception for Grandfathered Contracts – For senior executives, there is an
exception if the noncompete was entered into prior to the effective date of the
FTC regulations (Sept. 4, 2024). "Senior executives" mean workers who
(i) are in a policy-making position, and (ii) received annual compensation of
at least $151,164 in the preceding year (or annualized if was employed for only
part of the year; and "policy-making position" means the president,
chief executive officer or equivalent, any other officer of a business entity
who has policy-making authority, or any other natural person who has
policy-making authority for the business entity similar to an officer with
policy-making authority. [3] Thus, with respect to senior executives, any
noncompete clauses entered into prior to Sept. 4, 2024 can continue to be
enforced. [4] After the effective date, no new noncompete
provisions can be entered into.
3.
Notice Requirement – The new FTC
rule provides that employers must provide notice to workers (other than senior
executives) who are bound by an existing noncompete that they will not be
enforcing any noncompete provisions against them. [5]
The notice may 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 cell
phone text message. [6]
4.
Model language –
The FTC rules provides a model notice that employers can use for workers, which
states how prior noncompetes may not be binding. [7]
5.
Sale Exception – The Final Rule does not prohibit enforcement of noncompete
clauses that are entered into with respect to the bona fide sale of a business,
including a bona fide sale of (i) a business entity, (ii) an individual’s
interest in a business entity or (iii) all or substantially all of a business
entity’s operating assets. [8]
6.
Only for Post-Employment Bans – The FTC ban specifically applies to
post-employment noncompetes, so it does not affect restrictions on moonlighting
in the same field.
7.
Non-Solicitation Clauses – Non-solicitation clauses that do not prohibit or function to
prevent a worker from switching jobs or starting a new business are generally not restricted by the FTC
rule, as noted in the preamble to the 2024 final rule.
8.
Objective –
The FTC's final rule aims to enhance worker mobility, encourage
entrepreneurship, and spur innovation by banning noncompete provisions and
promoting a more dynamic economy.
C. Court
Challenges and Possible Stay
1. Challenges
in Federal District Court in Texas – Within 24 hours of when the FTC
announced the final rule banning noncompete clauses, two lawsuits were filed in
Texas to challenge the rule, (i) Ryan, LLC v. FTC [9]
on Apr. 23, 2024 in the Northern District in Texas, and (ii) U.S. Chamber of
Commerce v. FTC [10]
the following day in the Eastern District in Texas. However, the U.S. District
Court for the Eastern District of Texas dismissed the U.S. Chamber of Commerce
case because, under the first to file rule, the Ryan LLC case was filed first.[11]
Instead, the U.S. Chamber of Commerce intervened in the Ryan, LLC case. The Texas Northern District judge, with
regard to the Ryan, LLC v. FTC case, indicated that it may issue an injunction
to delay the effective day of the FTC noncompete ban. Ryan LLC filed a motion for preliminary
Injunction seeking a stay of the final rule on May 1, On June 13, 2024, the
judge decided that oral argument is not required for this case. A decision is
expected on or before July 3, 2024.
2. Challenge
in Federal District Court in Pennsylvania – In ATS Tree Services, LLC v.
FTC, a similar suit was filed on Apr. 25, 2024 in the Eastern District in
Pennsylvania. [12]
ATS Tree Services filed a motion for
preliminary Injunction on May 14 seeking a stay of the effective date. If a
hearing is necessary it will be held on July 10, 2024. A decision is expected
on July 23, 2024.
The Fifth Circuit in Texas (where the Ryan case was filed) is more employer friendly than the Third Circuit in Pennsylvania (were the ATS Tree Services case was filed), and a conflict of circuits may allow a subsequent appeal to the U.S. Supreme Court.
3. Arguments
for Challenges – Arguments made by the lawsuits include that: (i) the rules
implicates the major questions doctrine, which would necessitate additional
legal authority from Congress; (ii) the FTC rule is arbitrary and capricious
under the Administrative Procedure Act because the evidence the FTC relies on
cannot justify a nationwide ban of noncompetes in all situations; (iii) the FTC
rule incorrectly expands what is a prohibited an unfair method of competition;
and (iv) the rule unlawfully infringes on state contract laws.
4. Stay is
Very Possible – As noted above, at least one of these cases is likely to
trigger a stay on the FTC ban's effective date, as noted above.
II. States
that Have Banned Noncompete Provisions (all Since 2021)
A. Four
States Ban All Noncompete Agreements – In the past three years, California,
Minnesota, North Dakota and Oklahoma have passed broad legislation banning post-employment
noncompete agreements, regardless of salary. (California has had long-standing
legislation banning most noncompete agreements, but this was expanded by 2023
legislation even to out-of-state contracts.)
B. Ten
States and D.C. Ban Noncompete Agreements for Non-Highly Paid Employees – Colorado,
Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia,
Washington and the District of Columbia have all passed laws in the past three
years prohibiting post-employment noncompete agreements unless the employee
earned above a certain threshold. T
C. New York
– In New York a bill that would ban almost all noncompete agreements was passed
but was vetoed by Governor Hochul because it was too broad.
III. Existing State Law
Regarding Noncompete Agreements.
A. Existing States' Case-law Would be
Applicable if Statutory Ban is Stayed – If the FTC
ban on noncompete clauses is stayed or struck down in court, or reversed or
limited in future legislation or FTC guidance, preexisting state law and state
cases would become operative. In states that have not enacted recent bans on
noncompete provisions (or where such state bans have been struck down), the
existing case law in those states will again be operative.
B. Enforceability of noncompete agreements
– State laws vary regarding enforceability of noncompete provisions. Generally,
noncompete provisions will be enforced in most states if the restrictions are
reasonable in geographical scope and
reasonable in time period, and they are necessary to protect legitimate
business interests.
For example, in New York, which is fairly liberal in allowing
noncompete restrictions, the noncompete restrictions will be enforceable if:
(i) the time period of restriction is reasonable, (ii) the geographical scope
is reasonable, (iii) the burden on the employee is not unreasonable, (iv)
public policy is not harmed, and (v) the restrictions are necessary for the
employer's protection.[13] In New
Jersey noncompete restrictions will be enforced only if reasonable under the
circumstances.[14]
Texas and Florida statutes restrict noncompete requirements unless they are
reasonable restrictions necessary to protect legitimate business interests.[15]
California by statute, even prior to the 2023 ban, would generally
void noncompete provisions, providing that "except as provided in this
Chapter, every contract by which anyone is restrained from engaging in a lawful
profession, trade or business of any kind is to that extent void." [16]
The Ninth Circuit allowed "narrow restraint" enforcement of
noncompete provisions that are very limited, but the California Supreme Court
rejected this exception.[17]
The 2023 California legislative ban would, presumably, supersede these
prior rules.
D. Blue-penciling Noncompete Agreements
– Where noncompete provisions are overbroad and therefore unenforceable on
their terms, many states will "blue pencil" the restrictive covenants
to a limited scope for which they would be enforceable. For example, in
New York restrictive covenants will be blue penciled.[18]
Often, employment agreements will add language to specifically provide for
blue penciling.
IV. Points
to Consider re FTC Final Rule
A. Review Noncompetes – Employers should review noncompete provisions that would violate a statutory ban and see if nonsolicitation and nondisclosure covenants can provide the needed protection.
B. Court
Challenges and Possible Stay – As noted
above, at least one of the cases challenging the FTC noncompete ban is likely to
trigger a stay on the FTC ban's effective date, as noted above.
C. Sept. 4, 2024 Grandfather for Senior Executives and Modifications – As noted
above, for executives earning over $151,164 annually and in a policy-making
position, there is a grandfather exception from the FTC ban if the agreement
was entered into prior to Sept. 4, 2024. It may be beneficial for that reason
to separate the noncompete from other terms of the employment agreement so that
the noncompete can remain unaltered in its grandfathered form. It is not clear to what extent modifications to, or
extensions of the terms of a pre-negotiated non-compete in connection with a
separation) would result in loss of grandfathered status for senior executives.
C. Notice –
Unless the FTC rule is stayed before its effective date, make sure to send out
the notice to those with non-grandfathered noncompete agreements, as discussed
above.
D. Garden-Leave
– These are generally not covered by the FTC rule, because the employee is
still employed for that period.
E. Cease
and Desist – The FTC cannot assess civil penalties for using unfair methods of
competition, but if an entity is ordered to cease and desist from FTC
violations, monetary penalties can sometimes be obtained in court.
F. Modifications – It is unclear whether
the negotiated non-compete in connection with a separation (even narrowing an
existing scenario) would result in loss of grandfathered status for senior
executives;
[1] Federal Trade Commission (FTC) New Final Noncompete Clause Rule in
26 CFR § 910, announced by the FTC on April 23, 2024, and published in 89 Fed.
Reg. 38342 (May 7, 2024). The effective date is Sept. 4, 2024.
[2] 16 CFR § 910.2(a)(1).
[3] 16 CFR §
910.1
[4] 16 CFR § 910.2(a)(2).
[5] 16 CFR § 910.2(b)(1).
[6] 16 CFR § 910.2(b)(2)(b).
[7] 16 CFR § 910.2(b)(4) (figure 1).
[8] See 16 CFR § 910.3.
[9] Ryan LLC v. Federal Trade Commission, No. 3:24-cv-00986, (N.D.
Tex. Apr. 23, 2024).
[10] Chamber
of Commerce of the U.S. v. Federal Trade Commission,
No. 6:24-cv-00148 (E.D. Tex., Apr. 24, 2024).
[11] ATS
Tree Services, LLC v. Federal Trade Commission, No. 2:2024cv01743 (E.D. Pa.
Apr. 25, 2024).
[12] Chamber of Commerce of the U.S. v. Federal Trade Commission, -- F.Supp.3d --, 2024 WL 1954139 (E.D. Tex., May 3, 2024).
[13] See,
e.g., Service Systems Corp. v. Harris, 341 N.Y.S.2d 702 (4th Dep't 1973);
Mallory Factor Inc. v. Schwartz, 146 A.D.2d 465, 536 N.Y.S.2d 752 (1st Dep't
1989); International Paper Co. v. Suwyn, 951 F. Supp. 445 (S.D. N.Y. 1997).
[14] E.g.,
Community Hosp. Group, Inc. v. More, 183 N.J. 36, 869 A.2d 884 (2005).
[15] Texas
Business & Commerce Code §15.50; Florida Statutes Annotated §542.335.
[16] California
Business & Professional Code §16600.
[17] The
Ninth Circuit provided a narrow restraint exception in Campbell v. Trustees of
Leland Stanford Jr. University, 817 F.2d 499 (9th Cir. 1987) and General
Commercial Packaging v. TPS Package Engineering, Inc., 126 F. 3d 1131 (9th Cir.
1997). The California Supreme court rejected this narrow restraint exception in
Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 81 282 (Cal. S. Ct. 2008).
[18]
See,
e.g., Deborah Hope Doelker, Inc. v. Kestly, 87 A.D.2d 763, 449 N.Y.S.2d 52 (1st
Dep't 1982); Muller v. N.Y. Heart Ctr. Cardiovascular Specialists P.C., 238
A.D.2d 776, 656 N.Y.S.2d 464, 465 (3d Dep't 1997); BDO Seidman v. Hirshberg, 93
N.Y.2d 382, 690 N.Y.S.2d 854, 712 N.E.2d 1220 (1999).
