Monday, June 24, 2024

FTC and Other Bans on Noncompete Clauses - and Pending Litigation Regarding Potential Stay of FTC Rule


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 ExceptionThe 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.  There are also non-compete rules from a few states prior to 2020, like Massachusetts in 2018 (and California, as noted above).

 

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 DesistThe 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).