Legal Challenges to the FTC’s “Final Rule” Banning Non-Compete Clauses

June 5, 2024

The Federal Trade Commission (“FTC”) announced the Non-Compete Clause Rule (the “Final Rule”) on April 23, 2024, with an expected effective date of September 4, 2024. The Final Rule deems non-compete clauses in employment contracts an unfair method of competition and a violation of Section 5 of the Federal Trade Commission Act. See 16 CFR § 910.1.

What Type of Non-Compete Clauses are Banned?

The Final Rule bans employers from entering agreements with workers prohibiting them from starting a competing business or restricting employment with competitors after the conclusion of the worker’s employment. It applies to all workers, including employees, independent contractors, interns, externs, volunteers, apprentices, and others.

The Final Rule will render existing non-compete agreements unenforceable. Employers will be required to provide written notice to covered workers that the non-compete cannot be enforced.

The Final Rule lists several exceptions to the non-compete ban. The rule does not cover pre-existing non-compete agreements with senior executives, defined as workers with authority to make policy decisions that control significant aspects of the business entity earning at least $151,164 annually. This includes presidents, chief executive officers or any officers with similar authority. 

The rule also excludes non-compete agreements related to the sale of businesses, and it does not apply to existing causes of action which accrued prior to the effective date.

The Final Rule will supersede state laws governing non-compete agreements to the extent that state laws conflict with the Final Rule. States may enforce laws that offer more protection to workers than the Final Rule. In December 2023, Governor Hochul vetoed a proposal that would ban non-compete agreements but indicated support for a bill that would allow non-compete agreements for workers earning over $250,000. 

Legal Challenges: Delegation of Legislative Authority and The Major Question Doctrine

The Final Rule already faces legal challenges, with many arguing that the ban on non-compete agreements is an overreach of the FTC’s authority. Lawsuits have already been filed contesting the Final Rule by the U.S. Chamber of Commerce in Texas, Ryan LLC also in Texas, and ATS Tree Services LLC in Pennsylvania.

Challengers of the Final Rule argue that the FTC lacks authority to issue the ban against non-compete agreements. The FTC contends that it derives authority from Section 5 of the FTC Act, which makes unfair methods of competition unlawful, and Section 6, which allows the FTC “to make rules and regulations for the purpose of carrying out the provisions.” 

Although the FTC interprets the rule-making power as authorization to issue the Final Rule, in recent years, the Supreme Court has refused to allow agencies to interpret statutes to grant rule-making authority where it has not been explicitly given by Congress. It is reasonable to believe that the Supreme Court will be consistent in deciding whether the Final Act will stand. In its 2022 decision in West Virginia v. EPA, the Supreme Court stated, “Agencies have only those powers given to them by Congress, and ‘enabling legislation’ is generally not an ‘open book to which the agency [may] add pages and change the plot line’.” Congress has not explicitly delegated authority to the FTC to make rules regarding non-compete agreements. Challengers to the Final Rule argue that even if Congress has delegated such power, it constitutes an unconstitutional delegation of authority.   

Opponents of the Final rule also argue that the rule will not withstand scrutiny under the major question doctrine. Under the major question doctrine, the Supreme Court considers whether an agency’s proposed rule or interpretation of a statute has significant political or economic implications. The Court also considers whether there is clear authority from Congress for the agency to act. By the FTC’s own estimate, the Final Rule could increase wages by $400-$488 billion over the next decade, increase the rate of business formation by 2.7% (an additional 8,500 businesses per year) and increase the number of patents each year by an average of 17,000-29,000. The Final Rule will undoubtedly have vast economic effects.

Additional Challenges Expected Based on Expansive Inclusion of Various Restrictive Covenants Under the Final Rule

The FTC’s expansion of what constitutes an “unfair method of competition” may present an additional hurdle for the FTC in upholding the Final Rule due to the breadth of its interpretation. 

Section 5 of the FTC Act does not define unfair methods of competition. To support the Final Rule, the FTC interprets Section 5 broadly to include employer non-compete agreements as an unfair method of competition. 

The Final Rule uses a functional test to determine whether a contractual term constitutes a non-compete. Overly broad non-solicitation and non-disclosure agreements may be prohibited under the Final Rule if their effect is that of a non-compete provision. This could include certain agreements not to solicit employees or customers, or not to disclose the employer’s information to third parties.

Given the ongoing lawsuits challenging the Final Rule, the validity of the rule is to be determined, leaving employers uncertain in moving forward with employment agreements. Under existing New York State law, non-compete clauses are subject to close scrutiny and are often nullified by the Courts. Whether or not the Final Rule is upheld, the best course of action for employers is to review their existing non-compete clauses and restrictive covenants, and confer with employment counsel to best protect their businesses from unfair competition by former employees.  

Lauren Maddox is an attorney licensed in the State of Florida and her New York license is pending. If you have additional questions, please contact an attorney at Adams Leclair LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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