Two days ago, the Federal Trade Commission (FTC) issued its “Final Rule” banning non-compete clauses in employment. Until now, the FTC never officially declared that such clauses constituted an “unfair method of competition.” The Final Rule seeks to upend centuries of state law governing the use of non-compete clauses in employment, including state laws that already limit or ban their use. The federal government’s encroachment into traditional state law is not necessarily unprecedented, but in this case, will likely fail.

Generally, the laws of most states will allow enforcement of a non-compete clause provided that it both protects a legitimate interest (e.g., confidential information and customer goodwill) and does not impose a greater burden than necessary to protect that interest. Other factors that determine the enforceability of a non-compete clause consider the impact on the employee and the public.

By a strict party line vote of 3-2, the FTC’s unelected commissioners have decided that businesses should not be entitled to the protection of non-compete agreements, regardless of whether they have a legitimate interest worthy of protection.

What is the FTC Anyway?

The FTC was created by the Federal Trade Commission Act (FTCA) , which Congress passed in 1914, in an effort to tighten and enhance the antitrust prohibitions of the Sherman Antitrust Act of 1890. The Sherman Act was intended to preserve “free and unfettered competition as the rule of trade.” Together with the federal Clayton Act, the Sherman Act prohibited unlawful mergers and business practices that harm consumers. The FTCA purported to ban “unfair methods of competition” and “unfair or deceptive acts or practices.” The FTC is a federal executive agency, comprising five commissioners, who each serve seven-year terms. Commissioners are nominated by the President and confirmed by the Senate. Only three FTC members can be of the same political party, and, in fact, the Final Rule was passed by a 3-2 vote, along party lines. The President selects the Chair out of the five-member commission.

The FTC seeks to expand its authority by concluding that unfair methods of competition include non-compete clauses, which it has the power to ban, despite the lack of congressional authority indicating that the FTC can create substantive (as opposed to procedural) rules that are tantamount to laws that a legislature would pass. Of course, legislators are elected to office by the people, while FTC commissioners are appointed by the President.

The Final Rule’s Prohibitions

The Final Rule contains separate provisions defining unfair methods of competition for two categories of workers. For non-senior executive employees (most workers), an unfair method of competition includes requiring the employee (i) to enter into, or attempt to enter into, a non-compete clause; (ii) to enforce a non-compete clause; or (iii) to represent that the employee is subject to a non-compete clause. An unfair method of competition with respect to a senior executive includes requiring the executive (i) to enter into, or attempt to enter into, a non-compete clause; (ii) to enforce, or attempt to enforce, a non-compete clause entered into after the effective date; or (iii) to represent that the senior executive is subject to a non-compete clause, where the non-compete clause was entered into after the effective date. Thus, the Final Rule will not apply retroactively to a “senior executive,” which the Final Rule defines as an employee earning over $151,164 per year, and who has “final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.” This definition ensures that only c-suite employees, and not all of them, would be considered senior executives under the Final Rule.

The Final Rule bans all non-compete clauses in employment agreements, and severance agreements. In other words, the Final Rule bans some, but not all, garden leave arrangements, in which an employee is free to enter into a reasonable non-compete agreement in exchange for severance pay covering some portion of the non-compete period. With one fell swoop, the Final Rule eliminates this “employee choice doctrine,” which could result in fewer employers agreeing to pay severance to terminated employees. In addition, the Final Rule will ban any other agreement that would function as a “de facto” non-compete clause, including non-solicitation or non-disclosure agreements.

What is the Effective Date of the Final Rule?

The Final Rule takes effect 120 days after its publication in the Federal Register, which has not yet happened. Once effective, the Final Rule will invalidate all existing non-compete clauses, except for those applying to senior executives, and prohibit new non-compete clauses for all employees, including senior executives.

In addition to invalidating pre-existing non-compete clauses, the Final Rule requires employers to send a notice to each current and former employee (except senior executives) informing them that their non-compete agreements are legally unenforceable.

What Will Happen Next?

As we predicted, lawsuits have already been filed to challenge the FTC’s Final Rule. The U.S. Chamber of Commerce and other business groups have sued the FTC, claiming that the FTC has exceeded its authority in wading into employment-related non-compete clauses. The Chamber’s lawsuit was filed in a Texas federal court and challenges the FTC’s authority to regulate this area of law and to issue substantive rules banning non-compete agreements.

Our prediction is that courts will stay (or strike) the Final Rule prior to its effective date on the grounds that Congress did not clearly authorize the FTC to regulate non-compete clauses between employers and employees. Courts will likely find that the Final Rule violates the “major questions doctrine,” which provides that an executive agency does not have the authority to resolve significant issues and rights unless Congress expressly empowers the agency to do so. For instance, in 2022, the Supreme Court applied the major questions doctrine in ruling that the Occupational Safety and Health Administration (OSHA) exceeded its authority with the issuance of its Emergency Temporary Standard (ETS) that mandated comprehensive vaccine mandates (“vaccine or test”) and stayed the enforcement of the rule. That ETS never went into effect.

What Should Employers Do?

The Final Rule will not take effect for more than four months, assuming it ever does. As a result, the best course of action now is to maintain the status quo. There is no need to eliminate reasonable non-compete clauses or assume that they are not valid simply based on the Final Rule. Employees should not assume that their non-compete obligations are no more. Nevertheless, many states, including New York and Connecticut, are considering bills that would limit the use of non-compete clauses. Regardless of whether the FTC’s Final Rule becomes effective, courts may be less likely to enforce borderline non-compete clauses unless the employer can identify a recognized protectable interest, and the restriction is not broader than necessary to protect that interest. Recognized protectible interests include the protection of trade secrets and truly confidential information, customer relationships and an employer’s investment in an employee’s reputation in the market.

We will continue to monitor the lawsuits challenging the Final Rule, as well as any further developments affecting this proposed ban.

In the meantime, please contact Salvatore Gangemi at sgangemi@murthalaw.com or at 203.653.5436 if you have any questions.