By: Michael P. Sawicki, Esq.
There has been a nationwide movement regarding the enforceability of employment-related noncompete agreements and certain restrictive covenants. On May 23, 2024, the Federal Trade Commission (FTC) issued a final ruling that employers could no longer stop their employees from going to work for rival companies, effectively banning noncompete agreements in the future, as well as those currently in place. The final rule defines “noncompete clause” as a term or condition of employment that either “prohibits” a worker from, “penalizes” a worker for, or “functions to prevent” a worker from, “(i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.” Thus, the definition in the Final Rule is clarified to go beyond express noncompetes to cover a broader range of provisions.
There are limited exceptions to the new rule for senior executives which are defined as employees “in policy-making positions” who make at least $151,164 annually. Existing noncompetes for senior executives can remain in force; however, employers are prohibited from entering into or enforcing new noncompetes with senior executives. Employers will be required to notify nonexecutive employees bound by an existing noncompete that it will no longer be enforceable. The FTC’s commentary on the final rule clarifies that “forfeiture-for-competition” clauses, where the agreement imposes adverse financial consequences on a former worker as a result of competition with the employer following termination of the employment relationship, is unlawful.
The FTC feels that this action will help create jobs, raise wages and increase competition among businesses. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business or bring a new idea to market,” the commission’s chair, Lina M. Khan stated. She estimated the decision would lead to the creation of 8,500 start-ups in a year and up to $488 billion in increased wages for workers over the next decade. The new ruling also has the support of President Biden.
In the final rule, the Commission has determined that a noncompete is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for employers to even enter into noncompetes with workers and to enforce certain noncompetes. According to the Commission, employers have alternatives to noncompetes that still enable companies to protect their proprietary information, such as trade secret laws and non-disclosure agreements. The prohibition against noncompete clauses does not apply to a noncompete clause that is entered into pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.
The final rule will become law 120 days after it is published in the Federal Register, but legal challenges have already been filed which could delay or block the change.
More to follow regarding this final ruling and its impact on employers and employees as this important change in the law develops. In the meantime, employers can take certain actions to mitigate the impact of the final rule, including:
Auditing existing noncompetes to determine which workers are “senior executives” or otherwise exempt from the final rule’s prohibition on noncompete clauses.
Determining whether any “senior executives” are currently not subject to noncompetes and negotiating with such individuals to enter into noncompetes prior to the final rule’s effective date.
Considering alternative retention strategies with deferred compensation such as retention bonuses or adjusting equity vesting schedules to encourage long-term employment.
Reviewing other restrictive covenants, such as confidentiality agreements and nonsolicitation clauses.
Effective October 1, 2023, Maryland enacted a revised partial restriction on employment-related noncompete agreements under Senate Bill 591. This public policy change was designed to protect lower wage employees and allow unrestricted movement in the workforce, even if their employment competes with their prior employer. The change in Maryland law prohibits employers from imposing a noncompete, conflict of interest, or similar agreement on employees earning 150 percent of the minimum wage.
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