New FTC Rule on Non-Compete Agreements: How to Prepare, Whether or Not the Rule Goes into Effect

July 19, 2024, 09:15 AM 2

The Federal Trade Commission (FTC) issued a final rule in April that will invalidate existing non-compete agreements and non-compete clauses in agreements.

Part of the justification for issuing this rule is that employers can protect their intellectual property through non-disclosure agreements (NDAs) and trade secret law: “[T]he Commission finds that employers have adequate alternatives to non-competes to protect these interests, including trade secret law and NDAs, and that these alternatives do not impose the same burden on competition as non-competes.” See Non-Complete Clause Rule A Rule by the Federal Trade Commission on 05/07/2024 89 FR 38403 in the 6 th paragraph beginning on the page.

There is a carve-out for an EXISTING non-compete clause for senior executives, but it is a violation of the new FTC rule to enter or enforce non-competes AFTER the effective date of the FTC rule. The senior executive must be paid at least $151,164 in the preceding year (or annualized if they only worked part of the prior year) and be in a policy-making position. The FTC estimates that this is only about 0.75% of employees.

What is a “non-compete clause according to the proposed rule?

Non-compete clause means:

(1) A term or condition of employment that 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.

(2) For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

If this rule goes into effect, employers will be required to send a notice to all employees and former employees that are under a non-compete agreement, stating that the employer will not enforce the non-compete agreement with the employee.

This cannot be just a general notice that is posted on the wall. The notice must be delivered by email, text, or sent by paper copy to each employee, and have the name of the employer, stating that they will not enforce the employer’s non-compete clause.

There are three exceptions in the new federal rules to these restrictions:

• SALE OF A BUSINESS. If the sale is a bona fide sale of the business and includes a non-compete clause, this clause will not be subject to the new FTC rule.
• EXISTING CAUSES OF ACTION. If you already have facts that allow you to enforce a non-compete before the effective date of the FTC rule.
• GOOD FAITH. If you can show that you had a good-faith basis to believe that actions to enforce a non-compete agreement were not subject to the FTC rule, you MIGHT get off the hook.
  • 910.2 Unfair methods of competition.

  (a) Unfair methods of competition—(1) Workers other than senior executives. With respect to a worker other than a senior executive, it is an unfair method of competition for a person:

  (i) To enter into or attempt to enter into a non-compete clause;

  (ii) To enforce or attempt to enforce a non-compete clause; or

  (iii) To represent that the worker is subject to a non-compete clause.

  (2) Senior executives. With respect to a senior executive, it is an unfair method of competition for a person:

  (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.

  What is the effective date of the FTC Rule? September 4, 2024, unless litigation regarding the rule delays the effective date.

  There is already one court in Texas that has issued a preliminary injunction to stop the FTC from enforcing the new rule against the plaintiffs in that case. See Ryan, LLC v. Federal Trade Commission Northern District of Texas Case No. 3:24-cv-00986. An appealable decision, however, is not expected in this case before the September 4, 2024, effective date of the new FTC rule.

  Another court in Pennsylvania is expected to have a ruling by the end of July 2024, where a nationwide injunction has been requested, and if granted would enjoin the FTC from enforcement of the new Rule until the case is finalized. See ATS Tree Services, LLC v. The Federal Trade Commission, Eastern District of Pennsylvania 2:2024-CV-01743. Oral Arguments were held July 10, 2024.

  2. What Employers Can Do Now to Protect Their Rights

  The comments accompanying the new FTC rule on non-compete agreements emphasize that employers still have rights to trade secrets and NDAs.

  REVIEW YOUR AGREEMENTS

  First, review your agreements.

  • Are there separate non-compete clauses in the agreements, or are the non-compete and nondisclosure clauses combined?
  • Does the agreement state that the company has trade secrets and that the employee agrees not to use or disclose the trade secrets?
  • If there is a nondisclosure clause, does the clause have a date or other limitation to ensure the clause is not too broad?
  • Does your agreement use the words compete, or non-compete?
  • Does the agreement focus on intellectual property owned by the company that needs protection?

  OPTION 1 – RE-DRAFT TO HAVE SEPARATE AGREEMENTS

  If you have separate non-compete clauses in your agreement, one recommendation is to redraft the agreement as two separate agreements. One agreement is the non-compete agreement, and the other is the confidentiality, nondisclosure, and trade secret agreement.

  If the non-compete clauses of an agreement are found to be unenforceable, different states will treat the agreement differently. If there are separate agreements, however, it will be easier to let the court invalidate one agreement without touching the other agreement.

  OPTION 2 – BOLSTER YOUR TRADE SECRET PROGRAM

  The FTC made it clear that trade secret enforcement is separate from non-compete agreements. The essence of a trade secret program is identifying what information in your business gives you an advantage because the competition does not have that information, and keeping that information secret. Secrecy is accomplished through reasonable security and agreements that include confidentiality clauses.

  Regardless of the FTC ruling, courts are more likely to enforce a trade secret agreement where the business shows that they have a defined secret and that the company needs to keep the information secret to maintain its investment in that secret. By focusing on a trade secret investment, rather than a company’s “investment” in training their employees, a company can shift the focus away from hurting the employee with a non-compete, and rather focus on protecting the company’s valuable assets. Even if this FTC rule never goes into effect, now is the second best time to strengthen your trade secret program. The best time is in the past.

  3. What Employers Must Do if the Rule Goes Into Effect

  NOTICE TO EMPLOYEES: If the current rule goes into effect, employers will be required to send notices to all current and former employees before or on the effective date of the new FTC rule.

  The FTC has a template, as follows:

  

  MODIFY AGREEMENTS FOR NEW EMPLOYEES: Employers will need to ensure their employment agreements do not have non-compete provisions. Asking a new employee to sign an employee agreement that contains a non-compete clause will be a violation of the new FTC rule after it goes into effect.

  MONITOR LEGAL UPDATES: Employers will also need to modify their agreements if the FTC and the courts interpret the new FTC Rule to include contract language that was thought to be outside of the rule. A contract does not need to have the word non-compete to be within the new rule. Rather, the rule states a contract or policy is anti-competitive if it “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” or “operating a business in the United States”. The policy can be an “oral” policy, meaning that executives and HR must be careful when talking to or about employees leaving to work with competitors.

  4. What are the Consequences if You Do Not Comply?

  The law does not set out specific consequences, but rather states that “it is an unfair method of competition for a person: (i) To enter into or attempt to enter into a non-compete clause; (ii)To enforce or attempt to enforce a non-compete clause; or (iii) To represent that the worker is subject to a non-compete clause.”

  What does FTC enforcement look like?

  Here are some notable examples:

  1. Facebook (now Meta) – 2019: $5 Billion Settlement – The FTC settled a case against Facebook for violating consumer privacy rights and not complying with a 2012 FTC consent order. Facebook settled for $5 Billion Dollars and entered a proposed order for the settlement in court. If this is approved by the court, it will be the largest fine ever imposed by the FTC. The 2019 case is ongoing as the court has not yet accepted the settlement, or entered the proposed order as of June 2024.
  2. T-Mobile – 2014: The FTC fined T-Mobile $90 million for billing customers for unauthorized third-party services, a practice known as “cramming.”
  3. Apple – 2014: The FTC fined Apple $32.5 million for billing consumers, mostly children, for unauthorized in-app purchases. Apple also had to change its billing practices to ensure that express, informed consent was obtained before billing.
  4. AT&T – 2019: The FTC fined AT&T $60 million for misleading customers about unlimited data plans, which involved throttling data speeds after a certain usage threshold was reached.
  5. Lumosity – 2016: The FTC fined Lumosity $2 million for deceptive advertising practices, as the company claimed its brain-training programs could improve cognitive performance and reduce cognitive decline without sufficient scientific evidence.
  6. McWane, Inc. – 2012: The FTC charged McWane, a leading supplier of ductile iron pipe fittings, with unlawfully maintaining its monopoly by excluding competitors and engaging in price fixing. McWane was found to have engaged in anti-competitive practices that harmed competition and consumers.

  If the new FTC rule goes into effect, it will allow the FTC to scrutinize employee agreements and bring lawsuits against companies. As demonstrated in the examples above, the FTC has the resources to fight Apple, Google, AT&T, and other large companies. The companies above are mostly large, but the FTC does sue small businesses.

  Here are some examples of small businesses sued by the FTC:

  1. Erik Chevalier and The Forking Path Co. – 2015: The FTC took action against Erik Chevalier, who ran a Kickstarter campaign through his company The Forking Path Co. for a board game called “The Doom That Came to Atlantic City.” Chevalier collected over $122,000 from backers but failed to deliver the game and used the funds for personal expenses.
  2. Roca Labs – 2015: Roca Labs, a small Florida-based company that sold weight-loss supplements, was sued by the FTC for making false and unsubstantiated claims about its products. The company also attempted to silence customers with non-disparagement clauses.
  3. Triangle Media Corporation – 2018: The FTC charged Triangle Media Corporation and its CEO, Michael Pereira, with running an operation that used deceptive “free trial” offers but then charged consumers full price for the trial product and enrolled them in expensive, ongoing continuity plans without their knowledge or consent.

  I am not saying that any of the companies that have been listed as examples in this article were doing good things. As any defendant in a court can tell you, the version in court can often look very different than the defendant’s view of what happened. Rather, I am sharing that if you do not comply you may be treated like these companies, and share the mark of having an FTC enforcement against you.

  A Good Opportunity

  The effective date of the new FTC rule making non-compete agreements unenforceable is still September 4, 2024, as of the writing of this article. Any company that currently has employee agreements with non-compete provisions needs to re-write the agreements for new employees prior to that date, because just presenting the agreement to an employee after September 4 is a violation of the new FTC rule. Employers also need to prepare and send a notice to all employees regarding the FTC rule.

  This is a good opportunity to consider how to protect your company with confidentiality and trade secret agreements rather than non-compete agreements. This new law is not expected to prevent a company from enforcing a trade secret agreement where the company can show that they have a trade secret.

  For more information about what qualifies as a trade secret, see the latest episode of Leveraging Inspiration. And here are links to episodes that specifically discuss trade secrets and how to prepare a program so you can enforce them.

  Update: On August 20, 2024 the District Court for the Northern District of Texas, Dallas Division issued an order. “The Non-Compete Rule, 16 C.F.R. § 910.1–.6, is hereby SET ASIDE and shall not be enforced or otherwise take effect on September 4, 2024, or thereafter.”

  For more discussion see the IPWatchdog article by Eileen McDermott, Texas Court Bars FTC’s Non-Compete Ban Nationwide

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