The U.S. Federal Trade Commission (FTC) has adopted a new regulation that is poised to gut a longtime fixture of the U.S. tech sector: the employment non-competition agreement, or non-compete. The popularity of non-competes has waned in recent years, driven partly by a trend toward state laws limiting them, but many tech workers have signed one at some point. These contracts typically bar an employee from working for the employer’s competitors during the employment relationship and for some period of time after it.
The new FTC rule was adopted on April 23, 2024 and should take effect in late August 2024, 120 days after its publication in the Federal Register. Numerous business groups have already sued to try to prevent it from taking effect. Unless a court orders the FTC to delay the rule’s implementation, however, it will take effect this year.
What the new FTC rule prohibits and requires
The FTC rule applies to non-competes with “workers,” including both employees and independent contractors. The rule will bar companies from entering into new non-competes, enforcing or trying to enforce any previously-signed non-competes with current or former workers, or telling current or former workers that they are bound by non-competes.
The affected agreements are those that bar workers, after their employment or contractor relationship ends, from seeking or accepting work with other U.S.-based companies or individuals or from operating U.S.-based businesses. The rule also prohibits agreements that “penalize” workers who engage in any of the same conduct or “function to” prevent them from doing so even if not explicitly stated. The rule encompasses both written and oral agreements, whether found in contracts or employee handbooks or policies.
The FTC rule also affects existing agreements. A company may continue to enforce existing non-competes with a subset of workers the rule defines as “senior executives.” Those are workers who earn at least $151,164 annually and hold a “policy-making position” (Presidents, Chief Executive Officers and other executives with “final authority to make policy decisions that control significant aspects of a business entity”). Only a small fraction of a company’s total workforce will qualify. Even for senior executives, however, starting on the rule’s effective date employers may no longer require new non-competes.
For the vast majority of workers, those who are not senior executives, companies must send them written notice that their non-competes cannot and will not be enforced. The rule includes details of the notice’s required content and how it must be delivered. Companies can either use a notice template included in the rule itself or write their own language.
Importantly, companies must send these notices out to current and former workers with non-competes regardless of whether the companies intend to enforce them.
Business practices that will remain unchanged by the new FTC rule
The FTC rule does not affect agreements that bar a person from working for two companies simultaneously. That is, the rule will not bar Company A from forbidding personnel to work for Company B (or any other companies) at the same time as A.
That does not mean, however, that such agreements are always allowed: numerous state laws continue to limit them. Maine employers, for example, will remain subject to the 2019 law that significantly restricts non-competes. Employers will need to keep navigating a patchwork of laws that vary by state and change often. (It is not surprising that many employers now are discontinuing non-competes altogether).
The new rule also exempts non-compete agreements that employees sign in the course of a bona fide sale of a company or its assets. Those are common in mergers and acquisitions.
What the new FTC rule means for shareholder agreements and clawback policies
The rule appears to bar “forfeiture-for-competition” agreements and plans. These arrangements claw back various types of equity or similar benefits (e.g. stock, options, or stock appreciation rights) from workers who join competitors. These are not employment agreements per se; they often appear as clauses in shareholder agreements and employee stock plans.
The FTC’s commentary to the rule asserts that these arrangements are illegal because they “penalize” work for competitors. It remains to be seen whether the rule will bar all such arrangements categorically (except for those used with “senior executives,” which are already exempt from the rule) or whether a case-by-case approach may be permissible.
Practical tips for employers under the new FTC rule
Companies should begin updating their standard documents relating to employees and contractors now to prepare for the rule’s August 2024 effective date. For most tech companies, those documents include template offer letters for employees and consulting agreements for contractors. Employees often also sign a separate agreement that contains a non-compete clause alongside confidentiality and intellectual property assignment provisions.
Companies should:
- Revise non-compete language company-wide. Wherever non-compete clauses appear – employee manuals, offer letters, contractor agreements or in other contracts – they must comply with the new FTC rule.
- Update non-disclosure agreements (NDAs). As non-competes wane, NDAs and trade-secret laws become companies’ primary protections against employees leaking company secrets to rivals. Review NDAs now to ensure they protect the right types of materials and conform to the latest state confidentiality laws.
- Strengthen trade-secret protection practices. State and federal trade-secret laws protect companies’ materials even in the absence of written NDAs, but they are effective only when companies take care that employees guard those secrets.
- Review shareholder agreements or other equity-related documents. As noted above, many tech workers and founders have agreements that provide consequences for unauthorized work for competitors. These should be reviewed to assess whether they may fall within the new rule’s scope, and revised where appropriate. Revising these agreements can require permission from a company’s outside investors, particularly for companies that have issued preferred stock in Series Seed, Series A or later financings.
- Prepare to send the required notices to current and former employees. Companies should confirm which past and current workers must receive notices, determine their addresses and prepare the notices for sending by late August 2024.
- Determine which current and former senior executives, if any, are subject to the rule’s exemption. If companies wish to enforce existing non-competes with individuals who qualify as “senior executives” under the rule, they should review the rule now to confirm those to whom it applies. If a company is not required to send those executives a notice that they are released from those agreements, then the company may instead wish to notify them that the agreements remain in effect. The rule has garnered significant attention, and some senior executives may mistakenly believe that their non-competes are no longer effective. A letter establishing the company’s position may be wise.
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