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New FTC Ban on Most Non-Competes

by | Apr 24, 2024 | Associate, Blog, Franchise, Uncategorized | 0 comments

On April 23, 2024, the Federal Trade Commission (“FTC”) announced a final Non-Compete Clause Rule (the “Rule”) banning non-competition agreements, often referred to as “non-competes.”

The sweeping regulation will nullify and prohibit almost all non-competes for ordinary workers and most upper-management employees.  However, the new Rule permits the continued validity and use of non-competes applicable to shareholders selling a business and to the parties of a franchise agreement.  Additionally, pre-existing non-competes with senior executives, as specifically defined, may remain in effect but may not be renewed.

By way of background, non-compete language is commonplace in countless types of contracts, especially employment agreements and franchise agreements, but also a wide of other contractual relationships. Non-competes typically prevent accepting a new position with a competing company after termination of employment or starting/continuing a competing business after termination of a franchise agreement, usually for a set period of time within a defined geographical area.  The stated motives behind non-compete clauses are usually to protect the investment in the employee or franchisee, as well as the intellectual property and other confidential and proprietary information disclosed during the relationship, but such agreements also discourage departures from an employer or franchise system.

According to the FTC, the non-compete ban aims to “protect[] the fundamental freedom of workers to change jobs, increas[e] innovation, and foster[] new business formation.” Further, the FTC suggests that the Rule will “ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to the market.”  The Rule goes so far as to require employers to inform employees that they are released from their non-competes.

The FTC’s Rule defines a “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”

However, this definition specifically relates to a “worker,” not to shareholders selling a business or to franchisees as part of a franchise system. The final Rule defines a “worker” as “a natural person who works or who previously worked, whether paid or unpaid, . . . whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.” As such, non-competes cannot be imposed on the ordinary employees of a company, but may apply to shareholders selling their ownership interest in a company, as is common in asset purchase agreements.  Regarding franchisees, the Rule states expressly that “the term ‘worker’ includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.” Accordingly, the Rule should not interfere with the continued use of appropriate non-compete provisions in franchise agreements, provided that the terms do not extend to the ordinary employees of the franchised business.

Significantly, the Rule does not reach confidentiality/non-disclosure agreements and intellectual property ownership agreements.  Employers are expected to rely more heavily on such agreements, but the FTC does warn that even these agreements may not be enforced in a manner that results in the equivalent of a non-compete.

The Rule will take effect 120 days after publication in the Federal Register. Litigation challenging the Rule has been filed already and court rulings are expected in the coming months.  The text of the Rule is accessible here.