FTC Announces Rule Banning Most Noncompete Clauses

The Federal Trade Commission (FTC) has issued a final rule that bans noncompete clauses in employment contracts across the United States. The rule affects approximately 18% of U.S. workers—totaling 30 million individuals—who are currently bound by noncompetes. This measure is designed to boost job mobility and wage growth by removing barriers that restrict employees from transitioning between competing roles. The decision has triggered considerable debate and is currently facing legal challenges. Critics argue the ban could harm business competitiveness and stifle innovation. Furthermore, the U.S. Chamber of Commerce contends that the FTC does not have the regulatory authority to enact such changes. To help clients, prospects, and others, Klatzkin has provided a summary of the key details below.

What’s a Noncompete Agreement?

Noncompete agreements are clauses in employment contracts that restrict former employees from working in similar professions or industries that compete directly with their previous employer. These agreements are typically bound by time, geography, or market scope to protect businesses’ interests like trade secrets, specialized training, and other confidential information. While noncompetes are common in high-skill industries—such as technology, sales, healthcare, and creative sectors—they often face scrutiny for being overly restrictive.

Overview of the Final Rule

Under the new FTC rule, most existing noncompete agreements will become unenforceable from the rule’s effective date. However, noncompetes for senior executives will still be valid. The rule also completely bans creating or enforcing any new noncompete agreements, including those for senior executives.

Key Elements:

• Complete Ban on New Noncompetes: From the effective date of the rule, all new noncompete agreements are banned, regardless of the employee’s level, including senior executives.
• Grandfathering Provision: The rule allows existing noncompete agreements for senior executives to continue. These executives are defined as high-level officers who meet specific salary thresholds.
• Business Sale Exception: The rule maintains an exception for noncompetes executed in connection with the sale of a business, acknowledging the need to protect the buyer’s investment.
• Notification Requirement: Employers are required to inform employees bound by existing noncompetes that these agreements will no longer be enforced. The FTC provides model language to facilitate compliance by businesses.
• Preemption of State Laws: The rule overrides state laws that permit noncompetes, creating a uniform federal standard.

Key Definitions: 

• Non-Compete Provisions: Non-compete provisions are defined broadly under the Final Rule to encompass any employment terms that prohibit, penalize, or functionally prevent a worker from (a) seeking or accepting subsequent employment in the United States with a different entity or (b) operating a business in the United States following the conclusion of their current employment. This definition specifically targets post-termination restrictions, explicitly excluding limitations on concurrent employment. The Final Rule adopts a “functional test” to determine whether an agreement operates as a noncompete under the guise of another form of contract, ensuring that restrictive covenants like non-disclosure agreements (NDAs) do not inadvertently function as noncompetes.
• Worker: The term “worker” covers any individual engaged in work, regardless of compensation, job title, or employment status. This includes employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide services to clients or customers. The broad definition ensures comprehensive application of the rule across various types of labor relationships, aiming to protect a wide array of workers from restrictive employment clauses.
• Senior Executives: Senior executives are defined specifically under the Final Rule as either: (1) the president, Chief Executive Officer, or an equivalent position within a business entity, or (2) any officer or individual in a policy-making position who earns more than $151,164 annually and holds final authority over significant business policies. While new noncompetes for senior executives are prohibited post-rule implementation, existing noncompetes for these high-level employees are protected under a grandfather rule, acknowledging potential access to sensitive business information.
• Covered Employers: Covered employers typically include all entities engaging workers under the broad definition provided. However, certain sectors and entities are exempt from the FTC’s jurisdiction, such as banks, non-profit organizations (such as 501(c)(3) organizations), insurance companies, transportation and communication carriers, and air carriers. Notably, the rule presents a gray area for some nonprofits that claim tax-exempt status but operate to the benefit of their profit-seeking members, suggesting that these entities might still fall under the rule’s jurisdiction depending on their organizational structure and activities.

Analysis

The FTC argues that banning noncompetes will promote innovation and increase wages. According to their projections, abolishing noncompete agreements will create over 8,500 new businesses annually, boost the average worker’s wage by $524 per year, and reduce healthcare costs by $194 billion over the next decade. Additionally, the FTC anticipates an increase in patent filings, estimating an average of 17,000 to 29,000 additional patents each year for the next ten years.

However, the rule has faced criticism from various industry groups. Critics argue that eliminating noncompetes could endanger trade secrets and weaken competition within certain sectors. Organizations like the American Hospital Association and the National Association of Manufacturers express concerns that the ruling could adversely affect operations, employee training programs, and customer service. Furthermore, the U.S. Small Business Administration has argued that noncompete agreements are vital for encouraging hiring and training, as well as protecting investments in research and development.

The FTC counters these concerns by highlighting alternatives to noncompetes that they say can still protect business interests. For instance, trade secret laws and NDAs are suggested as effective measures. The FTC notes that over 95% of workers bound by noncompetes have also signed NDAs, which continue to protect an employer’s confidential information even after an employee has left the company.

Additionally, some industry experts believe that the ban on noncompete agreements could lead to increased innovation, a trend observed in states like California, where regulations on noncompetes have been tightened in recent years. Despite these arguments, the Chamber of Commerce and the Business Roundtable have initiated lawsuits, potentially leading to prolonged legal battles and delayed implementation.

Contact Us

The new rule may be suspended while court cases are resolved and potential appeals are processed, which means the effective date could be significantly delayed. It is possible the delay could last for many months, or the rule could even be overturned. As it stands, noncompete agreements remain valid; however, New Jersey employers will want to remain aware of changes. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Klatzkin can help. For additional information, call 609-890-9189 or click here to contact us. We look forward to speaking with you soon.