Mid-Atlantic Health Law TOPICS

On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule banning most non-compete agreements entered into by for-profit businesses. The final rule is very similar to the proposed rule initially issued by the FTC in April 2023.  

The rule is an outgrowth of President Biden’s 2021 Executive Order on Promoting Competition in the American Economy, which directed the FTC to exercise its authority “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”  

The FTC promulgated the rule under its authority to prohibit “unfair methods of competition.” According to the FTC, non-competes restrict the freedom of workers to leave their current employment for better jobs and stifle competition.

By releasing workers from the constraints of non-competes, the FTC believes the rule will have many positive effects including the promotion of new business formation, innovation, increased wages for workers and reduced health care costs.  Opponents of the rule view it as an unconstitutional exertion of government authority that harms business and seeks to “micromanage” the economy. The rule faced immediate legal challenges, including a suit filed in a Texas federal court by the U.S. Chamber of Commerce.

What types of provisions are subject to the rule?

The rule prohibits any individual or entity from: 

1. Entering into or attempting to enter into a non-compete clause;
2. Enforcing or attempting to enforce a non-compete clause; or
3. Representing that a worker is subject to a non-compete clause.

What entities are subject to the rule’s restrictions?  

The rule restricts the use of non-compete provisions by any “person,” which the rule defines as “any natural person, partnership corporation, association, or other legal entity” within the FTC’s jurisdiction.

Are non-profit entities exempt from the rule?

The FTC is empowered to “prevent persons, partnerships, or corporations” from engaging in unfair methods of competition. An entity is a “corporation” under the FTC Act only if it is “organized to carry on business for its own profit or that of its members.” As a result, the FTC generally lacks jurisdiction over entities claiming tax exempt status under Section 501(c)(3) of the Internal Revenue Code.  

However, the FTC rejected calls from the health care industry seeking a clear exception for non-profit entities, stating that “not all entities claiming tax-exempt status as nonprofits fall outside the Commission’s jurisdiction.”  

Instead, the FTC stated that it would utilize a two-part test which “looks to both ‘the source of the income, i.e.., to whether the corporation is organized for and actually engaged in business for only charitable purposes, and to the destination of the income, i.e., to whether either the corporation or its members derive a profit’” in determining whether an entity is a true non-profit organization and exempt from the non-compete rule.

What types of workers are protected by the rule?

The rule broadly protects all “workers,” a term defined as including any natural person who works, with or without pay, and regardless of title. The term encompasses employees, 
contractors, interns, externs, volunteers, apprentices, and sole proprietors who perform a service for another person. 

There is an exception for franchise relationships. While the term “worker” includes individuals who work for a franchisee or franchisor, it does not include a franchisee in the context of a franchisee-franchisor relationship.

Are any workers excluded from the rule’s protection?

The final rule adds a carve-out not included in the proposed rule that permits enforcement of existing non-competes with “senior executives” such as a business entity’s president, CEO, and other officers.  The exception applies only if the executive (1) has “policy-making authority” and (2) earns more than $151,164 annually.  

“Policy making authority” means “final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.”  

If the rule takes effect, it can be expected that the issue of who qualifies as a “policy maker” will be a hotly litigated issue.  

The FTC believes the “senior executive” exception will apply to fewer than one percent of all workers and affects only existing agreements. Non-compete provisions in new agreements, even with highly paid executives, are prohibited under the FTC rule.

How do businesses notify workers about existing non-competes?

The FTC rule requires businesses to provide “clear and conspicuous notice” to each worker who is subject to an existing non-compete.  The notice must state that the non-compete clause “will not be, and cannot legally be, enforced against the worker.” The notice must be sent “on paper” to the worker’s last known address, or electronically by e-mail or text.  

The FTC has developed a model form for this purpose. Businesses that use the model form will be entitled to a “safe harbor” presumption that the form satisfies the notice requirement.

Are there any exceptions to the rule?  

The rule contains a limited exception for non-compete provisions entered into by a person pursuant to a bona fide sale of a business entity if the transaction involves the sale of the person’s ownership interest in the entity, or of all or substantially all of the entity’s operating assets.  

The rule also does not apply where a lawsuit related to a non-compete clause accrued before the effective date of the rule.  

Finally, it is not illegal to enforce or attempt to enforce a non-compete clause or to make a representation about a non-compete clause where a person has a good-faith basis to believe the FTC rule is inapplicable.

What is the effect of the FTC rule on state laws?    

The rule makes clear that it supersedes state laws to the extent that such laws would permit a person to engage in conduct that is prohibited by the rule or in conflict with the notice requirement. The rule does not, how-ever, prevent states from enforcing their own restrictions on non-competes or individuals from enforcing their rights under such laws.

When is the FTC rule effective?    

The rule becomes effective September 4, 2024, which is 120 days after it was published in the Federal Register.

Next steps for employers?    

The FTC rule has not yet become effective and faces significant legal challenges and most observers expect that its implementation will be delayed by litigation. Businesses may legally continue to utilize non-compete provisions under federal law unless and until the rule becomes effective but should proceed cautiously.  

Non-competes have been under attack from many state legislatures and are often viewed as “disfavored” provisions by courts. Employers continuing to use non-competes should do so following applicable legal principles in the jurisdictions where the restriction will be enforced.  

In general, that means non-competes must be narrowly tailored to protect only legitimate business interests, which requires that the provision be reasonable in terms of geographic scope, duration and the breadth of activities subject to restriction. 

Importantly, agreements should be drafted in a manner that will not impede the enforceability of other business protection provisions that may be contained in the agreement. For example, clauses governing confidentiality, non-solicitation of employees and customers, and providing intellectual property protections should be clearly delineated and separate from any non-compete provision in the event the non-compete is later deemed illegal.
 

Charles R Bacharach
410-576-4169 • cbacharach@gfrlaw.com