On April 23, 2024, the FTC voted 3-2 to approve its final rule banning non-competes for U.S. workers. Unless the federal courts block the rule (more about that later), it will go into effect on September 4, 2024.
(Update: The federal courts did block the rule. Sort of. See Texas Federal Court Enters Limited Preliminary Injunction Staying FTC’s Noncompete Clause Ban from my friends at Morgan Lewis.)
My law practice focuses on defending non-compete and trade secret claims, so as you might imagine, that was a busy week for me.
You can imagine the text messages from clients. “Hey, did you see this news about the FTC?”
I tried not to be too sarcastic. “Uh, yeah. I heard about it.”
I had two main things to tell my clients who have non-compete agreements:
First, don’t get too excited.
Second, it’s complicated.
Yes, it’s complicated, for several reasons. But in this blog post I will make it simple. You can determine if the FTC’s ban applies to your non-compete in five easy steps.
1. Did the company’s cause of action accrue before 9/4/24?
Sorry, if you’re already a defendant in a non-compete lawsuit, the FTC rule won’t do much for you.
Section 910.3(b) says:
Existing causes of action. The requirements of this part do not apply where a cause of action related to a non-compete accrued prior to the effective date.
Generally, a claim “accrues” when all the facts necessary to support it exist. So, if you’ve already violated a non-compete—allegedly—then the cause of action has already accrued.
There may be some borderline cases where there’s a dispute about whether the non-compete was breached before or after 9/4/24. But if there’s already a pending lawsuit, it’s safe to say the cause of action already accrued, and the new rule does not apply.
2. Is the non-compete clause part of an agreement to sell a business?
Generally, courts are more willing to enforce a non-compete that is part of the sale of a business, versus a non-compete in an ordinary employment agreement. I cover this at Non-Competes in the Sale of a Texas Business.
The FTC rule recognizes this with an important exception in Section 910.3(a):
Bona fide sale of business. The requirements of this part shall not apply to a non-compete clause that is entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.
Of course, there will be litigation over borderline cases, but if you’re non-compete is part of an agreement to sell a business, the FTC ban likely will not apply.
3. Is the non-compete ban retroactive?
But let’s say your non-compete is part of an employment agreement, and you haven’t violated it yet. Does the new rule retroactively ban your non-compete?
It depends on whether you’re a “senior executive.” If you were in a “policy-making position” and made more than $151,164 annually, then you’re a “senior executive.”
In that case, the rule does not prohibit the employer from seeking to enforce a non-compete you entered into before 9/4/24, the effective date of the rule. See Rule 910.2(a)(2).
But if you’re not a senior executive, then the rule applies, even if you entered into the non-compete before the effective date of the rule.
4. Are you in the Fifth Circuit?
So far, we’re assuming the rule actually goes into effect on September 4, 2024. That is not a certainty.
There are at least three federal lawsuits seeking to block the rule as unconstitutional and exceeding the FTC’s authority. For a good summary of these, see Analysis of FTC Non-Compete Ban Legal Challenges: Does the Ban Pass Constitutional Muster?
Two of these lawsuits are in Texas: Ryan, LLC v. FTC, Case No. 3:24-cv-00986, in the Northern District of Texas and Chamber of Commerce v. FTC, Case No. 6:24-cv-00148, in the Eastern District of Texas.
And let’s just say it’s no accident where they were filed.
I’ll save my opinion on the merits of those suits for another post. (Short version: I think a major weakness is that the arguments against the FTC rule tend to ignore the extent to which state law already imposed similar limits.)
But I will repeat the prediction I made when the rule was first proposed. I expect both the conservative Fifth Circuit and the 6-3 conservative majority on the Supreme Court will be hostile to what they will see as a partisan vote by a federal agency to sweep aside state non-compete law with the stroke of an administrative law pen.
My short-term prediction is that the rule will be blocked before its effective date of 9/4/24, and my long-term prediction is that SCOTUS will strike down the rule.
This is, admittedly, based on more on “vibes” than any detailed analysis of the merits. You can usually trust vibes when it comes to the Supreme Court.
But let’s suppose I’m wrong, and the rule goes into effect as planned. That brings us to the final and possibly most important question.
5. Is the restriction in your agreement a “non-compete clause”?
The FTC’s new Rule 910 generally declares it an “unfair method of competition” to enter into or enforce a “non-compete clause.”
But as with many things in the law, so much rides on definitions. How exactly does Rule 910 define a “non-compete clause”?
The rule defines a non-compete clause as:
(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.
Thus, in simplified terms, a “non-compete clause” prohibits, penalizes, or functions to prevent a worker from seeking or accepting work or operating a business.
That’s a pretty abstract definition. Let’s make it more concrete by applying it to two typical non-compete clauses.
Non-Compete 1 says:
Employee may not work for or operate any Competing Business in the Restricted Area during the Restricted Period in the same or similar capacity that Employee served for Company.
Assume that “Competing Business” is defined essentially as the business that Company does.
Non-Compete 2 is a little more complicated. It says:
After termination of employment, Employee is free to seek or accept work or operate a business in competition with Employer.
However, Employee may not solicit or accept business from any Restricted Customer in the Restricted Area during the Restriced Period.
“Restricted Customer” means any customer Employee dealt with or received confidential information about during Employee’s last year of employment with Company.
If you know anything about non-compete law, you know that generally a non-compete must have a reasonable time limitation and a reasonable geographic limitation. So to keep our hypotheticals simple, let’s assume the “Restricted Time Period” and “Restricted Area” are reasonable.
That leaves the scope of activity restrained. Let’s look at the scope of activity of both sample non-competes.
Non-Compete 1: Generally prohibited by both current Texas law and the FTC rule
Is the scope of activity restrained by Non-Compete 1 reasonable, under current Texas law?
The short answer is no. Of course, we’re talking reasonableness, a fuzzy concept, so it is almost always open to debate. And believe me, I have this debate often in my cases, with both opposing counsel and judges. But as a general rule, the scope of activity restrained by Non-Compete 1 is too broad. It’s what Texas courts have called an impermissible “industry-wide exclusion.” I cover this in detail in The Industry-Wide Exclusion Rule in Texas Non-Compete Litigation.
Furthermore, on its face Non-Compete 1 is a “non-compete clause” as defined by the FTC. I mean, it’s pretty clear: It prohibits the employee from working for a competing business.
So, we can say two things about Non-Compete 1.
First, the FTC rule prohibits it. Second, Texas law already prohibited it (generally).
Non-Compete 2: Generally allowed by both Texas law and the FTC rule
Non-Compete 2 is more difficult. As a lawyer who represents defendants in non-compete cases, I can certainly come up with an argument that Non-Compete 2 is unenforceable under Texas law.
But honestly, it’s not likely to be a winning argument. Most judges are going to see the scope of Non-Compete 2 as reasonably limited the proper purpose of protecting the company’s goodwill and confidential information.
I cover this topic in more detail in Wolfe’s First Law of Texas Non-Compete Litigation. The short version: you can’t take your customers with you.
So, as a general rule, Non-Compete 2 is probably enforceable under current Texas law.
But is it a prohibited “non-compete clause” under the FTC rule?
Answering this question requires two steps.
Step 5a: Does the clause expressly prohibit working for or operating a competing business?
On its face, Non-Compete 2 does not expressly prohibit working for or operating a competing business.
In fact, it says the opposite: “Employee is free to seek or accept work or operate a business in competition with Employer.”
So the answer is no. But that’s not the end of the story.
Step 5b: Does the clause function to prevent working for or operating a competing business?
Remember, the definition of “non-compete clause” includes a provision that “functions to prevent” a worker from seeking or accepting work for a competing business or operating a competing business.
Enter the functional test: Regardless of how the restriction is worded, does it function to prevent Employee from going to work for a competitor?
In other words, is it a “de facto” non-compete? This was the term the FTC used in its comments when the rule was originally proposed. I explained at What Everybody’s Missing About the FTC’s Proposed Non-Compete Rule.
On this question we must consult the FTC’s comments to the final rule, in particular the comments at page 38364 of the Federal Register, Volume 89, May 7, 2024. You can also find those comments at page 23 of this PDF.
Some key FTC comments:
- Pursuant to the term “functions to prevent,” the definition of non-compete clause also applies to terms and conditions that restrain such a large scope of activity that they function to prevent a worker from seeking or accepting other work or starting a new business after their employment ends, although they are not expressly triggered by these specific undertakings.”
- This prong of the definition does not categorically prohibit other types of restrictive employment agreements, for example, NDAs, TRAPs, and non-solicitation agreements.
- [T]he term “functions to prevent” clarifies that, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.
- [T]he definitions three prongs—“prohibit,” “penalize,” and “function to prevent”—are consistent with the current legal landscape governing whether a particular agreement is a non-compete.
As these comments indicate, a non-solicitation agreement does not necessarily function as a non-compete, but it could.
Suppose, for example, that the Company in Non-Compete 2 sells equipment to oilfield services companies. Suppose further that Employee’s customers include the five largest oilfield services companies in the geographic area at issue, and that they account for 90% of the market there.
In that case, Non-Compete 2 would arguably function to prevent Employee from accepting employment with a competing company, because as a practical matter all the customers he would want to sell to would be Restricted Customers.
That would arguably be a “de facto” non-compete clause, generally prohibited by the FTC rule.
Or is it? The lawyer for the company seeking to enforce the non-compete will argue otherwise.
That’s where the argument is going to be.
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Zach Wolfe (zach@zachwolfelaw.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at Zach Wolfe Law Firm (zachwolfelaw.com). Thomson Reuters has named him a Texas Super Lawyer® for Business Litigation every year since 2020.
These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.
Stephan is the sports journalist for the Maple Grove Report.
