24 April 2024

The FTC's rule on non-competes: What you need to know

The Federal Trade Commission (FTC) has issued a final rule that significantly alters the landscape for non-compete agreements in the United States.

What does the FTC rule say?

Under this new rule, employers can no longer impose non-compete clauses on workers, except for a narrow category defined as “senior executives.” For these high-ranking officials, whose roles and compensation thresholds align with the detailed criteria set by the FTC, existing non-compete agreements can still be enforced.

What is the definition of a “Senior Executive”?

According to the FTC, a senior executive is identified through two primary criteria: a compensation threshold and specific job responsibilities.

First, the individual must have received total annual compensation exceeding $151,164 in the previous year. This figure includes base salary, bonuses, equity, and other financial benefits, encompassing the broad spectrum of remuneration typical for high-level roles.

Secondly, the executive’s duties must include making policy decisions that significantly impact the business. This part of the definition seeks to differentiate senior executives from other high-earning employees who may influence the company’s strategic direction differently. Only those with the final authority to shape and implement key policies qualify under this rule, ensuring that the definition strictly applies to the upper echelons of corporate leadership.

So, both criteria must be met?

Yes, both criteria—the compensation threshold and the specific job responsibilities—must be met for an individual to be classified as a “senior executive” under the FTC’s non-compete rule.

Companies can’t enforce non-competes, but what else could they do?

Although the FTC’s new rule restricts using non-compete clauses for most employees, companies have several other legal tools to protect their business interests. These alternatives focus on safeguarding proprietary information and maintaining competitive advantage without unduly restricting the mobility of employees:

1. Non-Disclosure Agreements (NDAs): NDAs are a common and effective alternative to non-competes. Companies can use these agreements to prevent employees from sharing confidential and proprietary information with competitors or other external parties.

2. Non-Solicitation Agreements: These agreements restrict former employees from poaching clients, customers, or coworkers for a specified period after leaving the company. Non-solicitation agreements are valuable for businesses whose competitive edge relies heavily on customer relationships and internal talent.

3. Garden Leave Clauses: Under garden leave, an employee must stay away from work during the notice period while remaining on the payroll. This strategy delays the employee’s ability to immediately work for a competitor, thus temporarily protecting the company’s interests.

4. Intellectual Property (IP) Assignments: Companies can require employees, particularly those involved in research and development, to sign IP assignments. These agreements ensure that any inventions or proprietary work created during employment remain the company’s property.

5. Training Repayment Agreements: To secure their investment in employee training, companies can implement agreements that require employees to repay training costs if they leave within a certain period after receiving the training.

6. Enhanced Retention Strategies: Beyond legal agreements, companies can focus on retention strategies that make leaving less attractive. These include competitive salaries, robust career development opportunities, and a positive workplace culture.

Could this rule be challenged in the courts?

Yes, the FTC’s new rule on non-compete clauses could be subject to legal challenges. Such challenges are common when significant regulatory changes are introduced, especially those impacting a broad spectrum of industries and employment practices. Here are several bases on which the rule might be contested:

1. Authority of the FTC: Challengers may argue that the FTC overstepped its statutory authority granted by Congress. The legal contention would likely focus on whether the FTC has the power to ban non-compete clauses so broadly under the Federal Trade Commission Act.

2. Economic Impact: Businesses or industry groups could claim that the rule negatively affects economic interests, arguing that it hampers companies’ ability to protect trade secrets and investments in employee training. They might also assert that the rule was enacted without considering its economic repercussions.

3. Constitutional Challenges: The rule could face challenges based on constitutional grounds, saying it infringes on states’ rights to regulate employment matters within their jurisdictions or violates the Commerce Clause by overreaching in its regulation of interstate commerce.

4. Procedural Flaws: Opponents might contest the rule on procedural grounds, arguing that the FTC failed to follow proper procedures required under the Administrative Procedure Act during the rulemaking process, such as providing insufficient opportunity for public comment or inadequately addressing the comments received. The FTC says it considered more than 20,000 public comments on the proposed rule.

Should such challenges proceed, rule enforcement could be delayed or blocked by preliminary injunctions until the legal issues are resolved. Depending on the courts’ decisions, the outcomes of these challenges could lead to modifications of the rule or even its rescission.

What should companies be doing now from a risk management perspective?

Companies should take several proactive steps to adapt and ensure compliance. Here are essential actions they might be undertaking:

1. Contract Review and Revision: Companies should thoroughly review their current employment contracts and policies to identify and revise non-compete clauses that no longer comply with the new rule. This includes differentiating contracts for senior executives whom non-competes might legally bind.

2. Legal Consultation: It is important to engage with legal experts to understand the rule’s specifics and its implications for their business practices. Legal counsel can help navigate the complexities of the rule, advise on compliance, and anticipate potential areas of legal challenge.

3. Training and Communication: Organizations should be training their HR and legal teams on the changes brought by the new rule to ensure they understand how to implement compliant hiring and contract negotiation practices. Communicating these changes clearly to current and future employees is also essential to maintain transparency and trust.

4. Implementation of Alternative Protections: As non-compete agreements become restricted, companies might explore alternative legal mechanisms such as non-disclosure agreements (NDAs), non-solicitation agreements, and intellectual property assignments to protect their business interests without infringing on the new regulations.

5. Strategic Planning: Companies might reassess their approach to talent management, retention, and competitive positioning in the marketplace. This could involve boosting employee value propositions to retain top talent organically. 

6. Monitoring Regulatory Developments: Given that new regulations can evolve, particularly in response to legal challenges or further legislative actions, companies should stay informed about any changes or clarifications to the FTC’s rule and other related legal developments.

What will the impact be on hiring and recruitment?

The impact will be huge. Here are some of the key effects and adjustments we might expect:

1. Expanded Talent Pool: With the restriction on non-compete clauses, companies will have access to a broader talent pool. Employees previously bound by non-compete agreements will now be free to switch employers more easily. This can increase opportunities for companies to attract experienced professionals from competitors and other sectors.

2. Increased Competition for Talent: Companies will face stiffer competition for top talent. This could drive up demand for skilled workers, potentially leading to better compensation packages and benefits to attract and retain the best employees.

3. Enhanced Employee Mobility: The rule will likely encourage employee mobility. Workers will have greater freedom to move between jobs to pursue better opportunities, higher salaries, or more favorable working conditions without fearing legal repercussions.

4. Shift in Recruitment Strategies: Companies may need to adjust their recruitment strategies. Instead of relying on non-competes to retain talent, employers might focus more on creating attractive working environments and career development opportunities to attract and keep their employees.

5. Focus on Culture and Retention: There may be a greater emphasis on building a positive organizational culture and employee engagement as key strategies for talent retention. Companies must invest in training, development, and recognition programs contributing to job satisfaction and employee loyalty.

6. Re-evaluation of Employment Offers: Businesses might reevaluate what they include in employment offers. This could mean focusing more on immediate benefits and long-term career opportunities rather than restrictive clauses that bind employees to the company.

7. Legal and Compliance Adjustments: Recruitment processes will need to incorporate legal and compliance checks to ensure that all new hiring practices align with the updated regulatory environment and avoid any legal pitfalls that could arise from the misuse of restrictive clauses.

From a GRC perspective, here are the three immediate actions companies must take ahead of the FTC rule coming into force:

1. Conduct a Comprehensive Contract Audit:

Companies must review all existing employment contracts and policies to identify any non-compete clauses that will be affected by the new FTC rule. This audit should distinguish between agreements for senior executives, exempt under the rule, and other employees.

Ensuring all employment agreements comply with the new regulations is crucial to avoid legal liabilities and penalties. This step also helps update contract templates and guidelines used in future hiring.

2. Develop and Implement a Revised Compliance Framework:

Update the company’s compliance framework to incorporate the changes brought by the new rule. This includes drafting new policies and guidelines that align with non-competency restrictions.

A robust compliance framework will safeguard the company against potential legal challenges and regulatory scrutiny. It also ensures that all stakeholders, including HR, legal, and management teams, are on the same page regarding the company’s hiring and contracting practices.

3. Train and Communicate with Key Stakeholders:

Organize training sessions for HR personnel, internal recruiters, and managers about the implications of the new rule and the revised company policies. Simultaneously, communicate these changes to all employees to ensure transparency and understanding

Training and communication are essential to avoid confusion and ensure seamless adaptation to the new rule. They also help maintain trust and morale by showing the company’s commitment to fair employment practices and legal compliance.

At MBK Search, we help firms find world-class talent to build champion teams across regulated markets. Let’s start building — visit our website to find out how.

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