By: Justin M. Harrison and Benjamin J. Wilson
On April 23, 2024, the Federal Trade Commission (“FTC”) approved a proposed final rule that would effectively ban noncompete clauses in employment contracts. In issuing the final rule, the FTC stated that noncompete agreements are an “unfair method of competition” that constitute a violation of Section 5 of the Federal Trade Commission Act. The Rule is set to take effect 120 days from its entry in the Federal Register.
What Does the FTC Rule Prohibit?
The FTC Rule effectively prohibits any and all noncompete agreements, and voids all existing noncompetes, with few exceptions. A noncompete clause is defined by the FTC as a “term or condition of employment” that prevents a worker from working for a competitor or starting a competing business in the time following the end of that worker’s employment. Notably, while many existing noncompete agreements include geographical limitations, the FTC Rule does not contain any language addressing geographical limitations, instead incorporating the entire United States into the definition of a noncompete.
The rule also renders all existing noncompete agreements unenforceable except for preexisting noncompetes covering “senior executives.” In providing a carve-out for “senior executives,” the FTC defined the term “to mean workers earning more than $151,164 per year and who are in a “policy-making position.” Importantly, however, all noncompetes moving forward are prohibited, regardless of whether they apply to senior executives. Employers will also be required to provide notice to workers—other than senior executives—who are subject to an existing noncompete that the employer will not be enforcing any noncompetes against them.
Moreover, the new rule purportedly supersedes all current state laws limiting noncompete agreements, unless the state law provides greater protections than the FTC rule.
The FTC further noted that it received numerous comments from workers in higher-wage fields, including health care services. Specifically, the FTC identified many of the comments noting that the workers subject to noncompetes “lacked bargaining power” or otherwise “did not negotiate” or “receive compensation” for the noncompete provisions. Despite their higher earnings, the FTC opined that these workers were “often exploited and coerced,” further supporting its conclusion that noncompetes constitute an unfair method of competition.
While the FTC Rule does not expressly target other types of employment restrictions, such as nondisclosure agreements, the FTC acknowledged that where such restrictions are so broad as to function like noncompetes, they may be subject to the new rule. Another example referenced by the FTC are clauses requiring the repayment of a bonus when a worker leaves their job. Where a “repayment amount is no more than the bonus that was received, and the agreement is not tied to who the worker can work for, or their ability to start a business, after they leave their job,” a violation of the new rule will not be found. But where those other restrictions function to prevent a worker from seeking or accepting work with a competitor or start a competing business, the FTC has indicated that it may consider those restrictions to constitute an unfair method of competition.
What about Non-Profits?
The FTC also addressed whether the Rule applies to non-profit organizations. Critically, the FTC stressed that the “final rule applies to the full scope of the Commission’s jurisdiction.” It noted that Congress empowered the FTC to “prevent persons, partnerships, or corporations,” from engaging in unfair methods of competition. Under the FTC Act, 15 U.S.C. § 44,a “corporation” is “organized to carry on business for its own profit or for that of its members.” While this definition would seemingly exclude non-profits, the Commission noted that many of the comments received “erroneously assume[d]” that non-profits escaped the FTC’s jurisdiction.
The FTC clarified, however, that judicial and Commission precedent recognized that “not all entities claiming tax-exempt status as nonprofits” are outside of the FTC’s jurisdiction. The Eighth Circuit has previously recognized that “Congress took pains in drafting § 4 [of the FTC Act] to authorize the Commission to regulate so-called nonprofit corporations, associations and all other entities if they are in fact profit-making enterprises[] . . . [but] did not intend to bring within the reach of the Commission any and all nonprofit corporations regardless of their purposes and activities.” See Community Blood Bank of Kansas City Area, Inc. v. FTC, 405 F.2d 1011, 1018 (8th Cir. 1969). See also FTC v. University Health, Inc., 938 F.2d 1206, 1214–15 (11th Cir. 1991) (finding that nonprofit hospital was subject to FTC jurisdiction under the Clayton Act as an “other character of commerce”). Thus, whether a nonprofit is subject to FTC jurisdiction is determined on a case-by-case basis.
Relying on Community Blood Bank, the FTC has applied a two-part test to determine whether a nonprofit is subject to its jurisdiction. In order to be exempt from coverage, there must be “both . . . an adequate nexus between an organization’s activities and its alleged public purposes and that its net proceeds be properly devoted to recognized public, rather than private, interests.” In other words, the FTC looks to the source of the entity’s income—whether the entity is “organized for and actually engaged in business only for charitable purposes”—and the destination of the income—whether the entity or its members “derive a profit.”
The FTC specifically addressed two instances in which nonprofit healthcare providers were found subject to the Commission’s jurisdiction in support of this argument. In In the Matter of Preferred Health Servs., Inc., FTC No. 41-0099, 2005 WL 593181, at *1 (Mar. 2, 2005), the FTC exercised jurisdiction over a physician-hospital organization because it found that the organization engaged in “business for the pecuniary benefit of its physician members.” In another case, the FTC exercised jurisdiction over a non-profit, tax-exempt physician association that consisted of private, independent physicians and private, small-group practices that was organized for the pecuniary benefit of its for-profit members. In the Matter of Boulder Valley Individual Prac. Assoc., 149 F.T.C. 1147, 2010 WL 9434809, at *2 (Apr. 2, 2010). Accordingly, “tax-exempt” or “nonprofit” status is not an automatic exemption from the FTC Rule and will likely be determined on an ad hoc basis.
What’s Next?
The new rule will face swift legal challenges. More than 27,000 comments were submitted to the FTC. The U.S. Chamber of Commerce released a statement last year calling the proposed rule “blatantly unlawful,” and has already announced its intention to sue the FTC “to block this unnecessary and unlawful rule.” Similarly, the Society for Human Resource Management expressed its disagreement with the “sweeping blanket ban on the use of noncompete agreements.” It seems likely that enforcement of the FTC Rule will be stayed while these various lawsuits play out. One only need to look to Nat’l Federation of Independent Business v. Dept. of Labor, decided in the midst of the COVID-19 pandemic, where the Supreme Court of the United States ruled that the Occupational Safety and Health Administration (“OSHA”) had exceeded its authority in issuing its emergency temporary standard requiring employers to “vaccine or test.” In that decision, the Court reasoned that while Congress may have given OSHA the authority to regulate workplace dangers, Congress “has not given [OSHA] the power to regulate public health more broadly.” The Court then stayed the enforcement of the vaccine-or-test mandate while litigation continued in the lower courts. A similar outcome is likely here with the FTC Rule.
Although it seems likely that the FTC Rule will be enjoined, employers should begin to review and catalogue their restrictive covenants to ensure compliance with the FTC Rule, assuming it becomes effective. Among things for employers to consider are whether business interests can be protected with more narrowly-tailored restrictive clauses that do not “function to prevent” a worker from seeking work with a competitor at the end of their employment.
Jackson Kelly will be monitoring these and other employment law developments closely. If you have any questions or wish to discuss what the new rule means for you, please contact a member of the Labor and Employment Team today.