On April 23, 2024, the Federal Trade Commission (FTC) by a 3-2 party line vote made a bold move that ended noncompete agreements in all but exceptional cases. These agreements have long prevented workers from moving to rival firms or starting similar businesses for a certain period after leaving a job.
Not Just Used For The Top Dogs
Some think of noncompete agreements as the domain of high-flying executives in tech and finance, but the reality is much different. About 20% of U.S. workers, which is 30 million people, currently face these limits. Even those earning modest wages, like security personnel and sandwich shop workers, are caught in these restrictive contracts. A Federal Reserve Bank of Minneapolis study showed that noncompete agreements are so pervasive that they impact 12% of workers making $20 an hour or less.
Why Ban Noncompetes?
The FTC has made it clear: they believe noncompetes are bad for workers and the economy because they keep wages down by making it harder for employees to find better-paying jobs.
According to FTC Chair Lina M. Khan,“noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” Ms. Khan went on to say “the FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes
The FTC Rule Has Limited Exceptions
The FTC’s final rule expressly includes two limited exceptions where it does not apply. First, a buyer may require a noncompete in connection with the “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.” An earlier version of the rule required that the seller own 25 percent of the entity being sold, but the FTC eliminated that language from the final rule. Second, the final rule does not apply “where a cause of action related to a non-compete clause accrued prior to the effective date.”
Under the new FTC rule, existing noncompete agreements with senior executives, representing less than 0.75% of workers, can remain in force. However, employers cannot enter into or attempt to enforce new noncompetes, even if they involve senior executives.
Employers Must Provide Notice To Employees Who Had Noncompetes
The FTC will require that employers provide notice to workers other than senior executives who are bound by an existing noncompete to advise them that the employer will not be enforcing any noncompetes against them.
Legal Challenges Likely
However, it is essential to note that the rule already faces legal challenges that could impact or delay its implementation or result in its invalidation. The challengers argue that the final rule exceeds the FTC’s statutory authority, is arbitrary and capricious in violation of the Administrative Procedure Act, violates constitutional law, and ignores potential pro-competitive benefits of noncompetes.
The Upcoming Change And The Opposition
This new rule will become effective 120 days after the final rule’s publication (likely in August 2024), but not everyone is on board. Critics worry about employers losing trade secrets when employees jump ship. The U.S. Chamber of Commerce plans to sue, saying that the FTC is overreaching and that these agreements should be left to state law. U.S. Chamber to Sue FTC Over Unlawful Power Grab on Noncompete Agreements Ban | U.S. Chamber of Commerce (uschamber.com) Similarly, some businesses are up in arms, claiming the ban goes too far.
On the other side of the argument, experts like Alexander Hertel-Fernandez from Columbia University say that lower-wage workers don’t have the power to negotiate these terms— “When they get their job offer,” he said, “it’s really a take-it-or-leave-it-as-a-whole.” FTC votes to ban noncompete agreements for most workers | AP News
California Led The Way
As evidence that innovation can thrive without noncompete agreements, some point to California, which has long prohibited noncompete agreements. Under California law, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The few exceptions set forth in the statute permit enforceability of noncompete agreements include the sale of a business, dissolution of a partnership, or dissolution or termination of interests in a limited liability company. Critics of noncompete agreements suggest that California’s approach has been instrumental in fostering its dynamic tech sector. Entrepreneurs in California have been able to move freely, which has been crucial for the birth of significant tech companies and the industry’s overall growth.
Illinois Sought To Curtail Noncompete Agreements In 2021
In 2021, the Illinois legislature prohibited an employer from entering into a covenant not to compete unless the employee’s actual or expected annual earnings exceed $75,000 annually. That amount increases by $5,000 every five years through 2037.
Illinois also prohibited employers from entering into a covenant not to solicit, which involves an employee soliciting its employers’ employees for employment or soliciting employees for the purpose of selling products or services of any kind or interfering with the employer’s relationships with clients, prospective clients, vendors, prospective vendors, suppliers, and prospective suppliers) unless the employee had actual or expected annual earnings of $45,000 per year (which increases by $2,500 every five years through 2037).
A Future Without Limits?
The FTC’s decision to ban noncompete agreements represents a significant shift in the labor market. While the rule faces legal challenges, its implications could be far-reaching, offering a new era of job mobility and economic opportunity. As the debate continues, the outcome of this rule could shape the future of work in America.
