New FTC Rule Would Generally Ban All Non-Compete Agreements Except for Agreements with “Senior Executives” Entered Into Before the Effective Date

As widely expected, the Federal Trade Commission (FTC) voted on April 23 to issue a rule generally barring post-employment non-compete provisions in employment arrangements.  The new rule is relatively short, taking up eight pages in a 570-page rule release.  But, as the total length of the release indicates, there are many nuances to consider.

The effective date of the new rule will be 120 days after publication in the Federal Register, which is expected to occur soon.  By the effective date, employers must provide a notice to all employees with non-compete clauses (“NCCs”) covered by the new prohibition, which notice states that the NCC will not be, and cannot legally be, enforced against the worker.¹  Details of the notice are contained in the rule, including model language for this purpose. 

A discussion of the new rule’s key features follows, including, in particular, the exception for NCCs with senior executives entered into before the effective date, since there are some actions employers may want to consider before the effective date in connection with this exception.   

The final rule generally prohibits employers from entering into or enforcing an NCC.  An NCC is a term or condition of employment that prohibits or “penalizes” a worker from working in the United States for a different employer, or operating a business, after the current term of employment ends.  In addition to the exception for senior executives discussed below, there is an exception for NCCs entered into as part of the sale of a business, and the rule does not cover franchisee/franchisor contracts.  Finally, the rule does not apply to industries the FTC does not regulate, including nonprofit organizations, banks, savings and loan companies, transportation and communications common carriers, air carriers, and some other entities.

Much of the nuance within the rule relates to what counts as an NCC. The most clear-cut NCC banned by the rule is a provision preventing an employee from working for a competitor post-employment, where the remedy is injunctive relief.  Allowing future employment but imposing some type of monetary penalty for competition (i.e., a “liquidated damages” clause) is also clearly an NCC under the rule.

The rule also applies to clauses that “function to prevent” a worker from new employment.  The FTC indicates this phrase was intended to apply 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.”  How far this goes is unclear.  It doesn’t prohibit all limitations. The FTC noted the language is not intended to “categorically” prohibit other types of restrictive employment agreements, such as non-disclosure agreements, training agreement repayment provisions, and non-solicitation agreements.  We expect the boundaries of the “function to prevent” language to remain unclear for some time. 

One interesting area relates to what the FTC refers to as “garden leave agreements.”  This term—a Briticism—refers to the practice of instructing an employee to cease all work activities but keeping the employee on the payroll until formal termination and continuing to pay all or some portion of the current compensation.  The payments cease, however, if the worker goes to work for someone else.  The FTC notes that it would not be an NCC if the worker continues to be employed and receives “the same total annual compensation and benefits on a pro rata basis.”

At least from an executive compensation standpoint, a notable feature of the new rule is its exception for NCCs that are entered into before the effective date with “senior executives” (“SEs”).  The challenging part of this exception is determining what constitutes an SE, since the FTC’s language is different than the “executive officer” concept found in various SEC regulations.

The SE definition requires that the person meet a compensation threshold ($151,164) and be in a “policy-making position.”  The term “policy-making position” is defined to include the CEO and “any other officer of an entity that has ‘policy-making authority.’”  “Policy-making authority” has the following definition:

“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 an affiliate of a common enterprise.”

The FTC asserts that its definition is intended to be broadly aligned with the SEC’s definition of “executive officer” in SEC Rule 3b-7, which refers in part to a registrant’s:

“[P]resident, any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration or finance), any other person who performs a policy making function, any other officer who performs a policy making function or any other person who performs similar policy making functions.”

There are two potentially significant differences between the definitions.  First, the SEC definition includes someone in charge of a principal business unit while the FTC definition excludes someone in charge of business decisions for only a subsidiary.

Second, someone is only an SE if he or she has “final authority to make policy decisions.”  While it is essential, of course, that the subordinates of the CEO in a large corporation have authority to make significant decisions without consulting the CEO, that is not necessarily equivalent to saying they have final authority—we expect that in many cases the CEO has retained authority to make the final decision in case of disagreement.  Our uncertainty is increased by the fact that the FTC supports its position with a 2013 district court case that apparently held that only the CEO of the small company in question had the authority to make company policy.

While further parsing on the FTC’s lengthy explanation of its new rule may lessen our uncertainties over the SE definition, our efforts so far lead us to the conclusion that companies interested in preserving NCCs with top executives may need to immediately begin working with counsel to determine which officers will fit within the FTC definition.  It is even conceivable that this process may result in a decision to establish corporate documentation to establish who has “final authority” over certain policy decisions, so as to more readily fit within the FTC’s new rule.²

In summary, we think a company may want to begin immediately reviewing the new FTC rule if it has NCCs with executives it wants to preserve, is considering entering into NCCs with such executives, or has other post-employment restrictions that might arguably count as NCCs.

1  A number of commentators on the FTC’s proposed rule (issued in January 2023) questioned the FTC’s statutory authority to generally ban NCCs.  So far, we are aware of two lawsuits challenging the final rule that have been filed in Texas federal courts, including one filed by the U.S. Chamber of Commerce.  This blog expresses no opinion on these potential challenges, but in deciding how to respond to the final rule, the possibility of a successful legal challenge needs to be borne in mind.  For example, it would appear important that any notice of non-enforceability be drafted in a way that preserves enforceability if the FTC’s rule is ultimately determined to be illegal.

2 For example, a resolution might state that, unless and until the CEO or the board of directors determines otherwise, Officer X has “final authority” to make decisions with regard to [list areas of final authority].”

David Gordon
Managing Director

Dave Gordon’s practice as an executive compensation consultant covers a variety of industries, including extensive experience with financial institutions and utilities. Based on his years of experience as an executive compensation lawyer, he acts as the senior resource on numerous technical issues for the Firm. He frequently acts as an expert witness.

Dina Bernstein
Principal

Dina Bernstein has extensive experience advising on all aspects of executive compensation, working with companies on an ongoing basis, as well as in the context of mergers and acquisitions, spin-offs, initial public offerings, and other corporate events. Dina provides guidance to private and public companies across various industries regarding cash and equity incentive compensation arrangements, employment, severance and change in control agreements, overall compensation program design, pay governance practices, taxation, stock exchange listing requirements and securities regulation compliance.