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Background

On April 23, 2024, the Federal Trade Commission (“FTC”), via a 3-2 vote, adopted a final rule banning employers from entering into non-compete clauses (the “Rule”). The FTC regulates competition in America, and in its vote on the Rule, the FTC determined that non-compete clauses are an “unfair method of competition” in violation of Section 5 of the Federal Trade Commission Act.

While the Rule is currently set to be effective 120 days after publication, or September 4, 2024, the Rule is likely to face significant legal challenges and its implementation will likely be delayed pending those challenges.  Already, multiple lawsuits challenging the rule have been filed.

The Rule

The Rule expressly prohibits non-compete clauses, with very limited exceptions.

In issuing the Rule, the FTC asserted that a non-compete clause “has the effect of prohibiting the worker from seeking or accepting employment.”

The Rule, if it were to take effect, would essentially ban the usage of non-competes in employment agreements (or severance agreements) going forward.  Most existing non-competes would also be banned, with a small exception for existing non-compete agreements with senior executives. As defined by the Rule, senior executives are workers who have an annual compensation of over $151,164 and who have “policy-making” authority over the organization. Employers will not be able to enter into comparable agreements with senior executives once the Rule goes into effect, however, they will be able to enforce existing non-compete clauses with senior executives who meet the definition outlined in the Rule. The Rule would also require employers to provide notice to employees who signed a non-compete that the employer will not seek to enforce it.

While the Rule explicitly prohibits non-compete clauses, it is less clear regarding the extent to which non-solicitation provisions may be prohibited.  Under the final Rule, non-solicitation clauses “are generally not non-compete clauses”, as the main function of a non-solicitation clause is to restrict an employee’s contact after they leave their job without necessarily prohibiting the employee from working elsewhere.  However, the broad language used by the FTC means that non-solicitation agreements can satisfy the definition of non-compete clause when a non-solicitation clause effectively functions to prevent an employee from seeking or accepting work elsewhere after the termination of their employment.

Agreements and clauses governing the protection of confidential and proprietary information, as well as trade secrets, of Employers, are not seemingly impacted by the Rule.

The Rule also exempts non-compete agreements entered into as part of the sale of a business. Specifically, the Rule “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.” Previous language in the Notice of Proposed Rule Making that a purchaser must be “a substantial owner of, or substantial member or substantial partner in, the business entity” to fall under the exception was not included in the final Rule. Instead, the sale of business will need to be a bona fide sale, which the Rule provides “is one made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule.” The Rule does not specifically address non-competes in the “sale of business” context when there is a transfer of equity as part of compensation contemplated.

In short, the FTC’s Rule, if it were to take effect, would have a substantial impact on businesses in North Carolina and elsewhere that utilize non-competition agreements.

Next Steps

While the Rule is scheduled to take effect on September 4, 2024, it remains highly likely that legal challenges to the Rule could delay its implementation. It is expected that parties challenging the new Rule in Court will ask those Courts to stay the Rule’s implementation pending the litigation.  Such action could delay the Rule’s implementation by months or years.

Against this backdrop, employers may opt to wait and see whether the Rule will take effect later this year before moving forward with notifying employees that the employer will not enforce their non-competes, or employers may want to proactively address the status of the Rule with their employees after consulting with counsel.

Employers should be aware of the possible changes to their business that may accompany the Rule. Tuggle Duggins will continue to monitor the Rule and will issue more guidance to its clients as the Rule evolves. Our employment law team at Tuggle Duggins can help keep you up to date and answer any questions that arise as a result of this Rule.

For more information, please contact Ross Hamilton at RHamilton@tuggleduggins.com or 336-271-5279 or Alex Morgan at AMorgan@tuggleduggins.com or 336-271-5217.

© 2024 Tuggle Duggins P.A. All Rights Reserved. The purpose of this bulletin is to provide a general summary of significant legal developments. It is not intended to constitute legal advice or a recommended course of action in any given situation. It is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature. Moreover, information contained in this bulletin may have changed subsequent to its publication. This bulletin does not create an attorney-client relationship between Tuggle Duggins P.A. and the recipient. Therefore, please consult legal counsel before making any decisions or taking any action concerning the issues discussed herein.

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