Non-Compete Contracts: Legally Undead

Contracts restraining competition by former employees and contractors have always faced enforcement headwinds, differing state-by-state in their strength and direction. California is most hostile; there, a statute purports to protect all residents from noncompete enforcement, even people who moved to California to beat a valid lawsuit filed elsewhere. Mississippi courts have been among the friendliest to enforcement petitions. All Congressional efforts to federalize non-compete law have failed.  But recently, two federal agencies have attempted bureaucracide. The General Counsel of the National Labor Relations Board is trying to kill hourly workers’ non-compete contracts for violating the National Labor Relations Act. More broadly, the Federal Trade Commission prohibited almost all non-competes effective September 4, 2024. This article explains the FTC’s proposed rule and the consequences of its recent defeat in a Texas federal court.

The Rule

The prohibition is in the form of a new “Non-Compete Clause Rule,” 16 C.F.R. Part 901, published in the May 7, 2024 Federal Register. It applies to all who work for an FTC-regulated entity. With just a few exceptions, “workers” includes Form W-2 employees and many independent contractors. The FTC regulates most private businesses and some government entities that function similarly to private businesses – county hospitals, for example – unless their authorizing legislation empowers those public entities to engage in such anti-competitive practices. Most non-profits are exempt from FTC regulation, and that gives them a competitive advantage. If the Rule takes effect, unregulated non-profits may poach employees from regulated businesses, sign those new hires to non-competes that the FTC can’t touch, and then sue if FTC-regulated competitors engage in competitive poaching.

Banned non-competes include contracts and non-contractual statements of policy that communicate materially adverse consequences for competition after the relationship ends. Formalities don’t matter. If a contract or policy statement restrains future worker competition, the Rule treats it as a functional non-compete. While the Rule purports to permit trade secret protection by nondisclosure agreements, some NDAs may fail this functional test.

There are a few important carve-outs. The Rule does not apply to non-compete clauses that bind the seller of a business. 16 C.F.R. § 910.3(a). It does not apply to an enforcement claim that accrued before the Rule’s effective date. 16 C.F.R. § 910.3(b). It permits non-compete clause enforcement against a “senior executive” after the Rule’s effective date if the clause became binding before the Rule’s effective date. 16 C.F.R. § 910.2(a)(2). A “senior executive” is a worker who –

1. Was in a policy-making position; and
2. Received from a person for the employment:

• Total annual compensation of at least $151,164 in the preceding year; or
• Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or
• Total compensation of at least $151,164 when annualized in the preceding year prior to the worker's departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.
• Total annual compensation is based on the worker's earnings over the preceding year. Total annual compensation may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during that 52-week period. Total annual compensation does not include board, lodging and other facilities as defined in 29 CFR 541.606 and does not include payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other similar fringe benefits.

16 C.F.R. § 910.1.

Litigating the Rule

Most employers that depend on non-competes seem to have bet on a judicial blockade of the FTC Rule. Several regulated entities and trade associations, including the U.S. Chamber of Commerce, promptly sued to enjoin FTC enforcement of the Non-Compete Clause Rule. In order of filing, the suits are Ryan LLC v. Federal Trade Commission, N.D. Tex. 3:24-cv-986 (Judge Ada Brown), ATS Tree Services LLC v. Federal Trade Commission, E.D. Pa.  (Judge Kelley Hodge); Properties of the Villages, Inc. v. Federal Trade Commission, M.D. Fla. 5:34-cv-316 (Judge Timothy Corrigan). Appeals from those decisions may be made to the Fifth (New Orleans), Third (Philadelphia) and Eleventh (Atlanta) Circuit Courts of Appeals, respectively. The U.S. Supreme Court may decide to hear further appeals, in its discretion.

Three preliminary rulings split on three basic questions: (1) Whether Congress gave the FTC authority to issue a substantive rule on this “unfair method of competition”; (2) If so, whether the Rule is arbitrary and capricious; and (3) If FTC enforcement of the Rule should be prohibited, who should be protected by that prohibition.  Judge Brown (N.D. Tex., Trump nominee) preliminarily prohibited FTC enforcement only as to the original parties contesting the Rule, not including association members.

Judge Corrigan (M.D. Fla., Bush nominee) entered a similarly narrow order. Judge Hodge (E.D. Pa., Biden nominee) permitted enforcement. Waves of briefs were filed by genuinely interested non-parties and by just plain busybodies denominated amici – “friends of the court.”

On August 20, 2024, Judge Brown entered a final judgment setting aside the FTC Rule under the Administrative Procedure Act, ruling that Congress did not give FTC authority to make the Rule and that, even if FTC had that authority, this particular exercise is arbitrary and capricious. That judgment forbids FTC Rule enforcement against anyone anywhere in the United States, pending appellate review.

Review by U.S. Circuit Courts of Appeal probably will stretch well into 2025, which suggests that a final Supreme Court opinion will be published in June 2026, at the earliest.

Surviving the Rule

Should enforcement bans be lifted on appeal, the FTC will be free to start enforcing the Rule by administrative proceedings leading to cease and desist orders, and then to hefty civil fines for disobedience. Targeted business would spend heavily to fight a losing administrative battle and would find it hard, during that battle, to enforce any non-compete. Very likely, your employees and contractors would treat the FTC’s action as a “get out of jail free” card.

Even if the FTC targets others, its ability to target you would make non-compete enforcement more difficult, time-consuming, and expensive. Opposing counsel would play the FTC card in defense of your non-compete enforcement claims, copying the FTC, requesting administrative action against you.

For those who could find themselves in that pickle, there would be no one size fits all solution. The protections that seem to be offered by federal and state trade secret laws usually are found to be less than met the reader’s eyes. Very rarely will a civil trade secret suit recover enough to cover losses plus the expense of proceedings. If you can’t find an aggressive prosecutor to bring criminal charges, you may have no adequate remedy.

The most common coping strategy probably would substitute a creative NDA for the employer’s current non-compete contracts.  An across-the board swap-out would need to comply with the laws of the likely enforcement states, and some states have peculiar requirements. Alabama, for example, requires that both parties sign after employment commences. There, offer letters won’t usually work. Some states will honor your contact’s choice of law provisions; others won’t. And even in the friendliest states, the equitable remedies you would need early in the case are granted, or not, within a wide zone of judicial discretion. Your judge may like your case, or you, or your lawyer, or not, and you would be stuck with that. The key would be to have an enforceable contract that courts would consider fair and that former employees would worry about breaking. 

Here’s the long and short of it: non-compete contracts today are like Leslie Nielsen’s Dracula character. FTC hostility may yet kill them completely, but today they’re “dead and loving it.”