The Beginning of the End for Non-Compete Covenants?

As many of you will have read, on 23 April 2024, the US Federal Trade Commission (FTC) voted to ban non-compete post-termination restrictions in workers’ contracts of employment.

The FTC published what is termed a ‘final rule’ prohibiting employers from entering into any new non-compete covenants on or after the ‘Effective Date’ and prohibiting employers from enforcing existing non-competes save for ‘Senior Executives’. Senior Executives are defined as those earning more than US$151,164 (in salary, commissions, bonuses etc) and who are in a ‘policy making position’; that requirement for a ‘policy making position’ would cover those with authority to make policy decisions for the whole company so would cover the CEO, Chairman etc but it is unlikely to capture most high earners in the financial sector (trader, brokers, asset managers etc) who will therefore enjoy the protection of this new ban.

The anticipated Effective Date is 4 September 2024.

The FTC’s ‘Fact Sheet’ set out the FTC’s rationale for this change which included the following:

1. that such clauses restricted a workers’ fundamental freedom to leave their existing employer for a better job or to start their own business;
2. that they exploit a worker’s lack of bargaining power when accepting a role, and ‘coerced’ workers to stay in jobs they would rather leave or forced people to leave their chosen profession or even relocate;
3. that they restrict the free movement of workers and prevent workers from accepting higher paid jobs;
4. that they reduce the wages of workers who aren’t subject to non-competes;
5. that they block new businesses from hiring qualified workers;
6. that they restrict the flow of knowledge between firms which reduces innovation and that deprives the consumer of better products and lower prices that comes with competition and innovation.

The final rule requires employers to notify affected workers that their non-compete covenants are no longer enforceable and ‘model wording’ for such a notification has been published by the FTC.

Non-competes are still permitted between the seller and the buyer of a business but the seller cannot agree non compete restrictions for any of the workers of the business being sold, only for themselves individually.   Save for that exception, the ban otherwise includes any clause that “prohibits, penalizes, or functionally prevents a worker from getting a different job or starting a business after leaving their employment”. The FTC guides states this includes

1. “Terms and conditions expressly saying that a worker can’t get another job, such as with a competitor, or start a business”
2. “Terms and conditions that require a worker to pay a penalty if they get another job or start a business” and
3. “Terms and conditions that aren’t labelled as non competes but are so restrictive that they effectively prevent a worker from getting a new job or starting a business”.

Non-solicitation and non-dealing covenants remain unaffected by the final rule but unless they are caught by the ‘functional’ anti-avoidance provision referred to above and after the Effective Date the FTC has asked for violations  to be reported to the Bureau of Competition by sending an email to non-compete@ftc.gov.

It is reported that there are a number of legal challenges against this final order which have already been lodged in the US, including an application for a preliminary injunction to stay the Effective Date for which the decision is due to be issued on 3 July 2024. We shall keep you updated on the progress of those challenges.

The UK Government has undertaken its own consultation on the reasonableness of employee non-compete covenants and in the earlier part of 2023 it announced an intention to limit the duration of non-compete clauses to 3 months ‘when parliamentary time allowed’. The rationale for this proposal mirrored some of the reasons given by the FTC for its recent decision, particularly the sense that limiting the use of non-compete covenants would create greater flexibility in the labour market as people find it easier to change jobs and that this would result in a widening of the talent pool which, in turn, would increase productivity. With an election looming, it is hard to see how Parliamentary time will allow for this initiative on this side of the pond but this is clearly a growing movement in both jurisdictions and what is certain is that we can expect changes.

For now, the FTC final rule has the potential to impact those dealing with senior executive exits with carried interest or deferred cash or stock benefits where the rules of such schemes, usually governed by the laws of one of the US states, includes non-compete covenants.

Should you have any queries related to Non-Compete Covenants, or indeed any other employment law related query, please contact Linky Trott or any other member of our Employment Team.

 

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