FTC bans non-competes effective September 4, 2024

In detail

General provisions of final rule

The final rule imposes a comprehensive ban on existing and new noncompete clauses with all workers on or after the final rule’s effective date, subject to certain exceptions. Franchises and businesses that otherwise fall outside the FTC’s jurisdiction, such as certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and certain tax-exempt entities, are not subject to the rule. Workers for this purpose include natural persons who provide services, whether paid or unpaid, as an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor.

The final rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” The “term or condition of employment” includes, but is not limited to, a contractual term or workplace policy, whether written or oral. Some examples include:

• A contractual term providing that, for two years after the worker’s employment ends, the worker may not engage in any business within a geographic area that competes with the employer unless the worker pays the employer liquidated damages of $50,000;
• A forfeiture-for-competition clause, which extinguishes an obligation to provide promised compensation or to pay benefits because of a worker seeking or accepting other work or starting a business after their employment ends;
• A severance arrangement in which the worker is paid only if they refrain from competing.

In its preamble to the final rule, the FTC notes that while nondisclosure agreements, training repayment agreement provisions, and non-solicitation agreements may not by their terms prohibit a worker from or penalize a worker for seeking or accepting other work or starting a business after their employment ends, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from such activities, then such a term or condition is a non-compete clause under the final rule. 

Observation: Various arrangements to which an analysis applies under Section 83 may include a non-competition provision that an employer treats as a “substantial risk of forfeiture” that impacts the timing of income taxation and/or FICA taxation. If the final rule makes existing non-compete provisions unenforceable in such arrangements, such taxation (and related payroll obligations of an employer) potentially could apply on the effective date of the final rule depending on the applicable terms.

Observation: In its preamble to the final rule, the FTC addresses comments relating to its lack of jurisdiction over nonprofits and relating to requests to clarify that organizations claiming tax-exempt status as nonprofits are exempt from the final rule. The FTC declines and instead summarizes the existing law pertaining to its jurisdiction over nonprofits. The FTC notes that its jurisdiction extends to corporations that are “organized to carry on business for its own profit or that of its members.” Although many tax-exempt organizations likely do not meet this standard, the FTC stresses that not all entities claiming tax-exempt status fall outside its jurisdiction. Many tax-exempt organizations provide severance or other compensation arrangements to which an analysis applies under Section 457(f) and include a non-competition provision that an employer may treat as a “substantial risk of forfeiture” that delays income taxation to the employee. If the final rule applies to a tax-exempt that fails to be a nonprofit under FTC standards, this could result in significant tax consequences not just for the employees in such arrangements but also the tax-exempt organization in relation to certain excise taxes imposed on it under Section 4960 for “excess tax-exempt organization executive compensation” as well as certain reporting obligations under Form 990, Return of Organization Exempt from Income Tax.

The final rule does not apply to non-competes entered by a person pursuant to a bona fide sale of a business entity. It does not limit or affect enforcement of state laws that restrict non-competes where the state laws do not conflict with the final rule, but it preempts state laws that conflict with the final rule. It also does not apply if a cause of action related to a non-compete provision accrued prior to the effective date.

Observation: Section 280G imposes a 20% employee-paid excise tax and disallows a corporate tax deduction for compensation payments made to certain service providers in connection with a change-in-control event of a corporation otherwise subject to Section 280G when the value of those payments exceeds certain thresholds. The value of payments associated with an enforceable non-compete clause currently is excluded from Section 280G and this can be a key factor in mitigating or eliminating Section 280G exposure, particularly in public company transactions. Whether the final rule’s exception for non-competes entered pursuant to a bona fide sale of business can apply will be an important consideration with respect to whether the Section 280G exception applies – for prior and future transactions.