I've had lots of questions lately about the new rule issued by the Federal Trade Commission that significantly restricts the use of non-compete clauses in employment contracts. This decision, announced in early 2024, aims to enhance labor mobility, foster competition and ultimately benefit both workers and the economy at large. Whether it will actually do so is up in the air.
Non-compete agreements are clauses included in employment contracts that prohibit employees from working for competitors or starting similar businesses for a specified period after leaving a company. Traditionally, employers have argued that these agreements are essential to protect trade secrets, proprietary information and investment in employee training. However, critics have long contended that non-competes are often used excessively and unjustly, stifling competition, suppressing wages and limiting job mobility.
A few years ago, Illinois enacted legislation that restricted the enforceability of non-competes: Employees with a salary of less than $75,000 per year cannot be held to the terms of such agreements. There are exceptions to these restrictions, depending on the specific business circumstances, such as agreements entered into in connection with the sale of a business or dissolution of a partnership. I've also found that many employers are completely ignorant of these developments.
Another fairly recent change in Illinois law on this topic dictates that non-competes must be supported by adequate "consideration" – which is defined as two years of continued employment or payment of additional professional or financial benefits.
Building on this trend, in January 2021, President Joe Biden issued an executive order, Promoting Competition in the American Economy, which specifically encouraged the FTC to address the use of non-compete clauses. This directive underscored the administration's view that these agreements could undermine fair competition and harm workers by locking them into their current jobs.
Acting on that order, this spring the FTC made a particularly aggressive move to broadly ban the use of non-compete clauses across most sectors. The rule applies to both future contracts and existing agreements, requiring companies to rescind any current non-competes and inform employees of this change. It will become effective as of Sept. 4, 2024. If not invalidated by a court, it will reshape the American labor market.
Key provisions of the rule include:
•It generally prohibits employers from entering into or maintaining non-compete agreements with workers. This applies to employees, independent contractors, interns and volunteers. It does not apply to nonprofit entities.
•Companies must actively void existing non-compete agreements and notify affected workers that such clauses are no longer in effect.
•There are few exceptions to this rule. One notable exemption is for non-competes associated with the sale of a business, but only where significant ownership interests are held.
•There is another exception for "senior executives." To fall under this exception, an employee must (a) have a salary of at least $151,000 and (b) be in a "policy-making position." A policy-making position is defined as someone who has policy-making authority to make decisions that control a major aspect of a business.
The new rule is likely to face legal challenges. Critics argue that the FTC has overstepped its authority or that the rule infringes on states' rights to regulate employment contracts. These legal battles could shape the future enforcement and refinement of the rule. Suits challenging the rule have already been filed by the United States Chamber of Commerce and the tax service firm Ryan.
"Companies will face substantial legal costs as they are forced to resort to other tools to attempt to protect their investments," the Chamber of Commerce said. "And the economy as a whole will suffer as startups and small businesses are unable to prevent dominant firms from hiring their best employees and gaining access to their confidential information."
Assuming a court issues a stay or preliminary injunction, employers and employees will be in limbo while the litigation (including appeals) plays out. That being said, I expect that employers will start looking to non-disclosure agreements as an alternative to non-competes. Unlike non-competes, NDAs do not restrict where an employee can work, but they do prohibit the use or disclosure of proprietary information.
Also, keep in mind that non-solicits are not addressed by the FTC's rule. A non-solicit generally prohibits an employee from calling on an employer's clients, customers or using its contact lists after separation of employment. They also typically prohibit soliciting a fellow employee to leave his or her job for another employer. Note, however, that a non-solicit agreement in Illinois will only bind an employee who makes more than $45,000 a year. However, I would not be surprised to see the FTC set out to put restrictions on non-solicits in the future.
