The FTC’s Final Rule banning non-competes in worker agreements contains a noteworthy exception that its provisions “do not apply where a cause of action related to a non-compete clause accrued prior to the effective date.”[1] The “existing cause of actions” exception, codified as Section 910.3(b), is a new addition that was not included in the FTC’s proposed rule issued last January. According to the FTC, Section 910.3(b) was added to the Final Rule in response to commenters who raised concerns that an invalidation or rescission of existing non-competes would be impermissibly retroactive, present due process concerns, and/or constitute an impermissible taking under the Fifth Amendment.[2]  However, it unclear whether this provision satisfactorily addresses these concerns, and it may have raised new concerns of its own.

The plain language of the exception suggests that parties may continue to bring suit for violations of then-existing non-competes after the Non-Compete Rule’s Effective Date, so long as the violation occurred prior to the Effective Date. Certain statements provided by the FTC in the Final Rule appear to support to this interpretation. As stated in the Federal Register, “Section 910.3(b) specifies that the final rule does not apply if a cause of action related to a non-compete provision accrued prior to the Effective Date. This includes, for example, where an employer alleges that a worker accepted employment in breach of a non-compete if the alleged breach occurred prior to the effective date.”[3]

However, other statements by the FTC indicate, rather, that the Commission considers the Effective Date as the cutoff date after which any enforcement action related to then-existing non-competes are prohibited, even if the cause of action accrued prior to the Effective Date.  For example, the FTC declared in the Federal Register that it “adopts § 910.3(b) . . . to be clear that the final rule does not render any existing non-competes unenforceable or invalid from the date of their origin. Instead, it is an unfair method of competition to enforce certain non-competes beginning on the effective date.[4]  No reference is made here excepting causes of action accruing before the Effective Date.

If the FTC intends to foreclose all suits arising from alleged prior violations of employee non-competes from the Effective Date forward, as it statements suggest, there is a marked tension between the FTC’s intended purpose and the plain language of the final rule.

This tension can conceivably be reconciled by interpreting the exception as a concession by the FTC to allow for existing non-competes claims that have accrued and been filed before the Effective Date to continue.  However, to read the additional requirement to file suit into the text contravenes what it means for a cause of action to “accrue.” The United States Supreme Court, for one, has held that a cause of action accrues “when the plaintiff has a complete and present cause of action,” and “when the plaintiff can file suit and obtain relief.”[5]

Under the doctrine articulated by the United States Supreme Court in Auer v. Robbins, deference is typically granted to an agency’s reasonable interpretations of its own genuinely ambiguous regulations unless “plainly erroneous or inconsistent with the regulation.”[6] We believe that the Final Rule’s use of the phrase “cause of action . . . accrued” in the final rule is unambiguous, however, and a contrary interpretation by the FTC would not be protected by Auer deference if challenged in court, particularly after the Supreme Court severely limited the doctrine’s applicability in Kisor v. Wilkie.[7]  

Notwithstanding questions regarding the proper interpretation of the existing causes of action exception, the exception may, by its existence, lend some credence to those who oppose the Final Rule on constitutional grounds. The FTC has given a preview[8] of its arguments as to why it believes the existing causes of action exception insulates the final rule to constitutional challenges for impermissible retroactivity, unlawful takings, and lack of due process.  The question is –  will this exception be enough to allow the Final Rule to survive constitutional challenge on these grounds?

Until the FTC provides further guidance with respect to the existing causes of action exception, it remains uncertain whether a party may face the FTC’s ire for enforcing or attempting a non-compete after the Effective Date for behavior that occurred prior to the Effective Date.  Of course, if the Final Rule is stayed or struck down before the Effective Date, we may never see whether this becomes an issue in practice.  What we anticipate seeing, however, is a flood of litigation in the lead up to the Final Rule’s Effective Date to enforce non-competes whose enforcement will become “unfair” on the Effective Date.


[1] 16 C.F.R. § 910.3(b).

[2] 89 Fed. Reg. 38349 (May 7, 2024).

[3] 89 Fed. Reg. 38341 (May 7, 2024).

[4] 89 Fed. Reg. 38345 (May 7, 2024) (emphasis added).

[5] Wallace v. Kato, 549 U.S. 384, 388, 127 S. Ct. 1091, 1095, 166 L. Ed. 2d 973 (2007) (internal quotations omitted).

[6] Auer v. Robbins, 519 U.S. 452, 117 S. Ct. 905, 137 L. Ed. 2d 79 (1997).

[7] See Kisor v. Wilkie, 588 U.S. 558, 574, 139 S. Ct. 2400, 2415, 204 L. Ed. 2d 841 (2019) (“First and foremost, a court should not afford Auer deference unless the regulation is genuinely ambiguous.); see also Auer v. Robbins, 519 U.S. 452, 117 S. Ct. 905, 137 L. Ed. 2d 79 (1997).

[8] 89 Fed. Reg. 38440-41 (May 7, 2024).

Last year on the Policy Matters podcast, the team explored the fundamentals of non-compete agreements and examined what the adoption of the FTC’s proposed non-compete rule could mean for employers. Today, host Leon Rodriguez is joined by Daniel Hart and Dawn Mertineit to discuss the groundbreaking rule set to shake up non-compete agreements in the workplace, slated for enforcement starting September 4, 2024. Join the speakers as they unpack the rule’s broad implications, mounting legal challenges it faces, and constitutional uncertainties looming over its implementation.

Click here to listen to the full episode.

Dawn Mertineit, partner in Seyfarth’s Trade Secrets, Non-Competes & Data Privacy practice, authored an article titled, “The FTC’s non-compete ban: What to know and how to respond” on International Employment Lawyer.

Another notable limitation is contained in the final rule’s definition of a non-compete. Non-competes do not include clauses that only prohibit a worker from accepting work or operating a business outside the United States. In landing on this definition, the FTC considered various public comments expressing concerns about a final rule that would have an extraterritorial impact. Among those concerns were comments highlighting (1) the potential exacerbation of a shortage of science and technology workers if employers in other countries could more easily poach American workers; (2) other countries’ relatively weaker protections for trade secrets; (3) the greater challenge in litigating trade secret misappropriation claims in some other jurisdictions; and (4) the potential conflict between the rule and certain other statutes or multilateral agreements, such as the Protecting American Intellectual Property Act of 2022 or the World Trade Organization’s Agreement on Trade-Related Aspects of Intellectual Property Rights (“TRIPS”).

While the FTC did not find all the aforementioned concerns to be validated, it nonetheless chose to limit the rule’s application to work performed in the United States. Thus, the final rule (if it goes into effect—more on that below) expressly limits the definition of a non-compete to agreements “that prevent workers from seeking or accepting work in the U.S. or operating a business in the U.S.” In other words, even for workers who do not meet the definition of a “senior executive” or are not otherwise covered by an exception to the rule, an employer can impose a non-compete if it only prevents the worker from accepting a role or operating a business abroad (subject to jurisdictional-specific statutory requirements and common law governing the scope of restrictive covenants, of course). That said, the rule seemingly would still apply to foreign workers to the extent it prevents them from working or operating a business in the United States.

To read the full article, click here.

All bets are off in a Boston-based dispute between DraftKings Inc. and one of its former vice presidents. On April 30, 2024, the District of Massachusetts granted DraftKings a twelve-month preliminary injunction preventing its former Senior Vice President of Growth, Customer, Michael Hermalyn, from violating his restrictive covenants with DraftKings or misappropriating its confidential information.

Background

DraftKings is an online sports and gaming platform based in Boston, Massachusetts. Hermalyn worked as a Senior Vice President at DraftKings until his resignation on February 1, 2024. His role involved developing and maintaining relationships with “VIP” (high-value) customers. As a senior-level employee, Hermalyn had access to detailed information and documents about DraftKings’s key customers, plans for developing celebrities and influencers, and employee compensation.

When he began his employment with DraftKings, Hermalyn executed a Nonsolicitation, Nondisclosure & Assignment of Inventions Agreement whereby he agreed that, for a period of twelve months after his employment with DraftKings, he would not work with or solicit DraftKings’s customers, clients, vendors, or employees as well as any prospective customers, clients, vendors, or employees about whom he learned confidential information. He further agreed to maintain the confidentiality of DraftKings’s information and, upon resignation, immediately surrender such information back to DraftKings. Finally, in exchange for a multimillion-dollar equity grant, Hermalyn agreed to a noncompetition agreement that prohibited him from competing with DraftKings anywhere in the world for a period of twelve months after his resignation. The agreements provided that they were governed by Massachusetts law.

At the start of 2024, Hermalyn discovered he was under investigation by DraftKings for workplace misconduct. He immediately contacted the CEO of Fanatics, a top competitor of DraftKings, to ask about applying for a Vice President position with them. Throughout January 2024, he met with Fanatics’s CEO and executive team to discuss the transition.

On January 26, following DraftKings’s investigation, Hermalyn learned he would be put on a performance improvement plan, receive reduced compensation, and lose his Senior Vice President title, hospitality perks, and executive assistant. The next day, Hermalyn again met with Fanatics’s CEO and was offered a job.

On a January 30 call with DraftKings employees, Hermalyn indicated he was in New Jersey with his family grieving a friend’s passing. He was actually in Los Angeles, staying at the house of Fanatics’s CEO. Hermalyn began moving his lease, driver’s license, car, voting registration, and doctor’s appointments to California in plans of moving there. From January 29-January 31, he did not attend meetings or respond to emails regarding his job at DraftKings.

On February 1, 2024, Hermalyn formally accepted the role of President of Fanatics VIP and Head of Fanatics’s Los Angeles office. The role involved virtually identical “VIP” work as did his job with DraftKings.

DraftKings alleges that, throughout January, Hermalyn improperly transferred and downloaded its proprietary information, starting one day after he contacted Fanatics. The documents at issue include a slide deck described as DraftKings’s “playbook” for its VIP operations, a pitch deck for prospective partners, a compensation spreadsheet regarding thousands of employees, and a spreadsheet describing hundreds of DraftKings’s business partners. DraftKings alleges Hermalyn then engaged in a cover-up, deleting his browsing history, the Dropbox application (which was unauthorized by DraftKings), and scores of files from his work computers. DraftKings also contends that, around the same time, Hermalyn solicited two DraftKings employees who were part of his VIP team. Hermalyn denies all of DraftKings’s allegations.

Both parties took the dispute to the courts. Hermalyn filed suit in California state court, seeking declaratory and injunctive relief to invalidate his restrictive covenants with DraftKings. Four days later, after Hermalyn assumed his Fanatics position, DraftKings initiated an action in the District of Massachusetts, seeking a temporary restraining order. The Court granted the TRO.

DraftKings then moved for a preliminary injunction while Hermalyn moved to dismiss or stay the suit. The Court granted the preliminary injunction, finding DraftKings had established a sufficient likelihood of success on the merits of its claims that Hermalyn had breached his restrictive covenants and misappropriated DraftKings’s trade secrets.

Restrictive Covenants

As to Hermalyn’s noncompetition agreement, the Court emphasized that Hermalyn was a “highly compensated senior executive with access to some of the company’s most confidential information” who was “uniquely positioned” to misuse DraftKings’s trade secrets. As a result, the noncompetition agreement was no broader than necessary to protect DraftKings’s legitimate interests. However, the Court found the global reach of the noncompete overbroad, reducing it to a nationwide scope.

The Court found the non-solicitation agreement similarly enforceable, finding it necessary to prevent the misuse of DraftKings’s confidential employee and customer information. The Court held an evidentiary hearing to weigh the credibility of the DraftKings employees Hermalyn allegedly solicited, and the Court found them credible while concluding, when compared to the employees’ testimony and the documentary evidence, “Hermalyn has struggled with candor to the Court.” Therefore, DraftKings had demonstrated a likelihood of success on its claim that Hermalyn wrongfully solicited its employees. However, the Court found insufficient evidence to indicate breach of the non-solicitation agreement as it pertained to DraftKings’s customers.

Finally, the Court also sided with DraftKings as to Hermalyn’s breach of his non-disclosure agreement. It determined that, at a minimum, evidence indicated Hermalyn had failed to immediately surrender confidential DraftKings materials back to the company, instead storing files on unauthorized file-sharing websites or across devices. Overall, DraftKings had sufficiently supported its breach of contract claims to justify injunctive relief.

Misappropriation Claim

The Court similarly found that DraftKings had established the information at issue constitutes a trade secret and had taken reasonable measures to ensure its confidentiality. The Court stressed the economic value of business strategy and relationship information contained in many of the documents. Hermalyn did not dispute the reasonableness of DraftKings’s protective measures, and the Court found this element of the misappropriation claim “easily satisfie[d]” given DraftKings’s use of confidentiality agreements, encrypted laptops, and other protections.

The Court also found DraftKings had sufficiently demonstrated that Hermalyn used improper means to obtain and disclose the trade secrets. Specifically, Hermalyn transferred various documents to himself, in part by using company devices and programs beyond their authorized use. Two alleged trade secrets documents had, in fact, been accessed while in the home of Fanatics’s CEO. The Court noted the various “memory lapses, evidentiary gaps, and inconsistencies in Hermalyn’s account of his interactions with DraftKings’s confidential documents” that led it to discredit his arguments.

Given the strong risk of harm to DraftKings by allowing a direct competitor to unfairly leverage its proprietary information, the Court issued a preliminary injunction precluding Hermalyn from violating his restrictive covenants for twelve months following his February 1, 2024 resignation or from misusing DraftKings’s confidential information. Hermalyn immediately moved to appeal the order.

Hermalyn’s Arguments

Hermalyn made various arguments that were rejected by the Court. First, he argued that California law should apply to his restrictive covenants, but the Court rejected his argument that, as the place Hermalyn purported to move to mere days before his resignation, California had a more significant relationship to the dispute. Second, he sought dismissal on forum non conveniens grounds. However, the parties had agreed to a forum selection clause that Hermalyn had not argued was invalid. Public interest factors did not favor disregarding an enforceable forum selection clause based on Hermalyn’s minimal connections to California. Finally, Hermalyn sought a stay of the case under Colorado River abstention. Hermalyn had filed his own suit in California state court to deem his restrictive covenants invalid. He asked that the Court stay the Massachusetts action pending resolution of the California action. However, the Court noted that the California case would not resolve all of the claims at issue in the Massachusetts case, as required for abstention, because trade secrets and common law claims would remain at issue.

Meanwhile, as discussed briefly by the federal court, the Los Angeles County Superior Court has yet to rule on Hermalyn’s request for a preliminary injunction, allow discovery, or discuss any jurisdictional issues that may be raised. Thus far, Hermalyn has lost his initial motion for a temporary restraining order in California state court, and the case remains in its early stages.

Conclusion

Even at this early stage of the proceedings, the Court openly expressed its skepticism of Hermalyn’s account. As technology has made it easier than ever to assess what company documents were accessed and how, including on what network (within what CEO’s house, no less), employers have substantial ability to monitor and address misconduct and misappropriation.

Plaintiff Fujikura Composite America, Inc. (“Fujikura”) is one of the most prominent golf club shaft designers and manufacturers. Per Fujikura, in the 2022-2023 PGA Tour season, half of all PGA tournaments were won by a player using a Fujikura shaft.

On May 1, 2024, in the United States District Court for the Southern District of California, Fujikura sued Alexander Dee, a former golf shaft engineer, and his new competing business, Aretara Golf. Fujikura alleges that Dee took certain shaft prototypes with him when he left his employment and used those prototypes to create competitive Aretera shafts that bear technical, branding, and visual similarities to unreleased Fujikura shafts. Fujikura claims to have analyzed Aretera shafts through an electron microscope and determined that certain shafts had identical features to some Fujikura shafts. Fujikura claims that Dee and Aretera misappropriated its trade secrets and that Dee breached his non-disclosure obligations to Fujikura.

While only one side of this story has been told so far, Fujikura’s allegations illustrate why non-compete agreements provide necessary protection for some businesses and why non-disclosure agreements and trade secret laws are sometimes insufficient. Presumably, to prove its case Fujikura will need to find actual evidence that Aretera had access to and used Fujikura’s prototypes. On the other hand, if Dee was subject to an appropriate non-compete agreement, Fujikura would be more likely to obtain an injunction precluding Dee from working at Aretera and developing competing products without the necessity of proving actual misappropriation and disclosure of Fujikura information.

Some states, like California where this lawsuit is pending, have already made the determination that non-competes are invalid except for certain limited exceptions. The vast majority of other states, however, have balanced interests differently and in many instances opted to allow non-compete agreements provided that such agreements are used with appropriate employees and drafted no broader than necessary to protect the employer’s legitimate business interests. This scenario stands as yet another example why the FTC’s wholesale ban on non-compete agreements is divorced from the reality that many businesses experience.

The district court in the Northern District of Texas recently set the briefing schedule on Plaintiff Ryan’s Motion to Stay the FTC Non-Compete Ban and Preliminary Injunction:

  • The Court ORDERS Defendant FTC to file any opposition to Plaintiff Ryan’s Motion for Stay of Effective Date and Preliminary Injunction, by May 22, 2024.
  • The Court further ORDERS Plaintiff Ryan to file any reply in support of its Motion by June 5, 2024.
  • The Court will issue a decision on the merits of Plaintiff Ryan’s Motion by July 3, 2024.
  • If the Court determines a hearing on the merits of Plaintiff Ryan’s Motion is warranted, the Court sets the date for the hearing as June 17, 2024.
  • By June 6, 2024, the Court will notify the parties if a hearing will be held on June 17, 2024.

The U.S. Chamber of Commerce has moved to intervene as a plaintiff in the case.

The Court subsequently granted that motion and issued a new briefing schedule as follows:

The Court finds that Intervenors’ motion is timely, they have an interest in the subject of the action, the disposition of this action may impair or impede their interest, and their interest may be inadequately represented by the existing parties. The Court further finds that Intervenors have a claim that shares a common question of law or fact with this action and that permitting intervention will not unduly delay or prejudice the adjudication of the original parties’ rights. Thus, it is ordered that Intervenors’ Motion to Intervene as Plaintiffs is hereby GRANTED.


Further, upon review of Defendant Federal Trade Commission’s position on the briefing schedule if intervention is granted, the Court MODIFIES the existing briefing schedule on injunctive relief, (see ECF No. 31), as follows:

  1. May 29, 2024: Deadline for Defendants’ consolidated response, with word limit of 4,250.
  2. June 12, 2024: Deadline for Intervenors’ and Ryan, LLC’s replies.
  3. June 13, 2024: Deadline for Court to notify the parties if a hearing will be held on June 17, 2024.
  4. June 17, 2024: Potential hearing date on Intervenors’ and Ryan, LLC’s motions to stay, if the Court deems it necessary.

It still appears that the Court will issue a decision by July 3rd in this important case.

We invite you to watch our webinar, “Deciphering the FTC’s Non-Compete Ban: Navigating the New Regulatory Terrain and Adequately Protecting Employers’ Interests.” Our multi-disciplinary team, comprised of Michael Wexler, Robert Milligan, Kate Perrelli, Suzie Saxman, Marc Fosse, and Cary Burke, dissected the ramifications of the new FTC rule banning most non-competes with workers and provided invaluable insights into how it impacts a variety of aspects of many businesses. 

Here are the key takeaways from the webinar:

  • Labor: The FTC rule is just the latest salvo in President Biden’s “whole of government” approach relating to restrictive covenants. For over a year, the NLRB’s general counsel has taken the position that restrictive covenants agreements as applied to non-supervisory employees are unlawful. With both the NLRB and FTC cracking down on non-competes, employers may wish to take this opportunity to revisit their practices with respect to restrictive covenants.
  • Trade Secrets: As the FTC Rule is the subject of pending legal challenges, it is a good time to review your restrictive covenant agreements, including non-competes, to make sure they comply with state laws. If the Rule becomes effective, other restrictive covenants will become even more important to protect business assets. If the Rule does not become effective, you have the benefit of having audited your agreements for state compliance.
  • M&A: While buyers in an M&A transaction will generally be able to benefit from non-competes given by sellers, with the FTC Rule, it will be more difficult to obtain enforceable non-competes from worker/sellers who hold small shares of the target and are not involved in negotiating the terms of the sale. M&A buyers will need to develop alternatives to a “one size fits all” approach to non-competes.
  • Employee Benefits: This is a good time to analyze the potential scope of employees who would have non-grandfathered agreements. For example, analyze now which employees in a nonqualified deferred compensation plan with a post termination noncompete and who are part of a top hat group would also be treated as senior executives.
  • Compliance: September 4, 2024 is the current scheduled effective date of the FTC Rule. Prudent employers should carefully follow whether the Rule is vacated and the FTC is enjoined from enforcing the Rule. At a minimum, employers should be prepared to send the required notices if there is no injunction prior to the effective date.  Employers should compile a list of impacted current and former employees, with relevant contact information and determine whether any of the impacted employees qualify for the “senior executive” and evaluate whether there are “senior executives” who should sign non-competes prior to the rule’s effective date. Model notice language is included in the FTC Rule and can be delivered by email or text message, or by delivering a paper notice by hand or mail. The notices must be sent before the effective date of the rule. But for right now employers should carefully monitor the federal action brought in the Northern District of Texas seeking to vacate the Rule and enjoin the FTC from enforcing it.

To view the webinar recording, click here.

On May 3, 2024, the United States District Court for the Eastern District of Texas entered an Order staying the proceedings in Chamber of Commerce v. FTC by granting the FTC’s motion to apply the first-to-file doctrine, in which a district court should generally order “stay, transfer, or dismissal” of a second-filed action that substantially overlaps with a pending, first-filed action—in this case, Ryan, LLC v. FTC.


The Court’s Order found that the first-to-file rule required the Eastern District’s deference to the Northern District’s action in Ryan because the two cases’ procedural postures were roughly the same, “the substantial overlap between the cases and the comity factors support consolidation, and Ryan is the first-filed case.”


Although the Court found a transfer or consolidation of the two pending cases would avoid duplication of judicial effort, potentially inconsistent judgments, and piecemeal litigation, it nonetheless questioned its authority to do so. Therefore, the Eastern District elected to stay proceedings in the Chambers case to allow the Chamber of Commerce to seek either intervention or addition as parties in the Ryan case, which we expect to occur.


As a result, the remaining unexpired deadlines in the Court’s briefing schedule are lifted, and the proceedings are currently stayed. The Order also requires the Chamber of Commerce to notify the Court if its claims are accepted in Ryan, or denied.


The Northern District of Texas, meanwhile, entered an Order on May 2, 2024, requiring the FTC respond by 5:00 p.m. CT on May 7th to the Ryan Plaintiff’s emergency motion for an expedited briefing schedule for its request for a preliminary injunction and stay of the Non-Compete Rule. The FTC had previously requested 21 days to respond to Plaintiff’s motion to expedite briefing. The Ryan Plaintiff also recently amended its pleadings to elaborate on its arbitrary-and-capricious claim and seek an order vacating the Non-Compete Rule under the Administrative Procedure Act (APA), which would apply a vacatur of the Non-Compete Rule to parties and non-parties alike, if granted.


As it currently stands, we should see the FTC’s response to the Ryan Plaintiff’s motion by Tuesday, May 7, 2024, in addition to the Chamber of Commerce’s efforts to join the Ryan suit, with the Court’s schedule on Plaintiff’s request for a preliminary injunction to shortly follow.

Last week on April 23, 2024, the FTC adopted a final rule that would effectively ban non-compete agreements in the context of employment relationships when the rule becomes effective on September 4, 2024, absent a stay or injunctive relief.  The rule would render unenforceable a broad array of employment-based non-competition agreements.  It would also require that employers provide notice to workers that certain non-competition agreements already entered into will not be and cannot be enforced.  Not surprisingly, before the weekend, at least three different lawsuits had been initiated challenging the validity of the FTC’s final rule as adopted. For firms engaged in M&A activity, investors and their advisors, they should carefully track whether the rule is struck down as it may impact standard buyer protection strategies with key employees of the target.

What the Rule Says

The core of the rule is found in 16 CFR 910.2(a), which states that it is an unfair method of competition under the Federal Trade Commission Act for an employer to enter into, attempt to enter into, enforce or attempt to enforce a non-compete clause against a worker.  The term “worker” is defined as a natural person who works for the employer and the term expressly includes independent contractors.  The term “non-compete clause” is defined very broadly as a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from, seeking or accepting employment after conclusion of employment or from operating a business in the United States after conclusion of employment.  Workers defined as “senior executives” are treated differently: while it is still an unfair method of competition to enter into a non-competition agreement with a senior executive after the effective date of the rule, employers are permitted to enforce non-compete clauses entered into with a senior executive before the effective date of the rule.

Limited Impact in M&A

As a general matter, the FTC’s final rule does not apply to non-compete arrangements entered into by a person pursuant to a bona fide sale of a business entity, sale of the person’s ownership interest in the business entity or sale of all or substantially all the assets of a business entity’s operating assets. 16 C.F.R. § 910.3(a). The language of the rule is unclear whether “sale of a business entity” requires sale of 100% of the interests in the business entity or whether a smaller stake, perhaps a mere majority interest, is sufficient to qualify as a “sale of a business entity”.  Despite this ambiguity, firms engaged in M&A activity can expect that non-compete  clauses will continue to be enforceable against sellers of business entities, at least, in the regular course, which among other things allows for allocation of purchase price to the non-compete for tax purposes. Seasoned corporate practitioners may raise an eyebrow to the use of the term “bona fide” in describing the exemption from the rule. Ostensibly the FTC seeks to limit employers from engaging in a “sham transaction” of a business interest to secure the benefit of the exemption in the proposed rule  Buyers of businesses will need to undertake due diligence around the enforceability of non-compete clauses purporting to bind key employees of the target company; some of those non-compete clauses may have been rendered unenforceable and constitute violations of the new rule. .

Major Impact in Capital Markets

While the FTC’s final rule may be of modest impact to those engaged in M&A work, those engaged in deploying growth capital will have a more complicated road ahead in connection with the FTC’s new rule. There is no exemption for non-compete clauses entered into as a condition for investing capital into early stage and growth companies. While sales of businesses are priced on established multiples or other well-understood pricing mechanisms, venture capital investors, private equity investors deploying growth equity, and other capital providers often find themselves betting on a prospective portfolio company’s management team to execute on business plans and pro forma projections. Accordingly, the human capital risk is heightened, and in the absence of a secondary liquidation of equity interests of the management team, investors who usually condition their capital on the management team members entering into non-compete arrangements will find that this tool is no longer available to them when it comes time to protect their investment

A Reprieve for Non-Competes with Senior Executives

In a change from the FTC’s initial proposed rule, the final rule does not impact existing   non-compete arrangements with “senior executives” who meet certain duty and remuneration thresholds, but this is not a solution for prospective non-compete arrangements with senior executives after the effective date. 16 C.F.R. § 910.1.

Near Term Mitigations

While venture capital and private equity investors will invariably be waiting to see how the litigation filed immediately on the heels of the FTC’s announcement shakes out, it is perhaps more important than ever to begin considering whether transaction terms protect capital providers.

  1. A common-place exercise in the venture capital world, asking members of an operating team to “re-vest” their equity, will likely creep upmarket as a regular term in any investment transaction that does not include a liquidation of existing ownership interests.
  2. In later-stage transactions wherein capital providers are providing capital in tranches, we will likely begin to see more covenants regarding the operating team continuing their employment with the issuer at the time of each tranche of capital is disbursed, more akin to private credit arrangements.
  3. The FTC rule incentivizes the  use of confidentiality clauses and trade secrets protection language to limit unfair competition by departing members of the management team and may result in an uptick litigation for such breaches, but less certainty compared to non-compete enforcement.

A Need for Vigilance and New Thinking

Broader in title than it is in fact, the FTC’s final rule on non-competes certainly gives rise to concern for those engaged in corporate transactional matters and more for those involved in emerging growth and middle-market capital formation. For capital providers the specter of allocating capital to an issuer or borrower who subsequently loses some or all its differentiating operating team is real.

Perhaps more than ever before, financial incentives for retention, perfection of intellectual property rights, and culture must be revisited and enhanced.


To learn more about the FTC’s final rule on non-competes and its implications, join us for our webinar on Friday, May 3, 2024.

On April 23, 2024, the Federal Trade Commission (FTC) voted in a 3 to 2 decision along party lines to adopt its Final Non-Compete Clause Rule (“Noncompete Rule”) banning post-employment non-compete clauses between employers and their workers. The Noncompete Rule is scheduled for publication in the Federal Register on May 7, 2024, giving the rule an Effective Date of September 4, 2024, pending any efforts to block the rule.

As anticipated, the Noncompete Rule was immediately met by legal challenges from business interests who assert that the FTC has brazenly overstepped its authority. Within hours of the Noncompete Rule’s announcement, the first lawsuit was filed against the FTC in the Northern District in Texas in Ryan, LLC v. Federal Trade Commission.[1] 3:24-cv-00986. The United States Chamber of Commerce, the nation’s largest business advocacy group, had announced prior to its unveiling that it planned to file suit to block the rule should the Agency vote to ban non-compete agreements. It followed through on its plans in a lawsuit filed this past Wednesday in the Eastern District of Texas.[2] As of the date of filing, a third lawsuit was filed against the FTC, its Chair Lina Khan, and each of the Commissioners in their official capacities on Thursday in the Eastern District of Pennsylvania which may potentially set up a circuit split for the Supreme Court’s review.[3]  We expect these three suits to be merely the tip of the iceberg.

The court in U.S. Chamber of Commerce v. FTC has set a scheduling order for Chamber’s motion for a preliminary injunction that, after entertaining any forum challenges, gives the FTC until May 31st to respond or file a motion for summary judgment, until June 12th for the Chamber’s reply and opposition to summary judgment, with all motions fully briefed by June 19th. From there, the Court will set a hearing on preliminary relief and summary judgment, and if necessary a consolidated bench trial, on a date close to the completion of briefing that should allow sufficient time for resolution of the case before the Noncompete Rule’s effective date for any desired appellate review.  

Each of the lawsuits offer similar grounds for challenging the Noncompete Rule, namely that: (1) the FTC lacked or exceeded the statutory authority to issue the Noncompete Rule, (2) the Noncompete Rule is an unconstitutional delegation of legislative power, and (3) the Noncompete Rule is arbitrary and capricious. The challengers’ arguments expose the infirmities of the Noncompete Rule in its current form, and in the months ahead, the courts will be tasked with answering the following questions.

  1. Did the FTC lack the statutory authority to issue the Noncompete Rule?

    The FTC claims to derive its authority to issue the Noncompete Rule from Section 5 of the FTC Act, which declared unlawful “unfair methods of competition,” and Section 6, which authorizes the Agency “to make rules and regulations for the purpose of carrying out the provisions” of the Act. The challengers to the Noncompete Rule, however, argue that the Agency relies on novel interpretations of the FTC Act to promulgate substantive rules as it never has in its 114-year history. The FTC previously acknowledged in its notice of proposed rulemaking (NPRM) in the lead up to the final Noncompete Rule that it has never before used its rulemaking authority to regulate employee non-compete agreements.[4]

    This places the Noncompete Rule squarely within the Major Questions Doctrine, a rule of constitutional interpretation holding that, when delegating rulemaking authority to agencies on questions of vast economic and political significance, Congress must provide clear and direct authority to the agency to do so, and the court will not defer to agency interpretations of its own enabling statutes.[5] The Court has previously applied the Major Questions Doctrine when agencies have claimed substantial new regulatory power over important economic areas,[6] or when the regulation will have a substantial aggregate economic impact.[7] In 2022, the Supreme Court invalidated the EPA’s renewable energy clean air regulations and OSHA’s vaccine mandate for private sector workers based on the Major Questions Doctrine, which recognizes that, when delegating rulemaking authority to agencies on questions of vast economic and political significance, “Congress does not usually ‘hide elephants in mouseholes.’”[8] The same reasoning is likely to apply here.

    Non-competes have been a matter of political significance over the past several years, with numerous states enacting new laws restricting use of non-competes with low-wage workers. As we have previously reported here, in the past few years, Congress itself has considered, but failed to enact, numerous bills that would have banned or placed limitations on use of non-competes with workers. See VA Hiring Enhancement Act (H.R.3401) (to void non-competes for physicians going to work at VA hospitals); Workforce Mobility Act of 2021 (H.R.1367) (to ban employee non-competes); Workforce Mobility Act of 2021(S.483) (same); Freedom To Compete Act of 2022 (S.2375) (to ban non-competes for workers who are not exempt under the Fair Labor Standards Act); Restoring Workers’ Rights Act of 2022 (H.R. 8755) (same); FTC Whistleblower Act of 2021 (H.R.6093) (to void non-competes for whistleblowers to the FTC); Employment Freedom for All Act (H.R.5851) (to void non-competes for any employee who is fired for not complying with their employer’s COVID-19 vaccine mandate).

    1. Does the Noncompete Rule violate the Non-Delegation Doctrine?

      Next, the challengers argue that, even if Congress had given the FTC authority to make rules on non-competes, such authority would be an impermissible delegation of authority under the Non-Delegation Doctrine. Article I of the Constitution provides that “[a]ll legislative Powers herein granted shall be vested in a Congress of the United States.” Accordingly, the U.S. Supreme Court has held that Congress may not transfer to another branch “powers which are strictly and exclusively legislative.” Although Congress may grant executive agencies substantial discretion to implement and enforce the laws it creates, it must still “lay down by legislative act an intelligible principle to which the person or body authorized to [exercise that authority] is directed to conform.”[9] The FTC’s authority for its noncompete ban again rests on its broad interpretation of Section 5 of the FTC Act that makes “unfair methods of competition” unlawful, but the Act itself provides no real intelligible principle to guide the Agency’s decision-making or discretion as would be required to survive judicial scrutiny. Even if Congress had intended to delegate to the FTC the power to make rules regarding employee noncompetes, the Agency’s vague reference to the phrase “unfair methods of competition” in Section 5 is too broad to meet this standard or pass constitutional muster.

      Though the FTC will argue the doctrine of “Chevron deference” will save its rulemaking here, that is unlikely to be successful. The 40-year-old doctrine requires federal courts to defer to an agency’s reasonable interpretations of gaps and ambiguities in statutes they implement, but it has also faced significant legal challenge in recent years. In January 2024, the Supreme Court heard oral arguments in two cases, Loper Bright Enterprises v. Raimondo[10]and Relentless, Inc. v. Department of Commerce,[11] which seek to overrule Chevron. It is expected that the Supreme Court Justices will do so, or significantly limit Chevron deference once and for all which could spell doom for the Noncompete Rule.

      1. Is the Noncompete Rule is arbitrary and capricious?

        In addition to the FTC’s dubious claim of authority, the legal challenges take aim at the Noncompete Rule itself as arbitrary and capricious. The lawsuits claim that the FTC failed to properly take into consideration the vast economic impact of such a radical shift in policy, including the lost prior expectations of employers and workers who are parties to existing non-compete agreements.

        The U.S. Chamber of Commerce points out that the Noncompete Rule imposes considerable retroactive consequences on businesses and workers in every sector of the economy, and if implemented, “will unilaterally void almost every existing noncompete agreement, thereby disrupting the settled expectations of parties that rely on the enforceability of reasonable noncompete agreements and depriving those who have given consideration for such agreements of the benefits of their bargain.”[12]

        Moreover, the legal challenges assert that the Noncompete Rule upends centuries of established contract law as noncompetes have been enforceable contracts since before the Nation’s founding. Indeed, enforcement of non-competes has been a feature of English common law since the early 18th century,[13] and they were not uncommon in 1914, when Congress passed the FTC Act. This raises the question of whether the purported benefit of the Noncompete Rule to workers and the economy as a whole touted by the Agency outweighs the costs to employers who have long relied on the expectation of enforceable noncompetes to protect their specialized training, investment, and confidential information and whether the FTC engaged in reasoned decision-making or considered reasonable alternative proposals to its categorical ban.

        CONCLUSION

        Ultimately, we believe that the answer to each of these questions above is likely to be a resounding “yes,” and that the FTC’s Noncompete Rule is unlikely to be upheld in its current form. Further, we expect more lawsuits to come and that a successful court challenge on any of the bases outlined above would result in an injunction, at a minimum, staying implementation of the Noncompete Rule pending further court order or agency action. Such injunctive relief is likely to occur at the outset of litigation and prior to the Noncompete Rule’s Effective Date.


        [1] Ryan, LLC v. Federal Trade Commission, Case No. 3:24-cv-00986, in the United States District Court for the Northern District of Texas.

        [2] Chamber of Commerce of the United States of America, et al. v. Federal Trade Commission, Case No. 6:24-cv-00148, in the United States District Court for the Eastern District of Texas (Tyler Division).

        [3] ATS Tree Services, LLC v. Federal Trade Commission, et al., Case No. 2:24-cv-01743, in the United States District Court for the Eastern District of Pennsylvania.

        [4]https://www.tradesecretslaw.com/2023/01/articles/ftcs-crackdown-on-non-competes/answering-the-296-billion-question-ftcs-proposed-rulemaking-on-worker-non-competes-likely-to-be-found-unconstitutional/#more-12135

        [5] See West Virginia v. Environmental Protection Agency, 142 S. Ct. 2587, 2622 (2022) (striking down EPA Affordable Clean Energy rules); National Federation of Independent Business v. Department of Labor, Occupational Safety and Health Administration, 142 S. Ct. 661, 669 (U.S. 2022) (striking down OSHA emergency temporary standard mandating COVID-19 vaccine or testing for private sector workers).

        [6] West Virginia v. Environmental Protection Agency, 142 S. Ct. 2587, 2622 (2022).

        [7] See, e.g., Texas v. United States, 809 F.3d 134, 181 (5th Cir. 2015).

        [8] See, e.g., West Virginia v. Environmental Protection Agency, 142 S. Ct. at  2622-2623 (citing Whitman v. American Trucking Assns., Inc., 531 U.S. 457 (2001)).

        [9] See Gundy v. United States, 139 S.Ct. 2116, 2123 (U.S. 2019) (“Congress does not usually ‘hide elephants in mouseholes.’”) (citing Mistretta v. United States, 488 U.S. 361, 372 (1989)).

        [10] Loper Bright Enterprises v. Raimondo (S. Ct. Docket No. 22-451).

        [11] Relentless, Inc. v. Department of Commerce (S. Ct. Docket No. 22-1219).

        [12] Chamber of Commerce of the United States of America, et al. v. Federal Trade Commission, Case No. 6:24-cv-00148.

        [13] Mitchel v. Reynolds, 24 Eng. Rep. 347 (Q.B. 1711).