The Federal Trade Commission (FTC) has recently issued a final rule that marks a significant shift in the employment landscape across the United States. This rule effectively bans non-compete clauses, which have long been a staple in employment, business purchase, and franchise agreements. Here’s what you need to know about this groundbreaking decision and its implications for franchise relationships.
Understanding the Ban
On April 23, 2024, the FTC announced a final rule that prohibits non-compete clauses nationwide. This decision is aimed at promoting competition, fostering innovation, and facilitating new business formation. The FTC’s Chair, Lina M. Khan, emphasized that non-compete clauses have historically suppressed wages, stifled new ideas, and hindered economic dynamism in violation of Section 5 of the FTC Act. The rule is set to take effect on August 22, 2024.
The final rule defines “non-compete clause” broadly, encompassing any employment term that restricts a worker from seeking or accepting work or operating a business after their employment ends. It introduces several key changes:
- Prohibition of New Non-Compete Clauses: Employers are banned from entering into or attempting to enforce new non-compete agreements with workers.
- Unenforceability of Existing Clauses: Current non-compete agreements with workers, except for those qualifying as “senior executives,” will become unenforceable.
- Notice Requirement: Employers must inform employees bound by non-compete clauses that these will not be enforced against them
Exceptions
While the rule is comprehensive, it does allow for narrow exceptions.
Notably, non-compete clauses are permissible as part of a bona fide sale of a business.
With respect to franchise relationships, the FTC’s rule has sparked discussions since the proposed rule was initially presented for comments. Franchise agreements often include non-compete provisions to protect the franchisor’s proprietary information and prevent market saturation.
The final rule prohibits noncompete agreements applicable to “workers.” The definition of “worker” clarifies that franchise relationships are exempt: “The term worker includes a natural person who works for a franchisee or franchisor, but does not include a franchisee in the context of a franchisee-franchisor relationship.” The final rule specifically excludes the franchisor-franchisee relationship; however, franchisors and franchisees are still subject to the ban to the extent that they have employees. That is, franchisors can include non-compete provisions in their franchise agreements but may not be able to do so in their employment agreements.
The Road Ahead
The FTC’s ban on non-compete clauses is a bold move that could reshape the American workforce and the franchise industry. As the effective date approaches, employers and franchisors must prepare for compliance and consider the strategic implications of this new rule. To safeguard the franchise system and protect other franchisees, franchisors should continue to enforce non-compete provisions in their franchise agreements and also rely on confidentiality provisions and trade secret and trademark law to protect their intellectual property.