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April 26, 2024

On April 23,2024, the Federal Trade Commission (FTC) issued a final rule intended to ban the use and enforcement of most non-compete clauses signed by workers. 

The new rule is not in effect yet. It will become effective 120 days after publication in the Federal Register unless it is enjoined by a court based on a challenge to the rule. As of the date of this article, several lawsuits have been filed by business groups seeking the invalidation of the rule. The U.S. Chamber of Commerce has already filed a lawsuit in a U.S. District Court in Texas arguing that the FTC overstepped its authority in issuing the rule. It is likely that the rule will be tied up in litigation for an extended period of time. Even if these challenges to the rule are not successful, there likely will be injunctions that prohibit the implementation or enforcement of the rule while the legal challenges are pending. It is quite possible that these cases will end up before the Supreme Court.

Pursuant to the rule, as of its effective date, all existing non-competes with workers who are not senior executives will no longer be enforceable. Existing non-competes with senior executives can remain in effect and be enforced. However, after the effective date, employers will be prohibited from entering into any non-competes with workers—whether or not they are senior executives. Once the rule takes effect, employers must notify any workers with non-compete clauses that the non-competes are unenforceable.

For direct selling companies, it is important to note that the rule applies to independent contractors. That is, the FTC’s ban on non-competes, if it is ultimately enacted, will prohibit the enforcement of provisions in distributor agreements that seek to prevent distributors from participating as a distributor for other direct selling companies following the termination of the distributor agreement for any reason. Therefore, when (if) the rule becomes effective, direct selling companies that have non-compete clauses in their distributor agreements (or other agreements with distributors) must likewise notify their distributors that such post-termination non-competes are not enforceable.

Note that the rule does not expressly prohibit non-disclosure or non-solicitation agreements. Non-solicitation agreements are generally not non-competes under the rule because while they restrict who a distributor may contact after the distributor agreement is terminated, they do not necessarily prevent such a former distributor from seeking or accepting other work or starting a business. Therefore, non-solicit and non-disclosure provisions of distributor agreements will remain valid unless they are so broad or onerous that they have the same functional effect as a non-compete.

The rule defines a 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.”

By virtue of the “after the conclusion of” language in the definition, direct selling companies can still prohibit distributors from competing while the distributor agreement is in effect; the rule seeks to eliminate post-termination restraints on competition, including restraints that would otherwise apply when a distributor voluntarily terminates the distributor agreement and enrolls as a distributor with a competing direct selling company.

Note that for a variety of reasons, we DO NOT recommend that direct selling companies have non-compete clauses in their distributor agreements. For one thing, such a provision may jeopardize the independent contractor nature of the relationship thereby resulting in the potential transformation of the sales force to employee status. Additionally, some states such as California and Minnesota already ban non-competes and such a ban may be on the horizon in other states including New York.

As noted above, the rule will apply to independent contractors. The term “worker” is defined in the rule as “natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.”

Regarding “senior executives”, the rule defines this category as employees who are in policy-making positions at the company and receive at least $151,164 in total annual compensation. As stated above, existing non-competes with senior executives can still be enforced, but after the rule is effective, employers will be prohibited from requiring new non-compete agreements from senior executives or any other worker.

As discussed above, it is quite likely that a court (or courts) will prohibit the rule from going into effect while the legal challenges to the rule make their way through the legal system. Therefore, direct selling companies and employers do not need to take any immediate action in response to the rule. If you have questions about the rule, you can feel free to reach out to us.

For information regarding the FTC’s reasoning for the rule, the FTC’s announcement can be accessed at this link.

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