What will the FTC’s new ban on non-compete agreements mean for California businesses? The short answer: nothing new! Of course, with some caveats.

On April 23, 2024, the Federal Trade Commission (the “FTC”) issued its long-awaited final rule on non-compete agreements (the “Final Rule”). The Final Rule sets forth a blanket prohibition on non-compete agreements, with certain limited exceptions, and establishes a floor upon which states can impose their own non-compete laws, so long as they do not conflict with the federal rules. California has preexisting laws which limit the applicability and enforceability of non-competition agreements. As detailed below, given that California’s existing restrictions on non-compete agreements are narrower than the FTC’s Final Rule, California businesses should expect to continue to comply with California non-compete law.

I. Explanation of FTC Final Rule

The Final Rule has been fomenting over a number years. In July 2021, President Biden issued an Executive Order encouraging the FTC to exercise its rulemaking authority to curtail the use of non-compete agreements.¹ In January 2023, the FTC issued a notice of proposed rulemaking banning non-compete agreements (the “Proposed Rule”).² After receiving more than 26,000 public comments, the FTC issued its final Non-Compete Clause Rule on April 23, 2024.

To support the issuance of the Final Rule, the FTC explained that one in five Americans—approximately 30 million people—are subject to non-compete agreements. As a policy matter, the FTC argued that non-compete agreements limit worker mobility and reduce wages.³ To address these concerns, the FTC’s Final Rule establishes that non-compete agreements constitute an unfair method of competition and a violation of Section 5 of the Federal Trade Commission Act (“FTC Act”) (15 USC 45), which prohibits "unfair or deceptive acts or practices in or affecting commerce."⁴

When will the Final Rule take effect?

The Final Rule will become effective 120 days after it is published in the Federal Register. The Final Rule is scheduled to be published in the Federal Register on May 7, 2024, and as such will likely become effective September 4, 2024.

What does the Final Rule prohibit?

With respect to most workers, the Final Rule prohibits employers from (1) entering into or attempting to enter into a non-compete clause with a worker; (2) enforcing or attempting to enforce a non-compete clause against a worker, or (3) representing that a worker is subject to a non-compete clause.⁵

Key Definitions:

“Worker.” The Final Rule defines “worker” broadly to include employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors, whether paid or unpaid.⁶

“Non-Compete Clause.” 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.”⁷

• The Final Rule further clarifies that “the definition of ‘non-compete clause’ would be limited to post-employment restrains (i.e., restrictions on what the worker may do after the conclusion of the worker’s employment) and would not apply to concurrent employment restraints (i.e., restrictions on what the worker may do during the worker’s employment).”⁸
• In its comments, the FTC also explained that “garden leave” or similar arrangements whereby a worker remains employed and continues receiving compensation but is removed from the workplace after termination notice is tendered does not violate the Final Rule.⁹
• The definition of “non-compete clause” is limited to terms or conditions that prevent workers from seeking or accepting work in the U.S. or operating a business in the U.S. The FTC clarified that “the final rule does not apply to non-competes if they restrict only work outside the U.S. or starting a business outside the U.S.”¹⁰

With respect to non-disclosure agreements ("NDAs") and non-solicitation agreements, the FTC’s comments explained that such agreements may be non-competes under the “functions to prevent” prong of the definition of the “non-compete clause,” if an employer adopts a term or condition that is so broad or onerous that it has the functional effect of prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends. This is referred to as the "functions-to-prevent" prong of the Final Rule.¹¹

Notice Requirement

In its Proposed Rule, the FTC previously required formal rescission of existing non-compete agreements. However, the Final Rule requires only that employers issue a clear and conspicuous notice to all non-senior executive workers who have existing non-compete agreements, explaining that those agreements will no longer be in effect and will not be enforced upon the effective date of the Final Rule.¹² This notice must be provided by the effective date of the Final Rule by hand-delivery, by mail at the worker’s last known street address, by email, or by text message. To assist employers, the Final Rule provides model language¹³ to be included in a notice and it is available on the FTC's website. An employer will comply with the notice requirement if it provides notice using the model language.¹⁴

What are the exceptions?

The Senior Executive Exception

Non-compete agreements between employers and senior executives executed prior to the effective date will remain in effect. However, non-compete agreements with any senior executives entered into after the effective date will no longer be enforceable.¹⁵

The Final Rule defines “senior executives” as employees who make more than $151,164 in base salary per year and are employed in a "policy-making position."¹⁶ The Final Rule defines those in a policy-making position to include a company’s President, CEO or equivalent, and others with “policy-making authority,” which means “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.”¹⁷

The Sale of Business Exception

The second exception to the Final Rule involves the sale of a business. The prohibition on non-competition agreements does not apply to agreements for the "bona fide sale of a business entity," of the person’s ownership interest in the business entity, or of all or substantially all of a business entity’s operating assets.¹⁸ The exception allows companies who buy businesses to enforce non-competition agreements against sellers to prevent the seller from continuing to operate in the region in ways which would undermine the buyer's realization of the full value of the purchase.

In its Proposed Rule, the FTC included a requirement that the restricted party be a "substantial owner of, or substantial member or substantial partner in the business entity at the time the person enters into the non-compete" in order to fall under the exception, and further provided that substantial owners, members, or partners must hold at least a 25% ownership interest in the entity being sold to qualify under the exception.¹⁹ However, in the Final Rule, the FTC left out the substantial-owner requirement, in part because it found the threshold failed to "reflect the relatively low ownership interest held by many owners, members, and partners with significant goodwill in their business"²⁰ and without the substantial-owner requirement "more small businesses will be able to utilize non-competes for more owners when they are selling their business."²¹

II. California Has A Long History Against Non-Compete Agreements

Historically, state law has governed the enforceability of non-compete agreements. Thus, while the Final Rule is new, a ban on non-compete agreements is not new in California. For more than 150 years, California has declared non-compete agreements unenforceable.²² In 1941, California codified its prohibition on non-competes in California Business and Professions Code sections 16600-16607.²³ Section 16600 declares as void, "every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind." So, while all employers will of course have to consider how the Final Rule impacts their business, it likely will have a minimal impact on California businesses.

Amid the FTC's consideration of a national non-compete ban, the California legislature enacted Assembly Bill 1076 and Senate Bill 699, which went into effect January 1, 2024, to further strengthen the State's prohibition on non-compete agreements. In enacting AB 1076, the California Legislature agreed with the California Supreme Court's interpretation in Edwards v. Arthur Andersen, which held that even "narrow restraints" on the ability to pursue a profession were incompatible with Section 16600.²⁴ Furthermore, like the FTC, the California Legislature also imposed a notice requirement on existing non-compete agreements. Specifically, for current and former employees employed after January 1, 2022 whose contracts included a non-compete clause that did not satisfy an exception to the non-compete ban, the Legislature required employers to notify the employees by February 14, 2024 that their non-compete clause or agreement was void.

The California legislature went further in enacting SB 699, which expanded the reach of its non-compete ban to include contracts signed outside of California. According to the Legislature, SB 699 would establish that "any contract that is void under (Cal. Bus. & Prof. Code section 16600-16607) is unenforceable regardless of where and when the contract was signed."²⁵

The FTC Final Rule Will Likely Have Minimal Impact in California

The Final Rule will not restrict California's ability to regulate non-compete agreements for California employees, except where California law conflicts with the Final Rule. Specifically, the Final Rule provides that states such as California, "may continue to enforce laws that restrict non-competes and do not conflict with the Final Rule, even if the scope of the State restrictions is narrower than the Final Rule."²⁶ In other words, the federal rule sets a floor, not a ceiling, allowing California to enforce stricter measures on non-compete agreements.²⁷ As a result, companies considering non-compete agreements in California should be aware of the similarities and differences between California law and the Final Rule, and pay particular attention to the exceptions each set of laws allows.

The FTC Final Rule and California Law Both Provide Exceptions to the Ban on Non-Compete Agreements

Unlike the Final Rule, California law does not have an exception for senior executives. Rather, California public policy favors employee mobility and competition and therefore prohibits noncompetition agreements with employees regardless of the employee's job title, rank, or seniority. Employers cannot rely on the Final Rule to impose a non-compete on a senior executive working in California, as such an agreement will still be impermissible under California law.

Like the Final Rule, California law also has an exception to the general ban on non-compete agreements in the context of the sale of a business, but California's exception is much narrower. Under California law, the sale of business exception only allows non-compete agreements for business owners who sell (i) the goodwill of a business, (ii) all of their ownership in a business entity; or (iii) all or substantially all of the assets of a business together with the goodwill of that business. In the context of such transactions, the buyer and seller may contractually agree that the seller will refrain from carrying on a competing business within a specified geographic area in which the business was sold, for a specified period of time.²⁸

California's sale of business exception is narrower than the Final Rule exception in two key respects. First, the California exception does not apply to individual sellers unless the individual seller is a "substantial stakeholder" in the business, a term that varies depending upon the nature and scope of the transaction. For example, a shareholder may hold a 10 percent stake in the company. If there are two other shareholders, and they both hold a 45 percent stake, then the 10 percent shareholder is likely not "substantial." In contrast, if a company has five 10 percent shareholders and ten 5 percent shareholders, then the 10 percent shareholder could be a "substantial shareholder."²⁹ Second, the FTC declined to adopt a geographic scope standard, making the geographic area covered by a non-compete agreement under the Final Rule exception broader than under California law.³⁰ Since California law is more restrictive than the Final Rule, California's rules remain in effect.

These specific differences are by no means the only differences between California and federal law on the subject of noncompetition agreements. Judicial opinions interpreting California noncompetition laws will also create differences in the applicability and enforcement of the rules by jurisdiction. Businesses seeking to enter into, or enforce, noncompetition agreements in California are strongly advised to consult with California counsel.

How will the FTC Final Rule will play out?

The Final Rule has already drawn legal action. The United States Chamber of Commerce sued the FTC on April 24, 2024, seeking to enjoin publication and enforcement of the Final Rule. The Chamber of Commerce argues in its complaint that the FTC has no authority to issue the Final Rule. While it is uncertain whether the court will uphold the Final Rule, businesses should proceed as if it will.³¹

California businesses should consult with legal counsel to ensure compliance with California law and the Final Rule regarding non-compete agreements. This includes reviewing existing employment agreements in light of SB 699, and ensuring compliance with California law should the business seek a non-compete agreement under California's sale of business exception. Employers should work with legal counsel to distribute the required notices informing employees that their non-compete agreements will no longer be enforced. Employers should also consult with their employment counsel to review their other restrictive covenants, including non-solicitation and confidentiality clauses, to ensure those clauses are narrowly tailored to protect legitimate business interests, thereby reducing the risk that they will be challenged by the "functions-to-prevent" prong in the Final Rule .

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¹ https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition-in-the-american-economy/
² https://www.federalregister.gov/documents/2023/01/19/2023-00414/non-compete-clause-rule
³ Final Rule at 7.
⁴ Final Rule at 2.
⁵ 16 C.F.R. §910.2(a).
⁶ 16 C.F.R. §910.1.
⁷ 16 C.F.R. §910.1.
⁸ Final Rule at 67.
⁹ Id. at 83.
¹⁰ Id. at 87.
¹¹ Id. at 77-78. 
¹² 16 C.F.R. §910.2(b)(1).
¹³ 16 C.F.R. §910.2(b)(2)(4).
¹⁴ 16 C.F.R. §910.2(b)(2)(5).
¹⁵ Id. at 90.
¹⁶ 16 C.F.R. §910.1(2).
¹⁷ Id.
¹⁸ 16 C.F.R. §910.3(a).
¹⁹ Final Rule at 336.
²⁰ Final Rule at 341.
²¹ Final Rule at 537.
²² Id. at 290 (citing Non-Compete Clause Rule, 88 Fed. Reg. 3482 at 3507)
²³ Cal. Bus. & Prof. Code § 16600.
²⁴ Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, 948-950.
²⁵ Stats. 2023, Ch. 157, Sec. 2 (SB 699).
²⁶ Final Rule at 389.
²⁷ Id. at 398.
²⁸ Cal. Bus. & Prof. Code § 16601.
²⁹ Vacco Industries, Inc. v. Van Den Berg (1992) 5 Cal.App.4th 34, 48-49 [finding an officer of a corporation to be a "substantial shareholder" despite owning about 3 percent of the company stock, because the officer was the ninth largest shareholder in the corporation]; Bosley Medical Group v. Abramson (1984) 161 Cal.App.3d 284, 287-291 [finding that there was only a "limited" interest where the defendant only held 7 percent of the shares, while plaintiff held 73 percent of shares].
³⁰ Final Rule at 421.
³¹ Cal. Gov. Code §12964.5 (f).