In January 2023, MarshBerry published an article summarizing the Federal Trade Commission’s (FTC) proposed rule that aimed to prohibit the use of non-compete agreements. On April 23, 2024, the FTC finalized the rule, voiding and banning nearly all employee non-compete agreements in the United States. However, there is significant opposition to the rule. In fact, the first lawsuits challenging the rule were filed within hours of the FTC announcing its vote.
Here’s what you need to know about the final rule and what effect it may have on the insurance distribution sector:
What is the background on this issue? On January 19, 2023, the FTC proposed a rule which would make non-compete clauses unlawful. The FTC then accepted and considered over 26,000 public comments on the proposed rule and on April 23, 2024 – 460 days after it was proposed – the FTC’s five Commissioners made it final by a vote of 3-2. The rule will now be published in the Federal Register and is intended to become effective 120 days after publication.
What is the Federal Trade Commission? The FTC was created by act of Congress in 1914 and is charged with preventing entities in the United States from engaging in unfair methods of competition, deemed unlawful by the same Act. The FTC is made up of five Commissioners, who are nominated by the President of the United States and confirmed by the Senate. Commissioners serve a seven-year term and no more than three Commissioners can be from the same political party. The sitting President chooses one Commissioner to Act as Chair. Notably, the Commissioners voted on the non-compete rule along party lines, with the three Democratic Commissioners voting in favor of the rule, and the two Republican Commissioners voting against it.
What specifically is a non-compete clause? The FTC 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 include the term or condition.” In layman’s terms, non-compete clauses prohibit workers from leaving an employer to work for, or start their own, business that competes with their current employer.
How is the enforceability of non-compete agreements currently handled? Prior to this rule, the enforceability of non-compete clauses was left to individual state law, which varies from state-to-state and undoubtedly leads to legal uncertainty, making compliance burdensome for both employers and workers.
What is the intent of the Non-Compete Clause Rule? The FTC estimates that one in five American workers – or approximately 30 million workers – are subject to a non-compete. In many cases, the FTC believes that non-compete clauses are used by employers to take advantage of their workers and therefore considers non-competes to be contrary to fair competition by reducing workers’ job mobility, limiting competition for workers’ services, and ultimately depriving workers of higher wages and more favorable working conditions.
What does the Rule specifically prohibit? The final rule provides that it is an unfair method of competition for employers to, among other things, enter into non-compete clauses with workers. According to the FTC, this rule amounts to a “comprehensive ban” on all new non-competes with workers. Employers are required to provide written notice to any employees, both current and past, who are covered by non-compete provisions and inform them that those provisions are no longer enforceable.
How does this rule impact the insurance distribution sector? Non-compete agreements manifest themselves in two distinct contexts within the insurance distribution sector:
- In the context of mergers and acquisitions, the principal(s) of an agency that is being sold to a buyer are typically required to agree not to compete with the buyer for certain periods of time, both post-closing of the transaction and after the date the principal’s employment with the buyer comes to an end. Notably, the FTC’s rule does not apply to non-competes entered into pursuant to a bona fide sale of a business entity.
- Second, non-competes exist from time to time in the employment context, most commonly between brokers and their producers and agents. The FTC’s rule does impact non-competes in this context.
The rule contains an exception for non-competes that were entered into before the final rule’s effective date, so long as the person subject to the non-compete qualifies as a “senior executive,” which means he or she must be in a “policy making position” and earn at least $151,164 per year. In turn, the FTC defines a “policy making position” as being the president, chief executive officer, or the equivalent, of an organization. These individuals must have “final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.” Very few individuals within an agency will qualify for this exception. Even some who hold ownership stakes may not qualify under the exception.
However, the rule itself is limited to non-compete clauses. It does not prohibit non-disclosure/confidentiality or non-solicitation agreements, nor does it prohibit reasonably drafted non-piracy and non-acceptance provisions, which tend to be more common in the insurance brokerage sector. Generally speaking, these provisions are narrower in scope and therefore more likely to be considered enforceable because they are designed to protect legitimate business interests as opposed to preventing employees from earning a living.
What’s Next?
There will be significant opposition to the FTC’s proposed rule. Arguments against the rule center on whether the FTC has the requisite authority to promulgate such a rule or whether issues such as this should be left to Congress to decide. As the old saying goes, the wheels of justice turn slowly and we can expect it to be years before this issue is finally decided, perhaps by the United States Supreme Court.
Key takeaways from the FTC rule on non-competes:
- Absent some other action, such as a court-imposed injunction, the rule is set to become effective 120 days after it is published in the Federal Register, which will likely be late summer or early fall 2024.
- The rule is meant to be a comprehensive ban on non-competes and only has three distinct exceptions, including the bona fide sale of a business.
- For non-competes that are currently in place, or are put in place prior to the effective date of the rule, to remain enforceable, the person subject to them must qualify as a “senior executive.” This means they are required to meet a certain earnings threshold, but also “have final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.” This is a very narrow standard and would largely render void most non-competes between agencies and producers/staff.
- Non-compete clauses that are put in place after the effective date of the rule are void regardless of one’s ownership or status as a “senior executive.”
- The rule does not apply to non-competes that arise in the context of the bona fide sale of a business and are entered into between owner(s) of the selling business (regardless of ownership percentage) and a buyer.
- The rule does not apply to confidentiality/non-disclosure, non-solicitation, non-piracy, and non-acceptance clauses that are common in the insurance space.
- There is significant opposition to the FTC’s rule. It may take years for the issue to be resolved.
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