FTC Issues Final Rule Banning Noncompetes

On April 23, 2024, the FTC, by a 3-2 vote, announced a Final Rule that has the effect of invalidating post-employment noncompetes on a nation-wide basis for the vast majority of workers.  The term worker includes employees, independent contractors, volunteers, interns, and externs.  The Rule reflects the Commission’s determination that it is an unfair method of competition, and therefore a violation of Section 5 of the FTC Act, for businesses to enter into or seek to enforce certain noncompetes with workers. As touted by the FTC, the Fina Rule “will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” Absent a successful legal challenge, the Rule becomes effective 120 days after its publication in the Federal Register (on or around August 21, 2024). 

 Summary of Final Rule

 At a high level, the FTC’s Final Rule: 

  • Bans entering into, or seeking to enforce, new noncompetes with all workers, including senior executives, after the effective date.
  • For existing noncompetes, bans entering into, or seeking to enforce, them against all workers, except senior executives, after the effective date.  For senior executives, existing noncompetes can remain in force.
  • Defines the term “senior executive” to refer to workers earning more than $151,164 in total annual compensation during the preceding year who are in a “policy-making position.” 
  • Total annual compensation may include salary, commissions, nondiscretionary bonuses, and other nondiscretionary compensation.
  • The Rule defines “policy-making position” as a business entity’s president, CEO or the equivalent, and any other officer of a business entity who has policy-making authority. It defines “policy-making authority” as final authority to make policy decisions that control significant aspects of a business entity or a common enterprise. The Rule explains that an individual who is an officer of an affiliated or subsidiary company who only has policy-making authority with respect to the subsidiary or affiliate or a division/department of the entity, but not the overall common enterprises, would not qualify as a “senior executive.”
  • Requires businesses to provide notice to current and former workers subject to the ban, no later than the Rule’s effective date, that they will not be enforcing any noncompetes against them. The FTC has published a model notice for this purpose.

Exceptions to the Ban

  • Existing noncompetes with senior executives.
  • Existing noncompetes with any worker for the purpose of pursuing a cause of action that accrued before the Rule’s effective date.
  • Non-competes entered into by a person “pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.”
  • Noncompetes that apply to competitive activities outside the U.S.
  • Noncompetes between franchisors and franchisees.
  • Noncompetes that ban concurrent employment, i.e., working for two businesses at the same time.
  • Noncompetes issued by entities that are not subject to the FTC Act, including certain financial institutions, common carriers, and nonprofit entities.

Alternatives to Noncompetes

The Commission found that employers have several alternatives to noncompetes that still enable firms to protect their investments without having to enforce a noncompete, including trade secret and patent laws, invention assignment and non-disclosure agreements (NDAs), and non-solicitation and no-hire restrictions.  However, the Commission cautioned that if any of these restrictions are sufficiently broad to have the “functional equivalent” of a non-compete, they may fall under the Rule and thereby be prohibited. Additionally, commentary to the Rule suggests that forfeiture-for-competition provisions, where a worker sacrifices money or equity benefits if they compete against their former employer, or liquidated damages provisions where a worker must pay a business money if they compete, are covered by the Rule and would thus be prohibited moving forward.

State Law Preemption

The Final Rule takes the position that it preempts all state laws “inconsistent with” the Rule, but not those state laws that offer greater protection than the Rule. 

Next Steps

Lawsuits have already been filed challenging the enforceability of the Final Rule.  It is possible an injunction could be issued in the coming days or weeks that will stay the Rule from taking effect until there is a hearing on the merits of the challenge. As these lawsuits play out, it would be wise to take the following preliminary steps to prepare for the Rule’s implementation in case it goes into effect as scheduled.

  • Identify current and former workers who have active noncompetes that are banned by the Final Rule.
  • Create a contact list for these individuals in case it becomes necessary to issue them a notice of non-enforcement required by the Final Rule.
  • Identify current and former workers who the business believes qualify as senior executives.  Review that list with counsel to ensure they meet the definition.
  • For senior executives who do not have a noncompete, consider issuing them one before the effective date of the Final Rule.
  • Consider modifying your organization’s template restrictive covenant agreement to conform the Final Rule.

The DOL Significantly Raises “White-Collar” Minimum Salary Threshold – Action Required

Summary of Final Rule

On April 24, 2024, the DOL announced its Final Rule raising the current minimum annual salary threshold ($35,568) to qualify as an exempt executive, administrative, professional (i.e., “white-collar”) employee under the FLSA.  The DOL also raised the current salary threshold ($107,432) to qualify under the highly compensated employee (“HCE”) exemption.  Specifically:  

  • On July 1, 2024, the minimum salary threshold for white-collar workers will increase to $844 per week ($43,888 per year). For HCEs, the minimum annual compensation level will increase to $132,964.
  • On January 1, 2025, the DOL will implement a new salary methodology, setting the standard salary level for white-collar workers at the 35th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region, resulting in a salary level of $1,128 per week (equivalent to $58,656 per year). For HCEs, the compensation level will be set at the annualized weekly earnings of the 85th percentile of full-time salaried workers nationally, resulting in a compensation level of $151,164.
  • Future updates to the salary and compensation levels will occur every 3 years and will apply up-to-date wage data to determine new salary levels. The 3-year update will take place on July 1, 2027.

*Up to 10% of the required salary amounts may be satisfied by nondiscretionary bonuses, incentive payments and/or commissions, if these payments are made at least annually.

What this Means

If employees who are currently classified as executive, administrative or professional exempt earn less than this new threshold, they will need to be paid an OT premium for any hours worked beyond 40 in a workweek. Even if an employee meets the new salary threshold, to qualify as exempt, an employee must also satisfy the “duties” test that applies to the applicable exemption. The final rule does not change the existing “duties” tests.   

Higher State/Local Pay Requirements Control 

The FLSA sets a national floor on wages and a premium for excess work. Some states and cities have stronger wage and hour protections, e.g., CA currently has a $66,560 salary threshold. In that case, the more protective standard applies to workers who reside in that state or city.

Next Steps

Absent a successful legal challenge, your business must be prepared to adjust its pay practices to comply with the Final Rule. Here are recommended next steps:  

  • Identify all employees currently classified as exempt executive, administrative and professional employees. Confirm they meet the applicable “duties test.”  If they don’t, they fail the exemption and they need to be reclassified.
  • If they do pass the duties test, identify those on the list who are earning below the new salary threshold.
  • For those employees, assess the cost of increasing their salaries to the new minimum and compare that to the cost of converting them to hourly and paying them OT at the 1.5x OT (or keeping them salaried at the same or reduced salary level and paying OT at the .5x OT rate).
  • If you decide to reclassify employees to OT-eligible (either hourly or salaried), implement training and update policies to clarify the rules for properly counting and tracking OT.
  • Avoid the common pitfalls of trying to skirt compliance by misclassifying current W-2 employees as 1099 contractors or offering “comp time” in lieu of paying OT.

It’s Time (again) to Conduct an Independent Contractor Classification Compliance Audit

If your organization uses independent contractors (“IC”), it’s time, once again, to assess whether they are properly classified due to the March 11, 2024 effective date for the Department of Labor’s (“DOL”) “Final Rule on Classifying Workers as Employees or Independent Contractors Under the Fair Labor Standards Act.”   

At a high level, the final rule represents an intentional shift by the DOL to a narrower interpretation of IC status under the “economic reality” test used by courts and government agencies to determine whether a worker is an employee or IC.  In effect, the new rule makes it harder for workers to qualify as ICs

The final rule applies the following six factors in making this analysis:  (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the potential employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral part of the potential employer’s business; and (6) skill and initiative.  This test relies on the totality of the circumstances where no one factor is determinative.  The DOL’s summary of how it interprets each of these factors  can be found here:  DOL FAQs.

States have adopted their own version of this test in analyzing misclassification cases under state law.   

The consequences for misclassifying a worker as an IC can be high in terms of financial penalties and business disruption.  Now is the time to conduct a compliance audit.  Please let me know if I can assist.

Arizona Paid Sick Time Update

In Nov. 2016, Arizona voters passed by proposition the “Fair Wages and Healthy Families Act” (the “Act”), which not only increased the state’s minimum wage (currently $14.35/hr.), but also created new requirements regarding paid sick time (“PST”) in Arizona. The Act became effective July 1, 2017.

In many respects, the PST portion of the Act is not a model of clarity.  In an effort to clarify some of the ambiguities, the AZ Industrial Commission has issued regulations and FAQs. See FAQs.  

Courts have also weighed in.  Recently, the AZ Court of Appeals issued a ruling, Papias v. Parker Fasteners (attached), that provides guidance that your organization would be well-advised to heed.  Specifically:  

  • The employer in Papias offered more PST than the Act requires. The Court clarified that when an employer provides more sick time hours than required by the Act, it is still obligated to comply with the rights outlined in the Act on the use of sick time.  Takeaway:  Consider limiting PST to the legally required maximum; if you offer more, the Act’s requirements and rights apply to the additional sick time hours.  
  • The amount of sick time available, taken year-to-date (“YTD”), and sick pay received must be recorded in, or an attachment to, the employee’s regular paycheck.  The Court clarified that an employee’s “regular paycheck” includes physical or electronic paychecks or paystubs and/or an online portal hosted by a payroll processing vendor that posts the required PST data.  Discrepancies between a vendor’s online portal and the employer’s records mean the employer did not meet its notification obligation. In this case, there were discrepancies due to confusion over whether the time was accrued or awarded as a lump sum and whether it was earned on an anniversary or calendar basis.  There was also a dispute whether the employee had access to the PST data on the vendor’s payroll portal.  Takeaway:  Make sure PST data published by the employer or its payroll vendor is regularly audited, and that the calculations are consistent with the employer’s PST policy; also, verify employees have access to the required PST data if posted on a payroll portal.
  • If the employer does not specify in writing the “acceptable means” for an employee to report PST usage, then any informal means the employee uses to communicate an illness, including text messages, is sufficient.  Takeaway:  Your policy should specify to whom when, and the means by which employees should report PST usage.      

I’m happy to assist your organization draft and/or review your PST policy (or PTO policy that encompasses PST) for compliance with the Act.

The EEOC Publishes an Updated “Know Your Rights” Poster

The EEOC recently released a new “Know Your Rights” poster (dated October 20, 2022), which replaces the previous “EEO is the Law” poster. The new poster must be posted by all covered employers.  This EEOC Fact Sheet provides answers to frequently asked questions about the new “Know Your Rights” poster.