Does The New Non Compete Rule Apply To The Franchisor Franchisee Relationship?

Does The New Non Compete Rule Apply To The Franchisor Franchisee Relationship?

The FTC Issued a new rule banning most non competes

On April 23, 2024, the Federal Trade Commission issued the final version of its new rule to ban most non competes.  The final rule is located at 16 CFR Part 910.  The rule is effective 120 days after the rule is published in the Federal Registry.  

Fortunately for franchisors, the rule does not impose an absolute ban on non-competes in the context of the franchisor/franchisee relationship.  

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Of course, the analysis should not stop there. It is important that franchisors and all business owners understand the scope and implication of this rule.  While the rule does not directly prohibit a franchisor from requiring a franchisee to sign a non compete, the rule does apply to a franchisors own workers and to the franchisees workers.  The goal of this post is to explain the rationale for the new rule, explain why the rule is limited in the franchise context, and encourage forward looking action to help franchisors protect against unfair competition. Franchisors who attempt to restrict their franchisees employees may also have to take action and change course.  

rationale for the new rule

A new rule has been in the works since at least January 2023, when the FTC proposed a ban on most non competes and sought public comment. Non-competes have been generally disfavored across the country, but remained enforceable so long as they satisfied certain state requirements in terms of application, scope, and duration. The new FTC rule supersedes state interpretation and largely bans non competes. On April 23, the final version was issued and the FTC issued a press release, stating the overall rationale for the new rule:

“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of a dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” said FTC Chair Lina M. Khan. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

Of course there are valid counter-reasons why employers should be able to protect their intellectual property and their investment in human capital by deploying noncompetes. Unfortunately, the FTC determined that these competing business objectives can be achieved without the use of  a non-compete.  

Text of the new rule banning non competes

The new rule deals with two types of staff: “Workers” and “Senior Executives“.  The rule makes non competes an unfair method of competition – in violation of federal law.  

Unfair Competition for Workers:

For Workers, the new rule is both prospective AND retroactive.  In dealing with Workers, the rule provides in pertinent part:

With respect to a worker other than a senior executive, it is an unfair method of competition for a person:

(i) To enter into or attempt to enter into a non-compete clause;

(ii) To enforce or attempt to enforce a non-compete clause; or

(iii) To represent that the worker is subject to a non-compete clause.

Unfair Competition for Senior Executives:

For Senior Executives, the new rule is only prospective.  In dealing with Senior Executives the rule provides in pertinent part:

With respect to a senior executive, it is an unfair method of competition for a person:

(i) To enter into or attempt to enter into a non-compete clause;

(ii) To enforce or attempt to enforce a non-compete clause entered into after the effective date; or

(iii) To represent that the senior executive is subject to a non-compete clause, where the non-compete clause was entered into after the effective date.

New FTC Rules effect on existing non compete

Once the rule is effective, any prior non compete against a “worker” will be unenforceable.  Further, employees are prohibited from certain conduct and must proactively provide notice to effected workers.  The new rule provides, in part:

(b) Notice requirement for existing non-compete clauses—(1) Notice required. For each existing non-compete clause that it is an unfair method of competition to enforce or attempt to enforce under paragraph (a)(1)(ii) of this section, the person who entered into the non-compete clause with the worker must provide clear and conspicuous notice to the worker by the effective date that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.

The employer must follow certain steps to ensure this notice is provided.  The rule sets forth certain criteria and provides a form notice approved by the FTC.  

Exceptions under new non compete rule

There are certain enumerated exceptions to the new non-compete rule.  Further, not every tpe of worker is encompassed by the new rule.  The definition of a “Worker” is particularly important in the context of a franchisor and franchisee relationship.  All businesses must also understand who qualifies as a senior executive. 

Three Exceptions:

(a) Bona fide sales of business. The requirements of this part 910 shall not apply to a non-compete clause that is 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.

(b) Existing causes of action. The requirements of this part 910 do not apply where a cause of action related to a non-compete clause accrued prior to the effective date.

(c) Good faith. It is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a non-compete clause where a person has a good-faith basis to believe that this part 910 is inapplicable.

Definition of a Worker:

Worker means a 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. 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. 

Definition of a Senior Executive:

Senior executive means a worker who:

(1) Was in a policy-making position; and

(2) Received from a person for the employment:

(i) Total annual compensation of at least $151,164 in the preceding year; or

(ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or

(iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.   

Total annual compensation is based on the worker’s earnings over the preceding year. Total annual compensation may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during that 52-week period. Total annual compensation does not include board, lodging and other facilities as defined in 29 CFR 541.606, and does not include payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other similar fringe benefits.

What type of Restrictive Covenants are encompassed by the rule?

Non-compete clause means:

(1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

(i) 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

(ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.

Are some Restrictive Covenants Okay for All workers?

Part of the rationale for issuing the new rule is that businesses can still protect their intellectual property in other ways.  This is particularly important in the franchise context.  That is not to say franchisors will not be negatively impacted, but the impact can be mitigated by working with legal counsel to protect intellectual property in other ways and prevent solicitation of current customers, vendors, employees, and others. Further, nothing in the rule prohibits an employer from restricting a workers competition while they are a worker. 

History shows that a proactive approach is essential when the stakes are high, as laws and rules constantly evolve. F0r example, having managers sign a non-compete will no longer be an option as long as this rule is in effect. Will the new rule shift the landscape for franchising?  Maybe.  For instance, some franchisors may choose not to stop allowing non-owners to attend training, have access to confidential materials, or serve as a manager of the business. 

Can the new non-Compete Rule be Challenged?

The FTC has issued its final rule, but that does not mean it is immune from being challenged in the Courts. Historically, the states have regulated noncompetes. Further, federal law making is reserved for Congress. The FTC’s has rulemaking authority under Section 6(g) of the FTC Act, 15 U.S.C. Sec. 46, which authorizes the Commission “to make rules and regulations for the purpose of carrying out the provisions of this subchapter.”  However, does the FTC have the authority to regulate non-competes in a broad sweeping rule?  Maybe not.  

The rule will likely be attacked the moment it hits the Federal Register.  

If challenges are successful, which they may very well be, then the FTC’s new non compete rule will be void and the issue will return to the state level. However, the rule will be effective soon and businesses will likely need to comply as the rule makes its way through the judicial process. 

Will non competes with franchisees remain enforceable?

Regardless of legal challenges, the reality is that only time will tell.  Non competes have historically been challenging to enforce and have more recently been prohibited in some states. Further, regulators are often looking to regulate in new ways.   

Although franchisors were left out of this final rule, the FTC has signaled that they intend to step up regulation in terms of franchising. Franchisors were excluded from the new rule based on the dynamic of the franchise relationship, but that does not mean that all restrictive covenants pass state or federal muster.

Keep an eye out as states, the NLRB, and FTC continue to consider ways to regulate the franchisor and franchisee relationship.  It is also possible that the text and rationale of the FTC rule will have an impact on decisions rendered in courts across the country, or that state or federal legislatures will pass new laws.  

Have questions? You should seek legal counsel, this post is not legal advice.  Franchisors should work with legal counsel to explore ways to protect intellectual property with an eye to the future.  

Meet the Author

Derek A. Colvin

Derek is a graduate of Penn State Law and Old Dominion University. He started his legal career in public service as a prosecuting attorney before entering private practice. He currently serves business clients as a partner at Waldrop & Colvin, the law department for your business.  He is laser-focused on delivering efficient and effective solutions for business legal needs.  As a seasoned litigator set on thinking critically and communicating effectively, Derek is well-suited to advise and protect your business as an independent owner,  franchisor, or franchisee

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Derek A. Colvin offers a free 15 minute consultation. You can  call or email  Derek Colvin directly or you can schedule a video conference today! 

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