How the New FTC Rule Banning Non-Competes Affects Franchisors

In April 2024, the Federal Trade Commission (“FTC”) issued a new rule that broadly prohibited the use of non-competition agreements (“non-competes”) for workers. This rule goes into effect September 4, 2024, but is expected to be subject to significant challenges in court. While the landscape and timing for the rule is likely to continue to change over the coming weeks and months, this post outlines the key impacts that the ban on non-competes will have on franchisors if it is fully implemented.

First and most importantly, the FTC rule applies to non-competes with “workers.” The definition of “worker” expressly excludes the relationship between a franchisor and a franchisee. For now, the non-competes that are in many franchise agreements can still be valid and unenforceable under federal law (outcomes under state law may vary).

The skies are not necessarily clear, however, for franchise agreement non-competes. The FTC is widely expected to update the federal franchise rule and may very well include similar limitations on the use of non-competes in franchise relationships. Further, while the non-compete rule excludes the “franchisee” from the definition of a worker, the impact of the rule on owners in a franchisee entity, owner spouses and other immediate family members, non-owner operators of the franchised business, and non-owner guarantors who may have signed individual non-competes with the franchisor is not clear from the text of the rule. Franchisors should contact their legal counsel to discuss how to approach the non-competes that may have been entered into with these individuals.

Second, people who are employees of the franchisor and franchisees are likely considered “workers” under the new non-compete rule. Franchisors and franchisees need to be prepared to comply with the requirements of the rule with respect to their employees in the same way that non-franchise businesses need to comply.  A summary of those requirements is below:

1. Subject to the small exception described in item (C), employers will no longer be able to enter into or enforce non-competes.
2. If an employer has historically entered into non-competes with its employees, the employer is required to provide notice to employees by the effective date of the rule that the non-compete agreement is not enforceable. The FTC has prescribed the form and method of notice.
3. A limited exception to the non-compete ban allows an employer to enforce an existing non-compete with senior executives who meet certain criteria. But after the effective date of the rule, no new non-compete agreements can be entered into with or enforced against senior executives.

Franchisors can contact their legal counsel to determine how to implement these laws. For more insights, you may also review the client alert provided by employment attorneys at Manning Fulton: https://www.manningfulton.com/news/ftc-bans-non-compete-clauses-in-employment-contracts/.

Third, the FTC ban on non-competes has some other important exceptions. It does not apply to non-solicitation, confidentiality, or non-disclosure provisions and agreements if those provisions and agreements do not have the same practical effect as a non-compete by preventing the employee from working. Franchisors should review these provisions and clauses in their employment agreements and determine if adjustments need to be made to increase the likelihood of their enforceability. Additionally, the new rule does not ban a non-compete that is entered into when a person sells an ownership interest in a business or the entire business is sold. If a franchisor is looking to sell or has franchisees looking to transfers, non-competes may be used in certain circumstances to prohibit the seller from competing.

Fourth, franchisors should counsel with their attorneys to discuss what guidance franchisors should provide to franchisees regarding implementation of the ban on non-competes.

Finally, franchisors should learn how to effectively use other strategies for brand protection. Confidentiality agreements, exercising lease rider or purchase rights to control properties and assets upon termination, expiration, or non-renewal, implementing practical limitations on franchisees’ employees’ access to confidential information and trade secrets, and developing controls for customer information, accounts, technologies, etc. that can be used to stop a terminated franchisee employee or franchisee from using proprietary materials and unfairly competing.

Manning Fulton franchise attorneys stand ready to help you navigate these new laws and protect your franchise business.