**By Mike Fadden

 

Introduction:

On January 5, 2023, the Federal Trade Commission (“FTC”) announced a new rule proposal that  would result in a ban on noncompete clauses in the United States.^[1] This proposed rule  specifically impacts  noncompete clauses in the employer-employee relationship, which “block people from working for a competing employer, or starting a competing business, after their employment ends”.^[2] The proposed rule would require employers to 1) refrain from entering into any future noncompete agreements with employees; 2) rescind any existing noncompete agreements with employees prior to the compliance date; and 3) provide notice to employees who were subject to noncompete agreements of their invalidity within 45 days of the compliance date.^[3]

FTC Authority for Proposed Rule:

Some criticism of this proposed rule revolves around whether it is within the FTC’s authority. Given this criticism, it’s worth looking closely at the authority under which the FTC is acting .

Originally passed in 1914, the Federal Trade Commission Act states that “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful.”^[4] The statute instructs the Commissioner of the FTC to “prevent persons, partnerships and corporations” from using unfair practices in their businesses.^[5] To effectuate this, Congress empowered the Commission “to make rules and regulations for the purpose of carrying out the provisions of this subchapter.”^[6]  While many agencies rely on the § 553 of the Administrative Procedure Act to undergo informal rulemaking, the FTC is subject to additional procedural requirements. In 1974, the DC Circuit Court heard National Petroleum Refiners Ass’n v. FTC and held that the FTC had the authority to promulgate legislative rules, and was not limited to adjudicatory proceedings only.^[7] Following this case, and with judicially recognized power in tow, the FTC went on to promulgate rules that regulated activities in various industries, and Congress responded by passing the Federal Trade Commission Improvement Act.^[8] This legislation requires  that the FTC allow for a more formal “presentation of oral evidence and cross-examination on ‘disputed material facts’ when ‘necessary for fair determination of . . . the rulemaking proceeding.’”^[9] The result of this additional legislation is a process that looks more like formal APA rulemaking as opposed to what has become standard notice-and-comment rulemaking.^[10]

 

FTC Reasoning for the Proposed Rule:

In the 216-page Notice for Proposed Rulemaking published by the FTC, the Commission lays out several reasons for the ban on noncompete clauses, relying heavily on empirical data. The reasoning can be classified into three main arguments in support of the noncompete ban.

First, the FTC cites numerous studies supporting that noncompete clauses create  downward pressure on employee wages. The commission was particularly convinced by one of these studies which spanned 23 years and concluded that the elimination of noncompete clauses could result in an increase in employee wages by 3.3%-13.9%.^[11] The Commission cites to five additional studies which analyze the impact of noncompete agreements in various contexts, including within specific industries, specific geographic regions and in the context of executive-level positions.^[12] Based on these various empirical reports, the Commission concludes the cumulative impact of a ban on noncompete agreements would be an increase to earnings across the United States by $250 – $296 billion on an annual basis.^[13]

Second, the FTC considers the existence of noncompete clauses to have a “stifling” effect on new business and new ideas.^[14] The FTC once again looked at numerous studies, but since innovation is not a metric which can be quantified, the studies looked at the impact of noncompete clauses on various indicators of innovation. These indicators include data such as the value of patents or the number of patents stemming from venture capital.^[15] The studies suggest that when noncompete clauses are unenforceable,^[16] the value of patents increase by 31%.^[17] In another study, researchers found that when noncompete clauses are enforceable, the number of venture-backed patents reduced by 6.6%.^[18] The FTC was also concerned by three different studies suggesting that enforcing noncompete clauses resulted in a decrease in new business formation, reduced entrepreneurship, or a reduction in both.^[19]

Third, the FTC expressed its concern over the bargaining power that employers hold relative to employees, which can therefore induce the signing of noncompete clauses.^[20] While the imbalance in employer-employee bargaining power is not unique to noncompete clauses, the Commission considers two factors that intensify this imbalance in the context of these clauses: 1) employers have greater experience in negotiating employment agreements due to the higher volume of employment agreements they  enter relative to employees,^[21] and 2) employees rarely engage legal counsel in reviewing an employment agreement, whereas employers are often assisted by counsel in the drafting of employment agreements.^[22]

 

Noncompete Justifications:

Unsurprisingly, employers prefer noncompete agreements and argue the enforceability of these agreements are important to their business. Central to their argument is the need for protection from high employee turnover which, in turn, allows for higher investment in employee training.^[23] In a 2019 study, researchers observed that enforceable noncompete clauses result in a 14.7% increase in likelihood to receive training .^[24] In another study of publicly traded companies, one researcher observed that the value of publicly traded companies increased by 9% when utilizing noncompete agreements.^[25] Ultimately, employers argue that without noncompete clauses being enforceable, they will be less incentivized to provide employee training because of the risk of turnover.

Another  argument in support of noncompete agreements is the concern of trade secrets being disseminated by former employees. While often cited by proponents of noncompete agreements, there is conflicting evidence on whether the concern is justified.^[26]

 

FTC Response to Justifications:

The FTC is aware of these justifications and counters by suggesting the use of alternative methods which would be less harmful to employees and consumers.^[27] In the NPRM, the FTC provides three alternative routes to protect an employer’s interests. First, in the mind of the FTC, existing trade secret law provides adequate protection against the potential loss of trade secrets in the absence of noncompete agreements.^[28] Second, employers can utilize non-disclosure agreements or confidentiality agreements with employees following the end of an employer-employee relationship.^[29] Third, employers could insulate themselves from risk of losing an employee following expensive training by utilizing employment agreements with a specific length.^[30]

Somewhat cheekily, the FTC also adds that to retain these employees following training investments (and in lieu of noncompete clauses), employers could insulate themselves from turnover risk by paying higher wages, providing better work-life balance, and general improvements to working conditions – an expensive alternative to low-cost noncompetes that employers are not likely to embrace.^[31]

Equitable Impact of Noncompete Bans:

In its NPRM, the FTC lays out numerous arguments in support of its proposed ban on noncompete clauses given the economic impact that would result. Buried within the lengthy description of various studies, the FTC cited evidence suggesting this proposed rule would narrow the racial and gender wage gaps in the United States. According to cited study, a ban on noncompete agreements nationwide would close the gap by 3.6% – 9.1%.^[32] It also cites research suggesting that when noncompete agreements are enforceable, the negative effect on entrepreneurship is felt more by women compared to men.^[33]

Legal Vulnerabilities:

The FTC will almost certainly face challenges to their authority to promulgate this rule, particularly considering the recent Supreme Court decision in West Virginia v. EPA, where the Court applied the major questions doctrine.^[34] In writing for the majority, Chief Justice Roberts states that when an agency asserts a statutorily conferred power over issues of “economic and political significance”, the Court has “reason to hesitate before concluding that Congress meant to confer such authority”.^[35] Chief Justice Roberts’ use of the major questions doctrine has left many looking to pull out a test to apply to future cases. In a post on the Yale Journal on Regulation, Professor Kirstin Hickman pulled such a standard from Justice Roberts’ opinion.

“…[W]hether the major questions doctrine applies depends upon (1) “the ‘history and the breadth of the authority that [the agency] has asserted,’” (2) “the ‘economic and political significance’ of that assertion,” and (3) the extent to which the agency is relying on “‘modest words,’ ‘vague terms,’ or ‘subtle device[s]’” rather than more direct delegations from Congress.”

 

While it’s not clear whether the Supreme Court would use the major questions doctrine to strike down the FTC’s proposed rule on noncompete agreements, at least one FTC commissioner is concerned about the statutorily shaky ground upon which the proposed rule stands.^[36]

 

Conclusion:

The FTC’s proposed rule to impose ban on the use of noncompete clauses in the employer-employee context has the potential for numerous economic benefits for employees in the United States. Among these benefits includes progress toward narrowing the racial and gender wage gap divide. While proponents of noncompete clauses argue for their necessity to protect their investments in training labor and trade secrets, there seem to be potential alternatives with less harmful impacts on employees and consumers. Despite the benefits this rule may result in, there exists a question over whether the FTC is exceeding their statutory authority, particularly given the application of the major questions doctrine in West Virginia v. EPA.

 

Mike Fadden is a Staff Member for Volume 41 of the Minnesota Journal of Law & Inequality

[1] Fed. Trade Comm’n, Non-Compete Rulemaking, https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.

[2] Fed. Trade Comm’n, FACT SHEET: FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete_nprm_fact_sheet.pdf.

[3] Id at §910.2.

[4] 15 U.S.C. § 45(a)(1).

[5] 15 U.S.C. § 45(a)(2).

[6] 15 U.S.C. § 46(g).

[7] National Petroleum Refiners Ass’n v. FTC, 482 F.2d 672 (D.C. Cir., 1974).

[8] Kristin E. Hickman & Richard J. Pierce, Jr., Federal Administrative Law, 513-14, (West Academic, 3d ed.) (2019).

[9] Id. See also, 15 U.S.C. 57(a)(e)(3)(B).

[10] Supra note 8.

[11] Supra note 1 at 20. (The Commission’s NPRM cites to Matthew S. Johnson, Kurt Lavetti, & Michael Lipsitz, The Labor Market Effects of Legal Restrictions on Worker Mobility 2 (2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3455381.).

[12] Supra note 1 at 20.

[13] Supra note 2 at 1.

[14] Id.

[15] Supra note 1 at 42.

[16] Many states have passed their own legislation on the enforceability of noncompete clauses providing researchers with the opportunity to compare states with high enforceability to those states with low enforceability of noncompete clauses. The Commission notes that this difference in enforceability from state to state has resulted in an increase of reliable data in recent years.

[17] Supra note 1 at 42.

[18] Id.

[19] Id at 37.

[20] Id at 81.

[21] Employee agreements are usually negotiated when an employee is hired for a new position. It follows that employers tend to go through the process of hiring new employees more frequently than an individual changes jobs and is faced with negotiating a new employment agreement.

[22] Id at 83.

[23] Id at 45.

[24] Evan Starr et al., Consider This: Training, Wages, and the Enforceability of Covenants Not to Compete, 72 I.L.R. Rev. 783, 797 (2019).

[25] Kenneth A. Younge & Matt Marx, The value of employee retention: evidence from a natural experiment, 25 J. Econ. & Mgmt. Strategy 652 (2016).

[26] Supra note 1 at 46.

[27] Id at 91.

[28] Id at 94.

[29] Id at 98.

[30] Id at 99.

[31] Id at 100.

[32] Id at 195.

[33] Id.

[34] West Virginia v. Environmental Protection Agency, 142 S. Ct. 2587 (2022).

[35] Id at 2595.

[36] Fed Trade Comm’n, Dissenting Statement of Commissioner Christine S. Wilson Regarding the Notice of Proposed Rulemaking for the Non-Compete Clause Rule, https://www.ftc.gov/legal-library/browse/cases-proceedings/public-statements/dissenting-statement-commissioner-christine-s-wilson-concerning-notice-proposed-rulemaking-non