THE FTC PROPOSES BAN ON Noncompete Agreements

In the 2022 Summer Edition of Earth Shaping News, I wrote the article, “Using Employee Contracts to Stabilize the Construction Workforce.” That article was a comment on the construction industry’s depleted workforce and high turnover rate. In the article, I discussed noncompete agreements, but concluded that “[t]here are no guarantees these contracts will always be enforceable . . .” If you had asked me then, I would have never guessed that just six months later the Federal Trade Commission would try to do just that.

Why Did the FTC Propose a Ban on Noncompete Agreements?

On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a rule that would prohibit employers and employees from entering noncompete agreements, but for a few exceptions. The FTC states that non-compete agreements harm competition, suppress labor mobility, and reduce wages for all workers.

This proposal is not only significant in terms of the impact it will have on the labor market, but also the scope of the FTC’s authority going forward. As to the latter issue, some opponents of the proposal see it as an overreach of the federal government’s regulatory power, or an encroachment on the states’ legislative authority.

The FTC was created in 1914 when President Woodrow Wilson signed the Federal Trade Commission Act (“Act”). Section 5 of the Act prohibits “unfair methods of competition in or affecting commerce.” In 2015, the FTC, under Chairwoman Edith Ramirez published a statement on the FTC’s enforcement principles regarding unfair methods of competition. Many critics claimed this statement essentially gutted the FTC’s ability to regulate unfair methods of competition. Six years later, Lina M. Khan—famed for criticizing anti-trust laws and Amazon— became the Chairwoman of the FTC. Less than one month in office, Chairwoman Khan repealed the 2015 statement. Since then, Chairwoman Khan’s tenure has been characterized as the face of the “progressive antitrust reform movement”.

With this in mind, it isn’t surprising that Chairwoman Khan’s FTC is proposing to ban noncompete agreements, except for limited circumstances. And while there is a legitimate argument that the FTC is overstepping its regulatory authority, one former FTC Chairman notes that even making such a proposal has symbolic power to begin potential change nationwide.

What Does the Proposed Rule Say?

Right now, we can’t affirmatively say what the final rule will say. The proposed rule is subject to a 60-day comment period in which the public can submit comments to the FTC on the proposed rule. At the close of this commenting period, the FTC will review the comments and either: (1) move forward with rule as proposed, (2) withdraw the proposed rule, or (3) revise the proposed rule.

What we know now is that the FTC is proposing all noncompete agreements going forward would be banned. Moreover, all existing noncompete agreements would be retroactively voided. To this end, within 180 days after enactment, all employers would have to notify each employee subject to a noncompete agreement that their noncompete agreement is withdrawn. The only instance in which noncompete agreements would be allowed is when a noncompete agreement is between a company and someone who has at least 25% ownership interest, and that someone later sells all or a substantial part of his or her ownership interest. Lastly, and highly relevant, the proposed rule would supersede any state law that conflicts with the proposed rule.

What is the Effect of the Proposed Rule?

If the proposed rule is enacted as is, or in a substantially similar form, it’s uncertain what will happen exactly. But it’s fair to assume that employers will face a variety of compliance issues that if not addressed could lead to substantially regulatory fines and potential litigation with employees. The FTC claims that this ban will result in higher wages, labor mobility, and increased market productivity. Opponents note it could create market instability, harder conditions for startup companies, and cause delays in businesses’ outputs due to turnover.

The proposed rule does not seem to ban nonsolicitation or claw-back agreements. These are two other contractual tools employers can use to try to protect themselves. These two tools are discussed in the 2022 Summer Edition of Earth Shaping News article, “Using Employee Contracts to Stabilize the Construction Workforce”. Moreover, the proposed rule does not diminish trade secret laws and the tools and remedies employers have under those laws.

What Happens Next?

It is almost certain that if the FTC tries to enact the proposed rule, or a rule in similar form, it will be challenged in the courts. Many legal pundits believe the FTC does have the authority to enact and enforce this rule, but each of these pundits realizes most of the Justices on the United States Supreme Court may not favor such broad regulatory power.

For now, noncompete agreements are governed by each state’s laws. It seems this will be the case for the rest of 2023. Still, businesses should closely follow any developments on this proposed rule and begin thinking of what they must do to be ready to protect themselves if the proposed rule is enacted.