FTC Proposes to Ban Non-Compete Clauses in Contracts Because They…Well…..Reduce Competition

On January 5, 2023, the Federal Trade Commission issued a Notice of Proposed Rulemaking (NPRM) that would prohibit businesses from imposing non-compete clauses on workers, and in some cases, independent contractors. The proposed rule was published on January 19, 2023, and the public must submit comments by March 20, 2023, although the comment period may be extended. The FTC believes that non-compete clauses impact about one in five American workers, approximately 30 million people.

The FTC asserts that because they prohibit workers across the board from seeking better opportunities that offer higher pay or better working conditions, and conversely they prevent businesses from hiring experienced workers with the precise qualifications they are seeking because the candidates are bound by these restrictive covenants, non-compete agreements impede workers and stifle competition.

The proposed rule would prohibit non-compete clauses as an unfair method of competition. Employers would be barred from entering non-compete clauses with their workers, which include employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to the business’ client or customer. The rule would require employers to affirmatively provide notice to their workers that existing non-compete clauses are invalid and are no longer in effect.

Discussing the proposed rule, FTC Chair Lina M. Khan said, “The freedom to change jobs is core to economic liberty and to a competitive, thriving economy. Non-competes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand. By ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.”

Who would be impacted?

According to the Economist, three-quarters of working Americans are employed by a business entity. Most of them are under contract or are subject to employee handbooks or policies that are “incorporated” into contracts, that provide for their pay, benefits, holidays, and even working attire. Many such contracts provide for whom and where an employee may work if they leave the company. Typically, the employer tries to prevent the former employee from working for a competitor in the same vicinity, by means of a non-compete agreement or a covenant not to compete.

The Economic Policy Institute estimates that roughly half, 49.4%, of U.S. businesses require some employees to enter a non-compete agreement, while nearly a third, 31.8%, require all employees to enter into a non-compete agreement, regardless of pay or job duties. But if the Federal Trade Commission has its way, a sea change is coming with regard to non-compete agreements that the FTC believes will stimulate economic growth and foster innovation in all occupations.

The FTC discussed several issues in support of the ban:

Non-compete clauses reduce wages.         

Non-compete clauses in workers’ contracts give employers the power to suppress wages because employers don’t have to compete for workers, proponents of the FTC proposed rule argue. Non-compete clauses even reduce the wages of workers who haven’t entered into non-compete agreements because, by inhibiting workers from leaving their current jobs, they suppress the number of vacant positions in the individual’s industry. The FTC estimates that the proposed rule could increase workers’ earnings across industries and job levels by $250 billion to $296 billion per year. The agency also claims that banning non-compete agreements across the board nationwide would help to close racial and gender wage gaps.

Non-compete clauses inhibit new businesses and new ideas.

The FTC also says that non-compete clauses hinder innovation. They are an obstacle to would-be entrepreneurs who, without the non-compete, would start new businesses. Non-competes also inhibit workers from bringing innovations to market with new employers.

Non-compete clauses can exploit workers and hinder economic liberty.

Non-compete clauses are usually a “take-it-or-leave-it” provision in employment contracts—sometimes referred to as a contract of adhesion. A potential new hire cannot negotiate to have the non-compete agreement removed from the contract because, in most situations, the contract the new worker is expected to sign is the same one that all new hires sign. Thus, non-compete agreements take advantage of workers’ lack of bargaining power and force workers to stay in jobs they would otherwise leave were there no non-compete.

Opponents of the proposed ban make several arguments in support of non-compete clauses:

The proposed rule is unconstitutionally broad.

Pro-business groups contend that the FTC does not have the legal authority to issue such a ban. The U.S. Chamber of Commerce said in a statement, “Since the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule. The Chamber is confident that this unlawful action will not stand . . . . Ban[ning] non-compete clauses in all employment circumstances overturns well-established state laws which have long governed their use and ignores the fact that, when appropriately used, non-compete agreements are an important tool in fostering innovation and preserving competition.” Further, opponents argue, the ban presents a separation of powers issue: the FTC, as an executive branch agency, is overreaching and impinging on what should be Congress’s purview.

Non-compete clauses will impede sharing of information with employees.

Businesses justify non-compete clauses by arguing that they need to protect confidential information and to get the most out of their investments in training and capital. Companies could very well limit the amount of information they share with workers. Employees could receive less skill training and minimum investment if any in their career development. Why would a company invest time and effort developing employees if it anticipates that those employees may leave without consequence? Companies certainly would not want to share its financial information, marketing plans and business forecasts if it expects such information to walk out the door with a departing employee.

One can foresee that businesses may be less inclined to develop lower-level employees and promote them to management. Just as some commentators relate the minimum wage increase the growing use of AI, robotic technology, and outsourcing jobs to other countries, there is some trepidation that companies would hire only experienced workers instead of contributing to the development of their existing workforce.

The absence of non-compete clauses actually suppresses wages.

Opponents of the FTC’s rulemaking also suggest that the agency is examining only one side of the wage equation. If a former coworker leaves and takes important information to competitors, the former employer’s competitiveness is impaired, such that the former company’s workers’ wages must be suppressed as a result of the damage to its competitive advantage. This interconnected downward pressure on wages should be included in any wage analysis of non-competes.

Hiring practices will become more onerous.

Businesses value trustworthiness in their employees and want to be assured that departing workers will not share confidential information with new employers. Non-compete agreements contractually require workers to maintain their former employers’ proprietary information. Absent a non-compete, employers may feel the need to protect themselves by more thoroughly examining the background of potential hires, which will make the hiring process more cumbersome and slower, to workers’ detriment.

The FTC argues that the fears of the opponents of the ban have already been disproven by the experience of several states that already ban non-compete clauses.

To some extent, some states already restrict employers’ ability to enforce non-compete clauses because they disempower workers and threaten a person’s ability to engage in their trade or business. And in California, North Dakota, and Oklahoma, three states where non-compete clauses are already legally unenforceable but which are extraordinarily economically and socially diverse, proponents of the ban argue that industries that depend on trade secrets prosper nonetheless.

If the proposed rule goes into effect as published, businesses would be prohibited from utilizing non-compete clauses in contracts regardless of worker classification. Non-compete clauses could prohibit neither employees nor independent contractors from taking their skills elsewhere to seek new or better opportunities Given their current prevalence, the elimination of non-competition clauses would be a sea change in employment law and may change the U.S. labor market for the foreseeable future.

You may submit your comments about this proposal to the Federal Trade Commission here.