On Jan. 5, 2023, the Federal Trade Commission (FTC) released a
Notice of Proposed Rulemaking (NPRM) to prohibit employers from entering or attempting to enter, maintaining, and/or representing to a worker that the worker is subject to, a non-compete agreement.1
The proposed rule is based on the FTC’s preliminary finding that non-compete agreements constitute an unfair method of competition and therefore violate section five of the Federal Trade Commission Act (FTCA).
Section 5 gives the FTC broad authority to stop most individuals and companies from “using unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce. …”2
The Commission’s Concerns are Well-founded
The impetus for the FTC’s proposed rule includes its conclusions that:
non-compete clauses prevent workers from leaving jobs and decrease competition for workers, lower wages for both workers who are subject to them as well as workers who are not.3
The FTC, in its proposed rule, estimates that it would “increase American workers’ earnings between $250 billion and $296 billion per year.” Though this comment is not intended to be a comprehensive endorsement of the FTC’s proposed rule, it is worth noting that the commission’s conclusions in these respects are well-founded.
Numerous studies have shown (as the FTC concludes) non-compete clauses suppress workers’ wages.
Martin Kuhn, Marquette 2004, is a shareholder with
Hawks Quindel, S.C.,, in Milwaukee, where he focuses on labor and employment matters for individual and union clients.
For example,
a study that examined executive compensation in Florida, Louisiana, and Texas before and after the adoption of stricter non-compete policies found that the stricter enforcement of non-compete policies resulted in a precipitous drop in executive compensation.
Similarly, in 2008, the state of Oregon banned non-compete agreements for many employees, including low-wage hourly workers. A recent
study of Oregon’s non-compete ban showed that workers’ wages after the ban rose on average by 2% to 3% initially, and roughly 5% a few years later.
Other studies have reached similar conclusions.
Research into the impact of non-compete agreements also supports the FTC’s finding that the agreements limit worker mobility. In
a 2009 study examining Michigan’s 1985 repeal of a statewide prohibition on most non-compete agreements, researchers found that the repeal resulted in a 8.1% drop in job mobility. Also,
a 2006 study analyzing habits of workers in the computing industry by region found significantly higher levels of job mobility among workers in California, where non-compete clauses are largely prohibited.
These and other studies underscore the validity of the FTC’s stated concerns in the proposed rule – namely that non-compete clauses take away a worker’s most powerful bargaining chip: the ability to leave and work elsewhere. This dissuades workers from seeking better alternatives, which in turn stifles workers’ ability to negotiate higher wages.
In addition to its findings related to wage-suppression and worker mobility, the FTC also notes that
[n]on-compete clauses … prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation which would otherwise occur when workers are able to broadly share their ideas.
Among other findings concerning the adverse impacts of non-competes on workers, employers, and the economy, the FTC estimates its proposed rule would save consumers up to $148 billion annually on health care related costs.4
How Does the FTC’s Proposed Rule Read?
The FTC identifies multiple mechanisms through which it seeks to achieve its stated objectives.Most notably, the proposed rule would establish that:
[i]t is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.5
The proposed rule defines a “non-compete clause” as:
a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.6
Though seemingly limited only to those traditional “non-compete” clauses endeavoring to restrict the entities with which a former worker may seek employment, the FTC’s proposed rule would likewise seek to eradicate “de-facto non-compete clauses,” or clauses that have the “effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”7
The proposed rule sets forth a “functional test” for determining whether a restrictive covenant rises to the level of a “de-facto non-compete,” weighing whether the clause “has the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”8
The FTC’s proposed rule contains other notable provisions. Among them are that:
the rule would apply not only to employees, but also volunteers, independent contractors, interns, apprentices, among others;9
the rule would require employers to rescind any existing “non-compete clauses” it maintained as of the rule’s effective date;10
within 45 days of rescinding the non-compete, employers would be required to notify affected workers that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker;11 and
the rule would supersede state law inconsistent with the rule.12
Exceptions from the Proposed Rule
While certainly most notable for the non-compete clauses it seeks to eradicate, the FTC’s proposed rule is likewise significant for the clauses it excludes. Indeed, the proposed rule would leave in place many of the clauses and agreements employers traditionally use to protect their confidential information, proprietary information, intellectual property, and other sensitive information.
The proposed rule does not extend to:
nondisclosure agreements, confidentiality agreements, nor other agreements/covenants whereby an employee covenants not to disclose the employer’s confidential information, proprietary information, intellectual property, and other such information and things;
clauses wherein employees covenant not to solicit an employer’s customers and/or potential customers for the purchase of competitive products and things about which the employee has specialized knowledge;
liquidated damages provisions or other such agreements whereby workers must pay the employer a designated sum of money if the worker engages in breaches to an agreement; and
clauses wherein employees covenant not to solicit for employment with a competitor, those of the employer’s employees about which the worker may have specialized knowledge.
Also note that the proposed rule contains an exception for agreements with individuals who are selling an ownership interest in a business.
FTC’s Authority
There currently exists no federal law governing the administration of non-competes. Instead, policy decisions are left to the states’ discretion.
Most states (Wisconsin included) have elected to sanction non-compete agreements, provided the agreement passes a “reasonableness” test, primarily judged based on the duration of the agreement, the affected geographic region, and the scope of prohibited activities, among other commonly-applied tests.
Certain states – California, Colorado, and North Dakota among them – have banned non-competes altogether, while others have limited their enforceability to one degree or another. States like Illinois, New Hampshire, and Washington use wage thresholds and other mechanisms to limit non-compete enforceability. In New Mexico, post-employment non-competes with health care practitioners are not enforceable. In Oregon, non-compete clauses with hourly workers are prohibited.
It is perhaps because of this scattershot of state laws that the FTC issued its proposed order, which followed President Biden’s July 2021 Executive Order urging the FTC and other agencies to limit non-competes as a way to promote competition in the American economy.13
As a matter of federal preemption, the proposed rule would supersede any state statute, regulation, order, or interpretation that is inconsistent with the provisions of the final rule except to the extent that the state equivalent provides workers with greater protections.14
The proposed rule cites sections 5 and 6 of the FTCA as basis for the commission’s authority to implement the rule and regulate a broad range of anti-competitive activities. Section 5 is cited at the outset of this comment, while section 6(g) authorizes the FTC to “make rules and regulations for the purpose of carrying out the provisions of” the FTCA, including the Act’s prohibition of unfair methods of competition.”15
What Happens Now?
The FTC’s proposed rule is open for public comment until March 10, 2023.
Once the comment period closes, the agency will likely move on to a final rule, though it also has the options of issuing a new proposed rule, or reopening the comment period. Once finalized, the rule will be published in the FederalRegister, giving way to a 60-day public comment period.
After public comment, the FTC may amend its proposed rule to address concerns or other issues raised during the comment period or it may abandon the rule altogether, although this is unlikely. Any final rule will go into effect 180 days after final publication in the Federal Register.
Assuming the FTC’s proposed rule (or a substantially similar version of it) takes effect, it will undoubtedly face swift legal challenges.
Suzanne P. Clark, president and CEO of the U.S. Chamber of Commerce, has
already vowed to sue the FTC should its proposed rule take effect.
FTC Commissioner Christine S. Wilson, the lone dissenting member on the proposed rule, has already
detailed several potential legal challenges to the rule, including that:
the FTC lacks authority to engage in “unfair methods of competition” rulemaking;
the “major questions doctrine” featured in
West Virginia v. Environmental Protection Agency could be applied to argue that the FTC lacks the authority to issue the proposed rule; and
the FTC’s proposed rule constitutes an impermissible delegation of legislative authority under the non-delegation doctrine.
This article was originally published on the State Bar of Wisconsin’s
Labor & Employment Law Section Blog. Visit the State Bar
sections or the
Labor & Employment Law Section webpages to learn more about the benefits of section membership.
Endnotes
1 Proposed Non-Compete Clause Rule § 910.2(a).
2 15 U.S.C. § 45(a)(1).
3 Federal Trade Commission,
Non-Compete Clause Rulemaking.
4SeeNPRM VII.B.2.c.
5 Proposed rule § 910.2(a).
6 Proposed rule § 910.1(b)(1).
7 Proposed rule § 910.1(b)(2).
8Id.
9 Proposed rule § 910.1(f).
10 Proposed rule § 910.2(b)(1).
11 Proposed rule § 910.2(b)(2)(A).
12 Proposed rule § 910.4.
13 3 C.F.R. 36987, 36995 (2021).
14 Proposed rule § 910.4.
15 15 U.S.C. § 46(g).
