The FTC Wants To Outlaw Noncompete Clauses, but Does It Have the Authority?

The Commission's lone dissenter says Congress has not charged it with regulating noncompete clauses.

The Federal Trade Commission (FTC) last week proposed a near-total ban on noncompete clauses for employees and contractors, calling them an "unfair method of competition." The rule would prohibit employers from enforcing existing noncompete clauses and making them a condition of future employment. If it can survive legal challenges, the FTC's ban on noncompetes would have a massive impact on the rights of employers and workers.

The noncompete clause usually sets a time or geographical limit within which an employee is barred from working for her employer's competitors or starting her own competing business. While there is broad agreement that noncompetes have been abused by employers, they also serve to protect proprietary data and incentivize companies to train their workers. In many contexts, noncompetes foster a mutually beneficial exchange between firms and workers. For instance, a worker who contractually agrees not to leave for a competitor in the same region may in turn receive skills training at his company he couldn't otherwise obtain.

"If noncompetes are banned outright…the effect will be less information-sharing within the company," George Mason University economist Tyler Cowen wrote Tuesday in Bloomberg. "New workers in particular, who have not demonstrated their long-term loyalty, will have a hard time getting access to information and getting ahead."

The FTC, however, portrays noncompetes as anti-competitive measures with no redeeming traits. Eschewing incremental reform, the agency has sprung straight to considering an outright ban that would go so far as to nullify existing noncompete agreements (with an exception for certain individuals attempting to sell a business).

While reasonable people can and do disagree about the merits of noncompete contracts, the FTC's announcement makes no mention of the fact that most states already regulate noncompete clauses and employees can generally sue to escape unreasonable ones. Indeed, there are colorable arguments for regulating some noncompetes, particularly those for entry-level positions. In 2016, for instance, multiple state attorneys general forced sandwich chain Jimmy John's to settle over clauses imposed on low-wage employees, despite there being no risk of spilling proprietary secrets. More deviously, one report from Cornell University's Matt Marx found that nearly 70 percent of engineers surveyed were not informed by their employer that they must sign a noncompete until after receiving a job offer, and about a quarter of respondents were informed on their first day.

The FTC proposal would further ban contractual terms that are "de facto non-compete clauses," which in effect prohibit "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." This language is broad and nonspecific, which means the FTC is essentially giving itself a regulatory blank check. FTC Chair Lina Khan, an unapologetically aggressive enforcer, may well exploit the text to its legal breaking point.

That is, if the new rule can survive judicial scrutiny.

FTC Commissioner Christine Wilson, the lone dissenter on the new policy, wrote that the FTC likely lacks the authority to enact the proposal. "Section 6(g) [of the FTC Act] was believed to provide authority only for the Commission to adopt the Commission's procedural rules," she argued. "For decades, consistent with the statements in the FTC Act's legislative history, Commission leadership testified before Congress that the Commission lacked substantive competition rulemaking authority."

Wilson and others contend that the proposed rule is unlikely to comply with the major questions doctrine—the centerpiece of Supreme Court Chief Justice John Roberts' watershed 2022 opinion in West Virginia v. EPA—which holds that an agency must have clear congressional authorization to regulate on a "major question." If the FTC proceeds in suddenly and unilaterally outlawing a standard business practice, it would almost certainly find itself in court.

An FTC spokesperson declined to comment on the matter.

"With all due respect to the majority, I am dubious that three unelected technocrats have somehow hit upon the right way to think about non-competes, and that all the preceding legal minds to examine this issue have gotten it wrong," Wilson wrote.

Employers and employees weigh many kinds of benefits and drawbacks when considering whether to sign a contract—monetary and otherwise. Fully banning noncompete clauses may help some, but will undoubtedly wreak unanticipated havoc on many others.

As put by Brian Albrecht, chief economist at the International Center for Law and Economics, "If implemented, the FTC's total ban of noncompetes replaces the decision making of businesses and workers, as well as the oversight of state governments, with a one-size-fits-all approach. Under that new regime, we need to ask: How quickly will they respond to new information—for example, that it had destructive implications? How easily can they make incremental changes?"