FTC Ruling on Non-Competition

Intro

Around 18 percent of American workers are currently in some form of a non-compete agreement, which is around 30 million people. On April 23, 2024, The Federal Trade Commision or FTC voted 3-2 to ban non-compete clauses nationwide. The ruling would effectively disband all current and previous non-compete agreements that are not currently in litigation or apart of certain non-affected industries. Such a ban would dramatically change the landscape of labor relations in some industries practically overnight once the ruling takes effect.

While many are affected by such agreements and now this consequent ban, many more have little to no idea about non-competes and the place they take in our economic system. At the outset such agreements are easily painted as wholly bad or wrong, a way that employers take advantage of their position to lock workers into place, and some employers do just that.

The ruling from the FTC and its complete ban paints non-competes in a completely negative light, but if investigated further the economic impact of non-competes is not as straightforward as the FTC would have it, and not nearly as simple. In addition, the nature if such a ban represents an overstep in federal authority with a regulatory agency attempting to dictate policy nationwide.

This article will detail the FTC ruling, its reasoning, the economics of non-competes themselves, and the current legal challenges to the ban.

Why the Ban?

The FTC determined that wages and competition were unlawfully harmed by non-compete clauses. The idea behind this is that non-competes keep workers in jobs that they may not want and limit their mobility because of the agreements. Some evidence even backs some of their claims up. Two studies conducted in 2009 and 2011 found that non-competes in Michigan reduced job mobility by 8 percent when non-competes were made enforceable. In addition, according to a 2016 Chamber of Commerce literature review of the available data, stricter non-compete enforceability led to lower wage growth and lower initial wages. Based on studies like these the FT concluded that non-competes were wholly harmful to the economy and should be completely done away with.  Also, in 2021the FTC received an executive order from the Biden administration to address non-competes on the grounds that it harmed competition and wages for U.S. workers. A decision such as this from the FTC then was a matter of when and not if.

Details of the Ban

Specifically, the ruling prohibits an employer from entering into, or attempting to enter into, a non-compete clause with a "worker”, this includes employees and independent contractors or representing that a worker is subject to a non-compete clause. The only workers not subject to this ruling would be “senior executives” with over $151,164 annual compensation.

Items not prohibited by the rule: Agreements made by non-profit organizations and non-competes entered into by a person pursuant to a bona fide sale of a business entity.

The ban itself is not solely non-competes themselves but non-compete clauses, which could be in any form of contractual agreements between employers and employees. This can extend to NDAs as well if the language of the NDA prohibits workers from entering into or attempting to enter into employment opportunities.  

The Economics of Non-Competes

Non-competes in labor relations seek to address an important problem known in economics as the “hold up” problem. This issue arises when two parties enter into a contractual agreement where certain investments are made but one or both of the parties stand to risk some or all of their investment due to unforeseen circumstances, in essence, it is trust, where a party needs an amount of legal recourse to fully trust the agreement they are entering into.

In labor relations an employer can risk two important things: training costs and trade secrets. Training costs in that if an employee leaves right after they were trained the employer received negative return on the employee, who received years of experience and knowledge from the employer in the form of training that can then be used at another job that could hurt the original company who trained them. Secondly are trade secrets, which in highly competitive industries can make or break the business. Things such as specific processes, such as a particular way SpaceX makes a rocket, or a client relationship such as a client list given to senior employees are vital to a business's success. Employers risk such things when they enter into relations with employees. Employees risk too, in that they risk their time and the potential other opportunities they could have obtained working elsewhere.

Between employers and employees there is a “hold up” or a stoppage of negotiations since there is too much perceived risk. A non-compete then gives employers recourse in the potential worst-case scenario and so gives them a reason to trust. It solves the “hold up” problem with potential legal recourse and makes certain labor relations happen. Of course this is a relatively niche solution, but other agreements such as an NDA perform a similar task.

Non-Competes in Detail

As mentioned before there is some research on non-competes and the research has found that many states that have non-competes and enforce them experience negative effects on wages and wage growth, that is that wages grow slower and are initially lower than their counterparts without non-competes or ones that do not enforce them.

With such data it seems easy to conclude that such agreements then are bad for the economy and for workers in general, just as the FTC concluded. However, in their 2016 study, the Chamber of Commerce explored a vital piece of the non-compete investigation which is how exactly non-compete agreements were conducted.

Studies found that less than half of workers in non-compete agreements report possessing trade secrets. In addition, around 19 percent of workers in California report to be a part of non-compete agreements, despite the fact that California doesn't enforce non-competes at all. A survey of the Institute of Electronics Engineers found that around 3 in 10 workers reported that their employers informed them of non-competes in their job offer. In that same survey 70 percent of workers were asked to sign a non-compete on or after their first day on the job.

What the FTC ruling completely missed was that behavior surrounding the non-competes was the issue, not the non-competes themselves. The real issue is that certain employers were not giving employees full information, or the workers were not informed enough themselves to understand their situation. In other instances, non-compete agreements are used for employees with no college degree and even entry level employees, not close to the intention of a non-compete. The issue then is transparency, not the outright ban of a niche contract agreement.

Ramifications of the Ban

According to the FTC the ban will result in amyriad of benefits.

The FTC Estimates the ban will result in:

●      $74-$194 billion in reduced spending on physician services

●      2.7% increase in the rate of new firm formation, resulting in an estimated 8500 new businesses created each year

●     An average estimate of 17-29k more patents each year

●     estimated $400-$488 in increased wages for workers over the next decade

Again, with some of the earlier reported data this seems like an easy conclusion to be drawn. However, the rule change would do nothing to curtail the bad behavior that resulted in the misuse of non-competes in the first place. While the complete ban of non-competes might have some positive effects, the policy change is only treating symptoms and none of the root causes.

The 2016 Chamber of Commerce study, despite detailing the numerous issues created by the non-competes, argues that the main issue too is lack of transparency. The study says that reform should come from making sure employers are forthright with employees in the realm of non-competes. To reiterate from earlier, non-competes help solve a difficult problem between employers and employees, a real economic problem. Banning the solution could lead to a great deal of unintended consequences as employers scramble to fight other ways of contracting with employees that also protects their businesses. Additionally, the 2016 study says that employers should only offer non-competes that are enforceable and that firms are required to provide "consideration” to employees who are engaged in a non-compete, basically making businesses incur a cost when entering into a non-compete. Such recommendations make sense as they dictate easy and simple rules when it comes to the agreement, allowing employees to be protected from lack of information and businesses to have an avenue of recourse should the agreement not function properly.

Overall, then, the FTC misses the mark when it comes to non-competes, and seemingly failed to look at the issue in detail despite its 500+ page ruling on the topic. It takes an overly simplified route of banning non-competes instead of understanding all the actors and behaviors that go into such agreements.  

Legal Challenges

As for reactions to the ruling, there have already been two lawsuits, one from the Northern District of Texas and the other from the Eastern District of Texas, filed against the FTC for their Aprilruling. Commentators suggest that there is a high probability that the ruling will never go into full effect.

Law firm Seyfarth and Shaw suggest that the lack of statutory authority to enact such a ruling with such sweeping consequences will ultimately mean that it will fail to be fully realized as a ruling. The ruling from the FTC seems to lack the specific power delegated from the legislature to actually make such a rule, they would need specific vested power to do so. In addition, some state laws might not be able to be superseded without such specified and delegated power. Overall, it will take some time for the Supreme Court to hear the cases, but it is still possible that the court will green light the ruling.

Federal Overstepping

The FTC’s ban represents a huge overstep in federal power over that of the states and even the legislative branch. Without clear and direct authority given, regulatory agencies are not allowed to act or create policy. The FTC however, and by direction of executive order, decided to attempt to fully ban an agreement in every state without any authority to do so. Such an attempt is a concern regardless of if it is eventually defeated in court. Concerning because such attempts are blatant overreach and disregard of the legislative branch of government. If anything, a ban would be more of a presentation of evidence for state legislatures to consider instead of banning them from using non-compete agreements. The more regulatory entities take on such direct and unsolicited policy making, the more distance Americans have between them and representation in the policy-making process. In the case of the FTC attempted ban, there is very little direct representation in the decision of the ban.

Legal challenges to such decisions must continue as they provide a response to federal overstepping. Also, there is little reason for federal agencies to step in and ban agreements between employees and employers. Such agreements should be left mostly alone unless criminal activity or verifiable issues are taking place.

Overall, the ban is an overstep to a high degree and should be concerning as there might be other attempts made in the future by other regulatory agencies.

What Should Employers do?

Since it will take some time for the matter to resolve there are several actions employers can take. Law firm Seyfarth Shaw suggested sending notices should the rule come into effect and to compile a list of impacted current and former employees. The Wagner Law group suggested that employers need to also consider state laws that they operate in and how strict or not strict their states are when it comes to non-competes.

Overall employers should stay updated on the ruling and prepare for the worst. Updated lists of affected employees and drafts of updated job offer letters, and the like might be prudent should the ruling go into effect.

Conclusion

The FTC ruling banning non-competes completely misses the mark when it comes to fully understanding non-competes and their place in labor relations. Despite being constitutionally and statutorily unsound, it also misunderstands the issue and simply tries to outright ban the agreement.

Basic economics gives profound insight into the issue, and while there are significant issues in terms of behavior when it comes to non-compete agreements. Understanding this allows for more precise remedies for the issue, and not ones that are particularly new either. Yet the FTC ignores this and simply tries to ban non-competes. This ruling is a fascinating study of how data can show one facet of an issue but can also completely miss other details and lead to overly simplistic policy changes that when considered fully, make no sense.  

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Resources Used

●     https://home.treasury.gov/system/files/226/Non_Compete_Contracts_Econimic_Effects_and_Policy_Implications_MAR2016.pdf

●     https://www.seyfarth.com/news-insights/ftc-non-compete-ban-what-you-need-to-know.html

●     https://forbes.com/sites/brucebrumberg/2024/05/08/ftc-ban-on-noncompetes-7-things-employees--executives-must-know/?sh=3d37db875ca5

●     https://www.ftc.gov/legal-library/browse/rules/noncompete-rule

●     https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes

●     https://www.wagnerlawgroup.com/blog/2024/05/ban-on-non-competition-agreements-what-employers-need-to-know-and-do-now/

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