FTC Ruling on Non-Competition

Intro

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

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

The ruling from the FTC and its complete banpaints non-competes in a completely negative light, but if investigated furtherthe economic impact of non-competes is not as straightforward as the FTC wouldhave it, and not nearly as simple. In addition, the nature if such a banrepresents an overstep in federal authority with a regulatory agency attemptingto dictate policy nationwide.

This article will detail the FTC ruling, itsreasoning, the economics of non-competes themselves, and the current legalchallenges to the ban.

Whythe Ban?

The FTC determined that wages and competitionwere unlawfully harmed by non-compete clauses. The idea behind this is thatnon-competes keep workers in jobs that they may not want and limit theirmobility because of the agreements. Some evidence even backs some of theirclaims up. Two studies conducted in 2009 and 2011 found that non-competes inMichigan reduced job mobility by 8 percent when non-competes were madeenforceable. In addition, according to a 2016 Chamber of Commerce literaturereview of the available data, stricter non-compete enforceability led to lowerwage growth and lower initial wages. Based on studies like these the FTCconcluded that non-competes were wholly harmful to the economy and should becompletely done away with.  Also, in 2021the FTC received an executive order from the Biden administration to addressnon-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 notif.

Detailsof the Ban

Specifically, the ruling prohibits an employerfrom entering into, or attempting to enter into, a non-compete clause with a“worker”, this includes employees and independent contractors, or representingthat a worker is subject to a non-compete clause. The only workers not subjectto this ruling would be “senior executives” with over $151,164 annualcompensation.

Items not prohibited by the rule: Agreementsmade by non-profit organizations and Non-competes entered into by a personpursuant to a bona fide sale of a business entity.

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

TheEconomics of Non-Competes

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

In labor relations an employer can risk twoimportant things: training costs and trade secrets. Training costs in that ifan employee leaves right after they were trained the employer received negativereturn on the employee, who received years of experience and knowledge from theemployer in the form of training that can then be used at another job thatcould hurt the original company who trained them. Secondly are trade secrets,which in highly competitive industries can make or break the business. Thingssuch as specific processes, such as a particular way SpaceX makes a rocket, ora client relationship such as a client list given to senior employees are vitalto a businesses success. Employers risk such things when they enter intorelations with employees. Employees risk too, in that they risk their time andthe 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 casescenario and so gives them a reason to trust. It solves the “hold up” problemwith potential legal recourse and makes certain labor relations happen. Ofcourse this is a relatively niche solution, but other agreements such as an NDAperform a similar task.

Non-Competesin Detail

As mentioned before there is some research onnon-competes and the research has found that many states that have non-competesand enforce them experience negative effects on wages and wage growth, that isthat wages grow slower and are initially lower than their counterparts withoutnon-competes or ones that do not enforce them.

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

Studies found that less than half of workersin non-compete agreements report possessing trade secrets. In addition, around19 percent of workers in California report to be a part of non-competeagreements, despite the fact that California doesn't enforce non-competes atall. A survey of the Institute of Electronics Engineers found that around 3 in10 workers reported that their employers informed them of non-competes in theirjob offer. In that same survey 70 percent of workers were asked to sign a non-competeon or  after their first day on the job.

What the FTC ruling completely missed was thatbehavior surrounding the non-competes was the issue, not the non-competesthemselves. The real issue is that certain employers were not giving employeesfull information, or the workers were not informed enough themselves tounderstand their situation. In other instances non-compete agreements are usedfor employees with no college degree and even entry level employees, not closeto the intention of a non-compete. The issue then is transparency, not the outrightban of a niche contract agreement.

Ramificationsof 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 onphysician services

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

●     An average estimated of 17-29kmore patents each year

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

Again with some of the earlier reported datathis seems like an easy conclusion to be drawn. However, the rule change woulddo nothing to curtail the bad behavior that resulted in the misuse ofnon-competes in the first place. While the complete ban of non-competes mighthave some positive effects, the policy change is only treating symptoms andnone of the root causes.

The 2016 Chamber of Commerce study, despitedetailing the numerous issues created by the non-competes, argues that the mainissue too is lack of transparency. The study says that reform should come frommaking sure employers are forthright with employees in the realm ofnon-competes. To reiterate from earlier, non-competes help solve a difficultproblem between employers and employees, a real economic problem. Banning thesolution could lead to a great deal of unintended consequences as employersscramble to fight other ways of contracting with employees that also protectstheir businesses. Additionally, the 2016 study says that employers should onlyoffer non-competes that are enforceable and that firms are required to provide“consideration” to employees who are engaged in a non-compete, basically makingbusinesses incur a cost when entering into a non-compete. Such recommendationsmake sense as they dictate easy and simple rules when it comes to theagreement, allowing employees to be protected from lack of information andbusinesses to have an avenue of recourse should the agreement not functionproperly.

Overall then, the FTC misses the mark when itcomes to non-competes, and seemingly failed to look at the issue in detaildespite its 500+ page ruling on the topic. It takes an overly simplified routeof banning non-competes instead of understanding all the actors and behaviorsthat go into such agreements.  

LegalChallenges

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

Law firm Seyfarth and Shaw suggest that thelack of statutory authority to enact such a ruling with such sweepingconsequences will ultimately mean that it will fail to be fully realized as aruling. The ruling from the FTC seems to lack the specific power delegated fromthe legislature to actually make such a rule, they would need specific vestedpower to do so. In addition, some state laws might not be able to be supersededwithout such specified and delegated power. Overall, it will take some time forthe Supreme Court to hear the cases but it is still possible that the courtwill green light the ruling.

Federal Overstepping

The FTC’s ban represents a huge overstep infederal power over that of the states and even the legislative branch. Withoutclear and direct authority given, regulatory agencies are not allowed to act orcreate policy. The FTC however, and by direction of executive order, decided toattempt to fully ban an agreement in every state without any authority to doso. Such an attempt is a concern regardless if it is eventually defeated incourt. Concerning because such attempts are blatant overreach and disregard ofthe legislative branch of government. If anything a ban would be more of apresentation of evidence for state legislatures to consider instead of banningthem from using non-compete agreements. The more regulatory entities take onsuch direct and unsolicited policy making, the more distance Americans havebetween them and representation in the policy-making process. In the case ofthe FTC attempted ban, there is very little direct representation in thedecision of the ban.

Legal challenges to such decisions mustcontinue as they provide a response to federal overstepping. Also, there islittle reason for federal agencies to step in and ban agreements betweenemployees and employers. Such agreements should be left mostly alone unlesscriminal activity or verifiable issues are taking place.

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

WhatShould Employers do?

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

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

Conclusion

The FTC ruling banning non-competes completelymisses the mark when it comes to fully understanding non-competes and theirplace in labor relations. Despite being constitutionally and statutorilyunsound, it also misunderstands the issue and simply tries to outright ban theagreement.

Basic economics gives profound insight intothe issue, and while there are significant issues in terms of behavior when itcomes to non-compete agreements. Understanding this allows for more preciseremedies for the issue, and not ones that are particularly new either. Yet theFTC ignores this and simply tries to ban non-competes. This ruling is afascinating study of how data can show one facet of an issue but can alsocompletely miss other details and lead to overly simplistic policy changes thatwhen considered fully, make no sense.  

ResourcesUsed

●     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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