FTC Authority to Ban Non-compete Clauses in Employment Agreements?

Posted in: Employment Law

On January 5, 2023, the Federal Trade Commission (FTC) published a notice of proposed rulemaking (NPRM, as published on the agency’s website, Jan. 6, 2023), or Proposed Rule) that would make it 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 the worker is subject to an enforceable non-compete clause.” (NPRM, at 69). A non-compete clause is defined by the proposed rule 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.” (Id. at 4). “Senior executives,” a term not yet defined, may or may not be excluded from the reach of the proposal (depending on the agency’s views after receiving comments).

The scope of the Proposed Rule is quite broad: the agency estimates that 49.4% of American firms use such clauses purporting to bind nearly 30 million workers in this country. Currently, non-compete contracts are regulated by state law: three states (California, North Dakota, and Oklahoma, as well as the District of Columbia) outright ban their enforcement, aside from a few narrow exceptions. (NPRM, at 129). Many others, as set forth in Sections 8.06-8.07 of the American Law Institute’s Restatement of Employment Law (2015) (Employment Restatement) stipulate such clauses are not enforceable unless justified by legitimate employer interests and narrowly tailored in duration and scope to meet only those interests.

The FTC’s authority to ban non-compete clauses is based on Sections 5 and 6(g) of the FTC’s authorizing statute, 15 U.S.C. § 41 et seq. Section 5 empowers the FTC “to prevent persons, partnerships, or corporations . . . from using unfair methods of competition in or affecting commerce.” 15 U.S.C. § 45(a)(2). And Section 6(g) allows the FTC to “make rules and regulations for the purpose of carrying out the provisions of” Section 5. 15 U.S.C. § 46(g). Thus, in order for a market actor’s conduct to violate Section 5 and be subject to the FTC’s rulemaking authority under Section 6(g), it must be an “unfair method of competition” under Section 5. The Proposed Rule is in keeping with the Biden administration FTC’s new emphasis on lowering barriers to competition in labor markets.

The agency maintains that non-compete clauses in employment contracts are an “unfair method of competition” under Section 5 largely because, taking advantage of the employer’s unequal bargaining leverage, they prevent employees from seeking higher pay and/or benefits with competitors of the employer, and effectively prevent other employers from bidding for those workers. With respect to undefined “senior executives,” non-compete clauses “may harm competition in product markets in unique ways”—“to the extent that senior executives may be likely to start competing businesses, be hired by potential entrants or competitors, or lead the development of innovative products and services.” (NPRM, at 80)

The Proposed Rule does not draw a distinction between employees having access to the employer’s trade secrets or other commercially valuable confidential information, which most states recognize as a legitimate basis for a reasonably time-limited restrictive clause. As Pennsylvania Law’s Professor Hovenkamp has noted, the proposed rule “simply plow[s] over” important distinctions that exist between non-compete clauses in employment contracts with low-skilled, low-wage employees and those with highly-trained, high-wage employees. (Hovenkamp, Noncompete Agreements and Antitrust’s Rule of Reason, Reg. Rev. (Jan. 16, 2023)).

The Proposed Rule is an advance over many state laws in providing a course of action for employees who are forced to sign non-compete clauses for the clauses’ in terrorem effect even though the workers in question lack access to trade secret information, and the employer should be fully aware that these covenants are unenforceable. Section 5.02(b) of the Employment Restatement provides that employers are subject to liability under the “public policy” tort, recognized in most states, for retaliating against job applicants and employees who “refuse[] to waive a nonnegotiable or nonwaivable right as a condition of employment”. Such clauses would be plainly unenforceable under Sections 8.06-8.07, and insistence on them would state a public policy tort.

There is a substantial question whether the agency has authority to intervene in this manner in employment contracts, where there is no evidence of collusion or tacit agreement between employers. Consider the following:

We are not aware of a situation where the FTC previously regulated contracts between single employers and their workers. Historically, the FTC has steered clear of regulating employer-employee relations generally.

In its NPRM, the agency cites to two cases in support of the proposition that “non-compete clauses have always been considered proper subjects for scrutiny under the nation’s antitrust laws.” This is a considerable overstatement. In the first case cited, U.S. v. Am. Tobacco Co., 221 U.S. 106, 183 (1911), the Supreme Court held that tobacco companies violated the Sherman Antitrust Act, 15 U.S.C. §1 et seq., by dint of a number of practices, one of which was the use of “constantly recurring” non-compete clauses “whose legality,” the Court noted, “isolatedly viewed, we are not considering . . . .” In the second, Newburger, Loeb & Co., Inc. v. Gross, 563 F.2d 1057, 1082 (2d Cir. 1977, the court of appeals noted that although such clauses “interfere[] with free competition for one of its former employee’s services,” they can “serve legitimate business purposes: they prevent a departing employee from expropriating his employee’s secrets and clienteles.” The clause in that case involved a partnership agreement, and the court affirmed the dismissal of the antirust claim.

From this sparse authority, it is not clear how broadly Section 5 of the FTC Act can be construed, even if courts ordinarily accord deference to reasonable agency interpretation of statutory provisions that evidence a delegation of interpretive authority for administrators. While the Supreme Court has acknowledged that “unfair methods or means of competition under Section 5 are not limited to precise practices that can readily be catalogued[,]” it has nonetheless made clear that unfair ends violative of Section 5 generally concern “the impact of particular practices on competition and monopoly.” Pan Am. World Airways, Inc. v. U.S. 371 U.S. 296, 307 (1963). Perhaps the agency’s current view that labor market restraints between a single employer and its employees come within its Section 5 authority may ultimately prevail, We note, however, that the agency’s website acknowledges that, with respect to single firms’—as opposed to horizontal conduct between competing firms—anticompetitive practices, “[a] company violates the law only if it tries to maintain or acquire a monopoly through unreasonable methods.” (Anticompetitive Practices, FTC).

We hope the agency will seriously evaluate these considerations in its final action after completion of the comment period which has been extended to April 19.

Reprinted with permission from the March 22, 2023 issue date of the “New York Law Journal” © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com

Samuel Estreicher is Dwight D. Opperman Professor of Law and Director of the Center of Labor and Employment Law and Institute of Judicial Administration at NYU School of Law. He also served as Chief Reporter of the American Law Institute’s Restatement of Employment Law (2015), which is referred to in the article. Zachary Garrett will receive a 2023 J.D. from NYU Law, and upon graduation will be a law clerk to Judge Carlos Bea of the U.S. Court of Appeals for the Ninth Circuit.

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