The Federal Trade Commission (FTC) will likely vote in April 2024 on its proposed rule to ban all non-compete clauses in employment agreements. The agency estimates that one in five U.S. workers are bound by non-compete clauses and that nearly half of American firms use such clauses. The FTC’s legal authority to promulgate such a rule was previously discussed in these pages (Samuel Estreicher & Zachary Garrett, FTC Authority to Ban Non-compete Clauses in Employment Agreements, Justia Verdict, March 27, 2023), and there remain questions over the FTC’s authority to use rulemaking in competition matters (Thomas W. Merrill, Antitrust Rulemaking: The FTC’s Delegation Deficit, George Mason Univ., Antonin Scalia Law School, Sept. 19. 2022). This column explores the FTC’s initial policy arguments advanced in its notice of proposed rulemaking (NPRM, as published on the agency’s website, Jan. 6, 2023).
We are supportive of a ban limited to workers who lack any access to their employer’s trade secrets. In such situations, employers are imposing unenforceable non-compete pacts simply for the purpose of discouraging worker mobility without any justification based on protecting confidential information. Although state law, including the “public policy” tort recognized in many jurisdictions (see Restatement of Employment Law § 5.02(d))[1], should be sufficient to deter non-compete clauses where employers have no legitimate purpose for their use, a narrow FTC ban would provide useful additional discouragement.
The agency’s burden here, however, is to justify its proposed nationwide ban of all non-compete clauses. Such a ban, if enforced, will require employers to take care to minimize employee access to confidential information, even where such access would otherwise be desirable for team production, worker skill enhancement, and innovation.
We discuss here the FTC’s initial policy justifications for a nationwide ban. The agency advances four claims for its proposed ban.
Claim 1: Non-compete clauses reduce workers’ wages
The FTC estimates that banning non-competes would “increase workers’ total earnings by $250 to $296 billion per year.” (NPRM, at 76). The FTC primarily bases its increased earnings estimate on a 2020 study by Johnson, Lavetti & Lipsitz (hereafter “JLL”)[2] “which found that a nationwide ban on non-compete clauses would “increase average earnings by 3.3-13.9%.” (NPRM at 20). The JLL study examined all non-compete statutory and common law changes between 1991 and 2014 and the resulting effects on worker wages. The FTC focuses on the lower end of the study’s earnings range because changes in state laws have decreased non-compete enforceability since 2014, meaning an outright ban would result in a lower increase in earnings than it would have at the time that the study concluded. (Id. at 162). The agency also applied a discount rate of 7% over a 10-year period and ”assume[s] that annualized benefits and costs persist for 10 years.” (Id. at 173). The agency acknowledges that it does not “have detailed or complete enough quantifiable and monetizable estimates to determine whether net costs are positive or negative,” which will depend significantly on “non-earnings-related benefits.” (Id.). The agency estimates that the greatest returns will go to CEOs (9.4%) rather than hourly workers (2.3%). (Id. at 167–69). FTC notes that upfront “compliance costs and the costs of firms updating their contractual practices would total $1.02 to $1.77 billion,” presumably on a non-recurring basis (Id. at 182). The FTC acknowledges that “worker training and firm investment in capital assets would likely decrease under the proposed rule,” and the agency estimates that “on average, 3.1% fewer workers would receive training in a given year.” (Id. at 182, 187).
Claim 2: Non-compete clauses stifle new businesses and ideas
To support this second claim, the NPRM cites a number of studies finding that “the weight of the evidence indicates non-compete clauses likely have a negative impact on new business formation,” although, the agency acknowledges, some studies were either statistically insignificant for at least one group or found to have no effect at all. (Id. at 37). The studies cited in support of the FTC’s position focus primarily on high-paying industries such as technology in an effort to demonstrate that “non-compete clauses restrain new business formation by preventing workers subject to non-compete clauses from starting their own businesses.” (Id. at 79). The FTC candidly cites evidence that an increase in the enforcement of non-competes may actually lead to an increase in the number of patents per capita, although noting that ”patenting may or may not reflect the true level of innovation, as firms may use patenting as a substitute for non-compete clauses”; and the FTC was “unable to extrapolate from the relevant studies or monetize” whatever benefit to innovation may be realized from banning non-compete clauses. (Id. at 43, 179). The agency also cites contrary evidence that the “job creation rate at startups increased by 7.8%” when Michigan increased the enforceability of non-compete clauses, although noting that “the job creation rate at startups may rise either because the number of jobs created by startups rose, or because employment overall fell.” (Id. at 180).
Claim 3: Non-compete clauses exploit workers and reduce economic freedom
The agency postulates that non-compete clauses are “exploitive and coercive” both at the time of contracting and when the employee ultimately departs. (Id. at 71–72). Due to the imbalance of bargaining power between workers and employers, the agency reasons that employers often coerce employees into signing “exploitative” non-competes because employers are “repeat players who are likely to have greater experience and skill at bargaining.” (Id. at 83). The NPRM asserts that workers “rarely seek the assistance of counsel in reviewing non-compete clauses” and that non-compete agreements restrict an employees’ ability to quit his or her job, although noting that these findings are “preliminary” and additional studies are needed in this area. (Id. at 86–87). The NPRM notes a combination of factors that contribute to the unequal bargaining power in the worker-employer relationship, such as the “decline in union membership… increased reliance by employers on various forms of outsourcing… and the proliferation of no-poaching agreements.” (Id. at 83).
Claim 4: Employers already have ways to protect trade secrets/investments that are less harmful to workers
Finally, the NPRM reasons, employers have alternative ways to protect valuable trade secrets, namely trade secret law and non-disclosure agreements (NDAs), rendering the need for noncompete agreements obsolete. (Id. at 98). The NPRM notes that trade secret law “has developed significantly in recent decades” and was recently buttressed by the enactment of the Defend Trade Secrets Act of 2016 (18 U.S.C. §1836 ), which established a civil cause of action under federal law for misappropriation of trade secrets by improper means. (NPRM, at 94). Furthermore, although the NPRM praises NDAs as a viable non-compete alternative, it also notes that broad NDAs can “function as de facto non-compete clauses.” (Id. at 99). The agency suggests additional measures that employers can use to protect valuable investments such as by providing worker training and signing workers to fixed-term contracts in lieu of signing a non-compete. (Id. at 99–100). Furthermore, as the FTC acknowledges, many states, as set forth in Sections 8.06-8.07 of the Restatement of Employment Law (2015), will enforce only non-compete clauses that are justified by legitimate employment interests and narrowly tailored in duration and scope, diminishing the need for a broad-based non-compete clause ban. (Id. at 140).
Conclusion
We await the final rule and the FTC discussion of the comments and other materials in the rulemaking record.
[1] Section 5.02(d) 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”.
[2] Matthew Johnson, Kurt Lavetti & Michael Lipsitz,The Labor Market Effects of Legal Restrictions on Worker Mobility (June 6, 2020). Available at SSRN: https://ssrn.com/abstract=3455381 or http://dx.doi.org/10.2139/ssrn.3455381
