Noncompetes are "an unfair method of competition" and violate US law, FTC says.

The Federal Trade Commission today proposed a rule that would prohibit employers from imposing noncompete clauses on workers, arguing that "noncompetes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act."

The contract clauses currently "bind about one in five American workers, approximately 30 million people," the FTC said in a fact sheet, writing that noncompetes prevent workers from seeking better jobs and prevent employers "from hiring qualified workers bound by these contracts."

"Noncompetes undermine core economic liberties," FTC Chair Lina Khan wrote. "Evidence suggests noncompetes also suppress earnings and opportunity even for workers who are not subject to a noncompete. FTC economists estimate that noncompetes lower US workers' collective income by $250-$296 billion [per year]."

Khan added that "locking workers in place can enable incumbents to close off markets to new rivals, undermining dynamism and healthy competition."

Employers would have to rescind existing noncompetes

The FTC said its proposed rule "would make it illegal for an employer to enter into or attempt to enter into a noncompete with a worker; maintain a noncompete with a worker; or represent to a worker, under certain circumstances, that the worker is subject to a noncompete."

The FTC said employers would have to "rescind existing noncompetes and actively inform workers that they are no longer in effect." The proposed rule would apply to employees and independent contractors, covering "anyone who works for an employer, whether paid or unpaid," the FTC said.

The FTC defined a noncompete clause 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."

A noncompete ban would affect many types of jobs and industries. "Companies use noncompetes for workers across industries and job levels, from hairstylists and warehouse workers to doctors and business executives," the FTC said. "In many cases, employers use their outsized bargaining power to coerce workers into signing these contracts."

The FTC pointed to a case involving Amazon, which sued former executive Gene Ferrell in 2017, alleging he violated a noncompete agreement when he left to join a tech startup called Smartsheet. "After unfavorable media coverage, Amazon dropped the suit," the FTC said. "Under the leadership of Gene and others, Smartsheet thrived and exceeded $500 million in annual revenue."

Rulemaking could test limits of FTC authority

The proceeding could test the limits of the FTC's rulemaking authority. "This proposed rule sets up [a] potential legal challenge to the scope of FTC authority to issue substantive rules (which SCOTUS has not previously addressed)," wrote Jonathan Adler, a law professor at Case Western Reserve University.

Adler noted that in a 1973 ruling, the US Court of Appeals for the District of Columbia Circuit embraced a "broad view of FTC rulemaking authority." But it is "questionable whether SCOTUS would uphold that precedent," he wrote.

The US Chamber of Commerce said it is considering a lawsuit against the FTC if the noncompete ban is adopted. "We don't believe they have the statutory authority," Sean Heather, the group's senior VP for international regulatory affairs and antitrust, told The Wall Street Journal. "They know they are on very tenuous ground."

The FTC is starting the process of implementing a noncompete ban by releasing a Notice of Proposed Rulemaking. The agency will invite the public to submit comments for 60 days after the NPRM is published in the Federal Register. The proposed rule would give employers 180 days to comply after it becomes final.

Among other questions, the FTC said it is seeking comment on "whether franchisees should be covered by the rule; whether senior executives should be exempted from the rule, or subject to a rebuttable presumption rather than a ban; [and] whether low- and high-wage workers should be treated differently under the rule."

Biden urged FTC to curtail noncompetes

In a July 2021 executive order on competition policy, President Joe Biden urged the FTC to exercise its "statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of noncompete clauses and other clauses or agreements that may unfairly limit worker mobility."

"Powerful companies require workers to sign noncompete agreements that restrict their ability to change jobs," Biden's executive order said.

The FTC's proposal argues that the agency has authority to issue the rule as follows:

Section 5 of the FTC Act declares "unfair methods of competition" to be unlawful. Section 5 further directs the Commission "to prevent persons, partnerships, or corporations... from using unfair methods of competition in or affecting commerce." Section 6(g) of the FTC Act authorizes the Commission to "make rules and regulations for the purpose of carrying out the provisions of" the FTC Act, including the Act's prohibition of unfair methods of competition. Taken together, Sections 5 and 6(g) provide the Commission with the authority to issue regulations declaring practices to be unfair methods of competition.

The FTC also disputed employers' arguments that noncompete clauses are needed to protect trade secrets. The "record to date shows that in California, North Dakota and Oklahoma—three states in which employers can't enforce noncompete clauses—industries that depend on trade secrets and other key investments have still flourished. This shows that employers have other ways of protecting these investments," the FTC said.