FTC Proposes Non-Compete Ban in Bid to Help Employees

Employee non-compete agreements, or non-competes, are clauses in employee contracts which require that the employee, after they leave their job, commit to not working for a competitor for an agreed-to period of time. Source for image: Greene and Hafer Law Firm

In the animated hit TV show Spongebob Squarepants, a large portion of conflict surrounds Plankton seeking the secret formula of the Krabby Patty. Behind the nostalgic show lies a true economic aphorism: businesses have proprietary information that they would prefer be restricted to employees only. Employers can protect their trade secrets through agreements with employees, one of which is employee non-compete agreements. These agreements, colloquially known as non-competes, are clauses in employee contracts which prohibit the employee from working for another competitor after leaving their job for an agreed-upon period of time. Non-competes have a purpose: increase investment in employees and protect firms’ intellectual property. But they have many negative consequences as well. After years of state regulation of non-competes, the Federal Trade Commission (FTC) has caught on and proposed to ban them.

On January 5, the FTC released a Notice of Proposed Rulemaking that would prohibit non-compete clauses in employee contracts and require termination of existing non-competes. In the 46 states where it is legal to enforce non-competes, employees face lower compensation, reduced mobility, fewer job offers, barriers to entry and exit, and worse conditions for entrepreneurship. Non-competes “lock in” employees, decreasing their bargaining power relative to their employee, which decreases their wage. 

One in five employees is currently constrained by a non-compete. Eleven percent of those who sign non-competes later leave their industry as a result. Between 30 and 40 percent of employees find out about non-competes after accepting the job; just 10 percent of employees negotiate over their non-competes. Additionally, 14 percent of those bound by non-competes earn less than $40,000 and 15 percent of workers lacking a college degree are subject to a non-compete. Non-competes by nature suppress workers’ freedom of trade. Women and minorities are also disproportionately subject to the effects of non-competes, leading to inequity.

Non-competes do not just impact the people that sign them. Where non-competes are higher in incidence and enforceability, all labor force participants experience negative externalities: lower wages, reduced mobility, and receive relatively fewer job offers. There is also a chilling effect, where risk aversion due to the threat of a non-compete lawsuit influences workers to stay in their jobs, regardless of whether the non-compete is enforceable. This is employer-endorsed fear-mongering.

Some economists claim that non-competes are fair and voluntary because they are mutually agreed upon; however, this claim could not be further from the truth. The 30 to 40 percent that only become aware of the non-compete agreement after accepting the job would likely disagree that they have agreed to the clause. The non-compete is also a cost to the job offer from employees’ perspectives, and therefore ought to be offset by an increase in compensation. The wage increase that theoretically covers the cost does not exist – therefore, non-competes are economically inefficient. 

Simply put, non-competes are a net-negative on the entire workforce and have long been in need of reform. 

The History of Non-Competes & Non-Compete Regulation

Non-compete agreements have been around since as early as 1414, but in 16th- and 18th- century British legal rulings, they were deemed illegal restraints of trade. They did not become common practice in the United States until after the Industrial Revolution. In the 1874 court case Oregon Steam Nav. Co. v. Winsor, the Supreme Court ruled that certain non-compete agreements are reasonable restraints on trade and may be allowed. Since then, non-compete agreements have been prevalent in employment law. 600 years after the first documented case involving non-competition restraints, the sandwich chain Jimmy John’s drew criticism for requiring its sandwich makers to sign non-competes. In 2016, the restaurant agreed to drop non-competes in a settlement with the New York attorney general’s office.

Several states, including Maryland, Oregon, Nevada, Maine, and New Hampshire, have set wage floors for non-compete enforcement. A 2008 study in Oregon found that these types of bans are proven to increase wages by 6% over five years after enacting the ban. 

These types of bans merely address the negative impacts of non-competes for low-wage workers. They do not fully remedy the externalities that reverberate through the entire labor force. The proposed all-out ban would cover the loss in wages, mobility, and job offers that occur in the workforce.​​ 

The FTC Decides to Act

To the federal government’s credit, in 2021, President Biden used an executive order to encourage the Federal Trade Commission (FTC) to "curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility" through its rulemaking authority. 

In 2022, the FTC, in their annual Statement of Regulatory Priorities, addressed the issue and stated that they planned to investigate whether non-competes violate Section Five of the FTC Act, and therefore would be prohibited under federal antitrust law. If true, this would give Congress the constitutional grounds, and obligation, to ban non-competes.

After a year of such investigation, the FTC preliminarily found that non-competes are an unfair form of competition, and violate the FTC Act. The Commission voted 3-1 to propose a ban to non-competes, seeking public comment on the rule. The agency estimates this rule will drive a $300 billion increase in workers’ wages, as well as expanding opportunities for 30 million American workers. The rule would decrease workers’ health costs by $148 billion, double company foundership in similar industries by former workers, and could close racial and gender pay gaps by up to 9.1 percent. 

This marks progress for the FTC as they look to expand antitrust rulemaking in the labor market. There is still a long road ahead for the ban to be approved, as the Chamber of Commerce has claimed that such rulemaking is outside of the FTC’s jurisdiction. Chamber vice president Neil Bradley stated that this is for states to legislate and that legal observers do not think Section Five of the FTC Act is applicable to non-competes. The non-compete rule will likely face legal challenges from the Chamber, so workers will have to wait to benefit from this new rule.