The FTC Seeks to Ban Non-Competes & Brings Related Enforcement Actions

The FTC Seeks to Ban Non-Competes & Brings Related Enforcement Actions

January 6, 2023, Covington Alert

Contract terms limiting employees’ ability to work for competitors are squarely in the crosshairs of the Federal Trade Commission. In back-to-back days during the first week of January, the FTC used enforcement actions and a newly proposed regulation to declare its position that virtually all non-compete agreements in employment contracts constitute unfair methods of competition and are therefore illegal under Section 5 of the FTC Act. This is part of the FTC’s broader initiative to use all of its tools and authorities to promote what it perceives to be fair competition in labor markets.

On January 4th, the FTC announced that it had voted 3-1 to issue consent decrees against three companies, declaring that their use of non-compete clauses in employment agreements constituted an unfair method of competition in violation of Section 5 of the FTC Act.  The following day, also by a 3-1 vote, the FTC proposed a new rule that – if enacted and upheld by the courts – would make it illegal for an employer to include a non-compete clause in an employment agreement with any worker.

In light of the FTC’s notice of proposed rulemaking and its recent enforcement efforts, companies that use non-competes or are considering whether to include a non-compete provision in an employment contract should consult antitrust counsel.  Although the proposed rule – if enacted – would constitute an outright ban on all or virtually all non-competes, federal courts have found such provisions to be valid as long as they are not unreasonable in duration and geographic scope, after considering the company’s proffered business justification for the restriction.

The remainder of this client alert summarizes the FTC’s proposed rule, and provides a brief discussion of the recent enforcement actions challenging non-competes.

The FTC’s Proposed Rule to Ban Non-Compete Clauses

The FTC’s proposed rule would make it illegal for an employer to (1) enter – or attempt to enter – a non-compete with a worker; (2) maintain a non-compete with a worker; or (3) represent to a worker that the worker is subject to a non-compete.[1]  The rule would have broad-based reach across the U.S. economy, applying to any employer (i.e., any entity or person that hires or contracts with a worker to work for a person)[2] and any worker (i.e., any natural person who works, whether paid or unpaid, for an employer, including independent contractors).

The three-member majority of commissioners justified the proposed ban by asserting that the imposition of non-compete clauses is “a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.”  According to a statement issued by Chair Lina M. Khan, the Commission acknowledges that “noncompetes may be unlawful in different contexts for different reasons; for example, employers’ use of noncompetes to bind low-wage workers may be coercive and unfair in ways that the use of noncompetes to bind senior executives is not.”  Nevertheless, she argues that a blanket ban is warranted because, “in the aggregate, employers’ use of noncompetes undermines competition across markets in ways that are harmful to workers and consumers and warrant a prohibition.”

Commissioner Christine S. Wilson issued a lengthy dissenting statement that makes three primary arguments.  First, the rule “represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction.”  Second, this “radical departure” is unjustified because the Commission lacks clear evidence or enforcement experience to support the rule.  Finally, Commissioner Wilson identifies three ways that the rule is “vulnerable to meritorious challenges”:

(1) the Commission lacks authority to engage in “unfair methods of competition” rulemaking, (2) the major questions doctrine addressed in West Virginia v. EPA applies, and the Commission lacks clear Congressional authorization to undertake this initiative; and (3) assuming the agency does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the Commission has replaced the consumer welfare standard with one of multiple goals.

As Commissioner Wilson’s dissent highlights, there is considerable debate about the extent of the FTC’s authority to promulgate rules regarding unfair methods of competition, a point which any legal challenge to the final rule is likely to raise.  The dissent also points to the Seventh Circuit’s 1963 decision in Snap on Tools, which likely will be relevant to any challenge to the proposed rule.  In interpreting Section 5 of the FTC Act – the same provision that the majority uses as the basis for its proposed rule – the Seventh Circuit held that “[r]estrictive [non-compete] clauses . . . are legal unless they are unreasonable as to time or geographic scope” and do not constitute “per se violation[s] of the antitrust laws.”[3]  That holding clearly conflicts with the FTC’s proposed rule and was not referenced in the Commission’s notice of proposed rulemaking.

The proposed rule will be subject to a public comment period, with comments due 60 days after the Federal Register publishes the notice of proposed rulemaking.  This is likely the only opportunity for interested parties to provide input on the proposed rule or the alternatives identified in the notice of proposed rulemaking.[4]  FTC staff typically reviews the comments that are submitted and may recommend changes to the rule that they deem warranted by the comments.  The commissioners usually consider any recommended changes, finalize the rule, and hold a vote on whether to issue the final version.  The rule would nominally take effect 180 days after the publication of the final version, which could be as early as mid-2023; however, the substance of the rule and the FTC’s legal authority to promulgate it will likely be challenged.

Recent Enforcement Actions Challenging Non-Competes

The day before it revealed its notice of proposed rulemaking, the FTC announced that it had reached consent agreements that prohibited three companies from enforcing non-compete restrictions.  According to the agency’s press release, this marked the first time – outside the context of merger enforcement – “that the agency has sued to halt unlawful noncompete restrictions.”  Particularly in light of the notice of proposed rulemaking, these enforcement actions – against Prudential Security, Inc. and Prudential Command Inc. (and those companies’ owners) and glass container manufacturers O-I Glass, Inc. and Ardagh Group S.A. – show that the current FTC will attempt to use all of its enforcement tools in new and sometimes unprecedented ways to address what it perceives as harmful restrictions on labor mobility.  In particular, the agency’s complaints allege that the non-compete provisions at issue constituted unfair methods of competition that violated Section 5 of the FTC Act.[5]

Commissioner Wilson voted against all three complaints and issued two separate dissenting statements.  In the O-I Glass and Ardagh matters, Commissioner Wilson’s statement highlighted the majority’s failure to allege that the non-compete provisions at issue were unreasonable in terms of duration or geographic scope, which she noted is “a significant departure from hundreds of years of legal precedent.”  In her Prudential Security dissent, Commissioner Wilson emphasized that she did not dissent because she endorsed or condoned Prudential’s conduct. Instead, she dissented to voice her “continuing disagreement with the new Section 5 Policy Statement and its application to these facts,” claiming that in this case the majority used the Policy Statement “to condemn conduct summarily as an unfair method of competition based on little more than the assignment of adjectives.”

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Takeaways

The federal antitrust agencies – and particularly the FTC – are pursuing an aggressive enforcement strategy against restrictions on labor mobility.  Companies should be cautious and consult antitrust counsel when considering whether to use non-compete clauses in employment contracts.  Keep in mind that the FTC’s rule is not in effect yet, and federal courts have held that non-compete provisions can be valid and justified when they are reasonably tailored to protect legitimate business interests. 

For further information on the proposed rulemaking or questions regarding the use of non-compete provisions, please contact the members of Covington’s Antitrust and Competition practice.