Have noncompete agreements become obsolete? The Biden administration’s FTC aims to end them

The U.S. Chamber of Commerce met the Federal Trade Commission’s late April announcement that it would ban all future employee noncompete agreements with a simple, uncompromising declaration: See you in court.

“The Federal Trade Commission’s decision to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive,” charged Chamber President Suzanne P. Clark in a statement.

Clark promised that her organization would “sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked.”

In a rare regulatory move, the final FTC rule against noncompetes went further than the original proposal. The agency explained that “existing noncompetes for the vast majority of workers will no longer be enforceable after the rule’s effective date,” about four months from now.

The agency allowed that existing C-suite noncompetes “can remain in force.” However, barring judicial intervention, once the rule takes effect, “employers are banned from entering into or attempting to enforce any new noncompetes, even if they involve senior executives.”

The courts will weigh in, but it’s possible that, by a vote of 3-2, the FTC has made noncompetes a thing of the past.

The FTC’s Polarizing Rule

By and large, the Chamber and many industry trade groups opposed the decision, while progressive groups supported it stoutly. The American Economic Liberties Project issued a news release the day the rule dropped with supportive statements from an even dozen progressive policy organizations.

“Noncompetes have enabled employers to suppress worker power for far too long,” said Rachel Dempsey, an attorney at Towards Justice, but this “historic step” would change that. “FTC’s final rule removes a key mechanism of exploitation and corporate control over U.S. workers,” said Angela Huffman, president of Farm Action.

Yet there were a few hints during the loud interest group bandwagon circling that the issue is not necessarily so clear cut and that the FTC’s far-reaching decision has promoted polarization rather than deliberation.

In her statement promising a court challenge, the Chamber’s Clark said such agreements “are either upheld or dismissed under well-established state laws governing their use,” thus signaling some openness to further state-based changes in how noncompetes are handled.

And some progressive groups seemed a little unsure of what to do about the phaseout of C-suite noncompetes. Declarations like Dempsey’s that “these contracts keep workers trapped at jobs with low wages and poor working conditions” could ring a little hollow when applied to, say, most chief financial officers.

There is a debate about the role that noncompetes have played in the U.S. economy, but you wouldn’t know that from what President Joe Biden’s appointee, FTC Chairwoman Lina Khan, has to say on the subject.

“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” Khan said when the rule was released. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

What Good Are Noncompetes?

Khan’s words represent the maximal case against noncompetes, or something close to it. The FTC issued some other numbers undergirding her claim of 8,500 new businesses yearly, which would work out to a 2.7% boost in business formation. Workers are predicted to earn $524 more annually, and healthcare costs could fall by $194 billion over 10 years. The number of patents filed in that same period is also predicted to skyrocket.

Or the FTC could be wrong, and none of those things could come to pass. A famous 2020 University of Chicago Law Review article found that most of the studies used to argue against noncompetes “are badly flawed and, even so, common characterizations of their findings often dramatically overstate the policy conclusions that the data can reasonably support.”

Authors Jonathan Barnett and Ted Sichelman, law professors at the University of Southern California and the University of San Diego, respectively, admitted that in some states where noncompetes are vigorously enforced, such agreements could impede some of the very things the FTC is warning against with its rule. However, they insisted that’s not the whole economic story of noncompetes.

“While it is frequently asserted that noncompetes may impede knowledge spillovers that foster innovation, it is frequently overlooked that noncompetes may encourage firms to invest in cultivating intellectual and human capital,” they explained.

Companies need to find a way to ensure that some of their most closely guarded secrets do not leak to the competition. Noncompetes are one relatively simple way of doing that, by keeping people with privileged information from quitting and taking that information with them to a rival firm.

Remove noncompetes and companies will have to develop more complicated ways of keeping their secrets, including sharing them less widely and consequently training fewer people. In a world shorn of noncompetes, “talent may be freer but it could well be worse off,” Barnett and Ted Sichelman warned.

Two Noncompete Regimes?

This “corporate secrets and training” picture does not square well with the one painted by progressive policy groups of the ills that noncompetes allegedly produce.

“Our research finds that more than one out of every four private-sector workers, including low-wage workers, are required to enter noncompete agreements as a condition of employment,” said Heidi Shierholz, president of the Economic Policy Institute.

“Many restaurant workers have been stuck at their job, earning as low as $2.13 per hour, because of the noncompete clause that they agreed to have in their contract,” charged Teofilo Reyes, chief of staff at the Restaurant Opportunities Centers United.

Stories of nurses not allowed to quit their jobs and go work for a rival healthcare firm are also ubiquitous.

It’s possible that there are two different but overlapping noncompete regimes in U.S. employment law that are currently classified under the same heading. The first noncompete regime is about keeping company secrets and processes in-house, and the second is about reducing employees’ bargaining power.

The FTC implicitly nods toward this understanding in its rule by invalidating the noncompetes of most workers but allowing existing C-suite noncompetes to stand, for now.

Politics and Contractors and Interest Rates

The rule will lead to much legal wrangling and will make for political fodder in an election year. It could also have other knock-on effects for many things, including federal contracting and even the Federal Reserve’s interest rate decisions.

David Berteau, president of the Professional Services Council, predicted “some very unique and, I think, deleterious consequences” for federal contractors in an interview on the Federal Drive podcast.

“When a contractor bids on a government solicitation, frequently, one of the requirements is to name and put resumes in of the key personnel that are going to be performing that work if you win, especially in the services contract arena,” Berteau said.

There is often a long interval between when the bids are made and when the contracts are awarded, and noncompetes are the standard “way of keeping those key personnel relevant for their bid during the process that the government is going through,” he said. Take that away and it will be harder for contractors to hold the promised team together through the bid period. “The government itself will suffer from this,” Berteau predicted.

If the FTC rule change hikes wages for a broad enough swath of workers, it could also trigger the Fed, and not in a good way.

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The Fed has cited metrics such as rising housing prices to justify higher interest rates and keep those rates up. In a late March press conference, Fed Chairman Jay Powell showed some concern over workers’ raises as well. Wage growth at the time was “gradually coming down to levels that are more sustainable over time, and that’s what we want,” he said.

When the Fed gets what it wants for long enough, people tend to get nice things like lower interest rates and cheaper home mortgages. Failing that, perhaps wage growth can lead to a boom in the avocado toast industry.