by Dennis Crouch
Non-compete agreements fly under the radar for most American lawyers. One reason is that such restrictions have long been banned within legal practice. As an example, the American Bar Association (ABA) Model Rule 5.6(a) prohibits lawyers from entering into agreements that restrict their right to practice law after terminating an employment, partnership, or other professional relationship. The rule’s stated aim is to protect clients’ freedom to choose their legal representation, but it also ensures that lawyers can practice their profession without restriction.
The increasing prevalence of non-compete agreements in other industries has drawn increasing scrutiny from policymakers and regulators, leading to the FTC’s recent rule banning most non-compete agreements across the United States. The new rule was announced on April 23, 2024 following a 3-2 vote by the FTC Commissioners (along party lines, with Democrats in the majority). It is set to take effect 120 days later (August 21, 2024). As I discuss below, two lawsuits have already been filed seeking to derail implementation.
Increase Innovation and Patent Reliance
Among many other aspects, the FTC’s implementation documents assert that the non-compete ban will lead to increased innovation and a more robust patent system. The FTC argues that by reducing the enforceability of non-compete clauses, worker mobility and knowledge sharing among skilled professionals will increase, resulting in more frequent and higher-quality patent filings. One study cited in the rule, found that decreasing non-compete enforceability significantly increases the number of patents filed. Citing Sampsa Samila & Olav Sorenson, Non-Compete Covenants: Incentives to Innovate or Impediments to Growth, 56 MGMT. SCI. 1023, 1023-1035 (2010) (increases the number of patents, number of firm starts, and employment). The idea here is that when employees are free to move between companies without the constraints of non-compete agreements, they can bring their expertise and ideas to new environments, fostering innovation across various firms and industries. The rule also cites separate finding that “the value of patents, relative to the assets of the firm, increases by about 31% when non-compete enforceability decreases.” Zhaozhao He, Motivating Inventors: Non-Competes, Innovation Value and Efficiency 21 (2023). One way of interpreting this is mechanism is increasing the relative value of patent rights as non-competes fall away as a proxy form of protection. In other words, the key mechanism for increasing patent value and reliance is that without non-compete agreements, companies may have fewer effective tools to prevent employees from leaving and sharing trade secrets, confidential information, and knowledge with competitors. With non-competes prohibited, firms may feel compelled to seek patent protection for any patentable innovations or inventions developed by employees in order to prevent that proprietary knowledge from walking out the door when employees depart. However, the causal link between non-compete bans and increased patenting is still quite speculative and debated. The studies are all pre-DTSA and expansion of privacy and trade secrecy protection regimes across corporate culture. And, of course, many valuable sources of competitive advantage, like client relationships, business strategies, and “negative knowhow”, cannot be patented.
The FTC acknowledges that while non-compete clauses may protect individual firms’ investments in human capital, they can ultimately stifle broader market innovation. The rule states that “[t]he economic analysis recognizes that non-competes can protect individual firm investments in human capital at the cost of broader market innovation and suggests that the net societal and economic impact of reducing non-compete enforceability is likely positive, fostering more open competition and innovation across the market.” Although some companies will experience short-term losses due to the inability to enforce non-compete agreements, the FTC expects the overall benefit to be net positive. The FTC particularly projects that loosening non-compete constraints could lead to thousands of new patents each year, as increased worker mobility and the resulting mixing of knowledge stimulates greater innovative activity. This projection is based on studies showing a direct correlation between non-compete policy relaxation and increased patenting rates. By allowing skilled workers to move more freely between companies, launch their own endeavors, and share their knowledge, the FTC believes that the rule will create a more dynamic and innovative environment, ultimately benefiting the patent system and the economy as a whole.
Still, the new rule faces some major obstacles to implementation. Notably, two lawsuits were immediately filed to block their implementation.
FTC’s Legal Authority
In its final rule barring non-competes, the FTC explains its authority to act with reference to sections 5 and 6(g) of the Federal Trade Commission Act (“FTC Act”). Section 5 prohibits unfair methods of competition, and section 6(g) authorizes the FTC to make rules for carrying out the provisions of the FTC Act. The rule identifies entering into non-compete agreements with workers as an unfair method of competition, thereby making such agreements unlawful if entered into on or after the effective date of the rule. As I discuss below, there has long been a fight over whether 6(g) empowers substantive rulemaking or only more internal procedural rules. This was decided in the FTC’s favor by at least one appellate panel, but the Supreme Court has not yet placed its mark on the issue. See, National Petroleum Refiners v. FTC, 482 F.2d 672 (D.C. Cir. 1973) (holding that Section 6(g) “empowered [the FTC] to promulgate substantive rules of business conduct”); United States v. JS & A Grp., Inc., 716 F.2d 451 (7th Cir. 1983).
Two Legal Challenges Already Filed
However, two recent lawsuits filed by the Chamber of Commerce (et. al) and Ryan, LLC challenge the FTC’s authority to issue this rule and its classification of non-compete agreements as unfair methods of competition.
The Chamber filed its complaint in the Eastern District of Texas (Tyler), alleging several violations of the Administrative Procedure Act (APA) and the US Constitution and seeking a nationwide preliminary injunction. Chamber of Com. of the U.S. v. Fed. Trade Comm’n, No. 6:24-cv-00148 (E.D. Tex. filed Apr. 24, 2024). The complaint alleges that the FTC lacks the authority to issue binding regulations related to “unfair methods of competition” under Section 6(g) of the FTC Act, contending that the “structure and history of the FTC Act, the Commission’s own historical understanding of its authority, and Congress’s subsequent amendments to the FTC Act demonstrate that Section 6(g) empowers the Commission only to develop internal rules to govern how it conducts investigations and carries out its functions, not to promulgate substantive rules that bind private parties and declare common business practices categorically unlawful.” See, Utility Air Regulatory Group v. EPA, 573 U. S. 302 (2014) (Congress must “speak clearly if it wishes to assign to an agency decisions of vast economic and political significance,” supporting the plaintiffs’ argument that the FTC lacks clear congressional authorization to issue the Noncompete Rule); Whitman v. American Trucking Ass’ns, 531 U.S. 457 (2001) (Congress does not “hide elephants in mouseholes”). This is a major push back – not just against this rule, but against all potential future rules from the nation’s leading consumer protection agency.
The complaint also asserts that the FTC’s attempt to designate all non-compete agreements as “unfair methods of competition” is contrary to Section 5 of the FTC Act, arguing that the “Commission’s categorical ban is inconsistent with history and precedent and departs from the Commission’s longstanding interpretation of Section 5, which considers the procompetitive benefits of any agreement that is not a per se violation of the antitrust laws.” Furthermore, the Chamber of Commerce Plaintiffs contend that if Section 5 of the FTC Act is interpreted as broadly as the Commission claims, it would violate the nondelegation doctrine, imposing “no intelligible limit on the Commission’s power and reflect[ing] a clear violation of the Constitution’s nondelegation principle.”
In addition to these statutory and constitutional challenges, the Chamber argues that the Noncompete Rule is arbitrary and capricious because it fails to engage in reasoned decision-making and fails to consider alternative proposals. The complaint asserts that the “record before the Commission does not remotely support its decision to categorically ban all noncompete agreements” and that the rule “rests on a deeply flawed cost-benefit analysis.”
Ryan, LLC, in its complaint filed in the Northern District of Texas, raises similar challenges. Ryan, LLC v. Fed. Trade Comm’n, No. 3:24-cv-986 (N.D. Tex. filed Apr. 23, 2024). The company argues that the FTC lacks statutory authority to promulgate substantive rules regarding unfair methods of competition, asserting that “Section 6(g) of the FTC Act—only grants the authority to promulgate procedural rules” and that “Congress’s decision to grant the Commission authority to promulgate substantive rules regarding unfair or deceptive acts or practices in the Magnuson-Moss Act, but to withhold similar authority with respect to unfair methods of competition” confirms this interpretation.
The primary arguments in both complaints focus on the FTC’s lack of statutory authority to promulgate substantive rules regarding unfair methods of competition and the potential violation of the nondelegation doctrine. If the courts agree with these arguments, the Non-compete Rule could be struck down, preventing its implementation and enforcement.
In a motion for a preliminary injunction filed alongside their complaint, the Chamber further argues it is likely to succeed on the merits and will suffer immediate and irreparable harm absent a preliminary injunction. The motion contends that the mere prospect of the rule taking effect is already preventing businesses from reasonably relying on existing non-compete agreements or entering into new ones, forcing them to resort to costlier and less effective methods to protect their confidential information and investments in employee training. The plaintiffs assert that these harms will only intensify once the rule takes effect, instantly invalidating millions of contractual protections that businesses have bargained for. Given this disruptive potential, the Chamber argues that the balance of hardships and the public interest also favor preliminary relief.
A decision on the motion for preliminary relief is likely to be the first substantive decision by Judge J. Campbell Barker who was assigned the case. Judge Barker was an IP litigator before joining the Texas Solicitor General’s office and then being appointed to the bench by Donald Trump. In a recent scheduling order, Judge Barker set the stage for an expedited resolution of the challenge.
The order notes that the case appears to primarily present legal disputes about agency action, which would not require discovery beyond the administrative record. As a result, Judge Barker has consolidated the preliminary injunction hearing with a trial on the merits and has given notice that he will consider summary judgment on the same schedule. The plaintiffs have until May 10, 2024, to supplement their motion with additional briefing and attachments pertinent to summary judgment, while the defendants have until May 31, 2024, to respond to both the request for preliminary relief and a demand for summary judgment (if any). Plaintiffs’ reply is due by June 12, 2024, and defendants’ reply in support their (likely) summary judgment motion be filed by June 19, 2024. The court will then set a hearing on preliminary relief and summary judgment, and if necessary, a consolidated bench trial.
This is quite an expedited schedule, but is designed to resolve the case in a way that even allows some time for appellate review before the 120 day implementation deadline of the FTC’s non-compete ban.
With respect to smaller businesses, the proliferation of non-competes has spiraled out of control in recent years. One key reason is the proliferation of on-line form employment contracts that include default non-compete clauses. In fact, if you ask ChatGPT today to generate a generic employment contract for you, it will include a default 12-month non-compete clause. That’s why you see even local flower shops today with employment contracts that include non-compete clauses, which they probably wouldn’t even have known to include without these forms. But once these clauses are in an employment contract, they act as a scarecrow against the employee taking on other employment. They’re an absolute scourge. But as detailed in earlier comments here, it is doubtful that FTC action will be effective at eradicating them.
FTC gone wild. FCC gone wild. PTO gone wild. Who’s next, Brandon?!
Dennis’ Dips—t’s really need a new writer.
When Jersey Mike’s and Subway started making clerks sign non-competes (NC) it was time for the govt to intervene. NC are supposed to be for high-level executives. Also, 99.9% of NC have sham consideration. Accepting the going rate of pay is not consideration for an NC, nor is ten dollars. If you want to prohibit me from working for six months, pay full salary (the going rate) for six months. Technology firms notorious for such bull. Same companies subcontract to China and freely give up technolgy to save money.
What kind of sandwich making technolgy are Jersey Mike’s and Subways trying to protect with Non-competes, since they make the sandwiches in front of the customers. Now if there was a special process such as in a Cartman Burger (see South Park), that might be a different case.
This:
link to youtu.be
To steel-man it, it’s probably business/customer info e.g., Joan at BigCorp orders 25 sandwiches every Tuesday for department meeting.
While I can sort-of see the issue for small, Mom and Pop shops, the trouble is that if you try to craft a little safe harbor, behemoth companies like Substandard will try to jam every last “sandwich engineer” through it.
Businesses try to pull a lot of crap. Some were setting arbitrary amounts like $10,000 as a cost for minimal training and making workers sign agreements that if they left before two years they had to pay for the training or could be sued. I am not sure what happens if they fired you for rotten job performance. It’s mainly bullsh*t by these employers.
I actually don’t think it was Jersey Mike’s that was requiring clerks to sign non-competes, I think you’re thinking of Jimmy Johns, and they apparently stopped that practice in 2016 following a public uproar and action by at least two state AGs. The clause used by Jimmy Johns was inexcusable and outrageous; a two-year non-compete barring the employee from working for another sandwich shop within three miles of any Jimmy Johns location. Because of the number of Jimmy Johns locations nationwide, the non-compete basically covered an area of about 6,500 square miles.
Actually, Jersey Mikes did it in a different way, “no-poach” agreements. I know Apple and Google amongst others tended not to hire each other employees but that was more of a “gentlemen’s agreement” not to do it. Jersey Mikes I believe ended up paying California $$$ with the usual “we didnt do anything wrong, but here is $$$”. On some level, there are no good guys, to some degree, they all suck. link to kentreporter.com
And Jimmy John is a scum bag trophy hunting jackhole.
“ This is a major push back – not just against this rule, but against all potential future rules from the nation’s leading consumer protection agency.”
Chamber of Commerce is filled with glibertarian s c u m b a g s. But so is East Texas, the 5th Circuit and the Supreme Court so this farce has legs.
lol, “the Supreme Court”
Remind me again who sm@cked you down when you celebrated that same Court’s “Ends Justify the Means” anti-patent nonsense?
Which countries outside the U.S. ban non-competes? Curious whether they have a thriving tech industry.
Non-competes are only one factor for a thriving tech industry.
(other factors used to include patents)
California has long banned non-competes and has the most thriving tech industry in the world.
The phrase “tech industry” is kind of vague, so it is hard to say with precision how much “tech industry” each country has, but I think that it is safe to say that no other country’s tech sector “thrives” to the same extent as ours. Clearly we are doing something right in this country, at least along the “tech” dimension. It is notable, if you put pins in a map for every “tech” unicorn’s headquarters, that you will see a chain stretching up and down the U.S. west coast, but ending abruptly at both our northern and southern borders.
“Cl’early” Greg continues to imbibe in his OMB-TDS Kool-Aid.
LOL, Exactly, I bet Squidward had to sign a NC because he might work at the Chum Bucket. Its ridiculous, some places have even required NC from janitors. There must be some proprietary way to clean a toilet and change the camphor stick in the urinal that employees will “steal” if they change jobs.
France does not ban non-competes altogether, but labor law courts frequently rule that the non-compete is null and void if it is overbroad (i.e., lasts for too long or has a too wide geographical scope), or unjustified (i.e., the company actually would not be prejudiced absent the non-compete), or if it provides insufficient financial compensation to the employee.
Whether France has a thriving tech industry is left to the reader’s appreciation.
Thanks, EA.
Israel effectively bans non-competes, though this was done over 20 years ago via judicial fiat (but then Israel has the most activist court system in the world). The high-tech sector doesn’t seem to have suffered as a result. (There’s still trade secret law as well as an unjust enrichment statute that help mitigate the potential effects of trade secret theft.)
Interesting. Thanks, DF.
Looking forward Lina Kahn getting smacked down by the courts over this, though I expect that it will take longer than it ought to for that to happen.
If there’s a branch of federal government for which this matter is proper, it’s Congress.
If there’s a branch of federal government for which this matter is proper, it’s Congress.
I agree. As a Californian, I want to make sure that the rest of the country does not copy the policy success that we have achieved on this issue. If tech workers could compete in a free market for their talent and experience outside California, the tech industry might move from our state. Best put up obstacles to stop such lucid and cogent policy decision-making.
I want to make s ure that
WaPo and Dooms bury are serving the right flavor of Kool-Aid.
(If you say “Orange,” you would be correct and get to have the special ‘almond aftertaste version’)
If I were in Congress, I would aid this advance by drafting and passing a very quick (and very simple) bill putting this into law.
And if you were in Congress, you’d quickly learn how difficult it would be to obtain a legislative majority to pass such a bill. There have been several bills introduced in Congress over the past few years to ban non-compete agreements nationwide, including the Freedom to Compete Act and the Workplace Mobility Act. These laws did not get very far, and it’s easy to see why. Only about four states in the U.S. currently have laws that outright ban non-compete agreements. The other states will uphold non-compete agreements that are narrowly tailored and reasonable with respect to duration, geographic scope, and prohibited activities. I suspect past Congressional efforts to ban non-competes stalled because of the reality that a complete ban would be disruptive to big industries in those states.
You can make excellent arguments why non-competes should simply be banned as a matter of policy, many of which are laid out in the FTC’s public statements on this issue. But most people who have studied the issue doubt that the FTC has statutory authority from Congress to promulgate these new rules, and the FTC internally knows they’ll likely be set aside by federal courts. But even when these rules are set aside (and they will be), reforms will continue at the state level, as more and more states are restricting them legislatively or through court decisions. These efforts will continue.
I hear you / and do not disagree that you are correct as far as the challenge against the Executive Branch agency exceeding its authority.
That’s why I suggested that Congress take a singular action.
(I would not mind banning any bill with more than three unrelated items as well)