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The FTC's non-compete ruling - why it matters to employers and employees

Brian Sommer Profile picture for user brianssommer April 29, 2024
Summary:
The FTC came down hard this week on the issue of employer-mandated non-compete agreements for employees. And, in mere days, lawsuits are being filed to prevent the enforcement of these pro-employee mandates. Here’s the skinny…

standards
(Pixabay)

A recent ruling from the United States Federal Trade Commission (FTC) essentially bans the use of non-compete agreements for most workers. The key question is whether this new ruling will stand should it get litigated.

A non-compete agreement has frequently been a requirement for certain jobs. Its use previously was limited to top executives but has expanded in recent years to include all kinds of workers (e.g., hair stylists). The intent of a non-compete agreement is to prohibit an employee or executive from leaving the firm to then work for a competitor. These agreements may bar the employee from going to a named competitor for a specific timeframe and may explicitly call out which firms an employee cannot take a job. These bans may last for a few months to many years. They may or may not apply to specific geographies, too. Jobseekers either accept these (one-sided) agreements or must decline the chance to work for this firm.

For employees, non-competes can severely limit career mobility as they materially reduce the number of potential employers one could work at or limit one’s options in the specific area of expertise they possess. For employers, non-competes can be part of a strategy to prevent ideas, innovations, R&D plans, etc. from moving to other firms. However, a non-disclosure agreement could resolve this matter without impinging on a worker’s career choices. Some see non-competes as a stick wielded by businesses to keep workers in the company and prevent competitors from poaching their talent. Employees can resent this as it seeks to use the threat of litigation as a means of retaining talent. 

Employees and job seekers can sometimes find themselves being asked to sign three legal agreements as a condition of employment:

  • Non-solicitation agreement – This prohibits a former employee from enticing other employees to leave the firm and work at another firm. 
  • Non-compete – This prohibits an employee from leaving the company to work for a competitor.
  • Non-disclosure – This prohibits an employee from disclosing trade secrets and other proprietary knowledge to third parties.

All of these agreements will have effective timeframes and other limitations. Some may be narrow in scope and negotiable while others could be overly broad and non-negotiable. 

What the FTC has ordered

In a press release issued by the FTC this week:

Non-competes are a widespread and often exploitative practice imposing contractual conditions that prevent workers from taking a new job or starting a new business. Non-competes often force workers to either stay in a job they want to leave or bear other significant harms and costs, such as being forced to switch to a lower-paying field, being forced to relocate, being forced to leave the workforce altogether, or being forced to defend against expensive litigation. An estimated 30 million workers—nearly one in five Americans—are subject to a non-compete.

Under the FTC’s new rule, existing non-competes for the vast majority of workers will no longer be enforceable after the rule’s effective date. Existing non-competes for senior executives - who represent less than 0.75% of workers - can remain in force under the FTC’s final rule, but employers are banned from entering into or attempting to enforce any new non-competes, even if they involve senior executives. Employers will be required to provide notice to workers other than senior executives who are bound by an existing non-compete that they will not be enforcing any non-competes against them.

What was the public sentiment regarding these proposed rule changes? Again, according to the FTC:

In January 2023, the FTC issued a proposed rule which was subject to a 90-day public comment period. The FTC received more than 26,000 comments on the proposed rule, with over 25,000 comments in support of the FTC’s proposed ban on non-competes. The comments informed the FTC’s final rule-making process, with the FTC carefully reviewing each comment and making changes to the proposed rule in response to the public’s feedback.

The number of comments was significant but it is the overwhelming support for this ban that was quite notable.

Why is this important?

The FTC noted:

'Non-compete 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 non-competes are banned,' said FTC Chair Lina M. Khan. 'The FTC’s final rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.'

The FTC estimates that the final rule banning non-competes will lead to new business formation growing by 2.7% per year, resulting in more than 8,500 additional new businesses created each year. The final rule is expected to result in higher earnings for workers, with estimated earnings increasing for the average worker by an additional $524 per year, and it is expected to lower health care costs by up to $194 billion over the next decade. In addition, the final rule is expected to help drive innovation, leading to an estimated average increase of 17,000 to 29,000 more patents each year for the next 10 years under the final rule.

Will these new rules stand?

Both Bloomberg and Forbes had pieces addressing this issue. Both of them forecast legal challenges to the new rules and are expecting the courts will roll back the new rules. Other writers were on the other end of the spectrum. 

Forbes contributor Aldon Abbott noted:

The rule will be subject to legal challenges as soon as it is published in the Federal Register. If struck down in federal court, which is likely, non-compete legal oversight would revert to state law and the FTC would have to go back to the drawing board. A more limited rule informing workers of non-compete requirements before signing employment contracts could make economic sense and be far more likely to pass legal muster.

And

The rule does not apply to entities outside the FTC’s statutory jurisdiction, including financial institutions, air carriers, and certain non-profits.

It would take effect 60 days after publication in the Federal Register. Firms must fully comply 180 days after publication, but enforcement likely will be delayed by the legal challenges.

Bloomberg’s Matthew Boyle had some of more nuanced reporting on the issue. He noted:

The move was cheered by President Joe Biden but pilloried by business groups like the US Chamber of Commerce, which immediately sued to block the ban. As the legal challenge plays out, employers and employees were trying to make sense of the 570-page rule and gauge its impact.

If true, the US Chamber of Commerce action means this matter will be litigated. Businesses will want to watch this case as it could trigger changes in how companies grow and manage their workforces. 

To see the other side of the issue, an MSNBC opinion piece by Helaine Olen noted: 

The US Chamber of Commerce — which claims its mission is to 'advance human progress through an economic, political and social system based on individual freedom' — was among the first to file a lawsuit to put a stop to the non-compete ban. The FTC’s actions, the Chamber said in a statement, are “a blatant power grab that will undermine American businesses’ ability to remain competitive.” Please. The only blatant power grabs here were from America’s employers, who have used non-competes for decades to avoid paying workers what they are worth. America’s businesses and their political enablers are just screaming mad they won’t be able to get away with it any longer.

I guess I’ll let that be the last word on this (for now). 

My take

HR and other leaders might want to use the next few weeks/months to reevaluate their employment practices, employment agreements and more. Specifically, they should:

  • Assess whether their current requirements for employees to sign non-competes is having the desired impact on operations, hiring and most of all EX (employee experience).
  • Understand how non-competes may be adversely affecting their employment or recruiting brands. 
  • Reassess the need for these agreements and whether a non-disclosure provides adequate alternative coverage.
  • Rethink whether any non-executive personnel should be bound by non-competes.

Should firms adopt the new regulations or make changes to their non-compete policies, HR will likely need to conduct a number of follow-up actions. These may include:

  • Changing onboarding activities, workflows and software to eliminate or change the non-compete activities and documentation
  • Communicating with affected employees about the policy change
  • Preparing for some employee departures to competitors, especially, if the company has been heavy-handed in enforcing non-competes in the past
  • Reevaluate the compensation offered to employees especially highly skilled or in-demand personnel. They may elect to move to greener/kindler pastures unless an employer is proactive in stemming attrition.
  • Etc.

And, one really scary thought is that HR could see a number of people be targeted by recruiters and competitors once the non-competes are lifted. For companies that haven’t exactly been winning the war for talent, this could exacerbate a talent shortage problem even more. 

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