FTC Enrages Corporate America by Eliminating Non-Compete Agreements

The Federal Trade Commission took action to prohibit employment contracts that stop employees from working for rivals. Then it was immediately sued by the son of a famous Supreme Court Justice.

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Today, the Federal Trade Commission, led by Chair Lina Khan, voted 3-2 to eliminate contracts that stop people from switching jobs, contracts known as ‘non-compete agreements.’ The rule goes into effect in 120 days, and prohibits nearly all non-competes. There are a few exceptions; the FTC rule can’t touch non-competes with certain nonprofits and within few regulated industries. But by and large, this rule, unless conservative judges step in aggressively, means that American employers will no longer be able to use non-compete provisions.

It’s a big win. And yet, within a few hours of the vote, well-known conservative lawyer Eugene Scalia, the son of former Supreme Court Justice Antonin Scalia, sued the FTC over its non-compete ban, with the goal of getting the judiciary to strike the rule down, and perhaps even declare the commission itself unconstitutional. So what happened? What are the legal arguments? What are the stakes? And who is likely to prevail? That’s what I’m writing about today.

The FTC released this graphic with its rule.

What Happened? What Is a Non-Compete?

Let’s start with the guts of the dispute, which is over the actual policy to eliminate non-compete agreements. These contracts are pervasive in America, largely because computers have made it easy to print out employment contracts. Over the past four years, the FTC has been accumulating evidence, through public comments and by reviewing economic data, showing that they are a serious problem in our economy, significantly depressing wages and business formation. I wrote about it extensively in 2023, when the government proposed the rule:

Since 2000, the use of non-competes at all levels of society has exploded. Eight years ago, one in five employees in the United States was bound by one of these contracts, or 35-40 million people. It’s no longer just high-level employees who have them, but sandwich shop workers and janitors. For instance, 30% of hair stylists works under a non-compete, as do 45% of family physicians. Non-competes facilitate consolidation, especially in health care, where doctors are trapped into practices bought by private equity groups.

Such contracts are already unenforceable or restricted in many states, including California, Colorado, Illinois, Maine, Maryland, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, Virginia and Washington. And a lot of non-competes are never enforced and barely noticed by the employer or employee.

Still, for many people, being bound by a non-compete can be a truly horrible experience, a soft form of indentured servitude if you are tethered to a place and a specific skillset. While the ostensible purpose of such contracts is that an employee and employer are bargaining in a relatively equal position over the terms of work, it’s usually the case that employees don’t know what they are signing or aren’t in a position to refuse. In some states where non-competes are legally unenforceable, employers still threaten employees who don’t know any better.

And this happens. A lot. One person who complained to me is a real estate agent who had to put up with sexual harassment by a particularly litigious boss. I’ve heard from doctors whose lives are ruined by being forced to work in a bad practice, but who cannot move because their family is rooted in a particular area. One comment to the FTC came from a graphic designers for signage who was bankrupted by a lawsuit from her control-hungry former boss and a small town judge. These agreements are in every industry - finance, doctors in rural areas, startup founders, printing, floor installations, title and escrow work, software, NASA contracting, computer anti-virus research, and video game production. The overall goal is to cut wages by reducing the ability of people to bargain with rival employers.

The arguments against banning non-competes can seem compelling, but they don’t stand up to scrutiny. Eliminating non-competes doesn’t harm business, it helps it; Silicon Valley exists precisely because non-competes are unenforceable in the state. And while workers can leave and take specialized knowledge or customers with them, such possibilities are better covered with non-solicitation agreements or trade secrets law.

Other practices, such as tenure-based wage increases, can reduce people leaving to go to competitors or setting up shop on their own. As for the idea that non-competes reduce investments in knowledge-industries, well, that California exists undercuts that claim. Notably, lawyers simply don’t allow non-competes in the legal profession, the American Bar Association has a rule prohibiting them. And yet, the legal profession seems to exist and function.

The Politics

The FTC has been playing out this process for years, because rules take a really long time to get right. Today, its decision got wide coverage in print, TV, and online, trending on different social networks and drawing substantial amounts of commentary, including from many people who would benefit. The President tweeted it out, members of Congress are discussing it, and it could even make an appearance in political campaigns.

Was there much opposition? Not really, at least not publicly, with one exception. Few want to oppose the FTC’s action directly, because it just feels icky to stand up for the right to prevent someone from quitting and getting a new job. So the opposition is going to be procedural, and left to the courts.

And yet, among big business, there is a high degree of public anger. The U.S. Chamber of Commerce already said they’d sue before the rule came out, but they were leap-frogged by Scalia’s client. Indeed, the speed and eagerness of the complaint was remarkable, revealing corporate lawyers will practically climb over hot coals to litigate against Khan in front of a Texas judge. The firm Scalia is representing, a tax company called Ryan LLC, immediately put its challenge on the top of the main page of its website, just below the slogan “Liberating our clients from the burden of being overtaxed, freeing their capital to invest, grow, and thrive.’ Presumably, the corporation is using its court challenge as a marketing technique to attract clients whose executives hate Lina Khan.

Here’s their website homepage:

Can the FTC Just Ban These Contracts?

Despite whatever handwringing you might hear about the FTC’s legal authority, the answer is yes. In Section 5 of the Federal Trade Act, Congress granted the FTC authority to ban “unfair methods of competition.” In Section 6(g), Congress granted the FTC the ability to “make rules and regulations for the purpose of carrying out the provisions” of its charter. The FTC has used its 6(g) authority many times, including 26 times between 1968-1973 on key high-profile issues, like banning the mailing of unsolicited credit cards (which banks did all the time until the commission acted to stop it.)

So the statute is clear. What about the courts? Well, in 1973, the D.C. Circuit Court ruled that the FTC “is authorized to promulgate rules defining the meaning of the statutory standards of the illegality the Commission is empowered to prevent.” So there we go.

And Congress? Well just a year later, in 1974, Congress changed the rule-making authority of the FTC on the consumer protection side, but left its rule-making authority on unfair methods of competition alone, even rejecting amendment in which “[t]he FTC would have been prohibited from prescribing rules with respect to unfair competitive practices.” So Congress didn’t curtail the FTC, even though it could have.

And these readings of FTC authority make sense historically as well. Congress created the FTC in 1914 because their attempt to regulate business through the Sherman Antitrust Act had failed, as judges just couldn’t stay on top of the innovation in commerce. So legislators sought to create a regulatory commission with a flexible mandate to define unfair practices.

There are significant limits in the FTC’s authority; only the FTC can bring a case that violates an FTC rule, private litigants can’t. And of course it’s all subjected to judicial review. But legislators debated whether to define bad practices clearly in statute, or let the FTC do it, and they chose the latter. Non-compete agreements, because they became commonplace relatively recently but are a method of commerce designed to inhibit competition, fall squarely within this remit.

So you’d think that the case for the FTC having legal authority would be a slam dunk. But it’s not, for reasons I’ll go into. In this case, Eugene Scalia made four main points opposing FTC authority to issue the rule. First, he argued the text of the law granting the FTC authority hasn’t been used a lot since the 1970s, and so it didn’t mean what it said. Second, he claimed the court precedent that interpreted the text was “controversial at the time and has not aged well,” aka it’s precedent that can be ignored. Third, he said that other antitrust statutes treat non-compete agreements differently. And fourth, he made the point that a non-compete ban is a big economic change best left to Congress. (Scalia also made some other arguments about how the FTC is structured in an unconstitutional manner, but that’s not particularly unique in this case.)

It’s not clear how any of Scalia’s points are relevant. The text of the statute and court precedent are what controls, not whether a lawyer thinks a precedent is old and bad. It also doesn’t matter if other antitrust laws don’t apply, because, well, they are other antitrust laws, not this antitrust law. Finally, while the change is economically significant, so what? The FTC’s authority is broad-based, that’s how Congress structured it. Doctrines putting limits on regulators are meant to limit regulators to their existing statutory authority, and the FTC has authority here.

What Are the Stakes? And Who Is Going to Win?

Still, at some level, who is right doesn’t matter, what matters is what a judge thinks. And in this case, the answer is that it’s not really clear. The case is initially going to Trump-appointed Dallas Judge Ada Brown, a former prosecutor, and plaintiff lawyer. After Brown hears the case, it might get appealed and go to the Fifth Circuit, and then the Supreme Court. It’s also possible that the case gets dismissed for procedural reasons, and a different version of it moves through the courts. Regardless, this one is likely to get appealed, regardless of the outcome at a lower level.

How will it be received by the higher courts? The question is how susceptible judges are to public scrutiny. Judges don’t like to be unpopular. But at the same time, corporate lawyers and judges have invented a suit of legal concepts to facilitate the consolidation of economic power, and many of those concepts are well-entrenched in the courts. Most came from a view in the 1960s and 1970s that regulators had lost sight of the underlying text of a law, and twisted and abused and expanded their authority untethered from legislative goals. But gradually, the logic of attacking the excess reach of regulators became simply attacking regulators, even when the text of the statute is clear. Today, there are a lot of different legal theories whose intent was to tether rules to what Congress wrote, but instead often give judges lots of ways to strike down rules that they don’t like.

The stakes on all sides are high. If the FTC’s rule is struck down, then it will fall to Congress and states to ban non-competes, which will eventually happen, but far more slowly. And the FTC will have a tool removed from its arsenal, though to be honest, it’s a tool the FTC hasn’t used very often. That said, if the commission has its authority upheld, then not only will non-competes be unenforceable, but the FTC will be able to write rules to address other unfair methods of competition. Writing a rule is bureaucratically nightmarish, so these aren’t going to come off the assembly line, and they require immense amounts of economic and legal work. But rule-writing is a way of addressing economy-wide unfair practices, as Congress intended for the FTC to operate, and it is potentially much faster than antitrust litigation, which can take 5-10 years.

At any rate, you should feel proud of this decision, as it’s been a long time coming, and something we’ve been involved in from the beginning. Big ideas take awhile, but that’s because they are big and have to be done properly. And this is yet another sign we’re starting to see the new way of thinking take root.

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cheers,

Matt Stoller