Examining the FTC’s Ban on Noncompetes and its Competition-Based Rationale

In April 2024, the Federal Trade Commission (FTC) issued its ban on noncompetes, citing the anticompetitive effects of these agreements, which restrict an individual’s ability to seek and obtain future employment.

The FTC’s conclusions, which cite the ban’s anticompetitive impacts on labor markets as well the markets for products and services, are not surprising. I explored this very topic in my past columns, which I will explain in more detail below.

It’s important to understand the magnitude of this decision and its potentially sweeping impact for employers and employees. Such agreements are ubiquitous in the United States. The FTC estimates that over 2.92 million firms use noncompetes.

Taft’s nineteenth century ruling

I wrote a column about what was then the FTC-proposed rule on noncompetes for the February/March 2023 issue of Today’s General Counsel magazine. I noted in my column that in 1898 William Howard Taft, then a judge in the Sixth Circuit, wrote in United States v. Addyston Pipe & Steel Co. that noncompete agreements were a type of restraint that were lawful under common law.

Judge Taft noted that business owners wanted to employ the best assistants and train them thoroughly, including in the secrets of the business. Judge Taft pointed out that the owner of a business would be reluctant to do so if the employee could start a rival business after learning the details and secrets of the owner.  A noncompete agreement was a restraint on the employee, but overall procompetitive.

Judge Taft cautioned, however, that courts that seek to determine how much restraint is in the public interest “set sail on a sea of doubt.” He, of course, would go on to become President of the United States and then Chief Justice of the Supreme Court.

With its recent final ruling, it is clear that the FTC does not believe that it is setting sail on a sea of doubt.

The FTC’s rationale

The FTC received over 26,000 comments to the proposed rule. It also considered empirical research. It took approximately 16 months for the FTC to digest these comments and the research. That effort is reflected in a 162-page web version of the final rule.

The FTC found that noncompetes negatively affected competition in markets for products and services. The anticompetitive effects included inhibiting the development of new businesses, inhibiting innovation, increasing concentration, and increasing consumer prices.

Significantly, the FTC also found that noncompetes tended to negatively affect competition in labor markets, including to suppress labor mobility and earnings, and to reduce job quality. This focus is not surprising given the Commission’s recent issuance of a revised policy statement on the meaning and scope of Section 5 of the FTC Act. The FTC clearly viewed the reach of Section 5 as going beyond the traditional consumer welfare standard to consider the impact of a restraint on labor markets.  (See my column in the July/August 2023 issue of Today’s General Counsel magazine on Section 5.)

The noncompete restraint described by Judge Taft in Addyston Pipe expressly referred to employers revealing the company’s secrets to employees. However, in its final rule, the FTC found that protecting trade secrets, confidential information, and other intellectual property was an insufficient justification for noncompetes because employers have less restrictive alternatives for protection of such information. These included reliance on trade secret law.

The intellectual property aspect

In addition, the FTC believed that the use of non-disclosure agreements could be used to protect valuable intellectual property. Although the FTC acknowledged that such alternatives may not be as protective as employers would like, it concluded that these alternatives reasonably accomplish the same purposes as noncompetes and burden competition to a less significant degree.

The final rule also acknowledged that traditionally noncompetes have been adjudicated on a case-by-case basis at the state level. The final rule found that a case-by-case adjudication would have an in terrorem effect on workers who would find the process expensive and burdensome, particularly because employers often employed onerous venue and choice of law provisions.

The final rule does not become effective until September 4, 2024. In the meantime, various court challenges have been mounted against the final rule’s complete ban on noncompetes. It remains to be seen how these challenges will play out, but it is evident from the final rule that the FTC has undertaken a thorough investigation to justify its total ban.