The new regulation goes into effect four months from now.
The rule covers what are known as noncompete clauses.
They have been routinely slipped for decades into employment agreements mostly in professional circles, such as in low-to-high level positions in areas such as marketing, engineering, sales, finance, and C-Suite (Chief Executive Officers, Chief Financial Officers, and Chief Operations Officers, among others) in highly competitive industries. The details of the legal language varied from company to company, but the basic principle was that, if one took a job in a company where these agreements had to be signed, that employee had to agree not to work for any competitor in their industry for a period of years after leaving the company.
In recent years, these noncompete requirements became common even in hourly paid positions in many companies as well.
The terms often even covered situations being laid off or fired by their employer, a choice which was out of their hands.
The agreements are also far more widely used than most people realize. Beside in technology companies, where there use has been more visible, they have also been in place in fields as diverse as hairstyling, where a valued stylist could single-handedly cause damage to the revenues of a former employer if they moved to another salon across the street, in the medical professions with “group” practices or as part of their deals in being granted rights to practice at given hospitals, and even in dance instruction.
For the employers, forcing people to sign contracts incorporating noncompete clauses was of considerable value. Despite employees already being bound by obvious restrictions regarding requirements to keep confidential company design, marketing, trade secret, inventions, business partnerships including planned potential mergers and acquisitions, forcing them to sign agreements that they could not work for a competitor effectively blocked the ability of those competitors to pick off some of their “best and brightest” employees with unique knowledge in their industries.
For the employees who were forced to sign off on those contracts because they had no other choice, the situation was as negative for them as it was positive for the organizations they were leaving, for whatever reason. Since the terms of those clauses meant one had to wait years before taking advantage of their unique knowledge by moving to a place where their talents were highly applicable, it basically forced anyone other than with substantial resources of their own to go into companies where the specific skillsets they had built for years were of far less value. That meant lower salaries than they might have commanded otherwise as a minimum. It also meant a new learning curve in the company they were joining, plus potentially years to regain the career momentum they had before.
And except for cases where the non-compete clauses were put in place after an employee was already on board, there was never any benefit for those employees to sign such a contract. An example of this might happen when an employee is being moved to a more senior position within an enterprise and signing a non-compete clause is something the employers would want to protect themselves. In those cases, since laws prevent companies from restricting an employee’s contract without providing additional compensation or other considerations, employers often provide additional stock options or other benefits to those employees in return for agreeing to the new non-compete clauses.
The government rationale behind making these clauses against the law is that they actively stifle competition and restrict innovation.
Many employers would argue otherwise regarding the innovation claim, on the grounds that they see themselves as innovators who are continuously pushing technology, process development, and service solutions forward. As to the claim that the clauses “stifle competition”, they will never admit it, but they are well aware that preventing some of their most brilliant innovators and gifted executives from going to competitors can force competitors to take longer to create new ideas make more mistakes in the process.
The rule change was originally proposed by the FTC on January 5, 2023, with a 3-1 vote in favor of putting the proposal out for review. At the time, the argument behind the rule was that noncompete clauses violate Section 5 of the Federal Trade Commission Act, the part of the Act which provides the FTC with authority to ban “unfair” methods of competition.
That clause of the Act in turn flows directly from multiple constitutional precedents related to anti-monopolistic practices and other actions organizations and corporations take to restrain trade unlawfully.
When the rule change was proposed, FTC Chair Lina Khan said there was “a raft of economic evidence” which demonstrates unequivocally “the ways that noncompete clauses undermine competition.”
“Noncompetes are basically locking up workers, which means that they’re not able to match with the best jobs for them,” Khan explained in a call with the press about the proposal at that time. “If this rule were to be finalized and go into effect … [it] would force employers to compete more vigorously over workers in ways that should lead to higher wages and improved working conditions, basically injecting competition into the labor market.”
A handful of states have banned noncompete clauses already, on similar grounds as the FTC is using. Those include California, North Dakota, Oklahoma, and Oregon. 11 states in the last few years also passed laws prohibiting the imposition of noncompete clauses in contracts for hourly workers or others with a wage below a given level.
Numerous studies involving those states and regional jursidictions, such as one published by SSRN (Social Science Research Network) in 2020 which studied Oregon’s 2008 switch from allowing noncompetes to banning them, concluded that salaries for those freed from noncompete contracts could jump by as much as 14-21%.
Other studies involving states where the ban has been in place going back to the 1990s, suggest that the rapid trajectory of innovation would never have been the same had noncompete clauses restricted the movement of labor between companies. Silicon Valley’s continuous seeding of new startups after the success of other more established businesses, is cited as one long-standing example of that track record. Just as Fairchild Semiconductor in the 1960s and early 1970s helped give birth to chipmaker giants Intel and AMD, for example, and graphics innovators such as Silicon Graphics which created the core technologies used by Pixar in movies and companies like Siemens in medical imaging, provided the initial technology “kick” which allowed companies like the current graphics and AI leader nVidia to grow, the evidence is strong that had noncompete clauses existed, the state of technology would be much different today in the United States than it is now.
Even with those handful of states choosing to prevent enforcement of noncompate clauses, the number of people bound by them across the rest of the country is staggering. A Department of Labor study estimated that roughly 18% of the American workforce is currently covered by such noncompete agreements, and that with related restrictions on the places they might chose to move to, the actual percentage of the population impacted by such agreements could by as much as double that.
When the rule was proposed by the FTC a year ago, it was estimated it would free over 30 million Americans from the burden of compliance with noncompete agreements. With a total labor force in the U.S. of approximately 168 million workers as of the end of March 2024, that amounts to 18% of all those employed in the country. It is an even larger percentage of the more highly paid members of that workforce.
Further estimates the FTC made in January 2023 of the impact of the rule change showed total wages might rise by as much as $300 billion annually if it were eventually to go into effect. While that would certainly provide a bump to the economy, it also might be inflationary, with more people spending more money on items. If employers responded to raising salaries as a means of retaining people now that noncompete clauses were not usable to prevent some job-hopping, that could also cause some of them to raise prices in their companies, especially in service industries where labor is a higher percentage of business costs.
To ensure that employees who are not quite sure if their employment contract noncompete clauses are still in force, the FTC rule change requires that employers must notify employees that those clauses are now void.
The new rule goes into effect in 120 days.
Even before that happens, it is likely there will be legal challenges which could postpone or alter the final form of the rule. One such challenge could come from various industry associations, which, considering how wide-ranging the impact of the rule change will be, could appear first just about anywhere.
One such place might be the U.S. Chamber of Commerce, which has been very vocal about its disagreement with what the FTC is about to do.
Sean Heather, an official of the U.S. Chamber, declared in January 2023 after the proposed rule was first made public that the actions of the FTC “to outright ban noncompete clauses in all employer contracts is blatantly unlawful.”
“Since the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule,” he added.
Even if the noncompete ban doesn't hold, some employees can expect non-disclosure agreements to become more stringent as employers seek alternate means to retain their advantage.