Non-Compete Clauses Ain’t Dead Yet

May 6, 2024

Sing with me, if it’s just for today.
Maybe tomorrow the good Lord will take you away.

-Aerosmith, 1973

Last month, the Federal Trade Commission (FTC) voted to adopt its Final Non-Compete Clause Rule banning non-compete clauses between employers and their workers. The Noncompete has an effective date of September 4, 2024, subject to pending legal challenges.

As a preliminary matter, it is important to note that the rule contains several exceptions:  The rule does not apply to non-profit entities (which includes the many health care systems with which physicians contract). It also does not apply to non-compete agreements that are entered into as part of an individual’s sale of his or her business.

Finally, the rule does not apply to non-compete agreements previously entered into by “senior executives,” which are defined as those in policy-making positions who make at least $151,164 annually.  Going forward, however, entry into even those such non-competes is banned.

Other than these limited situations, the rule bans non-compete agreements for each and every worker in the United States.  Thus, a company who hires a salesperson, who then becomes privy to the employer’s internal costs, profits, business plans, trade secrets, customer and prospective customer lists can move to a competitor of the employer, notwithstanding that the extremely valuable knowledge that the employer provided.  The same would be true of a corporate R&D employee who gained access to secret company product formulas.  The Rule would also allow the local cosmetologist to start a job, form relationships, learn the market and how the salon determines its pricing—and then open shop next door.

Legal challenges to the Noncompete Rule began immediately, essentially on the ground that the FTC blatantly overstepped its authority. The first lawsuit, Ryan, LLC v. Federal Trade Commission, was filed in the Northern District of Texas. Shortly thereafter, the United States Chamber of Commerce, the nation’s largest business advocacy group, filed suit in the Eastern District of Texas. A third lawsuit has also been filed against the FTC, its Chair Lina Khan, and each of the Commissioners in the Eastern District of Pennsylvania.  These actions are no doubt only the tip of the iceberg.

The plaintiffs in this initial run of lawsuits advance three primary arguments:

1. The FTC lacks the statutory authority to issue the Noncompete Rule

The FTC claims to derive its authority to issue the Noncompete Rule from Section 5 of the FTC Act, which declares “unfair methods of competition” to be unlawful, and Section 6, by which Congress authorized the agency “to make rules and regulations for the purpose of carrying out the provisions” of the Act. The challengers, however, argue that the FTC is improperly using these statutes to promulgate substantive rules more far-reaching than any others in the FTC’s 114-year history.  It is in fact true that by claiming jurisdiction over employer-employee arrangements, the agency reached substantially beyond its previous focuses, such as wrongful acts in connection with the sale of products.

This statutory argument brings into play what courts call the “Major Questions Doctrine,” a rule of constitutional interpretation that holds that when Congress purports to give rule-making authority to agencies on questions of vast economic and political significance, Congress must provide clear and direct authority to the agency to do so.  This Doctrine was used in 2022 to invalidate OSHA’s vaccine mandate for private sector workers.

2. The Noncompete Rule is “arbitrary and capricious”

The plaintiffs argue that the Noncompete Rule is arbitrary and capricious in violation of the requirements of the Administrative Procedures Act that a federal agency’s action must be both reasonable and reasonably explained. The lawsuits assert that the FTC failed to properly consider the immense economic impact of such a far-reaching shift in policy—for example, the lost prior expectations of employers who have signed non-compete agreements.  Further, the suits assert that the rule overturns centuries of the common law of contracts.  In considering these issues, courts must decide whether the benefits of the Noncompete Rule outweigh the resulting harm to employers who have relied on non-compete agreements to protect their investments in training of employees and exposure of employees to a company’s proprietary internal information. 

Should the Noncompete Rule be upheld, it will undoubtedly have far-reaching effects on business.  The rule does not bar non-disclosure clauses or contractual provisions prohibiting personal solicitation of company employees or customers, but in my experience, those clauses are much more likely than non-compete provisions to result in litigation involving difficult-to-prove allegations as to, for example, whether Ms. Smith changed her med spa of choice because of direct courting by the departed employee or whether she simply learned where the departed employee was working through social media or other broad-based advertising.  In contrast, with a noncompete, it’s pretty easy to discover if the former employee is working for a competitor.

3. The Noncompete Rule violates the “Non-Delegation Doctrine”

Finally, the plaintiffs next contend that, even if Congress had given the FTC clear authority to make rules on non-compete clauses, such authority would be an impermissible delegation of Congress’s authority under the Non-Delegation Doctrine: Article I of the Constitution provides that all “legislative powers” are vested in Congress.  Under this Doctrine, the Supreme Court has held that Congress may not transfer to another branch “powers which are strictly and exclusively legislative.” Although Congress may grant executive agencies substantial discretion to implement and enforce the laws it creates, the Court has declared that it must still “lay down by legislative act an intelligible principle to which the person or body authorized to [exercise such authority] is directed to conform.”  Add to this the fact that in recent years, Congress itself has considered, but failed to pass, several bills that would have banned or limited use of non-competes.  Thus, the argument goes, Congress could not have intended to provide the FTC with the right to enact a policy that Congress itself has expressly rejected.

As for the Noncompete Rule specifically, the plaintiffs argue that the FTC Act, although giving the agency jurisdiction over “unfair methods of competition,” itself provides no real “intelligible principle” to guide the agency’s decision-making or discretion in the non-compete arena, and the phrase “unfair methods of competition” in Section 5 is too broad to meet the constitutional standard.

The FTC will no doubt counter by relying on the Supreme Court’s 1984 decision in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.  The “Chevron Deference Doctrine” requires courts to defer to an agency’s “reasonable interpretations” of ambiguities or gaps in statutes passed by Congress.  However, a case is now before the Supreme Court that challenges the Chevron Deference principle, and court watchers expect a ruling later this year that will severely limit or outright overrule Chevron.

So stay tuned.  Employers should not shred their form employment agreements just yet, and employees should not assume that escaping their contractual prohibitions is a certainty come September.