[Federal Register Volume 88, Number 12 (Thursday, January 19, 2023)]
[Proposed Rules]
[Pages 3482-3546]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-00414]
[[Page 3481]]
Vol. 88
Thursday,
No. 12
January 19, 2023
Part II
Federal Trade Commission
-----------------------------------------------------------------------
16 CFR Part 910
Non-Compete Clause Rule; Proposed Rule
Federal Register / Vol. 88 , No. 12 / Thursday, January 19, 2023 /
Proposed Rules
[[Page 3482]]
-----------------------------------------------------------------------
FEDERAL TRADE COMMISSION
16 CFR Part 910
RIN 3084-AB74
Non-Compete Clause Rule
AGENCY: Federal Trade Commission.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: Pursuant to Sections 5 and 6(g) of the Federal Trade
Commission Act, the Federal Trade Commission (``Commission'') is
proposing the Non-Compete Clause Rule. The proposed rule would, among
other things, provide that it is an unfair method of competition for an
employer to enter into or attempt to enter into a non-compete clause
with a worker; to maintain with a worker a non-compete clause; or,
under certain circumstances, to represent to a worker that the worker
is subject to a non-compete clause.
DATES: Comments must be received on or before March 20, 2023.
ADDRESSES: Interested parties may file a comment online or on paper by
following the instructions in the Request for Comment part of the
SUPPLEMENTARY INFORMATION section below. Write ``Non-Compete Clause
Rulemaking, Matter No. P201200'' on your comment, and file your comment
online at https://www.regulations.gov, by following the instructions on
the web-based form. If you prefer to file your comment on paper, mail
your comment to the following address: Federal Trade Commission, Office
of the Secretary, 600 Pennsylvania Avenue NW, Suite CC-5610 (Annex C),
Washington, DC 20580.
FOR FURTHER INFORMATION CONTACT: Shannon Lane (202-876-5651), Attorney,
Office of Policy Planning, Federal Trade Commission.
SUPPLEMENTARY INFORMATION:
I. Overview of the Proposed Rule
A non-compete clause is a contractual term between an employer and
a worker that typically blocks the worker from working for a competing
employer, or starting a competing business, within a certain geographic
area and period of time after the worker's employment ends. Non-compete
clauses limit competition by their express terms. As a result, non-
compete clauses have always been considered proper subjects for
scrutiny under the nation's antitrust laws.\1\ In addition, non-compete
clauses between employers and workers are traditionally subject to more
exacting review under state common law than other contractual terms,
due, in part, to concerns about unequal bargaining power between
employers and workers and the fact that non-compete clauses limit a
worker's ability to practice their trade.\2\
---------------------------------------------------------------------------
\1\ See, e.g., U.S. v. Am. Tobacco Co., 221 U.S. 106, 181-83
(1911) (holding several tobacco companies violated Sections 1 and 2
of the Sherman Act due to the collective effect of six of the
companies' practices, one of which was the ``constantly recurring''
use of non-compete clauses); Newburger, Loeb & Co., Inc. v. Gross,
563 F.2d 1057, 1082 (2d Cir. 1977) (``Although such issues have not
often been raised in the federal courts, employee agreements not to
compete are proper subjects for scrutiny under section 1 of the
Sherman Act. When a company interferes with free competition for one
of its former employee's services, the market's ability to achieve
the most economically efficient allocation of labor is impaired.
Moreover, employee-noncompetition clauses can tie up industry
expertise and experience and thereby forestall new entry.'')
(internal citation omitted).
\2\ See infra Part II.C.
---------------------------------------------------------------------------
In recent decades, important research has shed light on how the use
of non-compete clauses by employers affects competition. Changes in
state laws governing non-compete clauses have provided several natural
experiments that have allowed researchers to study the impact of non-
compete clauses on competition. This research has shown the use of non-
compete clauses by employers has negatively affected competition in
labor markets, resulting in reduced wages for workers across the labor
force--including workers not bound by non-compete clauses.\3\ This
research has also shown that, by suppressing labor mobility, non-
compete clauses have negatively affected competition in product and
service markets in several ways.\4\
---------------------------------------------------------------------------
\3\ See infra Part II.B.1.
\4\ See infra Part II.B.2.
---------------------------------------------------------------------------
In this rulemaking, the Commission seeks to ensure competition
policy is aligned with the current economic evidence about the
consequences of non-compete clauses. In the Commission's view, the
existing legal frameworks governing non-compete clauses--formed decades
ago, without the benefit of this evidence--allow serious
anticompetitive harm to labor, product, and service markets to go
unchecked.
Section 5 of the Federal Trade Commission Act (``FTC Act'')
declares ``unfair methods of competition'' to be unlawful.\5\ Section 5
further directs the Commission ``to prevent persons, partnerships, or
corporations . . . from using unfair methods of competition in or
affecting commerce.'' \6\ Section 6(g) of the FTC Act authorizes the
Commission to ``make rules and regulations for the purpose of carrying
out the provisions of'' the FTC Act, including the Act's prohibition of
unfair methods of competition.\7\
---------------------------------------------------------------------------
\5\ 15 U.S.C. 45(a)(1).
\6\ 15 U.S.C. 45(a)(2).
\7\ 15 U.S.C. 46(g).
---------------------------------------------------------------------------
Pursuant to Sections 5 and 6(g) of the FTC Act, the Commission
proposes the Non-Compete Clause Rule. The proposed rule would provide
it is an unfair method of competition--and therefore a violation of
Section 5--for an employer to enter into or attempt to enter into a
non-compete clause with a worker; maintain with a worker a non-compete
clause; or, under certain circumstances, represent to a worker that the
worker is subject to a non-compete clause.\8\
---------------------------------------------------------------------------
\8\ See proposed Sec. 910.2(a). For ease of reference, this
NPRM employs the term ``use of non-compete clauses'' as a shorthand
to refer to the conduct that the proposed rule would provide is an
unfair method of competition.
---------------------------------------------------------------------------
The proposed rule would define the term ``non-compete clause'' as a
contractual term between an employer and a worker that prevents the
worker from seeking or accepting employment with a person, or operating
a business, after the conclusion of the worker's employment with the
employer.\9\ The proposed rule would also clarify that whether a
contractual provision is a non-compete clause would depend not on what
the provision is called, but how the provision functions. As the
Commission explains below, the definition of non-compete clause would
generally not include other types of restrictive employment covenants--
such as non-disclosure agreements (``NDAs'') and client or customer
non-solicitation agreements--because these covenants generally do not
prevent a worker from seeking or accepting employment with a person or
operating a business after the conclusion of the worker's employment
with the employer. However, under the proposed definition of ``non-
compete clause,'' such covenants would be considered non-compete
clauses where they are so unusually broad in scope that they function
as such.\10\
---------------------------------------------------------------------------
\9\ See proposed Sec. 910.1(b)(1).
\10\ See infra Part V (in the section-by-section analysis for
proposed Sec. 910.1(b)).
---------------------------------------------------------------------------
The proposed rule would define ``employer'' as a person--as the
term ``person'' is defined in 15 U.S.C. 57b-1(a)(6)--that hires or
contracts with a worker to work for the person.\11\ The proposed rule
would define ``worker'' as a natural person who works, whether paid or
unpaid, for an employer. The proposed rule would clarify that the term
``worker'' includes an employee, individual classified as an
independent contractor, extern, intern, volunteer, apprentice, or sole
proprietor who
[[Page 3483]]
provides a service to a client or customer.\12\
---------------------------------------------------------------------------
\11\ See proposed Sec. 910.1(c).
\12\ See proposed Sec. 910.1(f).
---------------------------------------------------------------------------
In addition to prohibiting employers from entering into non-compete
clauses with workers starting on the rule's compliance date, the
proposed rule would require employers to rescind existing non-compete
clauses no later than the rule's compliance date.\13\ The proposed rule
would also require an employer rescinding a non-compete clause to
provide notice to the worker that the worker's non-compete clause is no
longer in effect.\14\ To facilitate compliance, the proposed rule would
(1) include model language that would satisfy this notice requirement
\15\ and (2) establish a safe harbor whereby an employer would satisfy
the rule's requirement to rescind existing non-compete clauses where it
provides the worker with a notice that complies with this notice
requirement.\16\
---------------------------------------------------------------------------
\13\ See proposed Sec. 910.2(b)(1).
\14\ See proposed Sec. 910.2(b)(2)(A).
\15\ See proposed Sec. 910.2(b)(2)(C).
\16\ See proposed Sec. 910.2(b)(3).
---------------------------------------------------------------------------
The proposed rule would include a limited exception for non-compete
clauses between the seller and buyer of a business.\17\ This exception
would only be available where the party restricted by the non-compete
clause is an owner, member, or partner holding at least a 25% ownership
interest in a business entity.\18\ The proposed regulatory text would
clarify that non-compete clauses covered by this exception would remain
subject to federal antitrust law as well as all other applicable law.
---------------------------------------------------------------------------
\17\ See proposed Sec. 910.3.
\18\ See proposed Sec. Sec. 910.3 and 910.1(e).
---------------------------------------------------------------------------
The proposed rule would establish an effective date of 60 days, and
a compliance date of 180 days, after publication of a final rule in the
Federal Register.\19\
---------------------------------------------------------------------------
\19\ See proposed Sec. 910.5.
---------------------------------------------------------------------------
In this notice of proposed rulemaking (``NPRM''), the Commission
describes and seeks comment on several alternatives to the proposed
rule, including whether non-compete clauses between employers and
senior executives should be subject to a different standard than non-
compete clauses with other workers.\20\ The Commission also assesses
the benefits and costs of the proposed rule, the impact of the proposed
rule on small businesses, and compliance costs related to the proposed
rule's notice requirement.\21\
---------------------------------------------------------------------------
\20\ See infra Part VI.
\21\ See infra Parts VII-IX.
---------------------------------------------------------------------------
The Commission seeks comment on all aspects of this NPRM. Comments
must be received on or before March 20, 2023.\22\
---------------------------------------------------------------------------
\22\ Pursuant to Section 22(d)(4) of the FTC Act, 15 U.S.C. 57b-
3(d)(4), this NPRM was not included in the Commission's Spring 2022
Regulatory Agenda because the Commission first considered it after
the publication deadline for the Regulatory Agenda.
---------------------------------------------------------------------------
II. Factual Background
A. What are non-compete clauses?
A non-compete clause is a contractual term between an employer and
a worker that prevents the worker from seeking or accepting employment
with a person, or operating a business, after the conclusion of the
worker's employment with the employer.\23\ A typical non-compete clause
blocks the worker from working for a competing employer, or starting a
competing business, within a certain geographic area and period of time
after their employment ends. A non-compete clause may be part of the
worker's employment contract or may be contained in a standalone
contract. Employers and workers may enter into non-compete clauses at
the start of, during, or at the end of a worker's employment.
---------------------------------------------------------------------------
\23\ See proposed Sec. 910.1(b). The term ``non-compete
clause'' has also been used describe agreements between one or more
business not to compete against one another, see, e.g., Lumber
Liquidators, Inc. v. Cabinets To Go, LLC, 415 F. Supp. 3d 703, 709
(E.D. Va. 2009), as well as certain kinds of moonlighting during a
worker's employment, see, e.g., In the Matter of the Investigation
by Barbara D. Underwood, Att'y Gen. of the State of N.Y. of WeWork
Companies, Inc., Assurance of Discontinuance No. 18-101 (Sept. 18,
2018) at Exhibit B. As underscored above, however, this proposed
rule focuses only on post-employment restraints that employers
impose on workers.
---------------------------------------------------------------------------
If a worker violates a non-compete clause, the employer may sue the
worker for breach of contract. An employer may be able to obtain a
preliminary injunction ordering the worker, for the duration of the
lawsuit, to stop the conduct that allegedly violates the non-compete
clause. If the employer wins the lawsuit, the employer may be able to
obtain a permanent injunction ordering the worker to stop the conduct
that violates the non-compete clause; a payment of monetary damages
from the worker; or both.\24\ Where workers are subject to arbitration
clauses,\25\ the employer may seek to enforce the non-compete clause
through arbitration.
---------------------------------------------------------------------------
\24\ Donald J. Aspelund & Joan E. Beckner, Employee
Noncompetition Law Sec. 8:2, Sec. 8:22 (Aug. 2021).
\25\ See, e.g., Alexander J.S. Colvin, Econ. Pol'y Inst.,
Report, The Growing Use of Mandatory Arbitration (Apr. 6, 2018).
---------------------------------------------------------------------------
The below examples of non-compete clauses from recent news reports,
legal settlements, and court opinions are illustrative.
A contractual term between a security guard firm and its
security guards requiring that, for two years following the conclusion
of the security guards' employment with the firm, the security guard
may not ``[a]ccept employment with or be employed by'' a competing
business ``within a one hundred (100) mile radius'' of the security
guard's primary jobsite with the firm and stating that the security
guards may not ``[a]ssist, aid or in any manner whatsoever help any
firm, corporation, partnership or other business to compete with'' the
firm. The non-compete clause also contains a ``liquidated damages''
clause requiring the security guard to pay the firm $100,000 as a
penalty for any conduct that contravenes the agreement.\26\
---------------------------------------------------------------------------
\26\ Fed. Trade Comm'n, Complaint, In re Prudential Sec., Inc.
et al., Matter No. 221 0026 at ] 12-] 13 (December 28, 2022).
---------------------------------------------------------------------------
A contractual term between a glass container manufacturing
company and its workers typically requiring that, for two years
following the conclusion of the worker's employment with the company,
the worker may not directly or indirectly ``perform or provide the same
or substantially similar services'' to those the worker performed for
the company to any business in the U.S., Canada, or Mexico that is
``involved with or that supports the sale, design, development,
manufacture, or production of glass containers'' in competition with
the company.\27\
---------------------------------------------------------------------------
\27\ Fed. Trade Comm'n, Complaint, In re Ardagh Group S.A. et
al., Matter No. 211 0182 at ] 9 (December 28, 2022).
---------------------------------------------------------------------------
A contractual term between a sandwich shop chain and its
workers stating that, for two years after the worker leaves their job,
the worker may not perform services for ``any business which derives
more than ten percent (10%) of its revenue from selling submarine,
hero-type, deli-style, pita and/or wrapped or rolled sandwiches''
located within three miles of any of the chain's more than 2,000
locations in the United States.\28\
---------------------------------------------------------------------------
\28\ Dave Jamieson, Jimmy John's Makes Low-Wage Workers Sign
`Oppressive' Noncompete Agreements, HuffPost (Oct. 13, 2014). The
company agreed to remove the non-compete clause in 2016 as part of a
settlement. Office of the Att'y Gen. of the State of N.Y., Press
Release, A.G. Schneiderman Announces Settlement With Jimmy John's To
Stop Including Non-Compete Agreements In Hiring Packets (June 22,
2016).
---------------------------------------------------------------------------
A contractual term between a steelmaker and one of its
executives prohibiting the executive from working for ``any business
engaged directly or indirectly in competition with'' the steelmaker
anywhere in the world for
[[Page 3484]]
one year following the termination of the executive's employment.\29\
---------------------------------------------------------------------------
\29\ AK Steel Corp. v. ArcelorMittal USA, LLC, 55 N.E.3d 1152,
1156 (Ohio Ct. App. 2016).
---------------------------------------------------------------------------
A contractual term between an office supply company and
one of its sales representatives stating that, for two years after the
sales representative's last day of employment, the sales representative
is prohibited from ``engag[ing] directly or indirectly, either
personally or as an employee, associate, partner, or otherwise, or by
means of any corporation or other legal entity, or otherwise, in any
business in competition with Employer,'' within a 100-mile radius of
the sales representative's employment location.\30\
---------------------------------------------------------------------------
\30\ Osborne v. Brown & Saenger, Inc., 904 N.W.2d 34, 36 (N.D.
2017).
---------------------------------------------------------------------------
A contractual term between a nationwide payday lender and
its workers stating that, for one year after the worker leaves their
job, they are prohibited from performing any ``consumer lending
services or money transmission services'' for any entity that provides
such services, or to ``sell products or services that are competitive
with or similar to the products or services of the Company,'' within a
15-mile radius of any of the payday lender's 1,000 locations in the
United States.\31\
---------------------------------------------------------------------------
\31\ People of the State of Ill. v. Check Into Cash of Ill.,
LLC, Complaint, 2017-CH-14224 (Ill. Circuit Ct. Oct. 25, 2017), ]
29, ] 70, https://illinoisattorneygeneral.gov/pressroom/2017_10/Check_Into_Cash-Complaint.pdf.
---------------------------------------------------------------------------
A contractual term between an online retailer and its
warehouse workers prohibiting the workers, for 18 months after leaving
their job, from ``directly or indirectly . . . engag[ing] or
support[ing] the development, manufacture, marketing, or sale of any
product or service that competes or is intended to compete with any
product or service sold, offered, or otherwise provided by'' the
retailer--or that is ``intended to be sold, offered, or otherwise
provided by [the retailer] in the future''--that the worker ``worked on
or supported'' or about which the worker obtained or received
confidential information.\32\
---------------------------------------------------------------------------
\32\ Spencer Woodman, Exclusive: Amazon makes even temporary
warehouse workers sign 18-month non-compete clauses, The Verge (Mar.
26, 2015). The company removed the non-compete clause following the
media coverage. Josh Lowensohn, Amazon does an about-face on
controversial warehouse worker non-compete contracts, The Verge
(Mar. 27, 2015).
---------------------------------------------------------------------------
A contractual term between a medical services firm and an
ophthalmologist stating that, for two years after the termination of
the ophthalmologist's employment with the firm, the ophthalmologist
shall not engage in the practice of medicine in two Idaho counties
unless the ophthalmologist pays the firm a ``practice fee'' of either
$250,000 or $500,000, depending on when the ophthalmologist's
employment ends.\33\
---------------------------------------------------------------------------
\33\ Intermountain Eye & Laser Ctrs. P.L.L.C. v. Miller, 127
P.3d 121, 123 (Idaho 2005).
---------------------------------------------------------------------------
In addition to non-compete clauses, other types of contractual
provisions restrict what a worker may do after they leave their job.
These other types of provisions include, among others:
Non-disclosure agreements (NDAs)--also known as
``confidentiality agreements''--which prohibit the worker from
disclosing or using certain information;
Client or customer non-solicitation agreements, which
prohibit the worker from soliciting former clients or customers of the
employer (referred to in this NPRM as ``non-solicitation agreements'');
\34\
---------------------------------------------------------------------------
\34\ The term ``non-solicitation agreement'' can also refer to a
type of agreement between employers not to solicit one another's
employees. In this NPRM, however, the term refers only to
contractual provisions between employers and workers prohibiting the
worker from soliciting clients or customers of the employer.
---------------------------------------------------------------------------
No-business agreements, which prohibit the worker from
doing business with former clients or customers of the employer,
whether or not solicited by the worker;
No-recruit agreements, which prohibit the worker from
recruiting or hiring the employer's workers;
Liquidated damages provisions, which require the worker to
pay the employer a sum of money if the worker engages in certain
conduct; and
Training-repayment agreements (TRAs), a type of liquidated
damages provision in which the worker agrees to pay the employer for
the employer's training expenses if the worker leaves their job before
a certain date.\35\
---------------------------------------------------------------------------
\35\ See, e.g., Norman D. Bishara, Kenneth J. Martin, and
Randall S. Thomas, An Empirical Analysis of Non-Competition Clauses
and Other Restrictive Post-Employment Covenants, 68 Vand. L. Rev. 1,
13 (2015); Uniform Law Comm'n, Uniform Restrictive Employment
Agreement Act, Draft For Approval (2021) at Sec. 2.
---------------------------------------------------------------------------
These other types of restrictive employment covenants can sometimes
be so broad in scope that they serve as de facto non-compete
clauses.\36\
---------------------------------------------------------------------------
\36\ See, e.g., Wegmann v. London, 648 F.2d 1072, 1073 (5th Cir.
1981); Brown v. TGS Mgmt. Co., LLC, 57 Cal. App. 5th 303, 306, 319
(Cal. Ct. App. 2020).
---------------------------------------------------------------------------
In addition to restricting what workers may do after they leave
their jobs, employers have also entered into agreements with other
employers in which they agree not to compete for one another's workers.
These include no-poach agreements, in which employers agree not to
solicit or hire one another's workers, and wage-fixing agreements, in
which employers agree to limit wages or salaries (or other terms of
compensation).\37\
---------------------------------------------------------------------------
\37\ Fed. Trade Comm'n & U.S. Dep't of Justice Antitrust
Division, Antitrust Guidance for Human Resource Professionals (Oct.
2016) at 3.
---------------------------------------------------------------------------
The Commission seeks comment on its description in this Part II.A
of non-compete clauses. The Commission also encourages workers,
employers, and other members of the public to submit comments
describing their experiences with non-compete clauses.
B. Evidence Relating to the Effects of Non-Compete Clauses on
Competition
Non-compete clauses have presented challenging legal issues for
centuries.\38\ But only in the last two decades has empirical evidence
emerged to help regulators and the general public understand how non-
compete clauses affect competition in labor markets and product and
service markets.
---------------------------------------------------------------------------
\38\ See infra Part II.C.
---------------------------------------------------------------------------
In the early 2000s, researchers began to shed new light on the
impacts of non-compete clauses on innovation and productivity. As this
new body of research was evolving, news reports revealed non-compete
clauses were being imposed even on low-wage workers.\39\ These reports
surprised many observers, who had assumed only highly skilled workers
were subject to non-compete clauses.\40\ Researchers responded by
applying the tools of economic research to better understand how
employers were using non-compete clauses and how they were affecting
competition.
---------------------------------------------------------------------------
\39\ See, e.g., Jamieson, supra note 28.
\40\ See, e.g., Alan B. Kreuger & Eric A. Posner, The Hamilton
Project, Policy Proposal 2018-05, A Proposal for Protecting Low-
Income Workers from Monopsony and Collusion (February 2018) at 7.
---------------------------------------------------------------------------
1. Labor Markets
The empirical research on how non-compete clauses affect
competition shows that the use of non-compete clauses in the aggregate
is interfering with competitive conditions in labor markets.
Labor markets function by matching workers and employers. Workers
offer their skills and time to employers. In return, employers offer
pay, benefits, and job satisfaction.\41\ In a well-functioning labor
market, a worker who is seeking a better job--more pay, better hours,
better working conditions, more enjoyable work, or whatever the worker
may be seeking--can enter the labor market by looking for work.
Employers who have positions available compete for the worker's
services. The worker's
[[Page 3485]]
current employer may also compete with these prospective employers by
seeking to retain the worker--for example, by offering to raise the
worker's pay or promote the worker. Ultimately, the worker chooses the
job that best meets their objectives. In general, the more jobs
available--i.e., the more options the worker has--the stronger the
match the worker will find.
---------------------------------------------------------------------------
\41\ See, e.g., Dep't of the Treasury, Report, The State of
Labor Market Competition (March 7, 2022) at 3.
---------------------------------------------------------------------------
Just as employers compete for workers in a well-functioning labor
market, workers compete for jobs. An employer who needs a worker will
make it known that the employer has a position available. Workers who
learn of the opening will apply for the job. From among the workers who
apply, the employer will choose the worker that best meets the
employer's needs--in general, the worker most likely to be the most
productive. In general, the more workers who are available--i.e., the
more options the employer has--the stronger the match the employer will
find.
Through these processes--employers competing for workers, workers
competing for jobs, and employers and workers matching with one
another--competition in the labor market leads to higher earnings for
workers, greater productivity for employers, and better economic
conditions.
In a perfectly competitive labor market, if a job that a worker
would prefer more--for example, because it has higher pay or is in a
better location--were to become available, the worker could switch to
it quickly and easily. Due to this ease of switching, in a perfectly
competitive labor market, workers would easily match to the optimal job
for them. If a worker were to find themselves in a job where the
combination of their happiness and productivity is less than in some
other job, they would simply switch jobs, making themselves better off.
However, this perfectly competitive labor market exists only in
theory. In practice, labor markets deviate substantially from perfect
competition. Non-compete clauses, in particular, impair competition in
labor markets by restricting a worker's ability to change jobs. If a
worker is bound by a non-compete clause, and the worker wants a better
job, the non-compete clause will prevent the worker from accepting a
new job that is within the scope of the non-compete clause. These are
often the most natural alternative employment options for a worker:
jobs in the same geographic area and in the worker's field of
expertise. For example, a non-compete clause might prevent a nurse in
Cleveland from working in the health care field in Northeast Ohio, or a
software engineer in Orlando from working for another technology
company in Central Florida. The result is less competition among
employers for the worker's services and less competition among workers
for available jobs. Since the worker is prevented from taking these
jobs, the worker may decide not to enter the labor market at all. Or
the worker may enter the labor market but take a job in which they are
less productive, such as a job outside their field.
Non-compete clauses affect competition in labor markets through
their use in the aggregate. The effect of an individual worker's non-
compete clause on competition in a particular labor market may be
marginal or may be impossible to discern statistically. However, the
use of a large number of non-compete clauses across a labor market
markedly affects the opportunities of all workers in that market, not
just those with non-compete clauses. By making it more difficult for
many workers in a labor market to switch to new jobs, non-compete
clauses inhibit optimal matches from being made between employers and
workers across the labor force. As a result, where non-compete clauses
are prevalent in a market, workers are more likely to remain in jobs
that are less optimal with respect to the worker's ability to maximize
their productive capacity. This materially reduces wages for workers--
not only for workers who are subject to non-compete clauses, but for
other workers in a labor market as well, since jobs that would
otherwise be better matches for an unconstrained worker are filled by
workers subject to non-compete clauses.
a. Estimates of Non-Compete Clause Use
Based on the available evidence, the Commission estimates that
approximately one in five American workers--or approximately 30 million
workers--is bound by a non-compete clause.
A 2014 survey of workers by Evan Starr, JJ Prescott, and Norman
Bishara, which resulted in 11,505 responses, found 18% of respondents
work under a non-compete clause and 38% of respondents have worked
under one at some point in their lives.\42\ Among the studies of non-
compete clause use discussed here, this study has the broadest and
likely the most representative coverage of the U.S. labor force.\43\
Starr, Prescott, and Bishara also found that, among workers without a
bachelor's degree, 14% of respondents reported working under a non-
compete clause at the time surveyed and 35% reported having worked
under one at some point in their lives.\44\ For workers earning less
than $40,000 per year, 13% of respondents work under a non-compete
clause and 33% worked under one at some point in their lives.\45\
Furthermore, this survey shows 53% of workers who are covered by non-
compete clauses are hourly workers.\46\
---------------------------------------------------------------------------
\42\ Evan P. Starr, James J. Prescott, & Norman D. Bishara,
Noncompete Agreements in the U.S. Labor Force, 64 J.L. & Econ. 53,
53 (2021). A survey of workers conducted in 2017 by Payscale.com
reached similar results. This survey estimated that 24.2% of workers
are subject to a non-compete clause. Natarajan Balasubramanian, Evan
Starr, & Shotaro Yamaguchi, Bundling Employment Restrictions and
Value Appropriation from Employees 35 (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3814403. This survey
also found that non-compete clauses are often used together with
other restrictive employment covenants, including non-disclosure,
non-recruitment, and non-solicitation covenants. Id. at 17
(reporting that respondents that had a non-compete clause reported
having all three of the other restrictive employment covenants 74.7%
of the time). However, a key limitation of the Payscale.com survey
is that it is a convenience sample of individuals who visited
Payscale.com during the time period of the survey and is therefore
unlikely to be fully representative of the U.S. working population.
Id. at 13. While weighting based on demographics helps, it does not
fully mitigate this concern.
\43\ The final survey sample contained 11,505 responses,
representing individuals from nearly every demographic in the labor
force. Id. at 58.
\44\ Id. at 63.
\45\ Id.
\46\ Michael Lipsitz & Evan Starr, Low-Wage Workers and the
Enforceability of Noncompete Agreements, 68 Mgmt. Sci. 143, 144
(2021) (analyzing data from the Starr, Prescott, & Bishara survey).
---------------------------------------------------------------------------
Starr, Prescott, and Bishara also found, in states where non-
compete clauses are unenforceable, workers are covered by non-compete
clauses at approximately the same rate as workers in other states.\47\
This suggests employers maintain non-compete clauses even where they
likely cannot enforce them.
---------------------------------------------------------------------------
\47\ Starr, Prescott, & Bishara, supra note 42 at 81.
---------------------------------------------------------------------------
Other estimates of non-compete clause use cover subsets of the U.S.
labor force. One study, a 2021 study by Rothstein and Starr, is based
on National Longitudinal Survey of Youth (NLSY) data.\48\ The NLSY
consists of a nationally representative sample of 8,984 men and women
born from 1980-84 and living in the United States at the time of the
initial survey in 1997.\49\ The survey is an often-used labor survey
conducted by the Bureau of Labor Statistics, rather than a one-off
survey
[[Page 3486]]
directed solely at calculating the prevalence of non-compete clauses.
Using this data, Rothstein and Starr estimate the prevalence of non-
compete clauses to be 18%, which is comparable to the number estimated
by Starr, Prescott, and Bishara.\50\
---------------------------------------------------------------------------
\48\ Donna S. Rothstein & Evan Starr, Mobility Restrictions,
Bargaining, and Wages: Evidence from the National Longitudinal
Survey of Youth 1997 (2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3974897.
\49\ U.S. Bureau of Labor Statistics, NLSY97 Data Overview,
https://www.bls.gov/nls/nlsy97.htm.
\50\ Rothstein & Starr, supra note 48 at 7.
---------------------------------------------------------------------------
Finally, four occupations have been studied individually:
executives, physicians, hair stylists, and electrical and electronics
engineers. Both Shi (2021) and Kini et al. (2021) estimate prevalence
of non-compete clauses for executives. Shi (2021) finds the proportion
of executives working under a non-compete clause rose from ``57% in the
early 1990s to 67% in the mid-2010s.'' \51\ Kini et al. (2021) find
that 62% of CEOs worked under a non-compete clause between 1992 and
2014.\52\ Lavetti et al. (2020) find 45% of physicians worked under a
non-compete clause in 2007.\53\ In a survey of independent hair salon
owners, Johnson and Lipsitz (2021) find 30% of hair stylists worked
under a non-compete clause in 2015.\54\ Finally, in a survey of
electrical and electronic engineers, Marx (2011) finds that 43% of
respondents signed a non-compete clause.\55\
---------------------------------------------------------------------------
\51\ Liyan Shi, Optimal Regulation of Noncompete Contracts 27
(2022), https://static1.squarespace.com/static/59e19b282278e7ca5b9ff84f/t/626658ffb73adb2959bd4371/1650874624095/noncompete_shi.pdf.
\52\ Omesh Kini, Ryan Williams, & Sirui Yin, CEO Noncompete
Agreements, Job Risk, and Compensation, 34 Rev. Fin. Stud. 4701,
4707 (2021).
\53\ Kurt Lavetti, Carol Simon, & William D. White, The Impacts
of Restricting Mobility of Skilled Service Workers Evidence from
Physicians, 55 J. Hum. Res. 1025, 1042 (2020).
\54\ Matthew S. Johnson & Michael Lipsitz, Why Are Low-Wage
Workers Signing Noncompete Agreements?, 57 J. Hum. Res. 689, 700
(2022).
\55\ Matt Marx, The Firm Strikes Back: Non-Compete Agreements
and the Mobility of Technical Professionals, 76Am. Socio. Rev. 695,
702 (2011). Calculated as 92.60% who signed a non-compete clause of
the 46.80% who were asked to sign a non-compete clause.
---------------------------------------------------------------------------
Some observers have stated that the use of non-compete clauses by
employers appears to have increased over time.\56\ However, there is no
consistent data available on the prevalence of non-compete clauses over
time.
---------------------------------------------------------------------------
\56\ See, e.g., Rachel Arnow-Richman, Cubewrap Contracts and
Worker Mobility: The Dilution of Employee Bargaining Power via
Standard Form Noncompetes, 2006 Mich. St. L. Rev. 963, 981 n.59;
John W. Lettieri, American Enterprise Institute, Policy Brief, A
Better Bargain: How Noncompete Reform Can Benefit Workers and Boost
Economic Dynamism (December 2020) at 2.
---------------------------------------------------------------------------
While many workers are bound by non-compete clauses, many workers
do not know whether their non-compete clause is legally enforceable or
not. As part of their 2014 survey, Starr et al. asked surveyed
individuals ``Are noncompetes enforceable in your state?'' Of the
respondents, 37% indicated that they did not know whether or not their
non-compete clause was enforceable.\57\ Additionally, 11% of
individuals were misinformed: they believed that non-compete clauses
were enforceable in their state when they were not, or they believed
that non-compete clauses were not enforceable when they were.\58\
---------------------------------------------------------------------------
\57\ J.J. Prescott & Evan Starr, Subjective Beliefs About
Contract Enforceability 10 (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3873638.
\58\ Id. at 11.
---------------------------------------------------------------------------
Starr et al. also find that only 10.1% of workers with non-compete
clauses report bargaining over it.\59\ Additionally, only 7.9% report
consulting a lawyer, and only 11.4% of respondents thought that they
still would have been hired if they had refused to sign the non-compete
clause.\60\ Marx finds that only 30.5% of electrical engineers who
signed non-compete clauses were asked to sign prior to accepting their
job offer, and 47% of non-compete clause signers were asked to sign on
or after their first day of work.\61\
---------------------------------------------------------------------------
\59\ Starr, Prescott, & Bishara, supra note 42, at 72.
\60\ Id.
\61\ Marx (2011), supra note 55 at 706. Forty-seven percent is
calculated as the sum of 24.43% and 22.86%, the respective
percentage of requests that were made on the first day or after the
first day at the company.
---------------------------------------------------------------------------
b. Earnings--Effects on Workers Across the Labor Force
By inhibiting optimal matches from being made between employers and
workers across the labor force, non-compete clauses reduce the earnings
of workers. Several studies have found that increased enforceability of
non-compete clauses reduces workers' earnings across the labor market
generally and for specific types of workers.
Each of the studies described below analyzes the effects of non-
compete clause enforceability on earnings. While different studies have
defined enforceability of non-compete clauses in slightly different
ways, each uses enforceability as a proxy for the chance that a given
non-compete clause will be enforced.\62\
---------------------------------------------------------------------------
\62\ All the studies described below rely on twelve concepts of
enforceability based on Malsberger's ``Non-Compete Clauses: A State-
by-State Survey'' and Kini et al. supplemented with data from Beck,
Reed, and Riden LLP's state-by-state survey of non-compete clauses.
---------------------------------------------------------------------------
These studies use ``natural experiments'' resulting from changes in
state law to assess how changes in the enforceability of non-compete
clauses affect workers' earnings. The use of a natural experiment
allows for the inference of causal effects, since the likelihood that
other variables are driving the outcomes is minimal.
First, a study conducted by Matthew Johnson, Kurt Lavetti, and
Michael Lipsitz finds that decreasing non-compete clause enforceability
from the approximate enforceability level of the fifth-strictest state
to that of the fifth-most-lax state would increase workers' earnings by
3-4%.\63\ Johnson, Lavetti, and Lipsitz also estimate that a nationwide
ban on non-compete clauses would increase average earnings by 3.3-
13.9%.\64\ The authors also find that non-compete clauses limit the
ability of workers to leverage favorable labor markets to receive
greater pay: when non-compete clauses are more enforceable, workers'
earnings are less responsive to low unemployment rates (which workers
may typically leverage to negotiate pay raises).\65\
---------------------------------------------------------------------------
\63\ Matthew S. Johnson, Kurt Lavetti, & Michael Lipsitz, The
Labor Market Effects of Legal Restrictions on Worker Mobility 2
(2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3455381.
\64\ Id.
\65\ Id. at 36.
---------------------------------------------------------------------------
The second study of the effects of non-compete clause
enforceability on earnings, conducted by Evan Starr, estimates that if
a state that does not enforce non-compete clauses shifted its policy to
that of the state with an average level of enforceability, earnings
would fall by about 4%.\66\ Unlike many of the other studies described
here, this study does not use a change in enforceability of non-compete
clauses to analyze the impact of enforceability. Rather, it examines
the differential impact of enforceability on workers in occupations
which use non-compete clauses at a high rate versus workers in
occupations which use non-compete clauses at a low rate. While the
Commission believes that this research design may be less informative
with respect to the proposed rule than designs which examine changes in
enforceability, the study's estimated effects are in line with the rest
of the literature.
---------------------------------------------------------------------------
\66\ Evan Starr, Consider This: Training, Wages, and the
Enforceability of Non-Compete Clauses, 72 I.L.R. Rev. 783, 799
(2019).
---------------------------------------------------------------------------
The third study, conducted by Michael Lipsitz and Evan Starr,
estimates that when Oregon stopped enforcing non-compete clauses for
workers who are paid hourly, their wages increased by 2-3%, relative to
workers in states which did not experience legal changes. The study
also found a greater effect (4.6%) on workers
[[Page 3487]]
in occupations that used non-compete clauses at a relatively high
rate.\67\
---------------------------------------------------------------------------
\67\ Lipsitz & Starr, supra note 46 at 143.
---------------------------------------------------------------------------
The fourth study, conducted by Natarajan Balasubramanian, Jin Woo
Chang, Mariko Sakakibara, Jagadeesh Sivadasan, and Evan Starr, found
that when Hawaii stopped enforcing non-compete clauses for high-tech
workers, earnings of new hires increased by about 4%.\68\
---------------------------------------------------------------------------
\68\ Natarajan Balasubramanian, Jin Woo Chang, Mariko
Sakakibara, Jagadeesh Sivadasan, & Evan Starr, Locked In? The
Enforceability of Non-Compete Clauses and the Careers of High-Tech
Workers, 57 J. Hum. Res. S349, S349 (2022).
---------------------------------------------------------------------------
The fifth and sixth studies both show that enforceable non-compete
clauses reduce earnings for executives. One study, by Mark Garmaise,
finds that decreased enforceability of non-compete clauses increases
executives' earnings by 12.7%.\69\ Another study, by Omesh Kini, Ryan
Williams, and David Yin, finds that decreased enforceability of non-
compete clauses led to lower earnings for CEOs when use of non-compete
clauses is held constant. However, the study also finds use of non-
compete clauses decreases when non-compete clause enforceability
decreases. When that relationship is taken into account, decreased
enforceability results in greater earnings for CEOs. For example, if
the state which enforces non-compete clauses most strictly (Florida)
hypothetically moved to a policy of non-enforcement, then a CEO who had
a non-compete clause prior to the policy change would experience an
estimated 11.4% increase in their earnings, assuming their non-compete
clause was dropped.\70\
---------------------------------------------------------------------------
\69\ Mark J. Garmaise, Ties that Truly Bind: Noncompetition
Agreements, Executive Compensation, and Firm Investment, 27 J.L.,
Econ., & Org. 376, 403 (2011). The reduction in earnings is
calculated as e-1.3575*0.1-1, where -1.3575 is taken from
Table 4.
\70\ Kini, Williams, & Yin, supra note 52 at 4731. The 11.4%
increase is calculated as e\X\-1, where X is calculated as 9 times
the coefficient on CEO Noncompete x HQ Enforce (0.047), where 9 is
the enforceability index in Florida, plus the coefficient on CEO
Noncompete (-0.144), plus 9 times the coefficient on HQ Enforce (-
0.043).
---------------------------------------------------------------------------
Among the studies listed above, Johnson, Lavetti, and Lipsitz
likely has the broadest coverage. The study spans the years 1991 to
2014, examines workers across the labor force, and uses all known
common law and statutory changes in non-compete clause enforceability
to arrive at its estimates. The study by Starr also covers the entire
labor force, from 1996 to 2008. However, the Starr study is only able
to compare effects for occupations that use non-compete clauses at a
high rate to those that use them at a low rate. The next two studies
cover just one legal change, and only a subset of the labor force:
hourly workers in Oregon, in the case of Lipsitz and Starr, and high-
tech workers in Hawaii, in the case of Balasubramanian et al. Finally,
while the studies conducted by Garmaise and Kini et al. examine
multiple legal changes, they focus solely on executives.
One limitation of studies of enforceability alone--i.e., studies
which do not consider the use of non-compete clauses--is that it is
difficult to disentangle the effects of increased enforceability on
workers who are subject to non-compete clauses and workers who are not
subject to non-compete clauses. In other words, since effects are
observed across the labor force (or some subset of it), they include
both effects on workers with and without non-compete clauses. However,
due to the research cited in the next subsection--indicating non-
compete clauses reduce earnings for workers who are not subject to non-
compete clauses--the Commission believes it is reasonable to conclude
based on contextual evidence that the labor-force-wide effects
described in the studies above include effects on both workers with and
without non-compete clauses.
Three additional studies examine the association between non-
compete clause use--rather than enforceability--and earnings. Using the
2014 survey described in Part II.B.1.a, Starr et al. find that the use
of non-compete clauses is associated with 6.6% higher earnings in the
model including the most control variables among those they
observe.\71\ Using the Payscale.com data, Balasubramanian et al. find
that while non-compete clause use is associated with 2.1-8.2% greater
earnings (compared with individuals with no post-contractual
restrictions), this positive association is due to non-compete clauses
often being bundled with non-disclosure agreements. Compared with
individuals only using non-disclosure agreements, use of non-compete
clauses is associated with a 3.0-7.3% decrease in earnings, though the
authors do not disentangle this effect from the effects of use of non-
solicitation and non-recruitment provisions.\72\ Finally, Lavetti et
al. find that use of non-compete clauses among physicians is associated
with greater earnings (by 14%) and greater earnings growth.\73\ (The
Commission notes, however, this study does not consider how changes in
non-compete clause enforceability affect physicians' earnings. As
described below in the cost-benefit analysis for the proposed rule, the
Commission estimates the proposed rule may increase physicians'
earnings, though the study does not allow for a precise
calculation.\74\)
---------------------------------------------------------------------------
\71\ Starr, Prescott, & Bishara, supra note 42 at 75.
\72\ Balasubramanian, Starr, & Yamaguchi, supra note 42 at 40.
The percentage range is calculated as e-0.030-1 and
e-0.076-1, respectively.
\73\ Lavetti, Simon, & White, supra note 53 at 1051. The
increase in earnings is calculated as e\0.131\-1.
\74\ See infra Part VII.B.1.a.ii.
---------------------------------------------------------------------------
However, the Commission does not believe that studies examining the
association between non-compete clause use--rather than
enforceability--and earnings are sufficiently probative of the effects
of non-compete clauses on earnings. The Commission's concern is that
non-compete clause use and earnings may both be determined by one or
more confounding factors. It may be the case, for example, that
employers who rely most on trade secrets both pay more and use non-
compete clauses at a high rate (which would not necessarily be captured
by the control variables observed in studies of non-compete clause
use). This means these studies do not necessarily inform how
restricting the use of non-compete clauses through a rule would impact
earnings. This methodological limitation contrasts with studies
examining enforceability of non-compete clauses, in which changes in
enforceability are ``natural experiments'' that allow for the inference
of causal effects, since the likelihood that other variables are
driving the outcomes is minimal. A ``natural experiment'' refers to
some kind of change in the real world that allows researchers to study
the impact of the change on an outcome. In a natural experiment, the
change is effectively random, uninfluenced by other factors which could
have simultaneously affected the outcome. In such situations, it is
therefore most likely the change itself caused any impact that is
observed on the outcomes.
The belief that studies of non-compete clause use do not reflect
causal estimates is shared by the authors of at least one of the
studies of non-compete clause use. As noted in Starr et al., ``Our
analysis of the relationships between noncompete use and labor market
outcomes . . . is best taken as descriptive and should not be
interpreted causally.'' \75\ As a result, the Commission gives these
studies minimal weight. The study of physicians conducted by Lavetti et
al. partially mitigates this concern by comparing earnings effects in
high- versus low-enforceability states, though this analysis compares
only California and Illinois, meaning that it is
[[Page 3488]]
impossible to disentangle underlying differences in those two states
from the effects of non-compete clause enforceability.
---------------------------------------------------------------------------
\75\ Starr, Prescott, & Bishara, supra note 42 at 73.
---------------------------------------------------------------------------
c. Earnings--Effects on Workers Not Covered by Non-Compete Clauses
As described above, non-compete clauses negatively affect
competition in labor markets, thereby inhibiting optimal matches from
being made between employers and workers across the labor force. As a
result, non-compete clauses reduce earnings not only for workers who
are subject to non-compete clauses, but also for workers who are not
subject to non-compete clauses.
Two studies show non-compete clauses reduce earnings for workers
who are not subject to non-compete clauses. The first study, a 2019
study of the external effects of non-compete clauses conducted by Evan
Starr, Justin Frake, and Rajshree Agarwal, analyzed workers without
non-compete clauses who worked in states and industries in which non-
compete clauses were used at a high rate.\76\ They find that, when the
use of non-compete clauses in a given state and industry combination
increases by 10%, the earnings of workers who do not have non-compete
clauses, but who work in that same state and industry, go down by about
6.12% more when that state has an average enforceability level,
compared with a state which does not enforce non-compete clauses.\77\
In effect, this study finds when the use of non-compete clauses by
employers increases, that drives down wages for workers who do not have
non-compete clauses but who work in the same state and industry. This
study also finds this effect is stronger where non-compete clauses are
more enforceable.
---------------------------------------------------------------------------
\76\ Evan Starr, Justin Frake, & Rajshree Agarwal, Mobility
Constraint Externalities, 30 Org. Sci. 961, 6 (2019).
\77\ Id. at 11.
---------------------------------------------------------------------------
The Commission notes that, similar to some of the studies described
above, this study relies on use of non-compete clauses, as well as
cross-sectional differences in enforceability of non-compete clauses,
to arrive at their conclusions. While this approach calls into question
the causal relationship outlined in the study, the authors employ tests
to increase confidence in the causal interpretation; however, the tests
rely on what data the authors have available, and therefore cannot rule
out explanations outside of the scope of their data. This study also
analyzes the effect of non-compete clause use for certain workers on
workers in a different firm, meaning that factors simultaneously
driving non-compete clause use and outcomes within a certain firm will
not break the causal chain identified in the study.
Starr, Frake, and Agarwal show the reduction in earnings (and
mobility, discussed below) is due to a reduction in the rate of the
arrival of job offers. Individuals in state/industry combinations which
use non-compete clauses at a high rate do not receive job offers as
frequently as individuals in state/industry combinations where non-
compete clauses are not frequently used.\78\ The authors also
demonstrate decreased mobility and earnings are not due to increased
job satisfaction (i.e., if workers are more satisfied with their jobs,
they may be less likely to change jobs, and more likely to accept lower
pay).\79\ Finally, they show that decreased mobility and earnings are
not because workers are searching for jobs less frequently, suggesting
that job openings and firm behavior matter more to the underlying
mechanism.\80\
---------------------------------------------------------------------------
\78\ Id. at 10.
\79\ Id. at 13.
\80\ Id.
---------------------------------------------------------------------------
The second study, conducted by Johnson, Lavetti, and Lipsitz,
isolates the impact of a state's enforceability policy on workers not
directly affected by that policy to demonstrate non-compete clauses
affect not just the workers subject to those non-compete clauses, but
the broader labor market as well. In particular, the study finds that
increases in non-compete clause enforceability in one state have
negative impacts on workers' earnings in bordering states, and the
effects are nearly as large as the effects in the state in which
enforceability changed. Johnson, Lavetti, and Lipsitz estimate that the
impact on earnings of a law change in one state on workers just across
that state's border is 87% as great as for workers in the state in
which the law was changed (the effect tapers off as the distance to the
bordering state increases).\81\ When a law change in one state
decreases workers' earnings in that state by 4%, that would therefore
mean that workers just across the border (i.e., workers who share a
commuting zone--a delineation of a local economy \82\--but who live in
another state) would experience decreased earnings of 3.5%. The authors
conclude that, since the workers across the border are not directly
affected by the law change (i.e., contracts that they have signed do
not become more or less enforceable), this effect must be due to
changes in the local labor market.\83\
---------------------------------------------------------------------------
\81\ Johnson, Lavetti, & Lipsitz, supra note 63 at 51. Eighty
seven percent is calculated as the coefficient on the donor state
NCA score (-.181) divided by the coefficient on own state NCA score
(-.207).
\82\ See U.S. Econ. Rsch. Serv., Commuting Zones and Labor
Market Areas, https://www.ers.usda.gov/data-products/commuting-zones-and-labor-market-areas/.
\83\ Johnson, Lavetti, & Lipsitz, supra note 63 at 30.
---------------------------------------------------------------------------
d. Earnings--Distributional Effects
There is evidence that non-compete clauses increase racial and
gender wage gaps by disproportionately reducing the wages of women and
non-white workers. This may be, for example, because firms use the
monopsony power which results from use of non-compete clauses as a
means by which to wage discriminate. The study by Johnson, Lavetti, and
Lipsitz finds that while earnings of white men would increase by about
3.2% if a state's enforceability moved from the fifth-strictest to the
fifth most lax, the comparable earnings increase for workers in other
demographic groups would be 3.7-7.7%, depending on the characteristics
of the group (though it is not clear from the study whether or not the
differences are statistically significant).\84\ The authors estimate
that banning non-compete clauses nationwide would close racial and
gender wage gaps by 3.6-9.1%.\85\
---------------------------------------------------------------------------
\84\ Id. at 38.
\85\ Id.
---------------------------------------------------------------------------
e. Job Creation
While non-compete clauses may theoretically incentivize firms to
create jobs by increasing the value associated with any given worker
covered by a non-compete clause, the evidence is inconclusive. One
study, by Gerald Carlino, estimates the job creation rate at startups
increased by 7.8% when Michigan increased non-compete clause
enforceability.\86\ However, the job creation rate calculated in this
study is the ratio of jobs created by startups to overall employment in
the state: therefore, the job creation rate at startups may rise either
because the number of jobs created by startups rose, or because
employment overall fell. The study does not investigate which of these
two factors drives the increase in the job creation rate at startups.
---------------------------------------------------------------------------
\86\ Gerald A. Carlino, Do Non-Compete Covenants Influence State
Startup Activity? Evidence from the Michigan Experiment at 16 (Fed.
Reserve Bank of Phila. Working Paper 21-26, 2021).
---------------------------------------------------------------------------
Another study finds that several increases in non-compete clause
enforceability were associated with a 1.4% increase in average per-firm
employment at new firms (though not necessarily total employment).\87\
In this
[[Page 3489]]
study, the authors attribute the increase in average employment to a
change in the composition of newly founded firms. The increases in non-
compete clause enforceability prevented the entry of relatively small
startups which would otherwise have existed. Therefore, the firms which
entered in spite of increases in non-compete clause enforceability had
more workers on average: this increased the average job creation rate
at new firms, because the average entering firm was relatively larger.
However, if the mechanism identified by the authors is correct,
increases in enforceability generate fewer total jobs, because the same
number of large firms may enter (regardless of non-compete clause
enforceability), but fewer small firms enter.
---------------------------------------------------------------------------
\87\ Evan Starr, Natarajan Balasubramanian, & Mariko Sakakibara,
Screening Spinouts? How Noncompete Enforceability Affects the
Creation, Growth, and Survival of New Firms, 64 Mgmt. Sci. 552, 561
(2018).
---------------------------------------------------------------------------
A similar mechanism may explain the results in both studies above.
If that is indeed the case, then an increase in average per-firm
employment among startups is not a positive effect of non-compete
clause enforceability: instead, it could actually represent a negative
effect, since non-compete clauses prevent small firms from existing in
the first place, and overall job creation may decrease. The Commission
therefore believes, with respect to job creation rates, the evidence is
inconclusive.
2. Product and Service Markets
In addition to analyzing how non-compete clauses affect competition
in labor markets, researchers have also analyzed whether non-compete
clauses affect competition in markets for products and services. The
available evidence indicates the use of non-compete clauses interferes
with competitive conditions in product and service markets as well.
The adverse effects of non-compete clauses on product and service
markets likely result from reduced voluntary labor mobility. Non-
compete clauses directly impede voluntary labor mobility by restricting
workers subject to non-compete clauses from moving to new jobs covered
by their non-compete clause. Since non-compete clauses prevent some job
openings from occurring (by keeping workers in their jobs), they also
prevent workers who are not subject to non-compete clauses from finding
new jobs (since the new jobs are already occupied by workers with non-
compete clauses).
Influenced by Ronald Gilson's research positing that high-tech
clusters in California may have been aided by increased labor mobility
because non-compete clauses are generally unenforceable in that
state,\88\ many studies have examined how non-compete clauses affect
labor mobility. Even literature primarily focused on other outcomes has
examined labor mobility as a secondary outcome. Across the board, all
studies have found decreased rates of mobility, measured by job
separations, hiring rates, job-to-job mobility, implicit mobility
defined by job tenure, and within- and between-industry mobility. We
briefly describe each of these studies in turn.
---------------------------------------------------------------------------
\88\ Ronald J. Gilson, The Legal Infrastructure of High
Technology Industrial Districts: Silicon Valley, Route 128, and Non-
Compete Clauses, 74 N.Y.U. L. Rev. 575 (1999).
---------------------------------------------------------------------------
A 2006 study conducted by Fallick, Fleischman, and Rebitzer
supported Gilson's hypothesis by showing that labor mobility in
information technology industries in metropolitan statistical areas
(MSAs) in California was 56% higher than in comparison MSAs outside
California. They note, however, the estimates may not be fully (or at
all) attributable to non-compete clause enforceability. Although the
Commission therefore does not find this particular study to be
sufficiently probative of the relationship between non-compete clauses
and labor mobility, its qualitative findings are in line with the rest
of the literature.\89\
---------------------------------------------------------------------------
\89\ Bruce Fallick, Charles A. Fleischman, & James B. Rebitzer,
Job-Hopping in Silicon Valley: Some Evidence Concerning the
Microfoundations of a High-Technology Cluster, 88 Rev. Econ. &
Statistics 472, 477 (2006).
---------------------------------------------------------------------------
To estimate the impacts of non-compete clause enforceability in a
fashion that may more plausibly attribute causality to the
relationship, in 2009, Marx, Strumsky, and Fleming examined the impact
on labor mobility of Michigan's switch to enforcing non-compete
clauses. They found that Michigan's increase in enforceability led to
an 8.1% decline in the mobility of inventors.\90\
---------------------------------------------------------------------------
\90\ Matt Marx, Deborah Strumsky, & Lee Fleming, Mobility,
Skills, and the Michigan Non-Compete Experiment, 55 Mgmt. Sci. 875,
884 (2009).
---------------------------------------------------------------------------
In 2011, Mark Garmaise examined how a suite of changes in non-
compete clause enforceability affected labor mobility. Garmaise found
executives made within-industry job changes 47% more often, between-
industry job changes 25% more often (though this result was not
statistically significant), and any job change 35% more often when non-
compete clauses were less enforceable.\91\
---------------------------------------------------------------------------
\91\ Garmaise, supra note 69 at 398.
---------------------------------------------------------------------------
A 2019 study by Jessica Jeffers uses several legal changes to
analyze the impact of non-compete clauses on workers' mobility, finding
that decreases in non-compete clause enforceability were associated
with an 8.6% increase in departure rates of workers, and a 15.4%
increase in within-industry departure rates of workers.\92\
---------------------------------------------------------------------------
\92\ Jessica Jeffers, The Impact of Restricting Labor Mobility
on Corporate Investment and Entrepreneurship 22 (2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3040393.
---------------------------------------------------------------------------
Evan Starr's 2019 study comparing workers in occupations which use
non-compete clauses at a high versus low rate found that a state moving
from mean enforceability to no enforceability would cause a decrease in
employee tenure for workers in high-use occupations of 8.2%, compared
with those in low-use occupations. Here, tenure serves as a proxy for
mobility, since tenure is the absence of prior mobility.\93\
---------------------------------------------------------------------------
\93\ Starr, supra note 66 at 798. The value is calculated as
8.2% = 0.56/6.46, where 0.56 is the reported impact on tenure and
6.46 is mean tenure in the sample.
---------------------------------------------------------------------------
Returning to an examination of executives, Liyan Shi's 2020 paper
qualitatively confirmed Garmaise's results, showing that executives
with enforceable non-compete clauses were 1.8 percentage points less
likely to separate from their employers, compared with executives
without enforceable non-compete clauses.\94\
---------------------------------------------------------------------------
\94\ Shi, supra note 51 at 26.
---------------------------------------------------------------------------
Starr, Prescott, and Bishara's 2020 study found that having a non-
compete clause was associated with a 35% decrease in the likelihood a
worker would leave for a competitor.\95\ However, they also found
enforceability does not impact this prediction, in contrast with prior
studies. Digging deeper into the mechanism, they find that what matters
is the worker's belief about the likelihood their employer would seek
to enforce a non-compete clause in court. Workers who did not believe
employers would enforce non-compete clauses in court were more likely
to report they would be willing to leave for a competitor.\96\ This
result confirms the need to ensure that workers are aware of the
proposed rule, though it suffers from the same limitations as do
previously discussed studies of the impacts of non-compete clause use,
rather than enforceability: that studies of use are not causally
interpretable, since they may conflate the effects of factors which
cause use for the effects of use itself.
---------------------------------------------------------------------------
\95\ Evan Starr, J.J. Prescott, & Norm Bishara, The Behavioral
Effects of (Unenforceable) Contracts, 36 J.L., Econ., & Org. 633,
652 (2020).
\96\ Id. at 664.
---------------------------------------------------------------------------
Two recent studies examined subgroups of the population affected by
[[Page 3490]]
state law changes. Balasubramanian et al., in 2022, focused on high-
tech workers whose non-compete clauses were banned in Hawaii, and
Lipsitz and Starr, in 2022, focused on hourly workers whose non-compete
clauses were banned in Oregon. The former found that the ban increased
mobility by 12.5% in the high-tech sector,\97\ while the latter found
that mobility of hourly workers increased by 17.3%.\98\
---------------------------------------------------------------------------
\97\ Balasubramanian et al., supra note 68 at S351.
\98\ Lipsitz & Starr, supra note 46 at 157.
---------------------------------------------------------------------------
Finally, a 2022 study by Johnson, Lavetti, and Lipsitz examined the
impact on labor mobility of all legal changes after 1991 across the
entire labor force. They found moving from the enforceability level of
the fifth strictest state to that of the fifth most lax state causes a
6.0% increase in job-to-job mobility in industries using non-compete
clauses at a high rate.\99\ Furthermore, they found when a state
changes its non-compete clause enforceability in that fashion, workers
in neighboring states experience 4.8% increases in mobility as measured
by job separations, and 3.9% increases as measured by hiring rates,
though neither result was statistically significant.\100\
---------------------------------------------------------------------------
\99\ Johnson, Lavetti, & Lipsitz, supra note 63 at 21.
\100\ Id. at 76.
---------------------------------------------------------------------------
As described below in Part IV.A.1.a.ii, the Commission does not
view reduced labor mobility from non-compete clauses--in and of
itself--as evidence non-compete clauses negatively affect competition
in product and service markets. Instead, reduced labor mobility is best
understood as the primary driver of effects in product and service
markets that the Commission is concerned about. These effects are
described below.
a. Consumer Prices and Concentration
There is evidence that non-compete clauses increase consumer prices
and concentration in the health care sector. There is also evidence
non-compete clauses increase industrial concentration more broadly.
Non-compete clauses may have these effects by inhibiting
entrepreneurial ventures (which could otherwise enhance competition in
goods and service markets) or by foreclosing competitors' access to
talented workers.
One study, by Naomi Hausman and Kurt Lavetti, finds increased
concentration, as measured by the Herfindahl-Hirschman Index (HHI), at
the firm level \101\ and increased final goods prices \102\ as the
enforceability of non-compete clauses increases. Hausman and Lavetti's
study focuses on physician markets, showing that while non-compete
clauses allow physician practices to allocate clients more efficiently
across physicians, this comes at the cost of greater concentration and
prices for consumers. Generally, greater concentration may or may not
lead to greater prices in all situations and may arise for reasons
which simultaneously cause higher prices (indicating, therefore, a
noncausal relationship between concentration and prices). In this case,
the authors claim that researching the direct link between changes in
law governing non-compete clauses and changes in concentration allows
them to identify a causal chain starting with greater enforceability of
non-compete clauses, which leads to greater concentration, and higher
consumer prices.
---------------------------------------------------------------------------
\101\ Naomi Hausman & Kurt Lavetti, Physician Practice
Organization and Negotiated Prices: Evidence from State Law Changes,
13 a.m. Econ. J. Applied Econ. 258, 284 (2021). Note that Hausman
and Lavetti find decreased HHI at the establishment level (where an
establishment is a physical location, and a firm is a company which
may own multiple establishments). For the purposes of consumer
outcomes such as a price or product quality, the relevant measure of
concentration is at the firm level, since firms are unlikely to
compete against themselves on price or quality.
\102\ Id. at 280.
---------------------------------------------------------------------------
While there is no additional direct evidence on the link between
non-compete clauses and consumer prices, another study, by Michael
Lipsitz and Mark Tremblay, shows increased enforceability of non-
compete clauses at the state level increases concentration, as measured
by an employment-based HHI.\103\ Lipsitz and Tremblay theorize non-
compete clauses inhibit entrepreneurial ventures which could otherwise
enhance competition in goods and service markets, and show that the
potential for harm is greatest in exactly those industries in which
non-compete clauses are likely to be used at the highest rate.\104\ If
the general causal link governing the relationship between
enforceability of non-compete clauses, concentration, and consumer
prices acts similarly to that identified in the study by Hausman and
Lavetti, then it is plausible that increases in concentration
identified by Lipsitz and Tremblay would lead to higher prices in a
broader set of industries.
---------------------------------------------------------------------------
\103\ Michael Lipsitz & Mark Tremblay, Noncompete Agreements and
the Welfare of Consumers 6 (2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3975864.
\104\ Id. at 3.
---------------------------------------------------------------------------
In many settings, it is also theoretically plausible that increases
in worker earnings from restricting non-compete clauses may increase
consumer prices by raising firms' costs (though there is countervailing
evidence, especially in goods manufacturing \105\). However, we are not
aware of empirical evidence that this occurs, and there are also
countervailing forces--such as the impacts on concentration described
above and positive impacts on innovation \106\--that would tend to
decrease consumer prices. Additionally, the greater wages observed for
workers where non-compete clauses are less enforceable may be due to
better worker-firm matching, which could simultaneously increase wages
and increase productivity, which could lead to lower prices.
---------------------------------------------------------------------------
\105\ Sebastian Heise, Fatih Karahan, & Ay[scedil]eg[uuml]l
[Scedil]ahin The Missing Inflation Puzzle: The Role of the
Wage[hyphen]Price Pass[hyphen]Through, 54 J. Money, Credit & Banking
7 (2022).
\106\ See infra Part II.B.2.d.
---------------------------------------------------------------------------
In addition, the only study of how non-compete clauses affect
prices--the Hausman and Lavetti study described above--finds decreased
non-compete clause enforceability decreases prices in the healthcare
market, rather than increasing them. The study notes that, in theory,
changes in non-compete clause enforceability could impact physicians'
earnings, which could subsequently pass through to prices in healthcare
markets. However, the authors show that, where prices decrease due to
decreased non-compete clause enforceability, labor cost pass-through is
not driving price decreases. As the authors note, if price decreases
associated with non-compete clause enforceability decreases were due to
pass-through of decreases in physicians' earnings, then the most labor-
intensive procedures would likely experience the greatest price
decreases when enforceability decreased. However, they find the
opposite: there is little to no effect on prices for the most labor-
intensive procedures, in contrast with procedures which use relatively
less labor. As the authors explain, this shows that decreases in
healthcare prices associated with decreases in non-compete clause
enforceability are not due to pass-through of lower labor costs.\107\
---------------------------------------------------------------------------
\107\ Hausman & Lavetti, supra note 101 at 278.
---------------------------------------------------------------------------
b. Foreclosing Competitors' Ability To Access Talent
There is evidence that non-compete clauses foreclose the ability of
competitors to access talent by effectively forcing future employers to
buy out workers from their non-compete clauses if they want to hire
them. Firms must either make inefficiently high payments to buy workers
out of non-compete clauses with a former employer, which leads to
deadweight economic loss, or forego the payment--
[[Page 3491]]
and, consequently, the access to the talent the firm seeks. Whatever
choice a firm makes, its economic outcomes in the market are harmed,
relative to a scenario in which no workers are bound by non-compete
clauses.
Liyan Shi studies this effect in a 2022 paper. This paper finds
non-compete clauses are used to ensure that potential new employers of
executives make a buyout payment to the executive's current
employer.\108\ Such a mechanism could be tempered by the ability of a
labor market to provide viable alternative workers for new or competing
businesses. However, when a particular type of labor is somewhat
scarce, when on-the-job experience matters significantly, or when
frictions prevent workers from moving to new jobs, there is no way for
the market to fill the gap created by non-compete clauses. By studying
CEOs, who are difficult to replace and relatively scarce, Shi's paper
shows that non-compete clauses foreclose the ability of competitors to
access talent by effectively forcing them to make inefficiently high
buyout payments. Shi ultimately concludes that ``imposing a complete
ban on noncompete clauses would be close to implementing the social
optimum.'' \109\
---------------------------------------------------------------------------
\108\ Shi, supra note 51.
\109\ Id. at 35.
---------------------------------------------------------------------------
c. New Business Formation
The weight of the evidence indicates non-compete clauses likely
have a negative impact on new business formation. Three studies show
that non-compete clauses and increased enforceability of non-compete
clauses reduce entrepreneurship, new business formation, or both. A
fourth study also finds that non-compete clauses reduce the rate at
which men and women found new startups, though the result is not
statistically significant for men. A fifth study finds mixed effects
which likely support the theory that non-compete clauses reduce new
business formation, and a sixth study finds no effect.
New business formation may refer to entrepreneurs creating new
businesses from scratch or to businesses being spun off from existing
businesses. New business formation increases competition first by
bringing new ideas to market, and second, by forcing incumbent firms to
respond to new firms' ideas instead of stagnating. New businesses
disproportionately create new jobs and are, as a group, more resilient
to economic downturns.\110\ Recent evidence that new business formation
is trending downward has led to concerns that productivity and
technological innovation are not as strong as they would have been had
new business formation remained at higher levels.\111\ Non-compete
clauses restrain new business formation by preventing workers subject
to non-compete clauses from starting their own businesses. In addition,
firms are more willing to enter markets in which they know there are
potential sources of skilled and experienced labor, unhampered by non-
compete clauses.
---------------------------------------------------------------------------
\110\ See, e.g., The Importance of Young Firms for Economic
Growth, Policy Brief, Ewing Marion Kauffman Foundation (Sept. 24,
2015).
\111\ See, e.g., Cong. Budget Off., Federal Policies in Response
to Declining Entrepreneurship (December 2020).
---------------------------------------------------------------------------
Three studies show that non-compete clauses and increased
enforceability of non-compete clauses reduce entrepreneurship and new
business formation. First, Sampsa Samila and Olav Sorenson, in a 2011
study, examined the differential impacts of venture capital on business
formation, patenting, and employment growth. They found when non-
compete clauses are more enforceable, rates of entrepreneurship,
patenting, and employment growth slow. They find that a 1% increase in
venture capital funding increased the number of new firms by 0.8% when
non-compete clauses were enforceable, and by 2.3% when non-compete
clauses were not enforceable.\112\ Similarly, a 1% increase in the rate
of venture capital funding increased employment by 0.6% when non-
compete clauses were enforceable, versus 2.5% where non-compete clauses
were not enforceable.\113\
---------------------------------------------------------------------------
\112\ Sampsa Samila & Olav Sorenson, Noncompete Covenants:
Incentives to Innovate or Impediments to Growth, 57 Mgmt. Sci. 425,
432 (2011). The values are calculated as 0.8% = e\0.00755\-1 and
2.3% = e\0.00755+0.0155\-1, respectively.
\113\ Id. at 433. The values are calculated as 0.6% =
e\0.00562\-1 and 2.3% = e\0.00562+0.0192\-1, respectively.
---------------------------------------------------------------------------
The second study, conducted by Jessica Jeffers in 2019, uses
several state law changes to show a decline in new firm entry when non-
compete clauses are more enforceable. When non-compete clause
enforceability is made stricter (based on the relatively meaningful
changes examined in her study), the entry rate of new firms decreased
by 10% in the technology sector and the professional, scientific, and
technical services sector.\114\
---------------------------------------------------------------------------
\114\ Jeffers, supra note 92 at 32.
---------------------------------------------------------------------------
The third study, conducted by Evan Starr, Natarajan
Balasubramanian, and Mariko Sakakibara in 2018, finds that the rate of
within-industry spinouts (WSOs) decreases by 0.13 percentage points
(against a mean of 0.4%) when non-compete clause enforceability
increases by one standard deviation.\115\ The study's measured impact
on the entry rate of non-WSOs (i.e., spinoffs into other industries) is
statistically indistinguishable from zero (0.07 percentage point
increase associated with a one standard deviation increase in
enforceability).\116\ WSOs have been shown to be highly successful, on
average, when compared with typical entrepreneurial ventures.\117\ By
reducing intra-industry spinoff activity, non-compete clauses prevent
entrepreneurial activity that is likely to be highly successful.
---------------------------------------------------------------------------
\115\ Starr, Balasubramanian, & Sakakibara, supra note 87 at
561.
\116\ Id. at 561.
\117\ For reviews of the literature, see, e.g., Steven Klepper,
Spinoffs: A Review and Synthesis, 6 European Mgmt. Rev. 159-71
(2009) and April Franco, Employee Entrepreneurship: Recent Research
and Future Directions, in Handbook of Entrepreneurship Research
(2005) 81-96.
---------------------------------------------------------------------------
The fourth study, published by Matt Marx in 2021, examines the
impact of several changes in non-compete clause enforceability between
1991 and 2014.\118\ Marx finds that, when non-compete clauses are more
enforceable, men are 46% less likely to found a rival startup after
leaving their employer (though this result is statistically
insignificant), that women are 69% less likely to do so, and that the
difference in the effect of non-compete clause enforceability on
founding rates between men and women is statistically significant.\119\
This study therefore supports both the theory that non-compete clauses
inhibit new business formation and that non-compete clauses tend to
have more negative impacts for women than for men.
---------------------------------------------------------------------------
\118\ Matt Marx, Employee Non-compete Agreements, Gender, and
Entrepreneurship, Org. Sci. (Online ahead of print) (2021).
\119\ Id. at 9.
---------------------------------------------------------------------------
A fifth study finds mixed effects of non-compete clause
enforceability on the entry of businesses into the State of Florida.
Hyo Kang and Lee Fleming, in a 2020 study, examine a legal change in
Florida which made non-compete clauses more enforceable. This study
finds that larger businesses entered the state more frequently (by
8.5%), but smaller businesses entered less frequently (by 5.6%)
following the change.\120\ Similarly, Kang and Fleming found that
employment at large businesses rose by 15.8% following the change,
while employment at smaller businesses effectively did not change.\121\
---------------------------------------------------------------------------
\120\ Hyo Kang & Lee Fleming, Non[hyphen]Competes, Business
Dynamism, and Concentration: Evidence From a Florida Case Study, 29
J. Econ. & Mgmt. Strategy 663, 673 (2020).
\121\ Id. at 674. The value is calculated as 15.8% = e\0.1468\-
1.
---------------------------------------------------------------------------
[[Page 3492]]
In the Commission's view, however, the results of this study do not
necessarily show how non-compete clauses affect new business formation.
This study does not examine new business formation specifically;
instead, it assesses the number of ``business entries'' into the state.
As the authors acknowledge, many of these business entries are not new
businesses being formed in Florida (i.e., startups), but existing
businesses that are moving to the state.\122\ Because startups are
almost never large businesses, the authors' finding that larger
businesses entered the state more frequently is much more likely to
reflect businesses moving to the state, rather than new businesses
being formed in the state. (While a business's relocation to Florida
may benefit Florida, it is not net beneficial from a national
perspective, since the business is simply moving from somewhere else.)
The authors' finding that increased non-compete clause enforceability
decreased the entry of smaller businesses is more likely to reflect an
effect of non-compete clause enforceability on new business formation,
since smaller businesses are relatively more likely than larger
businesses to be startups.
---------------------------------------------------------------------------
\122\ Id. at 668.
---------------------------------------------------------------------------
A sixth study finds no effect of non-compete clauses on new
business formation. A 2021 study by Gerald Carlino analyzes the impact
of a legal change in Michigan that allowed the courts to enforce non-
compete clauses. This study finds no significant impact on new business
formation.\123\
---------------------------------------------------------------------------
\123\ Carlino, supra note 86 at 36.
---------------------------------------------------------------------------
d. Innovation
The weight of the evidence indicates non-compete clauses decrease
innovation. Innovation may directly improve economic outcomes by
increasing product quality or decreasing prices, or may promote
competition because successful new products and services force
competing firms to improve their own products and services. Non-compete
clauses affect innovation by reducing the movement of workers between
firms, which decreases knowledge flow between firms. Non-compete
clauses also prevent workers from starting businesses in which they can
pursue innovative new ideas.
One study shows increased enforceability of non-compete clauses
decreases the value of patenting, using a variety of legal changes.
Another study shows that increased non-compete clause enforceability
decreases the rate at which venture capital funding increases
patenting. Finally, using a legal change in Michigan which increased
enforceability, one study shows there were mixed effects on patenting
in terms of both quantity and quality, but mechanical patenting (a
large part of patenting in Michigan) increased.
The first study, a 2021 study by Zhaozhao He, finds the value of
patents, relative to the assets of the firm, increase by about 31% when
non-compete clause enforceability decreases.\124\ In contrast to the
other two studies of innovation, the study uses the value of patents,
rather than the number of patents, to mitigate concerns that patenting
activity may not represent innovation, but rather substitutions of
protections (in other words, that when non-compete clauses are made
less enforceable, firms may use patents instead of non-compete clauses
to seek to protect sensitive information).\125\ The study also analyzes
the impact of several legal changes to non-compete clause
enforceability, which means that the results may be most broadly
applicable.
---------------------------------------------------------------------------
\124\ Zhaozhao He, Motivating Inventors: Non-Competes,
Innovation Value and Efficiency 21 (2021), https://ssrn.com/abstract=3846964. Thirty one percent is calculated as e\0..272\-1.
\125\ Id. at 17.
---------------------------------------------------------------------------
The second study, by Samila and Sorensen, found that, when non-
compete clauses are enforceable, venture capital induced less
patenting, by 6.6 percentage points.\126\ However, as explained above,
the authors note patenting may or may not reflect the true level of
innovation, as firms may use patenting as a substitute for non-compete
clauses where they seek to protect sensitive information.\127\ The
final study of innovation, a 2021 study by Gerald Carlino, examined how
patenting activity in Michigan was affected by an increase in non-
compete enforceability. The study finds that mechanical patenting
increased following the law change, but drug patenting fell, and the
quality of computer patents fell (as measured by citations).\128\ The
increase in mechanical patenting appears to have primarily occurred
approximately 14 years after non-compete clause enforceability changed,
however, suggesting some other mechanism may have led to the increase
in patenting activity.\129\ We place relatively greater weight on
studies focused on multiple legal changes to non-compete clause
enforceability (such as the above referenced study by He), in which
factors unrelated to the legal changes at issue are less likely to
drive the results. The Carlino study also does not discuss whether
patenting activity is an appropriate measure of innovation, though the
other two studies suggest that it may be an unreliable measure at best.
The study by Samila and Sorensen examines the enforceability of non-
compete clauses across all states but does not consider changes in
enforceability: they are therefore unable to rule out that their
results could be due to underlying differences in the states rather
than non-compete clause enforceability.
---------------------------------------------------------------------------
\126\ Samila & Sorenson, supra note 112 at 432. The value is
calculated as 6.6% = e\0.0208+0.0630\-e\0.0208\.
\127\ Id.
\128\ Carlino, supra note 86 at 40.
\129\ Id. at 48.
---------------------------------------------------------------------------
The Commission therefore places greatest weight on the study by He,
which suggests innovation is largely harmed by non-compete clause
enforceability. Though the results from Carlino countervail this
finding, those results are subject to criticism (as is the
corroborating evidence found in Samila and Sorensen).
Two additional studies address firm strategies related to
innovation. The first, by Raffaele Conti, uses two changes in non-
compete clause enforceability (in Texas and Florida), and indicates
that firms engage in riskier strategies with respect to research and
development when non-compete clause enforceability is greater.\130\
Riskier research and development strategies lead to more breakthrough
innovations, but also lead to more failures, leaving the net impact
unclear. The paper does not quantify the total impact on innovation.
---------------------------------------------------------------------------
\130\ Raffaele Conti, Do Non-Competition Agreements Lead Firms
to Pursue Riskier R&D Strategies?, 35 Strategic Mgmt. J. 1230
(2014).
---------------------------------------------------------------------------
The second, by Fenglong Xiao, found increases in non-compete clause
enforceability led to increases in exploitative innovation (i.e.,
innovation which stays within the bounds of the innovating firm's
existing competences), and decreases in exploratory innovation (i.e.,
innovation which moves outside those bounds) in medical devices.\131\
Overall, this leads to an increase in the quantity of innovation as
measured by the introduction of new medical devices. This increase in
quantity, however, is the net result of an increase in exploitative
innovation and a decrease in explorative innovation, where the latter
is the mode of innovation which the empirical
[[Page 3493]]
literature has found to be associated with high growth firms.\132\
---------------------------------------------------------------------------
\131\ Fenglong Xiao, Non-Competes and Innovation: Evidence from
Medical Devices, 51 Rsch. Pol'y 1 (2022).
\132\ Alessandra Colombelli, Jackie Krafft & Francesco Quatraro,
High-Growth Firms and Technical Knowledge: Do Gazelles Follow
Exploration or Exploitation Strategies?, 23.1 Industrial and
Corporate Change 262 (2014).
---------------------------------------------------------------------------
While these two additional studies bring nuance to the changes in
the types of innovation pursued by firms when non-compete clause
enforceability changes, neither undermines the weight of the evidence
described above: that increased non-compete clause enforceability
broadly diminishes the rate of innovation.
e. Training and Other Investment
There is evidence that non-compete clauses increase employee
training and other forms of investment. Four studies have examined
investment outcomes: two examine the effects of non-compete clause
enforceability on investment (both of which find positive impacts on
investment), while two examine the relationship between non-compete
clause use and investment (only one of which finds positive impacts on
investment).
Of the two studies that examine the effects of non-compete clause
enforceability on investment, one looks at employee training, and one
looks at firm capital expenditures (e.g., investment in physical
assets, such as machines). The first study, a 2020 study by Evan Starr,
finds that moving from mean non-compete clause enforceability to no
non-compete clause enforceability would decrease the number of workers
receiving training by 14.7% in occupations that use non-compete clauses
at a high rate (relative to a control group of occupations that use
non-compete clauses at a low rate).\133\ The study further finds
changes in training are primarily due to changes in firm-sponsored,
rather than employee-sponsored, training.\134\ Firm-sponsored training
is the type of training non-compete clauses are often theorized to
protect, as the firm may be unwilling to make an unprotected
investment.
---------------------------------------------------------------------------
\133\ Starr, supra note 66 at 796-97.
\134\ Id. at 797.
---------------------------------------------------------------------------
The second study, a 2021 study by Jessica Jeffers, finds knowledge-
intensive firms invest 32% less in capital equipment following
decreases in the enforceability of non-compete clauses.\135\ While
firms may invest in capital equipment for many different reasons,
Jeffers examines this outcome (as opposed to labor-focused outcomes) to
avoid looking at research and development expenditure as a whole, which
is in large part composed of labor expenses. This allows the study to
isolate the effects of non-compete clause enforceability on investment
from other effects of non-compete clauses, such as reduced worker
earnings. Jeffers finds that there are likely two mechanisms driving
these effects: first, that firms may be more likely to invest in
capital when they train their workers because worker training and
capital expenditure are complementary (i.e., the return on investment
in capital equipment is greater when workers are more highly trained);
and second, that non-compete clauses reduce competition, and firms'
returns to capital expenditure are greater when competition is lower,
incentivizing firms to invest more in capital.\136\
---------------------------------------------------------------------------
\135\ Jeffers, supra note 92 at 28.
\136\ Id. at 29.
---------------------------------------------------------------------------
The first study that examines the impact of non-compete clause use
on investment is a 2021 study by Starr et. al. using their 2014 survey
of non-compete clause use. They find no statistically significant
impact on either training or the sharing of trade secrets (after
inclusion of control variables) but cannot examine other investment
outcomes.\137\ The second study, a 2021 study by Johnson and Lipsitz,
examines investment in the hair salon industry. It finds that firms
that use non-compete clauses train their employees at a higher rate and
invest in customer attraction through the use of digital coupons (on
so-called ``deal sites'') to attract customers at a higher rate, both
by 11 percentage points.\138\ However, the authors of both studies
caution that these results do not necessarily represent a causal
relationship.\139\ In each study, the use of non-compete clauses and
the decision to invest may be jointly determined by other
characteristics of the firms, labor markets, or product markets. For
this reason, the Commission places relatively minimal weight on these
studies in terms of how they inform the relationship between the
proposed rule and future potential firm investment.
---------------------------------------------------------------------------
\137\ Starr, Prescott, & Bishara, supra note 42 at 76.
\138\ Johnson & Lipsitz, supra note 54 at 711.
\139\ Starr, Prescott, & Bishara, supra note 42 at 73; Johnson &
Lipsitz, supra note 54 at 711.
---------------------------------------------------------------------------
Overall, the additional incentive to invest (in assets like
physical capital, human capital, or customer attraction, or in the
sharing of trade secrets and confidential commercial information) is
the primary justification for use of non-compete clauses. Any
investment which is lost due to the inability of firms to use non-
compete clauses would likely represent the greatest cost of the
proposed rule. Indeed, one study, by Kenneth Younge and Matt Marx,
finds that the value of publicly traded firms increased by 9% due to an
increase in non-compete clause enforceability.\140\ However, they
attribute this increase to the value of retaining employees, which
comes with the negative effects to parties other than the firm
(employees, competitors, and consumers) described in this Part II.B. In
particular, if benefits to the firm arise primarily from reductions in
labor costs, then the increase in the value of firms is in part a
transfer from workers to firms, and is therefore not necessarily a
procompetitive benefit of non-compete clauses. However, the authors do
not explore the extent to which increases in firm value arise from
decreases in labor costs. The authors additionally note that since the
time frame used in the study is short, ``there may be deleterious
effects of non-competes in the long run'' which are absent in their
findings.\141\
---------------------------------------------------------------------------
\140\ Kenneth A. Younge & Matt Marx, The value of employee
retention: evidence from a natural experiment, 25 J. Econ. & Mgmt.
Strategy 652 (2016).
\141\ Id. at 674.
---------------------------------------------------------------------------
The Commission requests comment on all aspects of its description,
in this Part II.B, of the empirical evidence relating to non-compete
clauses and their effects on competition. In particular, the Commission
seeks submissions of additional data that could inform the Commission's
understanding of these effects.
C. Current Law Governing Non-Compete Clauses
The states have always placed a variety of restrictions on the
ability of employers to enforce non-compete clauses. These restrictions
are based on public policy concerns American courts--and English courts
before them--have recognized for centuries. For example, in the English
opinion Mitchel v. Reynolds (1711), which provided the foundation for
the American common law on non-compete clauses,\142\ the court
expressed concerns that workers were vulnerable to exploitation under
non-compete clauses and these clauses threatened workers' ability to
practice their trades and earn a living.\143\
---------------------------------------------------------------------------
\142\ Harlan Blake, Employment Agreements Not to Compete, 73
Harv. L. Rev. 625, 630-31 (1960).
\143\ Mitchel v. Reynolds, 1 P. Wms. 181, 190 (Q.B. 1711)
(expressing concern that non-compete clauses threaten ``the loss of
[the worker's] livelihood, and the subsistence of his family,'' and
also ``the great abuses these voluntary restraints are liable to,''
for example, ``from masters, who are apt to give their apprentices
much vexation'' by using ``many indirect practices to procure such
bonds from them, lest they should prejudice them in their custom,
when they come to set up for themselves.'').
---------------------------------------------------------------------------
Today, while the enforceability of non-compete clauses varies
between
[[Page 3494]]
states, all fifty states restrict non-compete clauses between employers
and workers to some degree.\144\ Non-compete clauses between employers
and workers are generally subject to greater scrutiny under state
common law than other employment terms, due to ``the employee's
disadvantageous bargaining position at the time of contracting and
hardship at the time of enforcement.'' \145\ For these reasons, state
courts often characterize non-compete clauses as ``disfavored.'' \146\
---------------------------------------------------------------------------
\144\ Cynthia Estlund, Between Rights and Contract: Arbitration
Agreements and Non-Compete Covenants as a Hybrid Form of Employment
Law, 155 U. Pa. L. Rev. 379, 391 (2006).
\145\ Id. See also Restatement (Second) of Contracts sec. 188,
cmt. g (1981) (``Postemployment restraints are scrutinized with
particular care because they are often the product of unequal
bargaining power and because the employee is likely to give scant
attention to the hardship he may later suffer through loss of his
livelihood.'').
\146\ See, e.g., Navarre Chevrolet, Inc. v. Begnaud, 205 So. 3d
973, 975 (La. Ct. App. 3d 2016); Eastman Kodak Co. v. Carmosino, 77
A.D.3d 1434, 1435 (N.Y. App. Div. 4th 2010); Access Organics, Inc.
v. Hernandez, 175 P.3d 899, 904 (Mont. 2008); Bybee v. Isaac, 178
P.3d 616, 621 (Idaho 2008); Softchoice, Inc. v. Schmidt, 763 NW2d
660, 666 (Minn. Ct. App. 2009).
---------------------------------------------------------------------------
In addition to state common law, non-compete clauses have always
been considered proper subjects for scrutiny under the nation's
antitrust laws.\147\
---------------------------------------------------------------------------
\147\ See, e.g., Am. Tobacco Co., 221 U.S. at 181-83 (holding
several tobacco companies violated Sections 1 and 2 of the Sherman
Act due to the collective effect of six of the companies' practices,
one of which was the ``constantly recurring'' use of non-compete
clauses); Newburger, Loeb & Co., Inc., 563 F.2d at 1082 (``Although
such issues have not often been raised in the federal courts,
employee agreements not to compete are proper subjects for scrutiny
under section 1 of the Sherman Act. When a company interferes with
free competition for one of its former employee's services, the
market's ability to achieve the most economically efficient
allocation of labor is impaired. Moreover, employee-noncompetition
clauses can tie up industry expertise and experience and thereby
forestall new entry.'') (internal citation omitted).
---------------------------------------------------------------------------
1. State Law on Non-Compete Clauses
The question of whether or under what conditions an employer can
enforce a particular non-compete clause depends on the applicable state
law. Three states--California, North Dakota, and Oklahoma--have adopted
statutes rendering non-compete clauses void for nearly all
workers.\148\ Among the 47 states where non-compete clauses may be
enforced under certain circumstances, 11 states and the District of
Columbia have enacted statutes making non-compete clauses void or
unenforceable--or have banned employers from entering into non-compete
clauses--based on the worker's earnings or a similar factor.\149\ In
addition, the majority of these 47 states have statutory provisions
that ban or limit the enforceability of non-compete clauses for workers
in certain specified occupations. In most states, those limits apply to
just one or two occupations (most commonly, physicians).\150\
---------------------------------------------------------------------------
\148\ See Cal. Bus. & Prof. Code sec. 16600; N.D. Cent. Code
sec. 9-08-06; Okla. Stat. Ann. tit. 15, sec. 219A. While California
law permits non-compete clauses if they are necessary to protect an
employer's trade secrets, see Muggill v. Reuben H. Donnelley Corp.,
62 Cal. 2d 239, 242 (Cal. 1965), the scope of this exception is
unclear. In a recent case, the California Supreme Court declined to
address the issue. Edwards v. Arthur Andersen LLP, 189 P.3d 285, 289
n.4 (Cal. 2008).
\149\ Colorado, Colo Rev. Stat. Ann. sec. 8-2-113(2)(a)-(b), as
amended by H.B. 22-1317 (effective Aug. 10, 2022) (non-compete
clauses are void except where they apply to a ``highly compensated
worker,'' currently defined as a worker earning at least $101,250
annually, see Colo. Code Regs. sec. 1103-14:1.2); District of
Columbia, DC Code sec. 32-581.02(a)(1) (effective Oct. 1, 2022)
(where the employee's compensation is less than $150,000, or less
than $250,000 if the employee is a medical specialist, employers may
not require or request that the employee sign an agreement or comply
with a workplace policy that includes a non-compete clause);
Illinois, 820 Ill. Comp. Stat. 90/10(a) (effective Jan. 1, 2017) (no
employer shall enter into a non-compete clause unless the worker's
actual or expected earnings exceed $75,000/year); Maine, Me. Rev.
Stat. Ann. tit. 26, sec. 599-A(3) (effective Sep. 19, 2019) (an
employer may not require or permit an employee earning wages at or
below 400% of the federal poverty level to enter into a non-compete
clause with the employer); Maryland, Md. Code Ann., Lab. & Empl.
sec. 3-716(a)(1)(i) (effective Oct. 1, 2019) (non-compete clauses
are void where an employee earns equal to or less than $15 per hour
or $31,200 per year); Massachusetts, Mass. Gen. Laws Ann. ch. 149,
sec. 24L(c) (effective Jan. 14, 2021) (non-compete clauses shall not
be enforceable against workers classified as nonexempt under the
Fair Labor Standards Act (``FLSA'')); Nevada, Nev. Rev. Stat. sec.
613.195(3) (effective Oct. 1, 2021) (non-compete clauses may not
apply to hourly workers); New Hampshire, N.H. Rev. Stat. Ann. sec.
275:70-a(II) (effective Sept. 8, 2019) (employers shall not require
a worker who earns an hourly rate less than or equal to 200% of the
federal minimum wage to enter into a non-compete clause, and non-
compete clauses with such workers are void and unenforceable);
Oregon, Or. Rev. Stat. sec. 653.295(1)(e) (effective Jan. 1, 2022)
(non-compete clauses are void and unenforceable except where the
worker's annualized gross salary and commissions at the time of the
worker's termination exceed $100,533); Rhode Island, R.I. Gen Laws
sec. 28-59-3(a)(1) (effective Jan. 15, 2020) (non-compete clauses
shall not be enforceable against workers classified as nonexempt
under the FLSA); Virginia, Va. Code Ann. sec. 40.1-28.7:8(B)
(effective July 1, 2020) (no employer shall enter into, enforce, or
threaten to enforce a non-compete clause with an employee whose
average weekly earnings are less than the Commonwealth's average
weekly wage); Washington, Wash. Rev. Code Ann. sec. 49.62.020(1)(b)
and 49.62.030(1) (effective Jan. 1, 2020) (non-compete clause is
void and unenforceable unless worker's annualized earnings exceed
$100,000 for employees and $250,000 for independent contractors, to
be adjusted for inflation).
\150\ See Russell Beck, Beck Reed Riden LLP, Employee
Noncompetes: A State-by-State Survey (August 17, 2022), (hereinafter
``Beck Reed Riden Chart'').
---------------------------------------------------------------------------
States have been particularly active in restricting non-compete
clauses in recent years. Of the twelve state statutes restricting non-
compete clauses based on a worker's earnings or a similar factor
(including the DC statute), eleven were enacted in the past ten
years.\151\ States have also recently passed legislation limiting the
use of non-compete clauses for certain occupations.\152\ Other recent
state legislation has imposed additional requirements on employers that
use non-compete clauses. For example, Oregon, Maine, Massachusetts, New
Hampshire, and Washington have enacted laws requiring employers to
provide prior notice that a non-compete clause will be required as a
condition of employment.\153\ Massachusetts and Oregon have enacted
``garden leave'' provisions, which require employers to compensate
workers during the post-employment period in which the workers are
bound by the non-compete clause.\154\ Washington limited the
permissible duration of non-compete clauses to 18 months,\155\ and
Massachusetts and Oregon limited it to one year.\156\
---------------------------------------------------------------------------
\151\ See supra note 149.
\152\ See, e.g., Connecticut, Conn. Gen. Stat. Ann. sec. 20-681
(effective June 26, 2019) (home health care workers); Florida, Fla.
Stat. Ann. sec. 542.336 (effective June 25, 2019) (certain
physicians in certain counties); Hawaii, Haw. Rev. Stat. sec. 480-
4(d) (effective July 1, 2015) (technology workers); Indiana, Ind.
Code sec. 25-22.5-5.5-2 (effective July 1, 2020) (physicians); Utah,
Utah Code Ann. sec. 34-51-201 (effective May 18, 2018) (broadcasting
employees).
\153\ Oregon, Or. Rev. Stat. sec. 653.295(1)(a)(A) (effective
Jan. 1, 2008); Maine, Me. Rev. Stat. Ann. tit. 26, sec. 599-A(4)
(effective Sep. 19, 2019); Massachusetts, Mass. Gen. Laws Ann. ch.
149, sec. 24L(b)(i) (effective Jan. 14, 2021); New Hampshire, N.H.
Rev. Stat. Ann. sec. 275:70 (effective July 28, 2014); Washington,
Wash. Rev. Code Ann. sec. 49.62.020(1)(a)(i) (effective Jan. 1,
2020).
\154\ Massachusetts, Mass. Gen. Laws Ann. ch. 149, sec.
24L(b)(vii) (effective Jan. 14, 2021); Oregon, Or. Rev. Stat. sec.
653.295(7) (effective Jan. 1, 2022).
\155\ Washington, Wash. Rev. Code Ann. sec. 49.62.020(2)
(effective Jan. 1, 2020).
\156\ Massachusetts, Mass. Gen. Laws Ann. ch. 149, sec.
24L(b)(iv) (effective Jan. 14, 2021); Oregon, Or. Rev. Stat. sec.
653.295(3) (effective Jan. 1, 2022).
---------------------------------------------------------------------------
For workers not covered by these statutory restrictions, the
question of whether or under what conditions a non-compete clause may
be enforced against them depends on state common law.
In the 47 states where at least some non-compete clauses may be
enforced, courts use a reasonableness inquiry to determine whether to
enforce a non-compete clause, in addition to whatever statutory limits
they are bound to apply. While the precise language of the test differs
from state to state, states typically use a test similar to the test in
the Restatement (Second) of Contracts:
A promise to refrain from competition that imposes a restraint that
is ancillary
[[Page 3495]]
to an otherwise valid transaction or relationship is unreasonably in
restraint of trade if (a) the restraint is greater than is needed to
protect the promisee's legitimate interest, or (b) the promisee's need
is outweighed by the hardship to the promisor and the likely injury to
the public.\157\
---------------------------------------------------------------------------
\157\ Restatement (Second) of Contracts sec. 188 (1981).
---------------------------------------------------------------------------
The first basis on which a non-compete clause can be found
unreasonable is where the restraint is greater than needed to protect
the employer's legitimate interest. Nearly all states recognize the
protection of an employer's trade secrets as a legitimate
interest.\158\ Some states also recognize an interest in protecting
confidential information that is not a trade secret.\159\ Some states
also recognize an interest in protecting the employer's investment in
training, although many of these states define the interest as
protecting specialized training.\160\ A few states recognize an
interest in preventing an worker who provides ``unique'' services from
working for a competitor.\161\ Courts do not recognize protection from
ordinary competition as a legitimate business interest.\162\
---------------------------------------------------------------------------
\158\ See. e.g., Reed, Roberts Assocs. v. Strauman, 40 N.Y.2d
303, 308-09 (N.Y. 1976); see Beck Reed Riden Chart, supra note 150
(listing each state's approach).
\159\ See. e.g., Proudfoot Consulting Co. v. Gordon, 576 F.3d
1223, 1233-34 (11th Cir. 2009); see Beck Reed Riden Chart, supra
note 150 (listing each state's approach).
\160\ See, e.g., IDMWORKS LLC v. Pophaly, 192 F. Supp. 3d 1335,
1342 (S.D. Fla. 2016); see Beck Reed Riden Chart, supra note 150
(listing each state's approach).
\161\ See, e.g., Ticor Title Ins. v. Cohen, 173 F.3d 63, 70 (2d
Cir. 1999); see Beck Reed Riden Chart, supra note 150 (listing each
state's approach).
\162\ See, e.g., Valley Med. Specialists v. Farber, 982 P.2d
1277, 1281 (Ariz. 1999).
---------------------------------------------------------------------------
If the employer can demonstrate a legitimate interest, the employer
must then show the non-compete clause is tailored to that interest.
This analysis typically considers whether the non-compete clause
prohibits a greater scope of activity than necessary to protect the
employer's legitimate interests; \163\ covers a geographic area more
extensive than necessary to protect those interests; \164\ or lasts
longer than needed to protect those interests.\165\
---------------------------------------------------------------------------
\163\ See, e.g., Diversified Hum. Res. Grp., Inc. v. Levinson-
Polakoff, 752 SW2d 8, 11 (Tex. Ct. App. 1988).
\164\ See, e.g., Orkin Exterm. Co., Inc. v. Girardeau, 301 So.
2d 38, 39 (Fla. Ct. App. 1st 1974).
\165\ See, e.g., Jorgensen v. Coppedge, 181 P.3d 450, 454 (Idaho
2008).
---------------------------------------------------------------------------
The second basis under which a non-compete clause can be found
unreasonable is where the employer's need for the non-compete clause is
outweighed by the hardship to the worker and the likely injury to the
public. When assessing the ``hardship to the worker'' prong, courts
typically consider whether the non-compete clause would be unreasonable
in light of the worker's personal circumstances. For example, courts
have invalidated non-compete clauses where they would destroy a
worker's sole means of support.\166\
---------------------------------------------------------------------------
\166\ See, e.g., Chavers v. Copy Prods. Co. of Mobile, 519 So.
2d 942, 945 (Ala. 1988).
---------------------------------------------------------------------------
When assessing the ``likely injury to the public'' prong, the
factor most frequently considered by courts is whether enforcing the
non-compete clause against the worker would deprive the community of
essential goods and services.\167\ Because these cases arise in the
context of individual litigation, courts focus the ``likely injury to
the public'' inquiry on the loss of the individual worker's services
and not on the aggregate effects of non-compete clauses on competition
in the relevant market.
---------------------------------------------------------------------------
\167\ See, e.g., Dick v. Geist, 693 P.2d 1133, 1136-37 (Idaho
Ct. App. 1985).
---------------------------------------------------------------------------
State law also differs with respect to the steps courts take when
they conclude that a non-compete clause is unenforceable as drafted.
The majority of states have adopted the ``reformation'' or ``equitable
reform'' doctrine, which allows courts to revise the text of an
unenforceable non-compete clause to make it enforceable.\168\ Some
states have adopted the ``blue pencil'' doctrine, under which courts
may remove any defective provisions and may enforce the non-compete
clause if the remaining provisions constitute a valid non-compete
clause.\169\ A few states have adopted the ``red pencil'' doctrine,
under which courts declare an entire non-compete clause void if one or
more of its provisions are found to be defective.\170\
---------------------------------------------------------------------------
\168\ See, e.g., Butler v. Arrow Mirror & Glass, Inc., 51 SW3d
787, 794 (Tex. Ct. App. 2001). See also Beck Reed Riden Chart, supra
note 150 (listing each state's approach).
\169\ See, e.g., Compass Bank v. Hartley, 430 F. Supp. 2d 973,
980 (D. Ariz. 2006). See also Beck Reed Riden Chart, supra note 150
(listing each state's approach).
\170\ See, e.g., Hassler v. Circle C Res., 505 P.3d 169, 178
(Wyo. 2022). See also Beck Reed Riden Chart, supra note 150 (listing
each state's approach).
---------------------------------------------------------------------------
As noted above, the general language of the test for whether a non-
compete clause is reasonable is fairly consistent from state to state.
However, the specifics of non-compete clause law differ from state to
state. For example, states vary in how narrowly or broadly they define
legitimate interests for using a non-compete clause and the extent to
which courts are permitted to modify an unenforceable non-compete
clause to render it enforceable. As a result, among the 47 states where
non-compete clauses may be enforced, variation exists with respect to
the enforceability of non-compete clauses.\171\
---------------------------------------------------------------------------
\171\ Norman D. Bishara, Fifty Ways to Leave Your Employer:
Relative Enforcement of Non-Compete Clauses, Trends, and
Implications for Employee Mobility Policy, 13 U. Pa. J. Bus. L. 751,
778-79 (2011).
---------------------------------------------------------------------------
Because the enforceability of non-compete clauses varies from state
to state, the question of which state's law applies in a legal dispute
between an employer and a worker can determine the outcome of the case.
Non-compete clauses often contain choice-of-law provisions designating
a particular state's law for resolution of any future dispute.\172\
Some non-compete clauses include forum-selection provisions specifying
the court and location where any dispute will be heard.\173\ The
default rule under conflict-of-laws principles is that the court honors
the parties' choice of law, meaning the burden is typically on the
worker to argue that the law of a different forum should apply.\174\
---------------------------------------------------------------------------
\172\ Gillian Lester & Elizabeth Ryan, Choice of Law and
Employee Restrictive Covenants: An American Perspective, 31 Comp.
Lab. & Pol'y J. 389, 396-402 (2010).
\173\ Id. at 402-04.
\174\ Lester & Ryan, supra note 172 at 394. Cf. Cal. Lab. Code
Sec. 925(a) (stating that employers shall not require an employee
who primarily resides and works in California, as a condition of
employment, to agree to a provision that would either (1) require
the employee to adjudicate outside of California a claim arising in
California or (2) deprive the employee of the substantive protection
of California law with respect to a controversy arising in
California.
---------------------------------------------------------------------------
In addition, there is significant variation in how courts apply
choice of law rules in disputes over non-compete clauses.\175\ As a
result, it can be difficult for employers and workers to predict how
disputes over choice of law will be resolved.\176\ Additionally--aside
from the question of which state's law should apply--employers and
workers may be uncertain about whether the non-compete clause is
enforceable under the state's law. Furthermore, state non-compete law
may change; as described above in Part II.C.1, there have been many
changes in state non-compete law in recent years. The result is that
employers and workers may face considerable uncertainty as to whether
[[Page 3496]]
a particular non-compete clause may be enforced.
---------------------------------------------------------------------------
\175\ Id.
\176\ Id. at 394-95 (``The state of the law is perhaps
characterized more by inconsistency than anything else, so much so
that commentators lament the `disarray' and `mish-mash' of the law,
and criticize courts for their `post-hoc rationalizing of
intuitions' or their use of a `hodgepodge of factors, often with
insignificant explanation of how they decide what weight to give
each.''') (internal citations omitted).
---------------------------------------------------------------------------
Workers may also be subject to arbitration clauses, which require
that legal disputes with the employer--including disputes related to
non-compete clauses--be resolved through binding arbitration rather
than in court. Where such clauses are valid, the Federal Arbitration
Act requires that courts enforce them.\177\
---------------------------------------------------------------------------
\177\ See, e.g., Nitro-Lift Techs. v. Howard, 568 U.S. 17, 21-22
(2012).
---------------------------------------------------------------------------
Most state courts apply different rules to non-compete clauses when
they are entered into between the seller and buyer of a business,
compared with non-compete clauses that arise solely out of the
employment relationship.\178\ The three states in which non-compete
clauses are void in nearly all instances--California, North Dakota, and
Oklahoma--permit enforcement when non-compete clauses are entered into
between the seller and buyer of a business.\179\ In most of the other
states, non-compete clauses between the seller and buyer of a business
are either exempted from the state's non-compete clause statute,
subject to a more lenient test under the statute, or subject to more
lenient standard under the state's case law.\180\ Courts cite several
different reasons for why they accord different treatment to non-
compete clauses between the seller and buyer of a business. These
reasons include the relatively equal bargaining power of both parties
in the context of a business sale, relative to the employer-worker
context, where there is more likely to be unequal bargaining power; the
need to protect the buyer's right to the goodwill for which it has
paid; and the fact that the proceeds from the sale will ensure that the
seller of the business will not experience undue hardship.\181\
---------------------------------------------------------------------------
\178\ Based on a review of the state cases in Malsberger (2017),
supra note 62 and Fenwick & West LLC, Summary of Non-Compete
Clauses: A Global Perspective, https://assets.fenwick.com/legacy/FenwickDocuments/RS_Summary-of-Covenants.pdf.
\179\ Cal. Bus. & Prof. Code sec. 16601; N.D. Cent. Code sec. 9-
08-06; Okla. Stat. Ann. tit. 15, sec. 218.
\180\ See, e.g., Colo. Rev. Stat. Ann. sec. 8-2-113(3)(c)
(statutory exemption); Ga. Code Ann. sec. 13-8-57(d) (more lenient
statutory test); Jiffy Lube Int'l, Inc. v. Weiss Bros., Inc., 834 F.
Supp. 683, 691 (D.N.J. 1993) (more lenient standard under case law).
\181\ See, e.g., Woodward v. Cadillac Overall Supply Co., 240 NW
2d 710, 715 (Mich. 1976) (bargaining power); Bybee, 178 P.3d at 622
(Idaho 2008) (goodwill); Centorr-Vacuum Indus., Inc. v. Lavoie, 609
A.2d 1213, 1215 (N.H. 1992) (undue hardship).
---------------------------------------------------------------------------
2. Non-Compete Clauses and Antitrust Law
Non-compete clauses are ``contract[s] . . . in restraint of
trade.'' Therefore, they are subject to Section 1 of the Sherman
Act.\182\ The Commission has identified 17 cases in cases in which
private plaintiffs or the federal government have challenged a non-
compete clause between an employer and a worker under either Section 1
or an analogous provision in a state antitrust statute.\183\ (Three of
these 17 cases concerned non-compete clauses between the seller and
buyer of a business,\184\ and two of these 17 cases were brought under
state antitrust statutes.\185\)
---------------------------------------------------------------------------
\182\ See, e.g., Newburger, Loeb & Co., Inc., 563 F.2d at 1082.
\183\ U.S. v. Am. Tobacco Co., 221 U.S. 106 (1911); Alders v.
AFA Corp. of Fla., 353 F. Supp. 654 (S.D. Fla. 1973) (non-compete
clause between seller and buyer of a business); Bradford v. N.Y.
Times Co., 501 F.2d 51 (2d Cir. 1974); Golden v. Kentile Floors,
Inc., 512 F.2d 838 (5th Cir. 1975); U.S. v. Empire Gas Corp., 537
F.2d 296 (8th Cir. 1976); Newburger, Loeb & Co., Inc. v. Gross, 563
F.2d 1057 (2d Cir. 1977); Lektro-Vend Corp. v. Vendo Co., 660 F.2d
255 (7th Cir. 1981) (non-compete clause between seller and buyer of
a business); Aydin Corp. v. Loral Corp., 718 F.2d 897 (9th Cir.
1983); Consultants & Designers, Inc. v. Butler Serv. Grp., Inc., 720
F.2d 1553 (11th Cir. 1983); Caremark Homecare, Inc. v. New England
Critical Care, Inc., 700 F. Supp. 1033 (D. Minn. 1988); GTE Data
Servs., Inc. v. Elec. Data Sys. Corp., 717 F. Supp. 1487 (M.D. Fla.
1989); DeSantis v. Wackenhut Corp., 793 SW2d 670 (Tex. 1990) (state
antitrust law case); Borg-Warner Protective Servs. Corp. v.
Guardsmark, Inc., 946 F. Supp. 495 (E.D. Ky. 1996); Caudill v.
Lancaster Bingo Co., Inc., 2005 WL 2738930 (S.D. Ohio Oct. 24,
2005); Dallas South Mill, Inc. v. Kaolin Mushroom Farms, Inc., 2007
WL 9712116 (N.D. Tex. Feb. 23, 2007); Cole v. Champion Enters.,
Inc., 496 F. Supp. 2d 613 (M.D.N.C. 2007) (non-compete clause
between seller and buyer of a business) (state antitrust law case);
Signature MD, Inc. v. MDVIP, Inc., 2015 WL 3988959 (C.D. Cal. Apr.
21, 2015). There are also several opinions addressing whether non-
compete clauses between businesses violate Section 1. Courts
generally apply a less restrictive legal standard to non-compete
clauses between businesses. See, e.g., Lumber Liquidators, Inc., 415
F. Supp. 3d at 715-16.
\184\ Alders, 353 F. Supp. 654; Lektro-Vend, 660 F.2d 255; Cole,
496 F. Supp. 2d 613.
\185\ DeSantis, 793 SW2d 670; Cole, 496 F. Supp. 2d 613.
---------------------------------------------------------------------------
In two of these 17 cases, the parties challenging the non-compete
clause were successful to some degree. In the early antitrust case of
United States v. American Tobacco Co., the Supreme Court held that
several tobacco companies violated both Section 1 and Section 2 of the
Sherman Act because of the collective effect of six of the companies'
practices, one of which was the ``constantly recurring'' use of non-
compete clauses.\186\ This is the only case the Commission has
identified in which a court analyzed the collective, rather than
isolated, use of non-compete clauses.
---------------------------------------------------------------------------
\186\ Am. Tobacco Co., 221 U.S. at 181-83. Section 2 of the
Sherman Act, 15 U.S.C. 2, prohibits monopolization or attempted
monopolization.
---------------------------------------------------------------------------
More recently, a federal district court denied a motion to dismiss
a plaintiff's claim that a non-compete clause between a concierge
medicine firm and physicians violated Section 1. The court held that
while the reasonableness of the non-compete clause ultimately would be
a factual determination, the plaintiff stated a valid claim under
Section 1 where it alleged the firm ``includes post-contract non-
compete clauses with an unreasonably large liquidated damage provision
in its employment contracts,'' in addition to other practices.\187\
---------------------------------------------------------------------------
\187\ Signature MD, Inc., 2015 WL 3988959 at *7.
---------------------------------------------------------------------------
In the other 15 Sherman Act cases, the challenge to the individual
non-compete clause was unsuccessful. These claims failed for three main
reasons. First, in several of these cases, the parties challenging the
non-compete clause argued solely that the non-compete clause they were
challenging should be per se unlawful under Section 1. Courts rejected
these arguments, reasoning that non-compete clauses may serve
legitimate business interests in some instances \188\ and that courts
have had insufficient experience with non-compete clauses to warrant a
per se categorization under Section 1.\189\
---------------------------------------------------------------------------
\188\ See, e.g., Lektro-Vend, 660 F.2d at 265.
\189\ See, e.g., Aydin, 718 F.2d at 900.
---------------------------------------------------------------------------
The second main reason these challenges have been unsuccessful is
that, in the vast majority of these 15 cases, the party challenging the
non-compete clause did not allege the non-compete clause adversely
affected competition, which is an essential element of a Section 1
claim in rule of reason cases.\190\ In only one case did the plaintiff
appear to allege facts related to anticompetitive effect beyond the
effect on the person bound by the non-compete clause. In that case, the
court dismissed the plaintiff's claim because the plaintiff did not
sufficiently allege ``the amount of competition foreclosed by
defendant.'' \191\
---------------------------------------------------------------------------
\190\ See, e.g., Ohio v. Am. Express Co., -- U.S.--, 138 S. Ct.
2274, 2284 (2018).
\191\ GTE Data Servs., 717 F. Supp. at 1492.
---------------------------------------------------------------------------
Third, courts have also rejected challenges to non-compete clauses
based on reasoning that a corporation is not capable of conspiring with
its employees as a matter of law.\192\
---------------------------------------------------------------------------
\192\ See, e.g., Borg-Warner, 946 F. Supp. 499; Dallas South
Mill, 2007 WL 9712116 at *3.
---------------------------------------------------------------------------
Plaintiffs have also challenged non-compete clauses between
employers and workers under Section 2 of the Sherman Act, which
prohibits monopolization or attempted monopolization.\193\ The
Commission is not aware of a case in which a Section 2 claim relating
to an
[[Page 3497]]
employer's use of a non-compete clause has been successful.
---------------------------------------------------------------------------
\193\ 15 U.S.C. 2. See, e.g., BRFHH Shreveport, LLC. v. Willis
Knighton Med. Ctr., 176 F. Supp. 3d 606, 616-26 (W.D. La. 2016).
---------------------------------------------------------------------------
3. Federal and State Enforcement Activity Related to Non-Compete
Clauses
In recent years, state attorneys general in Illinois, New York, and
Washington have sued companies for unlawfully using non-compete
clauses. As of January 2020, state attorneys general have publicly
announced settlements with seven companies regarding the use of non-
compete clauses.\194\ In February 2022, the Antitrust Division filed a
statement of interest in a state non-compete clause case brought by
private plaintiffs.\195\
---------------------------------------------------------------------------
\194\ See Public Comments of 19 State Attorneys General in
Response to the Federal Trade Commission's January 9, 2020 Workshop
on Non-Compete Clauses in the Workplace at 6 n.23 (listing the
settlements).
\195\ Statement of Interest of the United States, Beck v.
Pickert Med. Grp., No. CV21-02092 (Nev. Dist. Ct. Feb. 25, 2022).
---------------------------------------------------------------------------
The Antitrust Division and the Commission have also taken steps in
recent years to address other types of contractual provisions that
restrict competition in labor markets. The Antitrust Division has
brought civil enforcement actions under Section 1 against several
technology companies for entering into no-poach agreements with
competitors. These enforcement actions ended with consent judgments
against the companies.\196\ In addition, the Antitrust Division has
brought criminal charges for wage-fixing and no-poach agreements
against companies and individuals.\197\ The Commission too has brought
civil enforcement actions against companies related to competition for
employment, which ended in consent judgments against the
companies.\198\ In addition, the attorney general of the State of
Washington has entered into settlement agreements with over 200
companies in which the companies have agreed to stop using no-poach
clauses.\199\
---------------------------------------------------------------------------
\196\ See Antitrust Guidance for Human Resource Professionals,
supra note 37 at 3-4 (citing cases).
\197\ U.S. v. Neeraj Jindal and John Rodgers, No. 4:20-cr-358-
ALM-KPJ (E.D. Tex. Dec. 9, 2020); U.S. v. Surgical Care Affiliates,
LLC and SCAI Holdings, LLC, No. 3:21-cr-011-L (N.D. Tex. Jan. 5,
2021); U.S. v. Ryan Hee and VDA OC, LLC, formerly ADVANTAGE ON CALL,
LLC, No. 2:21-cr-00098-RFB-BNW (D. Nev. Mar. 26, 2021); U.S. v.
DaVita, Inc. and Kent Thiry, No. 21-cr-00229-RBJ (D. Colo. Nov. 3,
2021); U.S. v. Patel, et al., 3:21-cr-220-VHB-RAR (D. Conn. Dec. 15,
2021); U.S. v. Manahe, et al., 2:22-cr-00013-JAW (D. Me. Jan. 27,
2022). The defendants in the Jindal case were found not guilty of
the wage-fixing charge, and the defendants in the DaVita cases were
found not guilty of all charges. Jindal, Jury Verdict (E.D. Tex.
Apr. 14, 2022); DaVita, Verdict (D. Colo. Apr. 15, 2022). However,
both courts found that the conduct alleged in the indictment
properly fell within the confines of the per se rule. Jindal,
Memorandum Opinion and Order, 2021 WL 5578687 (E.D. Tex. Nov. 29,
2021) at *4-*8; DaVita, Order Denying Defendants' Motion to Dismiss,
2022 WL 266759 (D. Colo. Jan. 28, 2022) at *4-*8. The court in
Manahe likewise recently denied a motion to dismiss, holding the
indictment charged a recognized form of per se illegal conduct. 2022
WL 3161781, at **7, 9 (D. Me. Aug. 8, 2022).
\198\ See Antitrust Guidance for Human Resource Professionals,
supra note 37 at 4 (citing cases).
\199\ Office of the Att'y Gen. of the State of Wash., Press
Release, AG Report: Ferguson's Initiative Ends No-Poach Practices
Nationally at 237 Corporate Franchise Chains (June 16, 2020).
---------------------------------------------------------------------------
The Commission seeks comment on all aspects of its description, in
this Part II.C, of the law currently governing non-compete clauses. The
Commission specifically seeks comment on the extent to which employers
use choice-of-law provisions to evade the laws of states where non-
compete clauses are relatively less enforceable. The Commission also
seeks comment on the extent to which a uniform federal standard for
non-compete clauses would promote certainty for employers and workers.
D. The Commission's Work on Non-Compete Clauses
This rulemaking represents the culmination of several years of
activity by the Commission related to non-compete clauses and their
effects on competition. This activity has included extensive public
outreach and fact-gathering related to non-compete clauses, other
restrictive employment covenants that may harm competition, and
competition in labor markets generally. The Commission has also
analyzed non-compete clauses in connection with its enforcement,
research, and merger review work.
The Commission first began focusing on non-compete clauses in the
mid-2010s, as a growing body of empirical research raised concerns
about the anticompetitive effects of non-compete clauses. In 2018 and
2019, the Commission held several ``Hearings on Competition and
Consumer Protection in the 21st Century.'' \200\ The Commission invited
public comment on a wide range of topics, including ``the use of non-
competition agreements and the conditions under which their use may be
inconsistent with the antitrust laws.'' \201\ Participants addressed
non-compete clauses at two of the hearings.\202\
---------------------------------------------------------------------------
\200\ Fed. Trade Comm'n, Hearings on Competition and Consumer
Protection in the 21st Century, https://www.ftc.gov/enforcement-policy/hearings-competition-consumer-protection.
\201\ Fed. Trade Comm'n, Notice, Hearings on Competition and
Consumer Protection in the 21st Century, 83 FR 38307, 38309 (Aug. 6,
2018).
\202\ Fed. Trade Comm'n, Transcript, Competition and Consumer
Protection in the 21st Century (Oct. 16, 2018), https://www.ftc.gov/system/files/documents/public_events/1413712/ftc_hearings_session_3_transcript_day_2_10-16-18_1.pdf; Fed. Trade
Comm'n, Transcript, Competition and Consumer Protection in the 21st
Century (June 12, 2019), https://www.ftc.gov/system/files/documents/public_events/1519667/ftc_hearings_session_14_transcript_6-12-19_0.pdf.
---------------------------------------------------------------------------
Also in 2019, the Open Markets Institute, 19 labor and public
interest organizations, and 46 individual advocates and scholars
petitioned the Commission to initiate a rulemaking to prohibit non-
compete clauses.\203\
---------------------------------------------------------------------------
\203\ Open Markets Inst. et al., Petition for Rulemaking to
Prohibit Worker Non-Compete Clauses (March 20, 2019).
---------------------------------------------------------------------------
As evidence mounted regarding the anticompetitive effects of non-
compete clauses, the Commission's focus on this issue increased. On
January 9, 2020, the Commission held a public workshop on non-compete
clauses. At the workshop, speakers and panelists addressed topics
including statutory and judicial treatment of non-compete clauses; the
Commission's authority to address non-compete clauses; the economic
literature regarding the effects of non-compete clauses; and whether
the Commission should initiate a rulemaking on non-compete
clauses.\204\ In connection with the workshop, the Commission sought
public comment on a wide range of topics related to a potential
rulemaking on non-compete clauses. The Commission received 328 comments
addressing these topics from researchers, advocates for workers,
employers, trade associations, attorneys, members of Congress, state
and local officials, unions, other organizations, and individual
members of the public.\205\
---------------------------------------------------------------------------
\204\ Fed. Trade Comm'n, Non-Competes in the Workplace:
Examining Antitrust and Consumer Protection Issues, https://www.ftc.gov/news-events/events/2020/01/non-compete clauses-
workplace-examining-antitrust-consumer-protection-issues.
\205\ Fed. Trade Comm'n, Docket FTC-2019-0093, Workshop on Non-
Compete Clauses Used in Employment Contracts, https://www.regulations.gov/document/FTC-2019-0093-0001/comment.
---------------------------------------------------------------------------
In addition, on August 5, 2021, the Commission issued a
solicitation for public comment on contract terms that may harm
competition, including ``non-compete clauses that prevent workers from
seeking employment with other firms.'' The Commission received 280
comments on this solicitation from a wide range of stakeholders.\206\
On December 6-7, 2021, the Commission and the Antitrust Division held a
workshop entitled ``Making Competition Work: Promoting Competition in
Labor Markets.'' The Commission sought
[[Page 3498]]
comment from the public in connection with this event and received 27
comments.\207\
---------------------------------------------------------------------------
\206\ Fed. Trade Comm'n, Solicitation for Public Comments on
Contract Terms that May Harm Competition (Aug 5, 2021), https://www.regulations.gov/document/FTC-2021-0036-0022.
\207\ Fed. Trade Comm'n, Docket FTC-2021-0057, Making
Competition Work: Promoting Competition in Labor Markets, https://www.regulations.gov/docket/FTC-2021-0057/comments.
---------------------------------------------------------------------------
As it has developed this proposed rule, the Commission has closely
considered the views expressed at these forums and the public comments
it has received through these engagement efforts. The comments have
informed the Commission's understanding of the evidence regarding the
effects of non-compete clauses; the law currently governing non-compete
clauses; and the options for how the Commission may seek to restrict
the unfair use of non-compete clauses through rulemaking, among other
topics.
The Commission has also focused on non-compete clauses in
connection with its enforcement, merger review, and research work. With
respect to enforcement, in 2021, the Commission initiated
investigations into the use of non-compete clauses by manufacturers of
glass containers used for food and beverage packaging. On December 28,
2022, the Commission accepted, subject to final approval, consent
agreements with two manufacturers in the industry.\208\ The glass
container industry is highly concentrated and is characterized by
substantial barriers to entry and expansion. Among these barriers, it
is difficult to identify and employ personnel with skills and
experience in glass container manufacturing.\209\
---------------------------------------------------------------------------
\208\ Fed. Trade Comm'n, Decision and Order, In re O-I Glass,
Inc. et al, Matter No. 211 0182 (December 28, 2022); Fed. Trade
Comm'n, Decision and Order, In re Ardaugh Group S.A. et al, Matter
No. 211 0182 (December 28, 2022).
\209\ Fed. Trade Comm'n, Analysis of Agreements Containing
Consent Order to Aid Public Comment, In re O-I Glass Inc. et al., In
re Ardaugh Group S.A. et al, Matter No. 211 0182 (December 28, 2022)
at 2.
---------------------------------------------------------------------------
The complaints allege the manufacturers required employees across a
variety of positions--including employees who work with the glass
plants' furnaces and forming equipment and in other glass production,
engineering, and quality assurance roles--to enter into non-compete
clauses. The complaints allege this conduct has a tendency or
likelihood to impede rivals' access to the restricted employees' labor,
to limit workers' mobility, and thus to harm workers, consumers,
competition, and the competitive process. As such, the complaints
allege each company has engaged in an unfair method of competition in
violation of Section 5 of the FTC Act.\210\ The proposed consent orders
would prohibit each manufacturer from ``entering or attempting to
enter, maintaining or attempting to maintain, or enforcing or
attempting to enforce a Non-Compete Restriction with an Employee, or
communicating to an Employee or a prospective or current employer of
that Employee that the Employee is subject to a Non-Compete
Restriction.'' \211\
---------------------------------------------------------------------------
\210\ Id. at 1-2.
\211\ Id. at 7.
---------------------------------------------------------------------------
In 2021, the Commission also initiated investigations into the use
of non-compete clauses in the security guard services industry. On
December 28, 2022, the Commission accepted, subject to final approval,
a consent agreement with Prudential Security, Inc., Prudential Command
Inc., and the firms' co-owners (collectively ``Prudential
Respondents''). Prudential Security, Inc. and Prudential Command Inc.
provided security guard services to clients in several states.
The Commission's complaint alleges the Prudential Respondents' use
of non-compete clauses is an unfair method of competition under Section
5 because it is restrictive, coercive, and exploitative and negatively
affects competitive conditions.\212\ The complaint further alleges the
Prudential Respondents' imposition of non-compete clauses took
advantage of the unequal bargaining power between Prudential
Respondents and their employees, particularly low-wage security guard
employees, and thus reduced workers' job mobility, limited competition
for workers' services, and ultimately deprived workers of higher wages
and more favorable working conditions.\213\ Under the terms of the
proposed order, Prudential Respondents--including any companies the co-
owners may control in the future--must cease and desist from entering,
maintaining, enforcing, or attempting to enforce any non-compete
clause.\214\
---------------------------------------------------------------------------
\212\ Fed. Trade Comm'n, Analysis of Agreement Containing
Consent Order to Aid Public Comment, In re Prudential Sec., Inc. et
al., Matter No. 211 0026 at 1, 5-7 (December 28, 2022).
\213\ Id. at 1.
\214\ Id.
---------------------------------------------------------------------------
These consent orders have been placed on the public record for 30
days in order to receive comments from interested persons. After 30
days, the Commission will again review the consent agreements and the
comments received and will decide whether it should make the proposed
orders final or take other appropriate action.\215\
---------------------------------------------------------------------------
\215\ Id. at 1-2; Glass Container Analysis to Aid Public
Comment, supra note 209 at 1.
---------------------------------------------------------------------------
In addition, as part of a 2020 settlement with the Commission,
three national rent-to-own companies agreed to refrain from enforcing
non-compete clauses that were entered into in connection with
reciprocal purchase agreements.\216\
---------------------------------------------------------------------------
\216\ Fed. Trade Comm'n, Press Release, Rent-to-Own Operators
Settle Charges that They Restrained Competition through Reciprocal
Purchase Agreements (Feb. 21, 2020), https://www.ftc.gov/news-events/news/press-releases/2020/02/rent-own-operators-settle-charges-they-restrained-competition-through-reciprocal-purchase-agreements.
---------------------------------------------------------------------------
With respect to merger review, on August 11, 2015, the Commission
approved a final order settling charges that Zimmer Holdings, Inc.'s
acquisition of Biomet, Inc. would have eliminated competition between
the companies in the markets for certain orthopedic medical products.
Among other things, the order requires Zimmer to ``remove any
impediments or incentives'' that may deter workers from accepting
employment with the divested businesses, including non-compete
clauses.\217\
---------------------------------------------------------------------------
\217\ Fed. Trade Comm'n, In the Matter of Zimmer Holdings, Inc.
et al., No. C-4534, Decision and Order (Aug. 11, 2015), https://www.ftc.gov/system/files/documents/cases/150820zimmerdo.pdf.
---------------------------------------------------------------------------
On November 10, 2021, the Commission approved a final order
settling charges that 7-Eleven's acquisition of Marathon Petroleum
Corporation's Speedway subsidiary violated federal antitrust laws.
Among other things, the order prohibits 7-Eleven from enforcing any
non-compete clauses against any franchisees or employees working at or
doing business with the divested assets.\218\
---------------------------------------------------------------------------
\218\ Fed. Trade Comm'n, Press Release, FTC Approves Final Order
Requiring Divestitures of Hundreds of Retail Gas and Diesel Fuel
Stations Owned by 7-Eleven, Inc. (Nov. 10, 2021), https://www.ftc.gov/news-events/news/press-releases/2021/11/ftc-approves-final-order-requiring-divestitures-hundreds-retail-gas-diesel-fuel-stations-owned-7.
---------------------------------------------------------------------------
On January 10, 2022, the Commission approved a final order settling
charges that dialysis service provider DaVita, Inc.'s acquisition of
University of Utah Health's dialysis clinics would reduce competition
in vital outpatient dialysis services in the Provo, Utah market. As
part of the order, DaVita was required to remove certain non-compete
clauses and prohibited from enforcing or entering into non-compete
clauses with certain parties.\219\ And on August 9, 2022, the
Commission issued a final consent order in which ARKO Corp. and its
subsidiary GPM agreed to roll back a sweeping non-compete clause they
[[Page 3499]]
imposed on a company to which they sold 60 gas stations.\220\
---------------------------------------------------------------------------
\219\ Fed. Trade Comm'n, In the Matter of Davita Inc. and Total
Renal Care, Inc., No. C-4752, Decision and Order (Jan. 10, 2022) at
12-14, https://www.ftc.gov/system/files/documents/cases/211_0056_c4752_davita_utah_health_order.pdf.
\220\ Fed. Trade Comm'n, Press Release, FTC Approves Final Order
Restoring Competitive Markets for Gasoline and Diesel in Michigan
and Ohio (Aug. 9, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/08/ftc-approves-final-order-restoring-competitive-markets-gasoline-diesel-michigan-ohio.
---------------------------------------------------------------------------
With respect to research, in September 2021, the Commission issued
a study analyzing acquisitions by five large technology companies that
were not reported to the Commission and the U.S. Department of Justice
under the Hart-Scott-Rodino Act.\221\ The study found 76.7% of
transactions included non-compete clauses for founders and key
employees of the acquired entities. The study also found that higher-
value transactions were more likely to use non-compete clauses.\222\
The study does not explain why the companies used non-compete clauses
or analyze the effects of these particular non-compete clauses on
competition.
---------------------------------------------------------------------------
\221\ Fed. Trade Comm'n, Non-HSR Reported Acquisitions by Select
Technology Platforms, 2010-2019: An FTC Study (September 2021) at 1.
\222\ Id. at 21-22. The table states that the figure is 77.3%.
The reason for this discrepancy is not clear.
---------------------------------------------------------------------------
The Commission seeks comment on its description, in this Part II.D,
of the Commission's work on non-compete clauses prior to this NPRM.
III. Legal Authority
Section 5 of the FTC Act declares ``unfair methods of competition''
to be unlawful.\223\ Section 5 further directs the Commission ``to
prevent persons, partnerships, or corporations . . . from using unfair
methods of competition in or affecting commerce.'' \224\ Section 6(g)
of the FTC Act authorizes the Commission to ``make rules and
regulations for the purpose of carrying out the provisions of'' the FTC
Act, including the Act's prohibition of unfair methods of
competition.\225\ Taken together, Sections 5 and 6(g) provide the
Commission with the authority to issue regulations declaring practices
to be unfair methods of competition.\226\
---------------------------------------------------------------------------
\223\ 15 U.S.C. 45(a)(1).
\224\ 15 U.S.C. 45(a)(2).
\225\ 15 U.S.C. 46(g).
\226\ Nat'l Petroleum Refiners Ass'n v. Fed. Trade Comm'n, 482
F.2d 672, 697-98 (D.C. Cir. 1973).
---------------------------------------------------------------------------
Courts have made clear Section 5's prohibition of unfair methods of
competition encompasses all practices that violate either the Sherman
or Clayton Acts.\227\ However, courts have long held the scope of
Section 5 is not confined to the conduct that is prohibited under the
Sherman Act, Clayton Act, or common law.\228\ Section 5 reaches
incipient violations of the antitrust laws--conduct that, if left
unrestrained, would grow into an antitrust violation in the foreseeable
future.\229\ Additionally, Section 5 reaches conduct that, while not
prohibited by the Sherman or Clayton Acts, violates the spirit or
policies underlying those statutes.\230\
---------------------------------------------------------------------------
\227\ See, e.g., Fed. Trade Comm'n v. Cement Inst., 333 U.S.
683, 693 (1948) (holding practices that violate the Sherman Act are
unfair methods of competition); Fashion Originators' Guild of Am. v.
Fed. Trade Comm'n, 312 U.S. 457, 464 (1941) (holding practices that
violate the Clayton Act are unfair methods of competition).
\228\ See, e.g., Fed. Trade Comm'n v. Motion Picture Advert.
Serv. Co., 344 U.S. 392, 394-95 (1953) (``The `Unfair methods of
competition', which are condemned by [Section] 5(a) of the [FTC]
Act, are not confined to those that were illegal at common law or
that were condemned by the Sherman Act. Congress advisedly left the
concept flexible to be defined with particularity by the myriad of
cases from the field of business.'') (internal citations omitted).
\229\ See, e.g., Cement Inst., 333 U.S. at 708 (``A major
purpose of [the FTC] Act was to enable the Commission to restrain
practices as `unfair' which, although not yet having grown into
Sherman Act dimensions would most likely do so if left
unrestrained.''); Fashion Originators' Guild, 312 U.S. at 466;
Triangle Conduit & Cable Co. v. Fed. Trade Comm'n, 168 F.2d 175, 176
(7th Cir. 1948).
\230\ See, e.g., Fashion Originators' Guild, 312 U.S. at 463
(stating that ``[i]f the purpose and practice of the combination of
garment manufacturers and their affiliates runs counter to the
public policy declared in the Sherman and Clayton Acts, the Federal
Trade Commission has the power to suppress it as an unfair method of
competition''); E.I. du Pont de Nemours & Co. v. Fed. Trade Comm'n
(Ethyl), 729 F.2d 128, 136-37 (2d Cir. 1984) (finding that the
Commission may bar ``conduct which, although not a violation of the
letter of the antitrust laws, is close to a violation or is contrary
to their spirit''). On November 10, 2022, the Commission issued a
policy statement describing the key principles of general
applicability concerning whether conduct is an unfair method of
competition under Section 5. Fed. Trade Comm'n, Policy Statement
Regarding the Scope of Unfair Methods of Competition Under Section 5
of the Federal Trade Commission Act (Nov. 10, 2022).
---------------------------------------------------------------------------
IV. The Commission's Preliminary Determination That Non-Compete Clauses
Are an Unfair Method of Competition
The Commission preliminarily determines it is an unfair method of
competition for an employer to enter into or attempt to enter into a
non-compete clause with a worker; maintain with a worker a non-compete
clause; or represent to a worker that the worker is subject to a non-
compete clause where the employer has no good faith basis to believe
the worker is subject to an enforceable non-compete clause.\231\ This
preliminary determination is the basis for this proposed rule, which
would provide that each of these practices is an unfair method of
competition under Section 5.\232\ This Part IV sets forth a series of
preliminary findings that provide the basis for this preliminary
determination. The Commission's preliminary determination and each of
these preliminary findings are subject to further consideration in
light of the comments received and the Commission's additional
analysis. The Commission seeks comment on all aspects of this Part
IV.\233\
---------------------------------------------------------------------------
\231\ For ease of reference, this Part IV employs the term ``use
of non-compete clauses'' as a shorthand to refer to this conduct.
\232\ See proposed Sec. 910.2(a).
\233\ The Commission intends for this Part IV to satisfy the
requirements in Section 22 of the FTC Act that, in an NPRM, the
Commission issue a preliminary regulatory analysis that contains ``a
concise statement of the need for, and the objectives of, the
proposed rule.'' 15 U.S.C. 57b-3.
---------------------------------------------------------------------------
A. Non-Compete Clauses Are an Unfair Method of Competition Under
Section 5
1. Non-Compete Clauses Are Unfair
Courts have held conduct is an ``unfair method of competition''
under Section 5 where the conduct is facially unfair. In Atlantic
Refining Co. v. FTC and FTC v. Texaco, Inc., the Court held the
Commission established an unfair method of competition where an oil
company used its economic power over its gas stations to coerce them
into buying certain tires, batteries, or accessories only from firms
that paid the oil company a commission.\234\ In Texaco, the Court held
the conduct was an unfair method of competition even though Texaco's
conduct was not overtly coercive, reasoning that Texaco's conduct was
``inherently coercive'' because its ``dominant economic power was used
in a manner which tended to foreclose competition.'' \235\ In FTC v.
R.F. Keppel & Bro., the Court held the Commission established an unfair
method of competition where a manufacturer exploited the inability of
children to protect themselves in the marketplace by marketing inferior
goods to them through use of a gambling scheme.\236\ In E.I. du Pont de
Nemours & Co. v. FTC (Ethyl), the U.S. Court of Appeals for the Second
Circuit reaffirmed that coercive conduct is quintessentially covered by
Section 5's prohibition of unfair methods of competition.\237\
---------------------------------------------------------------------------
\234\ Atl. Refin. Co., 381 U.S. at 369-70; Texaco, Inc., 393
U.S. at 228-29.
\235\ 393 U.S. 223 at 228-29 (1968). See also Shell Oil Co. v.
Fed. Trade Comm'n, 360 F.2d 470, 487 (5th Cir. 1966) (``A man
operating a gas station is bound to be overawed by the great
corporation that is his supplier, his banker, and his landlord.'').
\236\ 291 U.S. 304, 313 (1934).
\237\ 729 F.2d 128, 140 (2d Cir. 1984) (``In short, in the
absence of proof of a violation of the antitrust laws or evidence of
collusive, coercive, predatory, or exclusionary conduct, business
practices are not ``unfair'' in violation of Sec. 5 unless those
practices either have an anticompetitive purpose or cannot be
supported by an independent legitimate reason.'').
---------------------------------------------------------------------------
The Court has also held that, for coercive conduct to constitute
unfair
[[Page 3500]]
method of competition, it must burden commerce. In Atlantic Refining,
the Court determined ``a full-scale economic analysis of competitive
effect'' was not required; due to the nature of the conduct at issue,
the Commission merely needed to show the conduct burdened ``a not
insubstantial portion of commerce.'' \238\
---------------------------------------------------------------------------
\238\ 381 U.S. at 370-71. See also Texaco, Inc., 393 U.S. at 230
(finding that the practice unfairly burdened competition for a not
insignificant volume of commerce); R.F. Keppel & Bro., 291 U.S. at
309 (``A practice so widespread and so far reaching in its
consequences is of public concern if in other respects within the
purview of the statute.'').
---------------------------------------------------------------------------
In the cases described above, courts condemned conduct under
Section 5 based on the facial unfairness of the conduct. In other
cases, however, courts have condemned restrictive or exclusionary
conduct under Section 5 based not on the facial unfairness of the
conduct, but on the impact of the conduct on competition. For example,
in FTC v. Motion Picture Advertising Service Co., the Court held an
exclusive dealing arrangement violated Section 5 where there was
``substantial evidence'' the contracts ``unreasonably restrain
competition.'' \239\ Similarly, in L.G. Balfour Co. v. FTC, the U.S.
Court of Appeals for the Seventh Circuit held a firm's exclusive
dealing contracts violated Section 5 where such contracts were ``anti-
competitive.'' \240\ As the U.S. Court of Appeals for the Sixth Circuit
stated in Hastings Manufacturing Co. v. FTC, the Section 5
jurisprudence has established that ``acts [that are] not in themselves
illegal or criminal, or even immoral, may, when repeated and continued
and their impact upon commerce is fully revealed, constitute an unfair
method of competition within the scope of the Commission's authority to
regulate and forbid.'' \241\
---------------------------------------------------------------------------
\239\ 344 U.S. 392, 395-96 (1953).
\240\ 442 F.2d 1, 14 (7th Cir. 1971).
\241\ 153 F.2d 253, 257 (6th Cir. 1946).
---------------------------------------------------------------------------
For the reasons described below, the Commission preliminarily finds
the use by employers of non-compete clauses is an ``unfair'' method of
competition under Section 5. The Commission's preliminary findings
differ based on whether the worker is a senior executive. For workers
who are not senior executives, the Commission preliminarily finds the
use by employers of non-compete clauses is ``unfair'' under Section 5
in three independent ways. First, non-compete clauses are restrictive
conduct that negatively affects competitive conditions. Second, non-
compete clauses are exploitative and coercive at the time of
contracting while burdening a not insignificant volume of commerce.
Third, non-compete clauses are exploitative and coercive at the time of
the worker's potential departure from the employer while burdening a
not insignificant volume of commerce.
For workers who are senior executives, the Commission preliminarily
finds the use by employers of non-compete clauses is ``unfair'' under
Section 5 because such non-compete clauses are restrictive conduct that
negatively affects competitive conditions. As described below in Part
IV.A.1.a.ii, the Commission preliminarily concludes non-compete clauses
for senior executives may harm competition in product markets in unique
ways. The second and third preliminary findings described above--that
non-compete clauses are exploitative and coercive at the time of
contracting and at the time of a worker's potential departure--do not
apply to workers who are senior executives.\242\
---------------------------------------------------------------------------
\242\ As described below in Part VII.B.1.a.iv, the Commission
estimates that, when non-compete clauses are more enforceable, CEO
earnings are reduced. This may result from the negative effects on
competitive conditions that non-compete clauses have on labor
markets (discussed in greater detail below in Part IV.A.1.a.i)
rather than from exploitation or coercion.
---------------------------------------------------------------------------
The Commission seeks comment on whether this different unfairness
analysis should apply to other highly paid or highly skilled workers
who are not senior executives. Furthermore, in Part VI.C below, the
Commission seeks comment on how this category of workers--whether
``senior executives'' or a broader category of highly paid or highly
skilled workers--should be defined, and whether different regulatory
standards should apply to this category of workers.
The Commission seeks comment on its preliminary finding that non-
compete clauses are an ``unfair'' method of competition under Section
5.
a. Non-Compete Clauses Are Restrictive Conduct That Negatively Affects
Competitive Conditions
First, the Commission preliminarily finds non-compete clauses are
an ``unfair'' method of competition under Section 5 because they are
restrictive conduct that negatively affects competitive conditions.
As noted above, courts have condemned restrictive or exclusionary
conduct under Section 5 based not on the facial unfairness of the
conduct, but on the impact of the conduct on competition.\243\ Non-
compete clauses are restrictive conduct. By their express terms, non-
compete clauses restrict a worker's ability to work for a competitor of
the employer--for example, by accepting a job with a competitor or
starting a business that would compete against the employer. Non-
compete clauses also restrict rivals from competing against the
employer to attract their workers. Because non-compete clauses facially
restrain competition in the labor market, courts have long held they
are restraints of trade and proper subjects for scrutiny under the
antitrust laws.\244\ Furthermore, as described in detail in this NPRM,
there is considerable empirical evidence showing non-compete clauses
negatively affect competition in labor markets and product and service
markets.\245\ This evidence is summarized below.
---------------------------------------------------------------------------
\243\ See supra Part IV.A.1.
\244\ See, e.g., Am. Tobacco Co., 221 U.S. at 181-83 (holding
several tobacco companies violated Sections 1 and 2 of the Sherman
Act due to the collective effect of six of the companies' practices,
one of which was the ``constantly recurring'' use of non-compete
clauses); Newburger, Loeb & Co., Inc., 563 F.2d at 1082 (``Although
such issues have not often been raised in the federal courts,
employee agreements not to compete are proper subjects for scrutiny
under section 1 of the Sherman Act. When a company interferes with
free competition for one of its former employee's services, the
market's ability to achieve the most economically efficient
allocation of labor is impaired. Moreover, employee-noncompetition
clauses can tie up industry expertise and experience and thereby
forestall new entry.'')
\245\ See supra Part II.B.
---------------------------------------------------------------------------
i. Non-Compete Clauses Negatively Affect Competitive Conditions in
Labor Markets
As described in greater detail above in Part II.B.1, non-compete
clauses negatively affect competitive conditions in labor markets by
obstructing the sorting of workers and employers into the strongest
possible matches. Labor markets function by matching workers and
employers. In a well-functioning labor market, a worker who is seeking
a better job--more pay, better working conditions, more enjoyable work,
or whatever the worker may be seeking--can enter the labor market by
looking for work. Employers who have positions available compete for
the worker's services. The worker's current employer may also compete
with these prospective employers by seeking to retain the worker--for
example, by offering to raise the worker's pay or promote the worker.
Ultimately, the worker chooses the job that best meets their
objectives. In general, the more jobs available--i.e., the more options
the worker has--the greater the possibility the worker will find a
strong match.
Just as employers compete for workers in a well-functioning labor
market,
[[Page 3501]]
workers compete for jobs. In general, the more workers who are
available--i.e., the more options the employer has--the stronger the
match the employer will find. Through these processes--employers
competing for workers, workers competing for jobs, and employers and
workers matching with one another--competition in the labor market
leads to higher earnings for workers, greater productivity for
employers, and better economic conditions.
In a perfectly competitive labor market, if a job that a worker
would prefer more--for example, because it has higher pay or is in a
better location--were to become available, the worker could switch to
it quickly and easily. However, this perfectly competitive labor market
exists only in theory. In practice, labor markets substantially deviate
from perfect competition. Non-compete clauses, in particular, impair
competition in labor markets by restricting a worker's ability to
change jobs. If a worker is bound by a non-compete clause, and the
worker wants a better job, the non-compete clause will prevent the
worker from accepting a new job within the scope of the non-compete
clause. These will often be the most natural alternative employment
options for a worker: jobs in the same geographic area and in the
worker's field of expertise. The result is less competition among
employers for the worker's services. Since the worker is prevented from
taking these jobs, the worker may decide not to enter the labor market
at all, or the worker may enter the labor market but take a job outside
of their field of expertise in which they are less productive.
Non-compete clauses affect competition in labor markets through
their use in the aggregate. The effect of an individual worker's non-
compete clause on competition in a particular labor market may be
marginal or may be impossible to discern statistically. However, the
use of a large number of non-compete clauses across a labor market
demonstrably affects the opportunities of all workers in that market.
By making it more difficult for many workers in a labor market to
switch to new jobs, non-compete clauses inhibit optimal matches from
being made between employers and workers across the labor force. As a
result, where non-compete clauses are prevalent in a market, workers
are more likely to remain in jobs that are less optimal with respect to
the worker's ability to maximize their productive capacity. This
materially reduces wages for workers--not only for workers who are
subject to non-compete clauses, but other workers in a labor market as
well, since jobs that would otherwise be better matches for an
unconstrained worker are filled by workers subject to non-compete
clauses.
The Section 5 analysis as to whether conduct negatively affects
competitive conditions does not require a showing that the conduct
caused actual harm.\246\ However, whether conduct causes actual harm
can be relevant to whether it is an unfair method of competition.\247\
There is significant empirical evidence that non-compete clauses cause
actual harm to competition in labor markets, and that these harms are
substantial.
---------------------------------------------------------------------------
\246\ See Fed. Trade Comm'n v. Sperry & Hutchinson Co., 405 U.S.
233, 244 (1972) (explaining that ``unfair competitive practices
[are] not limited to those likely to have anticompetitive
consequences after the manner of the antitrust laws''); In re Coca-
Cola Co., 117 F.T.C. 795, 915 (FTC 1994) (rejecting argument that
Section 5 violation requires showing ``anticompetitive effects'').
\247\ See Ethyl, 729 F.2d at 138 (evidence of actual harm can be
``a relevant factor in determining whether the challenged conduct is
unfair'').
---------------------------------------------------------------------------
As described above in Part II.B.1.a, the Commission estimates at
least one in five American workers--or approximately 30 million
workers--is bound by a non-compete clause. The proliferation of non-
compete clauses is restraining competition in labor markets to such a
degree that it is materially impacting workers' earnings--both across
the labor force in general, and also specifically for workers who are
not subject to non-compete clauses. The available evidence indicates
increased enforceability of non-compete clauses substantially reduces
workers' earnings, on average, across the labor market generally or for
specific types of workers.\248\ The Commission estimates the proposed
rule, which would prohibit employers from using non-compete clauses,
would increase workers' total earnings by $250 to $296 billion per
year.\249\
---------------------------------------------------------------------------
\248\ See supra Part II.B.1. While there is evidence that
increased enforceability of non-compete clauses increases the rate
of earnings growth for physicians, Lavetti, Simon, & White, supra
note 53 at 1051, the Commission estimates that the proposed rule may
increase physicians' earnings, although the study does not allow for
a precise calculation. See infra Part VII.B.1.a.ii.
\249\ See infra Part VII.B.1 (describing the Commission's
assessment of the benefits of the proposed rule).
---------------------------------------------------------------------------
In addition to the evidence showing non-compete clauses reduce
earnings for workers across the labor force, there is also evidence
non-compete clauses reduce earnings specifically for workers who are
not subject to non-compete clauses.\250\ One study finds when the use
of non-compete clauses by employers increases, that drives down wages
for workers who do not have non-compete clauses but who work in the
same state and industry. This study also finds this effect is stronger
where non-compete clauses are more enforceable. This study shows the
reduction in earnings (and also reduced labor mobility) is due to a
reduction in the rate of the arrival of job offers.\251\ Another study
finds similarly that changes in non-compete clause enforceability in
one state have negative impacts on workers' earnings in bordering
states and that the effects are nearly as large as the effects in the
state in which enforceability changed (though the effect tapers off as
the distance to the bordering state increases).\252\ The authors
conclude that, since the workers across the border are not directly
affected by the law change--because contracts that they have signed do
not become more or less enforceable--this effect must be due to changes
in the local labor market.\253\
---------------------------------------------------------------------------
\250\ See supra Part II.B.1.c.
\251\ Starr, Frake, & Agarwal, supra note 76 at 4.
\252\ Johnson, Lavetti, & Lipsitz, supra note 63 at 51.
\253\ Id. at 30.
---------------------------------------------------------------------------
The Commission preliminarily concludes non-compete clauses
negatively affect competitive conditions in labor markets regardless of
the worker's income or job function. Whether a worker is a senior
executive or a security guard, non-compete clauses block the worker
from switching to a job in which they would be better paid and more
productive--restricting that worker's opportunities as well as the
opportunities of other workers in the relevant labor market. The
available data do not allow the Commission to estimate earnings effects
for every occupation. However, the evidentiary record indicates non-
compete clauses depress wages for a wide range of subgroups of workers
across the spectrum of income and job function. The Commission
therefore estimates the proposed rule would increase earnings for
workers in all of the subgroups of the labor force for which sufficient
data is available.\254\
---------------------------------------------------------------------------
\254\ See infra Part VII.B.1.a.
---------------------------------------------------------------------------
The Commission seeks comment on its preliminary finding that non-
compete clauses negatively affect competitive conditions in labor
markets.
ii. Non-Compete Clauses Negatively Affect Competitive Conditions in
Markets for Products and Services
The adverse effects of non-compete clauses on product and service
markets largely result from reduced labor mobility. Several studies
show the use of non-compete clauses by employers
[[Page 3502]]
reduces labor mobility. All of these studies have found decreased rates
of labor mobility, as measured by job separations, hiring rates, job-
to-job mobility, implicit mobility defined by job tenure, and within-
and between-industry mobility.\255\ The Commission does not view
reduced labor mobility from non-compete clauses--in and of itself--as
evidence that non-compete clauses negatively affect competition in
product and service markets. Instead, reduced labor mobility is best
understood as the primary driver of the effects in product and service
markets the Commission is concerned about.
---------------------------------------------------------------------------
\255\ See supra Part II.B.2.
---------------------------------------------------------------------------
Reduced labor mobility from non-compete clauses negatively affects
competitive conditions in product and service markets in several
respects. First, there is evidence non-compete clauses increase
consumer prices and concentration in the health care sector. There is
also evidence non-compete clauses increase industrial concentration
more broadly. Non-compete clauses may have these effects by inhibiting
entrepreneurial ventures (which could otherwise enhance competition in
goods and service markets) or by foreclosing competitors' access to
talented workers.\256\
---------------------------------------------------------------------------
\256\ See supra Part II.B.2.a.
---------------------------------------------------------------------------
Second, non-compete clauses foreclose the ability of competitors to
access talent by effectively forcing future employers to buy out
workers from their non-compete clauses if they want to hire them. Firms
must either make inefficiently high payments to buy workers out of non-
compete clauses with a former employer, which leads to deadweight
economic loss, or forego the payment--and, consequently, the access to
the talent the firm seeks. Whatever choice a firm makes, its economic
outcomes in the market are harmed, relative to a scenario in which no
workers are bound by non-compete clauses. There is evidence of this
mechanism in the market for CEOs.\257\
---------------------------------------------------------------------------
\257\ See supra Part II.B.2.b.
---------------------------------------------------------------------------
Third, the weight of the evidence indicates non-compete clauses
have a negative impact on new business formation. New business
formation increases competition first by bringing new ideas to market,
and second, by forcing incumbent firms to respond to new firms' ideas
instead of stagnating. Non-compete clauses restrain new business
formation by preventing workers subject to non-compete clauses from
starting their own businesses. In addition, firms are more willing to
enter markets in which they know there are potential sources of skilled
and experienced labor, unhampered by non-compete clauses.\258\
---------------------------------------------------------------------------
\258\ See supra Part II.B.2.c.
---------------------------------------------------------------------------
Fourth, the weight of the evidence indicates non-compete clauses
decrease innovation. Innovation may directly improve economic outcomes
by increasing product quality or decreasing prices, or may promote
competition because successful new products and services force
competing firms to improve their own products and services. Non-compete
clauses affect innovation by reducing the movement of workers between
firms, which decreases knowledge flow between firms. Non-compete
clauses also prevent workers from starting businesses in which they can
pursue innovative new ideas.\259\
---------------------------------------------------------------------------
\259\ See supra Part II.B.2.d.
---------------------------------------------------------------------------
As noted above in Part II.B.2.e, there is also evidence non-compete
clauses increase employee training and other forms of investment. The
Commission considers this evidence below in Part IV.B as part of its
analysis of the justifications for non-compete clauses.
The Commission believes non-compete clauses for senior executives
may harm competition in product markets in unique ways, to the extent
that senior executives may be likely to start competing businesses, be
hired by potential entrants or competitors, or lead the development of
innovative products and services. Non-compete clauses for senior
executives may also block potential entrants, or raise their costs, to
a high degree, because such workers are likely to be in high demand by
potential entrants. As a result, prohibiting non-compete clauses for
senior executives may have relatively greater benefits for consumers
than prohibiting non-compete clauses for other workers. The Commission
seeks comment on this analysis as well as whether this reasoning may
apply to highly paid and highly skilled workers who are not senior
executives.
The Commission seeks comment on its preliminary finding that non-
compete clauses negatively affect competitive conditions in markets for
products and services.
b. Non-Compete Clauses Are Exploitative and Coercive at the Time of
Contracting
The Commission preliminarily finds non-compete clauses for workers
other than senior executives are exploitative and coercive because they
take advantage of unequal bargaining power between employers and
workers at the time the employer and worker enter into the non-compete
clause.
As noted above, courts have held conduct that is exploitative and
coercive can violate Section 5 where it burdens a not insignificant
volume of commerce.\260\ Courts have long recognized bargaining power
between employers and workers is unequal and, as a result, workers are
vulnerable to exploitation and coercion through the use of non-compete
clauses at the time of contracting. Courts have expressed this concern
since at least the early eighteenth century. In the foundational
English case Mitchel v. Reynolds, the court cited ``the great abuses
these voluntary restraints are liable to . . . from masters, who are
apt to give their apprentices much vexation'' by using ``many indirect
practices to procure such bonds from them, lest they should prejudice
them in their custom, when they come to set up for themselves.'' \261\
As another court stated, more recently:
---------------------------------------------------------------------------
\260\ See supra Part IV.A.1.
\261\ 1 P. Wms. at 190.
---------------------------------------------------------------------------
The average, individual employee has little but his labor to sell
or to use to make a living. He is often in urgent need of selling it
and in no position to object to boiler plate restrictive covenants
placed before him to sign. To him, the right to work and support his
family is the most important right he possesses. His individual
bargaining power is seldom equal to that of his employer. . . . Under
pressure of need and with little opportunity for choice, he is more
likely than the seller to make a rash, improvident promise that, for
the sake of present gain, may tend to impair his power to earn a
living, impoverish him, render him a public charge or deprive the
community of his skill and training.\262\
---------------------------------------------------------------------------
\262\ Arthur Murray Dance Studios of Cleveland v. Witter, 105
NE2d 685, 703-04 (Ohio Ct. Com. Pl. 1952). See also Restatement
(Second) of Contracts (1981) sec. 188 cmt. g (``Postemployment
restraints are scrutinized with particular care because they are
often the product of unequal bargaining power and because the
employee is likely to give scant attention to the hardship he may
later suffer through loss of his livelihood.'').
---------------------------------------------------------------------------
Indeed, courts have cited the imbalance of bargaining power between
workers and employers as a central reason for imposing stricter
scrutiny on non-compete clauses between employers and workers than on
non-compete clauses between businesses or between the seller and buyer
of a business.\263\
---------------------------------------------------------------------------
\263\ See, e.g., Alexander & Alexander, Inc. v. Danahy, 488 NE2d
22, 29 (Mass. App. Ct. 1986); Diepholz v. Rutledge, 659 NE 989, 991
(Ill. Ct. App. 1995); Palmetto Mortuary Transp., Inc. v. Knight
Sys., Inc., 818 SE2d 724, 731 (S.C. 2018).
---------------------------------------------------------------------------
The imbalance of bargaining power between employers and workers
results from several factors. Many of these
[[Page 3503]]
factors relate to the nature of the employer-worker relationship in the
United States generally. Most workers depend on income from their jobs
to get by--to pay their rent or mortgage, pay their bills, and keep
food on the table. For these workers, particularly the many workers who
live paycheck to paycheck, loss of a job or a job opportunity can
severely damage their finances.\264\ For these reasons, the loss of a
job or an employment opportunity is far more likely to have serious
financial consequences for a worker than the loss of a worker or a job
candidate would have for most employers. In addition, employers
generally have considerable labor market power, due to factors such as
concentration and the difficulty of searching for a job.\265\ The
considerable labor market power of employers has significantly
diminished the bargaining power of U.S. workers.\266\
---------------------------------------------------------------------------
\264\ See, e.g., Jennie E. Brand, The Far-Reaching Impact of Job
Loss and Unemployment, 41 Ann. Rev. of Socio. 359 (2015);
CareerBuilder, Living Paycheck to Paycheck is a Way of Life for
Majority of U.S. Workers, According to New CareerBuilder Survey
(Aug. 24, 2017), https://press.careerbuilder.com/2017-08-24-Living-Paycheck-to-Paycheck-is-a-Way-of-Life-for-Majority-of-U-S-Workers-According-to-New-CareerBuilder-Survey (reporting that 78% of
American workers live paycheck to paycheck); Jeff Ostrowski,
Bankrate, Survey: Fewer than 4 in 10 Americans could pay a surprise
$1,000 bill from savings (Jan. 11, 2021), https://www.bankrate.com/banking/savings/financial-security-january-2021/.
\265\ Treasury Labor Market Competition Report, supra note 41 at
i-ii.
\266\ Id. at ii (``As this report highlights, a careful review
of the credible academic studies places the decrease in wages at
roughly 20 percent relative to the level in a fully competitive
market'').
---------------------------------------------------------------------------
Several additional factors contribute to the imbalance of
bargaining power between employers and workers generally. These include
the decline in union membership, which forces more workers to negotiate
with their employers individually; \267\ increased reliance by
employers on various forms of outsourcing, which allows employers to
fill persistent vacancies without having to raise wages or improve
conditions for incumbent workers; \268\ and the proliferation of no-
poaching agreements, which limit the mobility of workers and, as a
result, their bargaining power.\269\
---------------------------------------------------------------------------
\267\ See, e.g., Alan Krueger, Luncheon Address: Reflections on
Dwindling Worker Bargaining Power and Monetary Policy at 272 (Aug.
24, 2018), https://www.kansascityfed.org/Jackson%20Hole/documents/6984/Lunch_JH2018.pdf.
\268\ Id.
\269\ Id. at 273.
---------------------------------------------------------------------------
While the employer-worker relationship is defined by an imbalance
of bargaining power generally, the imbalance of bargaining power is
particularly acute in the context of negotiating employment terms such
as non-compete clauses, for several reasons. First, as courts have long
recognized, employers are repeat players who are likely to have greater
experience and skill at bargaining, in the context of negotiating
employment terms, than individual workers.\270\ Second, and relatedly,
workers are not likely to seek the assistance of counsel in reviewing
employment terms,\271\ while employers are more likely to seek the
assistance of counsel in drafting them.
---------------------------------------------------------------------------
\270\ See, e.g., Samuel Stores, Inc. v. Abrams, 108 A. 541, 543
(Conn. 1919).
\271\ In one survey, only 7.9% of workers with non-compete
clauses reported consulting a lawyer in connection with the non-
compete clause. Starr, Prescott, & Bishara, supra note 42, at 72.
---------------------------------------------------------------------------
Third, research indicates consumers exhibit cognitive biases in the
way they consider contractual terms,\272\ and the same may be true of
workers. Consumers rarely read standard-form contracts.\273\ Consumers
also tend to focus their attention on a few salient terms of the
transaction, such as price and quantity, and tend to disregard other
terms, particularly terms that are relatively obscure.\274\ Consumers
are particularly likely to disregard contingent terms--terms concerning
scenarios that may or may not come to pass--or to be unable to assess
what the impact of those terms may be.\275\ Consumers also tend to
disregard onerous terms or terms that involve difficult trade-offs,
such as giving up legal rights or future opportunities.\276\ Workers
likely display similar cognitive biases in the way they consider
employment terms. These reasons explain why the imbalance of bargaining
power between workers and employers is particularly high in the context
of negotiating employment terms such as non-compete clauses.
---------------------------------------------------------------------------
\272\ See, e.g., Arnow-Richman (2006), supra note 56 at 981;
Russell Korobkin, Bounded Rationality, Standard Form Contracts, and
Unconscionability, 70 U. Chi. L. Rev. 1203, 1206 (2003); Robert
Hillman & Jeffrey Rachlinski, Standard-Form Contracting in the
Electronic Age, 77 N.Y.U. L. Rev. 429, 450-54 (2002).
\273\ Korobkin, supra note 272 at 1206.
\274\ Arnow-Richman (2006), supra note 56 at 981; Hillman &
Rachlinksi, supra note 272 at 452.
\275\ See, e.g., Estlund, supra note 144 at 413 (2006). See also
Fed. Trade Comm'n, Credit Practices Rule, 49 FR 7740, 7744 (Mar. 1,
1984) (noting that consumers tend disregard contingent provisions
and concentrate their search on factors such as interest rates and
payment terms).
\276\ Arnow-Richman (2006), supra note 56 at 981; Korobkin,
supra note 272 at 1203-31.
---------------------------------------------------------------------------
There is considerable evidence employers are exploiting this
imbalance of bargaining power through the use of non-compete clauses.
Non-compete clauses are typically standard-form contracts,\277\ which,
as noted above, workers are not likely to read. The evidence shows
workers rarely bargain over non-compete clauses \278\ and rarely seek
the assistance of counsel in reviewing non-compete clauses.\279\
Furthermore, research indicates that, in states where non-compete
clauses are unenforceable, workers are covered by non-compete clauses
at roughly the same rate as workers in other states,\280\ suggesting
that employers may believe workers are unaware of their legal rights,
or that employers may be seeking to take advantage of workers' lack of
knowledge of their legal rights. In addition, there is evidence
employers often provide workers with non-compete clauses after they
have accepted the job offer--in some cases, on or after their first day
of work--when the worker's negotiating power is at its weakest, since
the worker may have turned down other job offers or left their previous
job.\281\
---------------------------------------------------------------------------
\277\ Starr, Prescott, & Bishara, supra note 42 at 72 (``Taken
together, the evidence in this section indicates that employers
present (or employees receive) noncompete proposals as take-it-or-
leave-it propositions.'').
\278\ Id.
\279\ Id.
\280\ Id. at 81.
\281\ Marx (2011), supra note 55 at 706.
---------------------------------------------------------------------------
Because there is a considerable imbalance of bargaining power
between workers and employers in the context of negotiating employment
terms, and because employers take advantage of this imbalance of
bargaining power through the use of non-compete clauses, the Commission
preliminarily finds non-compete clauses are exploitative and coercive
at the time of contracting.
As noted above, for coercive conduct to constitute unfair method of
competition, it must also burden a not insignificant volume of
commerce. The Commission preliminarily finds non-compete clauses burden
a not insignificant volume of commerce due to their negative effects on
competitive conditions in labor markets and product and service
markets, which are described above.\282\
---------------------------------------------------------------------------
\282\ See supra Part IV.A.1.a.i-ii.
---------------------------------------------------------------------------
This preliminary finding does not apply to workers who are senior
executives. Non-compete clauses for senior executives are unlikely to
be exploitative or coercive at the time of contracting, because senior
executives are likely to negotiate the terms of their employment and
may often do so with the assistance of counsel. The Commission seeks
comment on whether there are other categories of highly paid or highly
skilled workers (i.e., other
[[Page 3504]]
than senior executives) to whom this preliminary finding should not
apply.
The Commission seeks comment on all aspects of its preliminary
finding that non-compete clauses are exploitative and coercive at the
time of contracting.
c. Non-Compete Clauses Are Exploitative and Coercive at the Time of the
Worker's Potential Departure From the Employer
The Commission preliminarily finds non-compete clauses for workers
other than senior executives are exploitative and coercive at the time
of the worker's potential departure from the employer, because they
force a worker to either stay in a job they want to leave or choose an
alternative that likely impacts their livelihood.
For most workers who want to leave their jobs, the most natural
employment options will be work in the same field and in the same
geographic area. However, where a worker is bound by a non-compete
clause, the worker's employment options are significantly limited. A
worker who is subject to a non-compete clause, and who wants to leave
their job, faces an undesirable choice that will likely affect their
livelihood: either move out of the area; leave the workforce for a
period of time; leave their field for period of time; pay the employer
a sum of money to waive the non-compete clause; or violate the non-
compete clause and risk a lawsuit from the employer. By forcing a
worker who wants to leave their job to either stay in their job or take
an action that will likely negatively affect their livelihood, non-
compete clauses coerce workers into remaining in their current jobs.
Courts have long expressed concern about this coercive effect of non-
compete clauses--that non-compete clauses may threaten a worker's
livelihood if they leave their job.\283\
---------------------------------------------------------------------------
\283\ See, e.g., Mitchel, 1 P. Wms. at 190 (citing ``the
mischief which may arise from [non-compete clauses] . . . to the
party, by the loss of his livelihood'').
---------------------------------------------------------------------------
Workers have an inalienable right to quit their jobs.\284\ The
Supreme Court has described this ``right to change employers'' as a
critical ``defense against oppressive hours, pay, working conditions,
or treatment.'' \285\ Strictly speaking, non-compete clauses do not
prevent workers from quitting their jobs. However, non-compete clauses
``burden the ability to quit, and with it the ability to demand better
wages and working conditions and to resist oppressive conditions in the
current job.'' \286\ Non-compete clauses burden the ability to quit by
forcing workers to either remain in their current job or, as described
above, take an action--such as leaving the labor force for a period of
time or taking a job in a different field--that would likely affect
their livelihood. For this reason, the Commission finds non-compete
clauses are exploitative and coercive at the time of the worker's
potential departure.
---------------------------------------------------------------------------
\284\ Bailey v. Alabama, 219 U.S. 219, 242 (1911).
\285\ Pollock v. Williams, 322 U.S. 4, 17-18 (1944).
\286\ See Estlund, supra note 144 at 407.
---------------------------------------------------------------------------
As noted above, for coercive conduct to constitute unfair method of
competition, it must also burden a not insignificant volume of
commerce. The Commission preliminarily finds non-compete clauses burden
a not insignificant volume of commerce due to their negative effects on
competitive conditions in labor markets and product and service
markets, which are described above.\287\
---------------------------------------------------------------------------
\287\ See supra Part IV.A.1.a.i-ii.
---------------------------------------------------------------------------
This preliminary finding does not apply to workers who are senior
executives. Non-compete clauses for senior executives are unlikely to
be exploitative or coercive at the time of the executive's departure.
Because many senior executives negotiate their non-compete clauses with
the assistance of expert counsel, they are likely to have bargained for
a higher wage or more generous severance package in exchange for
agreeing to the non-compete clause.\288\ The Commission seeks comment
on whether there are other categories of highly paid or highly skilled
workers (i.e., other than senior executives) to whom this preliminary
finding should not apply.
---------------------------------------------------------------------------
\288\ See, e.g., Stewart J. Schwab & Randall S. Thomas, An
Empirical Analysis of CEO Employment Contracts: What Do Top
Executives Bargain For?, 63 Wash. & Lee L. Rev. 231, 256-57 (2006)
(noting that 84% of CEO employment contracts that included both a
non-compete clause and a severance payment have a severance payment
that is equal to or greater than the length of the non-competition
period).
---------------------------------------------------------------------------
The Commission seeks comment on all aspects of its preliminary
finding that non-compete clauses are exploitative and coercive at the
time of the worker's potential departure from the employer.
2. Non-Compete Clauses Are a Method of Competition
For conduct to be an ``unfair method of competition'' under Section
5, it must be both ``unfair'' and a ``method of competition.'' In
Ethyl, the court distinguished between a ``condition'' of a
marketplace, such as an oligopolistic market structure, and a
``method'' of competition, which it described as ``specific conduct
which promotes'' an anticompetitive result.\289\ When an employer uses
a non-compete clause, it undertakes conduct in a marketplace. This
conduct implicates competition; indeed, it has demonstrable effects on
competition in both labor markets and markets for products and
services.\290\ For these reasons, the Commission preliminarily finds
non-compete clauses are a method of competition under Section 5. The
Commission seeks comment on this preliminary finding.
---------------------------------------------------------------------------
\289\ 729 F.2d at 139.
\290\ See supra Part II.B.
---------------------------------------------------------------------------
B. The Justifications for Non-Compete Clauses Do Not Alter the
Commission's Preliminary Determination
For the reasons described above in Part IV.A, the Commission
preliminarily determines non-compete clauses are an unfair method of
competition under Section 5. In this Part IV.B, the Commission
preliminarily finds the justifications for non-compete clauses do not
alter the Commission's preliminary determination that non-compete
clauses are an unfair method of competition.
The circumstances under which a business justification can overcome
a finding that conduct is an unfair method of competition are narrow.
In Fashion Originators' Guild of America v. FTC, the Court held that,
in light of ``the purpose and object of this combination, its potential
power, its tendency to monopoly, [and] the coercion it could and did
practice upon a rival method of competition,'' the Commission did not
err by refusing to hear evidence related to justifications, ``for the
reasonableness of the methods pursued by the combination to accomplish
its unlawful object is no more material than would be the
reasonableness of the prices fixed by unlawful combination.'' \291\ In
Atlantic Refining, the Court similarly held the Commission did not err
by refusing to consider ``evidence of economic justification for the
program,'' because, while the arrangements at issue ``may well provide
Atlantic with an economical method of assuring efficient product
distribution among its dealers . . . the Commission was clearly
justified in refusing the participants an opportunity to offset these
evils by a showing of economic benefit to themselves.'' \292\
---------------------------------------------------------------------------
\291\ 312 U.S. at 467-68.
\292\ 381 U.S. at 371.
---------------------------------------------------------------------------
Similarly, in L.G. Balfour Co., the Commission challenged as an
unfair method of competition the use of exclusive dealing contracts by
a firm that manufactured and sold jewelry and other items bearing the
insignia of fraternities and high schools. The firm argued the
contracts were justified, in
[[Page 3505]]
part because the fraternities and schools benefitted from uniformity in
the design and workmanship of the items. The court reasoned ``[w]hile
it is relevant to consider the advantages of a trade practice on
individual companies in the market, this cannot excuse an otherwise
illegal business practice.'' \293\ The court found the exclusive
contracts were not justified, because the fraternities and schools had
other means for accomplishing the goal of maintaining high quality for
their jewelry and because the firm did not establish that its
competitors could not satisfy its customers' needs.\294\
---------------------------------------------------------------------------
\293\ 442 F.2d at 15, citing Motion Picture Advert. Serv. Co.,
344 U.S. 392.
\294\ Id. at 14-15.
---------------------------------------------------------------------------
In this Part IV.B, the Commission considers the commonly cited
business justifications for non-compete clauses but preliminarily finds
they do not alter the Commission's preliminary determination that non-
compete clauses are an unfair method of competition, for two reasons.
First, employers have alternatives to non-compete clauses that
reasonably achieve the same purposes while burdening competition to a
less significant degree. Second, the asserted benefits from these
commonly cited justifications do not outweigh the considerable harm
from non-compete clauses.
1. Commonly Cited Justifications for Non-Compete Clauses
The most cited justifications for non-compete clauses are that they
increase employers' incentive to make productive investments, including
in worker training, client attraction, or in creating or sharing trade
secrets with workers. According to these justifications, without non-
compete clauses, employment relationships are subject to an investment
hold-up problem. Investment hold-up occurs where an employer--faced
with the possibility a worker may depart after receiving some sort of
valuable investment--opts not to make that investment in the first
place, thereby decreasing the firm's productivity and overall social
welfare. For example, according to these justifications, an employer
may be more reticent to invest in trade secrets or other confidential
information; to share this information with its workers; or to train
its workers if it knows the worker may depart for or may establish a
competing firm. Courts have cited these justifications when upholding
non-compete clauses under state common law or antitrust law.\295\
---------------------------------------------------------------------------
\295\ See, e.g., U.S. v. Addyston Pipe & Steel Co., 85 F. 271,
281 (6th Cir. 1898); Polk Bros., Inc. v. Forest City Enters., 776
F.2d 185, 189 (7th Cir. 1985).
---------------------------------------------------------------------------
As described above in Part II.B.2.e, there is evidence non-compete
clauses increase worker training and capital investment (e.g.,
investment in physical assets, such as machines). Non-compete clauses
may increase an employer's incentive to train their workers or invest
in capital equipment because workers bound by non-compete clauses are
less likely to leave their jobs for competitors. The author of the
study assessing effects on capital investment finds there are likely
two mechanisms driving these effects. First, firms may be more likely
to invest in capital when they train their workers because worker
training and capital expenditure are complementary (i.e., the return on
investment in capital equipment is greater when workers are more highly
trained). Second, non-compete clauses reduce competition, and firms'
returns to capital expenditure are greater when competition is lower,
incentivizing firms to invest more in capital.\296\
---------------------------------------------------------------------------
\296\ Jeffers, supra note 92 at 29.
---------------------------------------------------------------------------
The Commission is not aware of any evidence of a relationship
between the enforceability of non-compete clauses and the rate at which
companies make other types of productive investments, such as
investments in creating or sharing trade secrets. Similarly, the
Commission is not aware of any evidence non-compete clauses reduce
trade secret misappropriation or the loss of other types of
confidential information. The Commission's understanding is there is
little reliable empirical data on trade secret theft and firm
investment in trade secrets in general, and no reliable data on how
non-compete clauses affect these practices. The Commission understands
these are difficult areas for researchers to study, due to, for
example, the lack of a governmental registration requirement for trade
secrets and the unwillingness of firms to disclose information about
their practices related to trade secrets.\297\
---------------------------------------------------------------------------
\297\ See, e.g., David S. Levine & Christopher B. Seaman, The
DTSA at One: An Empirical Study of the First Year of Litigation
Under the Defend Trade Secrets Act, 53 Wake Forest L. Rev. 105, 120-
22 (2018).
---------------------------------------------------------------------------
The Commission is also not aware of any evidence that increased
investment due to non-compete clauses leads to reduced prices for
consumers. Indeed, the only empirical study of the effects of non-
compete clauses on consumer prices--in the health care sector--finds
increased final goods prices as the enforceability of non-compete
clauses increases.\298\
---------------------------------------------------------------------------
\298\ See supra Part II.B.2.a.
---------------------------------------------------------------------------
2. Employers Have Alternatives to Non-Compete Clauses for Protecting
Valuable Investments
There are two reasons why the business justifications for non-
compete clauses do not alter the Commission's preliminary determination
non-compete clauses are an unfair method of competition. The first is
employers have alternatives to non-compete clauses for protecting
valuable investments. These alternatives may not be as protective as
employers would like, but they reasonably accomplish the same purposes
as non-compete clauses while burdening competition to a less
significant degree.
As noted above, the most commonly cited justifications for non-
compete clauses are that they increase an employer's incentive to make
productive investments--such as investing in trade secrets or other
confidential information, sharing this information with its workers, or
training its workers--because employers may be more likely to make such
investments if they know workers are not going to depart for or
establish a competing firm. However, non-compete clauses restrict
considerably more activity than necessary to achieve these benefits.
Rather than restraining a broad scope of beneficial competitive
activity--by barring workers altogether from leaving work with the
employer for a competitor and starting a business that would compete
with the employer--employers have alternatives for protecting valuable
investments that are much more narrowly tailored to limit impacts on
competitive conditions. These alternatives restrict a considerably
smaller scope of beneficial competitive activity than non-compete
clauses because--while they may restrict an employee's ability to use
or disclose certain information--they generally do not prevent workers
from working for a competitor or starting their own business
altogether.\299\
---------------------------------------------------------------------------
\299\ See, e.g., MAI Basic Four, Inc. v. Basis, Inc., 880 F.2d
286, 287-88 (10th Cir. 1989) (stating that workers subject to NDAs--
unlike workers subject to non-compete clauses--``remain free to work
for whomever they wish, wherever they wish, and at whatever they
wish,'' subject only to the terms that prohibit them from disclosing
or using certain information.'').
---------------------------------------------------------------------------
a. Trade Secret Law
Trade secret law provides employers with an alternative means of
protecting their investments in trade secrets. Trade secret law is a
form of intellectual property law that protects confidential
[[Page 3506]]
business information.\300\ It also serves as an alternative to the
patent system, ``granting proprietary rights to particular
technologies, processes, designs, or formulae that may not be able to
satisfy the rigorous standards for patentability.'' \301\ Even where
information meets standards for patentability, companies may choose to
rely on trade secret law and not obtain a patent, because they wish to
keep information out of the public domain.\302\
---------------------------------------------------------------------------
\300\ Brian T. Yeh, Protection of Trade Secrets: Overview of
Current Law and Legislation, Cong. Rsch. Serv. Report R43714 (April
22, 2016) at 4.
\301\ Id.
\302\ Id. at 4-5.
---------------------------------------------------------------------------
Trade secret law has developed significantly in recent decades.
Prior to the late 1970s, trade secret law across the states was
inconsistent, leading to significant uncertainty regarding the scope of
trade secret protections and the appropriate remedies for
misappropriation.\303\ Recognizing the need for more uniform laws, the
American Bar Association approved the Uniform Trade Secrets Act
(``UTSA'') in 1979.\304\ Forty-seven states and the District of
Columbia have adopted the UTSA.\305\ The three states that have not
adopted the UTSA offer protection to trade secrets under a different
statute or under common law.\306\
---------------------------------------------------------------------------
\303\ Uniform Trade Secrets Act With 1985 Amendments (Feb. 11,
1986), Prefatory Note at 1.
\304\ Id. Prefatory Note at 3.
\305\ See Levine & Seaman, supra note 297 at 113.
\306\ Yeh, supra note 300 at 6 n.37.
---------------------------------------------------------------------------
The UTSA provides a civil cause of action for trade secret
misappropriation, which refers to disclosure or use of a trade secret
by a former employee without express or implied consent.\307\ The UTSA
also provides for injunctive and monetary relief, including
compensatory damages, punitive damages, and attorney's fees.\308\ In
some states, under the ``inevitable disclosure doctrine,'' courts may
enjoin a worker from working for a competitor of the worker's employer
where it is inevitable the worker will disclose trade secrets in the
performance of the worker's job duties.\309\ The inevitable disclosure
doctrine is highly controversial. Several states have declined to adopt
it altogether, citing the doctrine's harsh effects on worker
mobility.\310\ Other states have required employers to meet high
evidentiary burdens related to inevitability, irreparable harm, and bad
faith before issuing an injunction pursuant to the doctrine.\311\
---------------------------------------------------------------------------
\307\ UTSA, supra note 303 at sec. 1(2).
\308\ Id. at secs. 2-4.
\309\ See, e.g., PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th
Cir. 1995) (affirming the district court's order enjoining an
employee from assuming his responsibilities at a competing employer
for six months).
\310\ See Bayer Corp. v. Roche Molecular Sys., Inc., 72 F. Supp.
2d 1111, 1120 (N.D. Cal. 1999); LeJeune v. Coin Acceptors, Inc., 849
A.2d 451, 471 (Md. 2004).
\311\ See, e.g., Eleanore R. Godfrey, Inevitable Disclosure of
Trade Secrets: Employee Mobility v. Employer Rights, 3. J. High
Tech. L. 161 (2004).
---------------------------------------------------------------------------
In addition, in 2016, Congress enacted the Defend Trade Secrets Act
of 2016 (``DTSA''), which established a civil cause of action under
federal law for trade secret misappropriation.\312\ The DTSA brought
the rights of trade secret owners ``into alignment with those long
enjoyed by owners of other forms of intellectual property, including
copyrights, patents, and trademarks.'' \313\ Similar to state laws
modeled on the UTSA, the DTSA authorizes civil remedies for trade
secret misappropriation, including injunctive relief, damages
(including punitive damages), and attorney's fees.\314\ The DTSA also
authorizes a court, in ``extraordinary circumstances,'' to issue civil
ex parte orders for the ``seizure of property necessary to prevent the
propagation or dissemination of the trade secret that is the subject of
the action.'' \315\
---------------------------------------------------------------------------
\312\ Defend Trade Secrets Act of 2016, Public Law 114-153, 130
Stat. 376 (May 11, 2016).
\313\ U.S. Senate, Report to Accompany S. 1890, the Defend Trade
Secrets Act of 2016, S. Rept. 114-220 at 3.
\314\ 18 U.S.C. 1836(b)(3).
\315\ 18 U.S.C. 1836(b)(2).
---------------------------------------------------------------------------
Furthermore, trade secret theft is a federal crime. The Economic
Espionage Act of 1996 (``EEA'') makes it a federal crime to steal a
trade secret for either (1) the benefit of a foreign entity (``economic
espionage'') or (2) the economic benefit of anyone other than the owner
(``theft of trade secrets'').\316\ The EEA authorizes substantial
criminal fines and penalties for these crimes.\317\ The EEA further
authorizes criminal or civil forfeiture, including of ``any property
constituting, or derived from, any proceeds obtained directly or
indirectly as a result of'' an EEA offense.\318\ The EEA also requires
offenders to pay restitution to victims of trade secret theft.\319\
---------------------------------------------------------------------------
\316\ 18 U.S.C. 1831 (economic espionage); 18 U.S.C. 1832 (theft
of trade secrets).
\317\ 18 U.S.C. 1831-1832.
\318\ 18 U.S.C. 1834, 2323.
\319\ 18 U.S.C. 1834, 2323.
---------------------------------------------------------------------------
Under these laws, the term ``trade secret'' is defined expansively
and includes a wide range of confidential information. The UTSA
generally defines a ``trade secret'' as information that (1) derives
independent economic value from not being generally known to other
persons who can obtain economic value from its disclosure or use and
(2) is the subject of reasonable efforts to maintain its secrecy.\320\
The DTSA and EEA use a similar definition.\321\ The Supreme Court has
held ``some novelty'' is required for information to be a trade secret,
because ``that which does not possess novelty is usually known.'' \322\
Overall, the definition of ``trade secret'' covers a wide range of
information employers seek to protect from disclosure. As the high
court of one state noted, ``[t]here is virtually no category of
information that cannot, as long as the information is protected from
disclosure to the public, constitute a trade secret.'' \323\
---------------------------------------------------------------------------
\320\ UTSA, supra note 303 at sec. 1(4).
\321\ 18 U.S.C. 1839(3).
\322\ Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470, 476 (1974).
\323\ U.S. West Commc'ns, Inc. v. Off. of Consumer Advoc., 498
NW2d 711, 714 (Iowa 1993). See also Confold Pac., Inc. v. Polaris
Indus., Inc., 433 F.3d 952 (7th Cir. 2006) (Posner, J.).
---------------------------------------------------------------------------
The viability of trade secret law as a means for redressing trade
secret theft is illustrated by the fact that firms regularly bring
claims under trade secret law. A recent analysis by the legal analytics
firm Lex Machina finds 1,382 trade secret lawsuits were filed in
federal court in 2021.\324\ Perhaps due to the enactment of the DTSA,
the number of cases filed increased 30% from 2015 to 2017--from 1,075
to 1,396 cases--and has remained steady ever since.\325\ In addition,
an analysis by the law firm Morrison Foerster finds 1,103 trade secret
cases were filed in state courts in 2019.\326\ The number of cases
filed in state court has held steady since 2015, when 1,161 cases were
filed.\327\ The fact that a considerable number of trade secret
lawsuits are filed in federal and state court--approximately 2,500
cases per year--and the fact that this number has held steady for
several years suggests employers view trade secret law as a viable
means of obtaining redress for trade secret theft.
---------------------------------------------------------------------------
\324\ Lex Machina, Infographic, Trade Secret Litigation Report
2021, https://lexmachina.com/resources/infographic-trade-secret-report/.
\325\ Kenneth A. Kuwayti, John R. Lanham, & Candice F. Heinze,
Morrison Foerster, Client Alert, Happy Anniversary, DTSA: The Defend
Trade Secrets Act at Five (May 25, 2021).
\326\ Id.
\327\ Id.
---------------------------------------------------------------------------
In sum, intellectual property law already provides significant
legal protections for an employer's trade secrets. Trade secret law may
not be as protective as some firms might like, but overall, it provides
employers with a viable means of protecting their investments in trade
secrets.
b. Non-Disclosure Agreements
Employers that seek to protect valuable investments also have the
[[Page 3507]]
ability to enter into NDAs with their workers.\328\ NDAs, which are
also commonly known as confidentiality agreements, are contracts in
which a party agrees not to disclose information the contract
designates as confidential. NDAs may also prohibit workers from using
information that is designated as confidential. If a worker violates an
NDA, the worker may be liable for breach of contract.
---------------------------------------------------------------------------
\328\ In this NPRM, we use the term ``NDA'' to refer to
contractual provisions that are designed to protect trade secrets or
other business information that has economic value. Employers may
also seek to use NDAs to protect other kinds of information, such as
information about discrimination, harassment, sexual assault,
corporate wrongdoing, or information that may disparage the company
or its executives or employees. These types of NDAs have been widely
criticized for, among other things, their pernicious effects on
workers. See, e.g., Rachel Arnow-Richman et al., Supporting Market
Accountability, Workplace Equity, and Fair Competition by Reining In
Non-Disclosure Agreements, UC-Hastings Research Paper Forthcoming at
2-6 (January 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4022812.
---------------------------------------------------------------------------
Employers regularly use NDAs to protect trade secrets and other
confidential business information. Researchers estimate between 33% and
57% of U.S. workers are subject to at least one NDA.\329\ In most
states, NDAs are more enforceable than non-compete clauses.\330\
---------------------------------------------------------------------------
\329\ Id.
\330\ See Chris Montville, Reforming the Law of Proprietary
Information, 56 Duke L.J. 1159, 1179-83 (2007).
---------------------------------------------------------------------------
The widespread use of NDAs by firms has raised concerns that NDAs
may inhibit innovation and worker mobility.\331\ Scholars have also
raised concerns that overbroad NDAs can function as de facto non-
compete clauses.\332\ However, the protection of trade secrets and
other limited confidential business information is widely recognized as
a legitimate use of NDAs.\333\
---------------------------------------------------------------------------
\331\ See Rex N. Alley, Business Information and Non-Disclosure
Agreements: A Public Policy Framework, 116 Nw. L. Rev. 817, 832
(2022).
\332\ See, e.g., Arnow-Richman et al., supra note 328 at 5. See
also Brown, 57 Cal. App. 5th at 319.
\333\ See Montville, supra note 330 at 1179-83.
---------------------------------------------------------------------------
NDAs that are unusually broad in scope may function as de facto
non-compete clauses, hence falling within the scope of the proposed
rule.\334\ However, appropriately tailored NDAs, which would fall
outside the scope of the proposed rule,\335\ burden competition to a
lesser degree than non-compete clauses. Such NDAs may prevent workers
from disclosing or using certain information, but they generally do not
prevent workers from working for a competitor or starting their own
business altogether. As the U.S. Court of Appeals for the Tenth Circuit
has stated, workers subject to NDAs--unlike workers subject to non-
compete clauses--``remain free to work for whomever they wish, wherever
they wish, and at whatever they wish,'' subject only to the terms that
prohibit them from disclosing or using certain information.\336\
---------------------------------------------------------------------------
\334\ See proposed Sec. 910.1(b)(2) (describing the functional
test for whether a contractual term is a non-compete clause) and
infra Part V (in the section-by-section analysis for proposed Sec.
910.1(b)).
\335\ Id.
\336\ MAI Basic Four, Inc., 880 F.2d at 287-88.
---------------------------------------------------------------------------
c. Other Means of Protecting Valuable Investments
In addition to trade secret law and NDAs, employers have additional
means of protecting valuable investments. For example, if an employer
wants to prevent a worker from leaving right after receiving valuable
training, the employer can sign the worker to an employment contract
with a fixed duration. An employer can establish a term of employment
long enough for the employer to recoup its training investment without
restricting a worker's ability to compete with the employer after the
worker's employment ends. Employers that wish to retain their workers
can also pay the worker more, offer them better hours or better working
conditions, or otherwise improve the conditions of their employment.
These are all viable alternatives for protecting training investments,
and other investments an employer may make, that do not restrict a
worker's ability to work for a competitor of the employer or a rival's
ability to compete against the worker's employer to attract the worker.
Proponents of non-compete clauses sometimes assert that, without
non-compete clauses, firms will be unable to protect their trade
secrets or other valuable investments. However, there are three states
in which non-compete clauses are generally unavailable to employers
today: California, North Dakota, and Oklahoma. In these three states,
employers generally cannot enforce non-compete clauses, so they must
protect their investments using one or more of the alternatives
described above. The experiences of these states suggest the
alternatives described above are fundamentally viable for protecting
valuable firm investments.
Non-compete clauses have been void in California since 1872, in
North Dakota since 1877, and in Oklahoma since 1890.\337\ California is
a state where large companies have succeeded--it is home to four of the
world's ten largest companies by market capitalization--and it also
maintains a vibrant startup culture.\338\ Since the 1980s, California
has become the global center of the technology sector, and technology
firms are highly dependent on protecting trade secrets and other
confidential information.\339\ (Indeed, researchers have posited that
high-tech clusters in California may have been aided by increased labor
mobility due to the unenforceability of non-compete clauses.\340\) In
North Dakota and Oklahoma, the energy industry has thrived, and firms
in the energy industry depend on the ability to protect trade secrets
and other confidential information.
---------------------------------------------------------------------------
\337\ Gilson, supra note 88 at 616 (California); Werlinger v.
Mutual Service Casualty Ins. Co., 496 N.W.2d 26, 30 (N.D. 1993)
(North Dakota); Brandon Kemp, Noncompetes in Oklahoma Mergers and
Acquisitions, 88 Okla. Bar J. 128 (Jan. 21, 2017) (Oklahoma).
\338\ Josh Dylan, What Is Market Cap In Stocks?, Nasdaq.com
(Aug, 12, 2022); Ewing Marion Kauffman Found., State
Entrepreneurship Rankings, https://www.realclearpublicaffairs.com/public_affairs/2019/02/25/kauffman_foundation_state_entrepreneurship_rankings.html.
\339\ See, e.g., Gilson, supra note 88 at 594-95.
\340\ Id.; Fallick, Fleischman, & Rebitzer, supra note 89.
---------------------------------------------------------------------------
The economic success in these three states of industries highly
dependent on trade secrets and other confidential information
illustrates that companies have viable alternatives to non-compete
clauses for protecting valuable investments. Relative to non-compete
clauses, these alternatives are more narrowly tailored to limit impacts
on competitive conditions.
The Commission seeks comment on its preliminary finding that
employers have reasonable alternatives to non-compete clauses for
protecting their investments.
3. The Asserted Benefits From These Justifications Do Not Outweigh the
Harms From Non-Compete Clauses
The second reason why the commonly cited business justifications
for non-compete clauses do not alter the Commission's preliminary
determination that non-compete clauses are an unfair method of
competition is that, overall, the asserted benefits from these
justifications do not outweigh the harms from non-compete clauses.
As described above, the Commission preliminarily finds that, for
some workers, non-compete clauses are exploitative and coercive because
they take advantage of unequal bargaining power between employers and
workers at the time of contracting.\341\ The
[[Page 3508]]
Commission also preliminarily finds that, for some workers, non-compete
clauses are exploitative and coercive at the time of the worker's
potential departure from the employer because they force a worker to
either stay in a job they want to leave or choose an alternative that
likely impacts their livelihood.\342\ For these workers, for whom non-
competes are facially unfair, the justifications for non-compete
clauses must overcome a high bar to alter the Commission's preliminary
determination that non-compete clauses are an unfair method of
competition.\343\
---------------------------------------------------------------------------
\341\ See supra Part IV.A.1.b.
\342\ See supra Part IV.A.1.c.
\343\ See, e.g., Fashion Originators' Guild, 312 U.S. at 467-68;
Atl. Refining Co., 381 U.S. at 371.
---------------------------------------------------------------------------
In addition, non-compete clauses cause considerable harm to
competition in labor markets and product and service markets. There is
evidence non-compete clauses harm both workers and consumers. Non-
compete clauses obstruct competition in labor markets because they
inhibit optimal matches from being made between employers and workers
across the labor force. The available evidence indicates increased
enforceability of non-compete clauses substantially reduces workers'
earnings, on average, across the labor force generally and for specific
types of workers.\344\
---------------------------------------------------------------------------
\344\ See supra Part II.B.1.b.
---------------------------------------------------------------------------
In addition to the evidence showing non-compete clauses reduce
earnings for workers across the labor force, there is also evidence
non-compete clauses reduce earnings specifically for workers who are
not subject to non-compete clauses.\345\ These workers are harmed by
non-compete clauses, because their wages are depressed, but they do not
necessarily benefit from any incentives for increased training that
non-compete clauses may provide.
---------------------------------------------------------------------------
\345\ See supra Part II.B.1.c.
---------------------------------------------------------------------------
Overall, these harms to workers are significant. The Commission
estimates that the proposed rule, which would prohibit employers from
using non-compete clauses, would increase workers' total earnings by
$250 to $296 billion per year.\346\
---------------------------------------------------------------------------
\346\ See infra Part VII.B.1.a.
---------------------------------------------------------------------------
The available evidence also indicates non-compete clauses
negatively affect competition in product and service markets. There is
evidence non-compete clauses increase consumer prices and concentration
in the health care sector.\347\ There is also evidence non-compete
clauses foreclose the ability of competitors to access talent by
effectively forcing future employers to buy out workers from their non-
compete clauses if they want to hire them.\348\ The weight of the
evidence also indicates non-compete clauses have a negative impact on
new business formation and innovation.\349\ These harms are
significant. For example, with respect to consumer prices in the health
care sector alone, the Commission estimates health spending would
decrease by $148 billion annually due to the proposed rule.\350\
---------------------------------------------------------------------------
\347\ See supra Part II.B.2.a.
\348\ See supra Part II.B.2.b.
\349\ See supra Part II.B.2.c-d.
\350\ See infra Part VII.B.2.c.
---------------------------------------------------------------------------
In the Commission's preliminary view, the asserted benefits from
non-compete clauses do not outweigh these harms. In short, while there
is considerable evidence non-compete clauses harm both workers and
consumers, the evidence that non-compete clauses benefit workers or
consumers is scant.
As described above, the most common justification for non-compete
clauses is they increase employers' incentive to make productive
investments in, for example, trade secrets, customer lists, worker
training, and capital investment. There is evidence non-compete clauses
increase employee training and capital investment, as noted above.\351\
However, the considerable harms to workers and consumers are not
outweighed because an employer has some marginally greater ability to
protect trade secrets, customer lists, and other firm investments, or
because the worker is receiving increased training, or because the firm
has increased capital investments. If they were, workers would have
higher earnings when non-compete clauses are more readily available to
firms (i.e., when legal enforceability of non-compete clauses
increases) or prices for consumers would be lower. However, the
empirical economic literature shows workers generally have lower, not
higher, earnings when non-compete clause enforceability increases.
---------------------------------------------------------------------------
\351\ See supra Part II.B.2.e.
---------------------------------------------------------------------------
Moreover, the Commission is also not aware of any evidence these
potential benefits of non-compete clauses lead to reduced prices for
consumers. Indeed, the only empirical study of the effects of non-
compete clauses on consumer prices--in the health care sector--finds
increased final goods prices as the enforceability of non-compete
clauses increases.\352\ Furthermore, the Commission is not aware of any
evidence non-compete clauses reduce trade secret misappropriation or
the loss of other types of confidential information. The Commission's
understanding is there is little reliable empirical data on trade
secret theft and firm investment in trade secrets in general, and no
reliable data on how non-compete clauses affect these practices. The
Commission is also not aware of evidence that, in the three states in
which non-compete clauses are generally void, the inability to enforce
non-compete clauses has materially harmed workers or consumers in those
states.
---------------------------------------------------------------------------
\352\ See supra Part II.B.2.a.
---------------------------------------------------------------------------
As a result, the Commission preliminarily finds the asserted
benefits from non-compete clauses do not outweigh the harms. The
Commission seeks comment on this preliminary finding.
V. Section-by-Section Analysis
The Commission is proposing to create a new Subchapter J in Chapter
16 of the Code of Federal Regulations. Subchapter J would be titled
``Rules Concerning Unfair Methods of Competition.'' Within Subchapter
J, the Commission is proposing to create 16 CFR part 910--the Non-
Compete Clause Rule.\353\ The Commission describes each section of the
proposed rule below.
---------------------------------------------------------------------------
\353\ For ease of reference, this Part V refers to proposed 16
CFR part 910 as ``the Rule.''
---------------------------------------------------------------------------
Section 910.1 Definitions
Proposed Sec. 910.1 would contain definitions of terms that would
be used in the Rule.
1(a) Business Entity
Proposed Sec. 910.1(a) would define the term business entity. This
term would be used in proposed Sec. 910.3, which would contain an
exception for certain non-compete clauses. Under the exception, the
Rule would not apply to a non-compete clause entered into by a person
who is selling a business entity or otherwise disposing of all of the
person's ownership interest in the business entity, or by a person who
is selling all or substantially all of a business entity's operating
assets, when the person restricted by the non-compete clause is a
substantial owner of, or substantial member or substantial partner in,
the business entity at the time the person enters into the non-compete
clause. The proposed rule would also use the term business entity in
proposed Sec. 910.1(e), which would define substantial owner,
substantial member, or substantial partner as an owner, member, or
partner holding at least a 25% ownership interest in a business entity.
Proposed Sec. 910.1(a) would define the term business entity as a
partnership, corporation, association, limited
[[Page 3509]]
liability company, or other legal entity, or a division or subsidiary
thereof. The Commission is proposing to include divisions and
subsidiaries in the definition because it believes the exception in
proposed Sec. 910.3 should apply where a person is selling a division
or subsidiary of a business entity. The primary rationale for the sale-
of-a-business exception in proposed Sec. 910.3--that the exception may
help to protect the value of a business acquired by a buyer--would also
apply where a person is selling a division or subsidiary of a business
entity. Applying the sale-of-a-business exception where a person is
selling a division or subsidiary of a business entity would also be
consistent with many state laws that exempt non-compete clauses from
certain requirements when they are between the seller and buyer of a
business, including a division or subsidiary of the business.\354\
---------------------------------------------------------------------------
\354\ See, e.g., Cal. Bus. & Prof. Code sec. 16601; Mass. Gen.
Laws Ann. ch. 149, sec. 24L (definition of ``noncompetition
agreement''); R.I. Gen. Laws sec. 28-59-2(8)(iii).
---------------------------------------------------------------------------
The Commission seeks comment on proposed Sec. 910.1(a).
1(b) Non-Compete Clause
Proposed Sec. 910.1(b)(1) would define non-compete clause as a
contractual term between an employer and a worker that prevents the
worker from seeking or accepting employment with a person or operating
a business after the conclusion of the worker's employment with the
employer. The Commission believes this is a generally accepted
definition of the term non-compete clause.
Proposed Sec. 910.1(b)(1) would limit the coverage of the Rule to
non-compete clauses between employers and workers. The Rule would not
apply to other types of non-compete clauses--for example, non-compete
clauses between two businesses, where neither is a worker pursuant to
the Rule's definition of ``worker.'' \355\ While such non-compete
clauses would not be covered by the Rule, they would still be subject
to federal antitrust law and all other applicable law.
---------------------------------------------------------------------------
\355\ See proposed Sec. 910.1(f).
---------------------------------------------------------------------------
Furthermore, pursuant to proposed Sec. 910.1(b)(1), the Rule would
apply only to post-employment restraints--i.e., restrictions on what
the worker may do after the conclusion of the worker's employment with
the employer. The Rule would not apply to concurrent-employment
restraints--i.e., restrictions on what the worker may do during the
worker's employment.
Some non-compete clauses do not use language that expressly
prohibits a worker from competing against their employer, but instead
effect the same restriction by requiring workers to pay damages if they
compete against their employer. State courts generally view these
contractual terms as non-compete clauses.\356\ These contractual terms
would also be non-compete clauses under proposed Sec. 910.1(b)(1),
because they prevent a worker from seeking or accepting work with a
person or operating a business after the conclusion of the worker's
employment with the employer (unless the damages specified in the
contract are paid).
---------------------------------------------------------------------------
\356\ See, e.g., Wichita Clinic, P.A. v. Louis, 185 P.3d 946,
951 (Kan. Ct. App. 2008); Intermountain Eye & Laser Ctrs., 127 P.3d
121, 127 (Idaho 2005); BDO Seidman v. Hirshberg, 712 NE2d 1220,
1222-23 (N.Y. 1999).
---------------------------------------------------------------------------
Proposed Sec. 910.1(b)(2) would clarify the definition of non-
compete clause in proposed Sec. 910.1(b)(1) by explaining that whether
a contractual term is a non-compete clause for purposes of the Rule
would depend on a functional test. In other words, whether a
contractual term is a non-compete clause would depend not on what the
term is called, but how the term functions.
In addition to non-compete clauses, employers and workers enter
into many other types of covenants that restrict what a worker may do
after the worker leaves their job, including, among others, NDAs; non-
solicitation agreements; and TRAs.\357\ The definition of non-compete
clause would generally not include these types of covenants, because
these covenants generally do not prevent a worker from seeking or
accepting work with a person or operating a business after the
conclusion of the worker's employment with the employer. These other
types of covenants may affect the way a worker competes with their
former employer after the worker leaves their job. However, they do not
generally prevent a worker from competing with their former employer
altogether; and they do not generally prevent other employers from
competing for that worker's labor. For example, if a worker leaves
their job with their employer and goes to work for a competitor, an NDA
the worker signed with their employer may prevent the worker from
disclosing certain information to the competitor. However, a standard
NDA would not prevent the worker from seeking or accepting work with
the competitor.
---------------------------------------------------------------------------
\357\ See supra Part II.A.
---------------------------------------------------------------------------
The Commission is concerned, however, that some employers may seek
to evade the requirements of the Rule by implementing restrictive
employment covenants other than non-compete clauses that restrain such
an unusually large scope of activity that they are de facto non-compete
clauses. Under proposed Sec. 910.1(b)(2), such functional equivalents
would be non-compete clauses for purposes of the Rule, whether drafted
for purposes of evasion or not.
Courts have taken this approach when analyzing whether a
contractual term is a non-compete clause under state law. For example,
in Brown v. TGS Mgmt. Co., LLC, a California state court held an NDA
that defined confidential information ``so broadly as to prevent [the
plaintiff] from ever working again in securities trading'' operated as
a de facto non-compete clause and therefore could not be enforced under
California law, which generally prohibits enforcement of non-compete
clauses. The NDA in this case restrained a far broader scope of
activity than a typical NDA. For example, it defined ``confidential
information'' as any information that is ``usable in'' or ``relates
to'' the securities industry. As a result, the court concluded it
effectively prevented the worker from working in the securities
industry after his employment ended and was therefore a de facto non-
compete clause.\358\ Similarly, in Wegmann v. London, the U.S. Court of
Appeals for the Fifth Circuit concluded liquidated damages provisions
in a partnership agreement were de facto non-compete clauses ``given
the prohibitive magnitudes of liquidated damages they specify.'' \359\
---------------------------------------------------------------------------
\358\ 57 Cal. App. 5th 303, 306, 316-319 (Cal. Ct. App. 2020).
\359\ 648 F.2d 1072, 1073 (5th Cir. 1981).
---------------------------------------------------------------------------
The purpose of Sec. 910.1(b)(2) is to clarify that, if an employer
implements a restrictive covenant not called a ``non-compete clause''
but so unusually broad in scope it functions as such, the covenant
would be within the definition of non-compete clause in proposed Sec.
910.1(b)(1). Proposed Sec. 910.1(b)(2) would state that the term non-
compete clause includes a contractual term that is a de facto non-
compete clause because it has the effect of prohibiting the worker from
seeking or accepting work with a person or operating a business after
the conclusion of the worker's employment with the employer.
Proposed Sec. 910.1(b)(2) would also provide two examples of
contractual terms that may be de facto non-compete clauses. The first
example, based on Brown v. TGS Mgmt. Co., LLC, would be a non-
disclosure agreement between an employer and a worker written so
broadly it effectively precludes the worker from working in the same
field
[[Page 3510]]
after the conclusion of the worker's employment with the employer. The
second example, based on Wegmann v. London, would be a covenant between
an employer and a worker that requires the worker to pay the employer
or a third-party entity for training costs if the worker's employment
terminates within a specified time period, where the required payment
is not reasonably related to the costs the employer incurred for
training the worker.
The Commission stresses this list of examples would be a non-
exclusive list. Restrictive employment covenants other than NDAs and
TRAs may also constitute de facto non-compete clauses, depending on the
facts. In addition, NDAs and TRAs may constitute de facto non-compete
clauses under factual scenarios other than the scenarios outlined in
these examples.
The Commission seeks comment on proposed Sec. 910.1(b)(1) and (2).
In addition, the Commission is concerned that workplace policies
similar to non-compete clauses--such as a term in an employee handbook
stating workers are prohibited from working for competitors after their
employment ends--could potentially have negative effects similar to
non-compete clauses if workers believe they are binding, even if they
do not impose a contractual obligation. Therefore, the Commission also
seeks comment on whether non-compete clause should be defined not only
as a ``contractual term'' between an employer and a worker, but also as
a provision in a workplace policy.\360\
---------------------------------------------------------------------------
\360\ See, e.g., D.C. Code sec. 32-581.01(15).
---------------------------------------------------------------------------
1(c) Employer
The Rule would apply only to non-compete clauses between employers
and workers.\361\ Proposed Sec. 910.1(c) would define employer as a
person, as defined in 15 U.S.C. 57b-1(a)(6), that hires or contracts
with a worker to work for the person. 15 U.S.C. 57b-1(a)(6) defines
person as any natural person, partnership, corporation, association, or
other legal entity, including any person acting under color or
authority of state law. Thus, proposed Sec. 910.1(c) would effectively
define employer as any natural person, partnership, corporation,
association, or other legal entity, including any person acting under
color or authority of state law, that hires or contracts with a worker
to work for the person.
---------------------------------------------------------------------------
\361\ See proposed Sec. 910.1(b)(1).
---------------------------------------------------------------------------
A person, as defined in 15 U.S.C. 57b-1(a)(6), that hires or
contracts with a worker to work for the person would be an employer
under proposed Sec. 910.1(c) regardless of whether the person meets
another legal definition of employer, such as a definition in federal
or state labor law.
Some entities that would otherwise be employers may not be subject
to the Rule to the extent they are exempted from coverage under the FTC
Act. These entities include certain banks, savings and loan
institutions, federal credit unions, common carriers, air carriers and
foreign air carriers, and persons subject to the Packers and Stockyards
Act of 1921,\362\ as well as an entity that is not ``organized to carry
on business for its own profit or that of its members.'' \363\ Where an
employer is exempt from coverage under the FTC Act, the employer would
not be subject to the Rule.
---------------------------------------------------------------------------
\362\ 15 U.S.C. 45(a)(2).
\363\ 15 U.S.C. 44.
---------------------------------------------------------------------------
Furthermore, state and local government entities--as well as some
private entities--may not be subject to the Rule when engaging in
action protected by the state action doctrine. States are subject to
the antitrust laws.\364\ However, under the state action doctrine,
federal statutes do not limit the sovereign states' autonomous
authority over their own officers, agents, and policies in the absence
of clear congressional intent to do so.\365\ The key question is
whether the conduct at issue is ``compelled by direction of the state
acting as a sovereign.'' \366\ The state action doctrine may also be
invoked by private entities in certain limited scenarios--specifically,
where (1) the challenged restraint is clearly articulated as and
affirmatively expressed as state policy, and (2) the policy is actively
supervised by the state itself.\367\ Thus, some entities that would
otherwise be employers under proposed Sec. 910.1(c) may not be subject
to the Rule when engaging in action protected by the state action
doctrine. Where private entities are involved, this would likely
require a highly fact-specific inquiry.
---------------------------------------------------------------------------
\364\ Goldfarb v. Va. State Bar, 421 U.S. 773, 791-92 (1975).
\365\ Parker v. Brown, 317 U.S. 341, 350-51 (1943) (construing
the Sherman Act).
\366\ Goldfarb, 421 U.S. at 791.
\367\ Cal. Retail Liquor Dealers Ass'n v. Midcal Aluminum, Inc.,
445 U.S. 97, 105 (1980).
---------------------------------------------------------------------------
The Commission seeks comment on proposed Sec. 910.1(c).
1(d) Employment
The proposed rule would define the term non-compete clause as a
contractual term between an employer and a worker that prevents the
worker from seeking or accepting employment with a person, or operating
a business, after the conclusion of the worker's employment with the
employer. Proposed Sec. 910.1(d) would define employment as work for
an employer, as the term employer is defined in Sec. 910.1(c). This
proposed definition would clarify that an employment relationship
exists, for purposes of the Rule, regardless of whether an employment
relationship exists under another law, such as a federal or state labor
law. The Commission seeks comment on proposed Sec. 910.1(d).
1(e) Substantial Owner, Substantial Member, and Substantial Partner
The proposed rule would use the terms substantial owner,
substantial member, and substantial partner in proposed Sec. 910.3,
which would exempt certain non-compete clauses from coverage under the
Rule. This exception would only be available where the party restricted
by the non-compete clause is a substantial owner of, or substantial
member or substantial partner in, the business entity. Limiting the
exception to substantial owners, substantial members, and substantial
partners would ensure the exception is only available where the
seller's stake in the business is large enough that a non-compete
clause may be necessary to protect the value of the business acquired
by the buyer.
Proposed Sec. 910.1(e) would define substantial owner, substantial
member, and substantial partner as an owner, member, or partner holding
at least a 25% ownership interest in a business entity. The Commission
is proposing a threshold of 25% ownership interest because the
Commission believes the exception should be available where, for
example, a few entrepreneurs sharing ownership interest in a startup
sell their firm. In such a scenario, a non-compete clause may be
necessary to protect the value of the business acquired by the buyer.
For this reason, a threshold of, for example, 51% may be too high.
However, the Commission believes the exception should not be
available where the ownership interest in question is so small the
transfer of ownership interest would not be necessary to protect the
value of the business acquired by the buyer. For example, the exception
should not be available where a worker with a small amount of company
stock sells stock back to the company as part of a stock redemption
agreement when the worker's employment ends. The Commission believes a
25% threshold strikes the appropriate balance between a threshold that
may be too high (and would exclude many scenarios in which a non-
compete clause may be necessary to protect the value of the business
acquired by the buyer) and a threshold
[[Page 3511]]
that may be too low (and would allow the exception to apply more
broadly than is needed to protect such an interest).
Instead of establishing a threshold, the Rule could simply use the
terms substantial owner, substantial member, and substantial partner in
proposed Sec. 910.3 and leave the interpretation of those terms to
case-by-case adjudication. However, if the Rule does not define a
threshold, sellers of businesses may be unsure whether or not they are
substantial owners, substantial members, and substantial partners under
proposed Sec. 910.3. Defining a threshold would provide greater
clarity to the public and facilitate compliance with the Rule.
The Commission seeks comment on proposed Sec. 910.1(e).
1(f) Worker
The Rule would apply only to non-compete clauses between employers
and workers.\368\ Proposed Sec. 910.1(f) would define worker as a
natural person who works, whether paid or unpaid, for an employer.
Proposed Sec. 910.1(f) would further state the term worker includes,
without limitation, an employee, individual classified as an
independent contractor, extern, intern, volunteer, apprentice, or sole
proprietor who provides a service to a client or customer.
---------------------------------------------------------------------------
\368\ See proposed Sec. 910.1(b)(1).
---------------------------------------------------------------------------
As this definition states, the term worker would include not only
employees, but also individuals classified as independent contractors,
as well as other kinds of workers. Under proposed Sec. 910.1(f), the
term worker would include any natural person who works, whether paid or
unpaid, for an employer, without regard to whether the worker is
classified as an ``employee'' under the Fair Labor Standards Act (FLSA)
or any other statute that draws a distinction between ``employees'' and
other types of workers. Thus, gig economy workers such as rideshare
drivers would be considered workers for purposes of proposed Sec.
910.1(f).
The Commission is concerned that, if the Rule were to define
workers as ``employees'' according to, for example, the FLSA
definition, employers may misclassify employees as independent
contractors to evade the Rule's requirements. Furthermore, the
Commission has no reason to believe non-compete clauses that apply to
workers such as independent contractors or interns negatively affect
competitive conditions to a lesser degree than non-compete clauses that
apply to employees. Such non-compete clauses may, in fact, be more
harmful to competition, given that these other types of workers tend to
have shorter employment relationships. In addition, the Commission does
not believe employers have stronger business justifications for
applying non-compete clauses to independent contractors than they would
to employees.
Proposed Sec. 910.1(f) would also state the term worker does not
include a franchisee in the context of a franchisee-franchisor
relationship. The Commission believes that, in some cases, the
relationship between a franchisor and franchisee may be more analogous
to the relationship between two businesses than the relationship
between an employer and a worker. In addition, the evidentiary record
before the Commission relates primarily to non-compete clauses that
arise solely out of employment. The Commission has surveyed the
available evidence relating to non-compete clauses and is not aware of
research on the effects of applying additional legal restrictions to
non-compete clauses between franchisors and franchisees. Therefore, the
Commission believes it would be appropriate to clarify that a
franchisee--in the context of a franchisor-franchisee relationship--is
not a worker for purposes of proposed Sec. 910.1(f).
Proposed Sec. 910.1(f) would further clarify, however, the term
worker includes a natural person who works for the franchisee or
franchisor. In addition, proposed Sec. 910.1(f) would clarify non-
compete clauses between franchisors and franchisees would remain
subject to federal antitrust law as well as all other applicable law.
These laws include state laws that apply to non-compete clauses in the
franchise context. The Commission is not proposing to find that non-
compete clauses between franchisors and franchisees are beneficial to
competition.
The Commission seeks comment on proposed Sec. 910.1(f).
Section 910.2 Unfair Methods of Competition
2(a) Unfair Methods of Competition
Proposed Sec. 910.2(a) would state it is an unfair method of
competition for an employer to enter into or attempt to enter into a
non-compete clause with a worker; maintain with a worker a non-compete
clause; or represent to a worker that the worker is subject to a non-
compete clause where the employer has no good faith basis to believe
the worker is subject to an enforceable non-compete clause. In effect,
proposed Sec. 910.2(a) would categorically ban employers from using
non-compete clauses, because--as of the compliance date--employers
would be prohibited from maintaining pre-existing non-compete clauses
and entering into new non-compete clauses.\369\
---------------------------------------------------------------------------
\369\ However, employers could still use non-compete clauses
where they qualify for the exception in proposed Sec. 910.3 for
non-compete clauses between the seller and buyer of a business.
---------------------------------------------------------------------------
Part IV above explains the legal basis for the Commission's
preliminary determination that the practices listed in proposed Sec.
910.2(a) are unfair methods of competition. This section-by-section
analysis for proposed Sec. 910.2(a) describes how each of the three
prongs of proposed Sec. 910.2(a) would function and explains why the
Commission is proposing a categorical ban on non-compete clauses.
How Proposed Sec. 910.2(a) Would Function
Proposed Sec. 910.2(a) would prohibit an employer from entering
into or attempting to enter into a non-compete clause with a worker and
maintaining with a worker a non-compete clause. Proposed Sec. 910.2(a)
would use both the term ``enter into'' and the term ``maintain'' to
make clear it is an unfair method of competition for an employer to
either (1) enter into or attempt to enter into new non-compete clauses
as of the Rule's compliance date or (2) maintain pre-existing non-
compete clauses as of the compliance date. The Commission believes non-
compete clauses entered into before the compliance date implicate the
concerns described above in Part IV to the same degree as non-compete
clauses entered into as of the compliance date.\370\ As a result, the
Commission believes it would be appropriate to require employers to
rescind non-compete clauses entered into before the compliance date, as
well as to refrain from entering into or attempting to enter into new
non-compete clauses starting on the compliance date.
---------------------------------------------------------------------------
\370\ See supra Part IV (describing the reasons for the
Commission's preliminary determination that non-compete clauses
between employers and workers are an unfair method of competition).
---------------------------------------------------------------------------
Furthermore, requiring employers to rescind existing non-compete
clauses would not impose significant compliance costs, due to the safe
harbor in proposed Sec. 910.2(b)(3). Under this safe harbor, an
employer could comply with the requirement to rescind existing non-
compete clauses by providing notice to the affected workers. In
addition, proposed Sec. 910.2(b)(2)(C) would further reduce compliance
costs by providing language that would presumptively meet this notice
requirement.
[[Page 3512]]
Proposed Sec. 910.2(a) would prohibit an employer from attempting
to enter into a non-compete clause with a worker. An employer attempts
to enter a non-compete clause with a worker where, for example, the
employer provides the worker with the non-compete clause, but the
worker does not sign it. The Commission is concerned that attempting to
enter into a non-compete clause with a worker would have in terrorem
effects because, in this situation, the worker may still believe they
are subject to a non-compete clause even if they did not sign it. For
example, the worker may not recall whether they signed the non-compete
clause or may not realize they are not bound by the non-compete clause
unless they signed it.
Proposed Sec. 910.2(a) would also prohibit an employer from
representing to a worker that the worker is covered by a non-compete
clause where the employer has no good faith basis to believe the worker
is subject to an enforceable non-compete clause. Workers often lack
knowledge of whether employers may enforce non-compete clauses.\371\ In
addition, the available evidence indicates that, in states where non-
compete clause are void, workers are subject to non-compete clauses at
approximately the same rate as workers in other states, suggesting that
employers may believe workers are unaware of their legal rights.\372\
Because many workers lack knowledge of whether their employer may
enforce a non-compete clause under state law, they may also be unaware
of any final rule issued by the Commission prohibiting employers from
entering into or maintaining non-compete clauses. Employers may seek to
exploit this lack of awareness by representing to workers that they are
subject to a non-compete clause when they are not. This would likely
have an in terrorem effect on workers, causing them to refrain from
looking for work or taking another job, thereby furthering the adverse
effects on competition motivating this proposed rule. As a result, the
Commission believes it is appropriate for the Rule to prohibit
employers from representing to workers that they are covered by a non-
compete clause.
---------------------------------------------------------------------------
\371\ See Prescott & Starr, supra note 57 at 10-11.
\372\ See Starr, Prescott, & Bishara, supra note 42 at 81.
---------------------------------------------------------------------------
In addition, workers--particularly low-income workers--may lack
resources to litigate against their employers. As a result, mere
threats to enforce a non-compete clause may deter workers from looking
for work with a competitor or starting their own business, which would
result in the anticompetitive effects described above in Part IV.A.
Under this ``representation'' prong of proposed Sec. 910.2(a), an
employer would be prohibited from, among other things, threatening to
enforce a non-compete clause against a worker; advising a worker that,
due to a non-compete clause, they should not pursue a particular job
opportunity; or simply telling the worker that the worker is covered by
a non-compete clause. However, under proposed Sec. 910.2(a), this
prohibition on representation would only apply where the employer has
no good faith basis to believe the worker is subject to an enforceable
non-compete clause. Proposed Sec. 910.2(a) includes this ``no good
faith basis'' exception to ensure the representation prong is
consistent with the First Amendment. The Supreme Court has held ``there
can be no constitutional objection to the suppression of commercial
messages that do not accurately inform the public about lawful
activity.'' \373\ Accordingly, ``[t]he government may ban forms of
communication more likely to deceive the public than to inform it, or
commercial speech related to illegal activity.'' \374\ A rule that
prohibits an employer from representing to a worker that the worker is
subject to a non-compete clause--where the employer has no good faith
basis to believe that the worker is subject to an enforceable non-
compete clause--would meet this test because, under such circumstances,
an employer would be making a false claim and asserting an illegal
restraint on worker activity. An employer would have no good faith
basis to believe that a worker is subject to an enforceable non-compete
clause where non-compete clauses are not enforceable in the relevant
state or where the validity of the Rule--which would prohibit employers
from maintaining or entering into non-compete clauses--has been
adjudicated and upheld.
---------------------------------------------------------------------------
\373\ Cent. Hudson Gas & Elec. v. Pub. Serv. Comm'n of N.Y., 447
U.S. 557, 563 (1980).
\374\ Id. at 563-64.
---------------------------------------------------------------------------
Proposed Sec. 910.2(a) would not apply retroactively. An employer
would not violate proposed Sec. 910.2(a) where--prior to the
compliance date--it entered into or attempted to enter into a non-
compete clause with a worker; maintained with a worker a non-compete
clause; or represented to a worker that the worker is subject to a non-
compete clause. Instead, proposed Sec. 910.2(a) would require
employers to refrain from these practices starting on the compliance
date.
Why the Commission Is Proposing a Categorical Ban on Non-Compete
Clauses
Except for certain non-compete clauses between the seller and buyer
of a business,\375\ the proposed rule would categorically ban employers
from using non-compete clauses with workers. The proposed rule would
prohibit an employer from using a non-compete clause with any of its
workers, without regard to the worker's earnings or job function.
---------------------------------------------------------------------------
\375\ See proposed Sec. 910.3.
---------------------------------------------------------------------------
The Commission is proposing a categorical ban on non-compete
clauses because, fundamentally, non-compete clauses obstruct labor
market competition through a similar mechanism for all workers. Non-
compete clauses block workers in a labor market from switching to jobs
in which they would be better paid and more productive. This harms
workers who are subject to non-compete clauses. This also harms other
workers in the labor market, since jobs that may be better matches for
those workers are filled by workers who are unable to leave their jobs
due to non-compete clauses.\376\ And this harms other firms and
potential entrants into the market, who have a more limited pool of
workers from which to hire. Regardless of a worker's income or job
status, non-compete clauses block workers from switching to jobs in
which they would be better paid and more productive--restricting the
opportunities of all workers in that labor market.
---------------------------------------------------------------------------
\376\ See supra Part II.B.1.
---------------------------------------------------------------------------
The available data do not allow the Commission to estimate earnings
effects for every occupation. However, the evidentiary record indicates
non-compete clauses depress wages for a wide range of subgroups of
workers across the spectrum of income and job function--from hourly
workers to highly paid, highly skilled workers such as executives. The
Commission therefore estimates the proposed rule would increase
earnings for workers in all of the subgroups of the labor force for
which sufficient data is available.\377\ Excluding these workers from
the proposed rule would deny these workers the benefits of higher
earnings through increased competition in the market for their labor.
---------------------------------------------------------------------------
\377\ See infra Part VII.B.1.a.
---------------------------------------------------------------------------
The Commission recognizes there are compelling reasons for banning
non-compete clauses that apply more strongly to lower-wage workers.
Non-
[[Page 3513]]
compete clauses for lower-wage workers--such as sandwich shop workers,
warehouse workers, or security guards \378\--may be more likely than
non-compete clauses for higher-wage workers to be exploitative and
coercive at the time of contracting and at the time of the worker's
potential departure from the employer.\379\ In addition, the most
commonly cited justifications for non-compete clauses appear
particularly weak when applied to relatively lower-wage workers, to the
extent such workers are less likely to have access to trade secrets or
confidential information.\380\
---------------------------------------------------------------------------
\378\ See supra Part II.A (listing illustrative examples of non-
compete clauses).
\379\ See infra Part IV.A.1.b-c.
\380\ See supra Part IV.B (describing the most commonly cited
justifications for non-compete clauses).
---------------------------------------------------------------------------
The Commission believes there are also compelling reasons for
banning non-compete clauses that apply more strongly to highly paid or
highly skilled workers such as senior executives. As described above,
the weight of the available evidence indicates non-compete clauses
negatively affect new business formation, innovation, and the ability
of competitors to hire skilled workers.\381\ Non-compete clauses for
highly paid or highly skilled workers such as senior executives may be
contributing more to these harms than non-compete clauses for some
other workers, to the extent such workers may be likely to start
competing businesses, be hired by potential entrants or competitors, or
develop innovative products and services. Non-compete clauses for
highly paid or highly skilled workers such as senior executives may
also block potential entrants, or raise their costs, to a high degree,
because such workers are likely to be in high demand by potential
entrants. As a result, prohibiting non-compete clauses for highly paid
or highly skilled workers such as senior executives may have relatively
greater benefits for consumers than prohibiting non-compete clauses for
other workers.
---------------------------------------------------------------------------
\381\ See supra Part II.B.2.b-d.
---------------------------------------------------------------------------
For these reasons, the Commission preliminarily believes a
categorical ban on non-compete clauses would best achieve the objective
of the proposed rule, which is to remedy the adverse effects of non-
compete clauses on competition in labor markets and product and service
markets. However, the Commission also believes several alternatives to
a categorical ban may also accomplish the objectives of the proposed
rule to some degree, including different standards for senior
executives. These alternatives are described in detail in Part VI.
The Commission seeks comment on proposed Sec. 910.2(a).
2(b) Existing Non-Compete Clauses
Proposed Sec. 910.2(b) would clarify employers' obligations, and
impose additional requirements, related to non-compete clauses entered
into by the employer prior to the compliance date (``existing non-
compete clauses'').
2(b)(1) Rescission Requirement
Proposed Sec. 910.2(b)(1) would state that, to comply with
proposed Sec. 910.2(a)--which states it is an unfair method of
competition for an employer to maintain with a worker a non-compete
clause--an employer that entered into a non-compete clause with a
worker prior to the compliance date must rescind the non-compete clause
no later than the compliance date. The reasons why the Commission is
proposing this rescission requirement are described above in the
section-by-section analysis for proposed Sec. 910.2(a).
The requirements in Sec. 910.2(b)(1)-(3) do not apply where a
worker's obligation not to compete elapsed prior to the compliance
date. This is because the requirements in Sec. 910.2(b)(1)-(3) derive
from Sec. 910.2(a), which establishes it is an unfair method of
competition to maintain with a worker a non-compete clause. An employer
does not maintain with a worker a non-compete clause, in violation of
the Rule, where the obligation not to compete elapsed prior to the
compliance date. For example, if a worker left their job in 2019 and
was subject to a two-year obligation not to compete, that obligation
would have elapsed in 2021, and the employer would not violate the Rule
by failing to rescind the non-compete clause.
The Commission seeks comment on proposed Sec. 910.2(b)(1).
2(b)(2) Notice Requirement
Proposed Sec. 910.2(b)(2) would require that the employer provide
notice to a worker that the worker's non-compete clause has been
rescinded. Proposed Sec. 910.2(b)(2) would have three subparagraphs
that would impose various requirements related to the notice.
First, proposed Sec. 910.2(b)(2)(A) would state that an employer
that rescinds a non-compete clause pursuant to Sec. 910.2(b)(1) must
provide notice to the worker that the worker's non-compete clause is no
longer in effect and may not be enforced against the worker. Proposed
Sec. 910.2(b)(2)(A) would contain a notice requirement because the
Commission believes the available evidence indicates that many workers
are not aware of the applicable law governing non-compete clauses or
their rights under those laws.\382\ As a result, if the Commission were
to issue a final Non-Compete Clause Rule, many workers who had entered
into non-compete clauses may be unaware that, due to the Rule, their
employer is no longer permitted to maintain the non-compete clause. As
a result, these workers may continue to refrain from leaving their job
to work for a competitor or start their own business. This would
negatively affect competitive conditions in the same manner the
Commission is concerned about.\383\ A notice requirement would help
address this concern by ensuring workers are informed that their non-
compete clause is no longer in effect and may not be enforced against
them.
---------------------------------------------------------------------------
\382\ See Prescott & Starr, supra note 57 at 10-11.
\383\ See supra Part IV.A.1.a.
---------------------------------------------------------------------------
Proposed Sec. 910.2(b)(2)(A) would state further that the employer
must provide the notice to the worker in an individualized
communication. As such, an employer could not satisfy the notice
requirement by, for example, posting a notice at the employer's
workplace that workers' non-compete clauses are no longer in effect.
Proposed Sec. 910.2(b)(2)(A) would also state that the employer must
provide the notice on paper or in a digital format such as, for
example, an email or text message. As such, a notice communicated
orally would not meet the notice requirement. Allowing employers to
provide the notice in a digital format would also reduce compliance
costs for employers. Proposed Sec. 910.2(b)(2)(A) would also require
the employer to provide the notice to the worker within 45 days of
rescinding the non-compete clause.
Second, proposed Sec. 910.2(b)(2)(B) would state that the employer
must provide the notice to a worker who currently works for the
employer. The Commission believes that most employers have contact
information available for their current workers and can use this
contact information to provide the notice.
Proposed Sec. 910.2(b)(2)(B) would also state that the employer
must provide the notice to a worker who formerly worked for the
employer, provided that the employer has the worker's contact
information readily available. Providing the notice to former workers
may be even more vital than providing the notice to current workers
because former workers may be refraining actively from competitive
activity because they believe they are subject to
[[Page 3514]]
a non-compete clause. However, employers may not have contact
information readily available for all former workers. Proposed Sec.
910.2(b)(2)(B) would therefore require employers to provide the notice
to former workers only where the employer has the worker's contact
information readily available. The Commission believes that this
requirement would strike the appropriate balance between providing
notice to affected workers and minimizing compliance costs for
employers.
Third, proposed Sec. 910.2(b)(2)(C) would provide model language
that would satisfy the requirement in proposed Sec. 910.2(b)(2)(A)
that the employer ``provide notice to the worker that the worker's non-
compete clause is no longer in effect and may not be enforced against
the worker.'' The model language is designed to communicate the
relevant information in a simple and straightforward manner. Proposed
Sec. 910.2(b)(2)(C) would also clarify that an employer may also use
language that is different from the model language, provided that the
language communicates to the worker that the worker's non-compete
clause is no longer in effect and may not be enforced against the
worker. Proposed Sec. 910.2(b)(2)(C) would reduce compliance costs and
increase compliance certainty for employers by providing employers with
model language they could use, while simultaneously providing employers
with the flexibility to use other language that would communicate the
required information.
The Commission seeks comment on proposed Sec. 910.2(b)(2)(A)-(C).
2(b)(3) Safe Harbor
Proposed Sec. 910.2(b)(3) would contain a safe harbor for
compliance with the rescission requirement in proposed Sec.
910.2(b)(1). Proposed Sec. 910.2(b)(3) would state that an employer
complies with the rescission requirement described in Sec. 910.2(b)(1)
where it provides notice to a worker pursuant to Sec. 910.2(b)(2).
Consequently, to comply with the rescission requirement for purposes of
the Rule, an employer could simply send a notice to a worker that is
compliant with proposed Sec. 910.2(b)(2). An employer that does so
would not need to take any other steps to comply with the rescission
requirement in proposed Sec. 910.2(b)(1). The Commission believes that
this safe harbor would strike an appropriate balance between ensuring
that workers receive adequate notice of their rights under the Non-
Compete Clause Rule and minimizing compliance costs for employers.
The Commission seeks comment on proposed Sec. 910.2(b)(3).
Section 910.3 Exception
Proposed Sec. 910.3 would exempt certain non-compete clauses
between the seller and buyer of a business from coverage under the
Rule. Proposed Sec. 910.3 would state that the requirements of the
Rule shall not apply to a non-compete clause that is entered into by a
person who is selling a business entity or otherwise disposing of all
of the person's ownership interest in the business entity, or by a
person who is selling all or substantially all of a business entity's
operating assets, when the person restricted by the non-compete clause
is a substantial owner of, or substantial member or substantial partner
in, the business entity at the time the person enters into the non-
compete clause. Proposed Sec. 910.3 would also clarify that non-
compete clauses covered by this exception would remain subject to
federal antitrust law as well as all other applicable law.
The exception in proposed Sec. 910.3 would apply only in a narrow
set of circumstances. The Rule, as a whole, would only apply to non-
compete clauses between employers and workers.\384\ As a result, the
exception in proposed Sec. 910.3 would apply only where the party
restricted by the non-compete clause is a worker (for example, where
the seller of a business is going to work for the acquiring business).
Where the person restricted by the non-compete clause is not a worker,
the Rule would not apply as an initial matter.
---------------------------------------------------------------------------
\384\ See proposed Sec. 910.1(b).
---------------------------------------------------------------------------
The Commission is proposing the exception in Sec. 910.3 because
non-compete clauses between the seller and buyer of a business may be
unique in certain respects from non-compete clauses arising solely out
of employment. Specifically, non-compete clauses between the seller and
buyer of a business may be distinct from non-compete clauses that arise
solely out of employment because they may help protect the value of the
business acquired by the buyer.
This view is consistent with the law of the majority of the states,
under which non-compete clauses between the seller and buyer of a
business are treated differently from non-compete clauses arising
solely out of employment. For example, while non-compete clauses are
generally void in California, North Dakota, and Oklahoma, each of these
three states exempts non-compete clauses between the seller and buyer
of a business from this general rule.\385\ In the majority of the 47
states that enforce non-compete clauses under some circumstances, non-
compete clauses between sellers and buyers of businesses are reviewed
under a more lenient standard than non-compete clauses that arise
solely out of employment.\386\ A frequently cited reason for this
difference in treatment is that such non-compete clauses implicate an
additional interest relative to non-compete clauses that arise solely
out of employment: they protect the value of the business acquired by
the buyer.\387\ If non-compete clauses between the seller and buyer of
a business help protect the value of the business acquired by the
buyer, restricting these types of non-compete clauses could potentially
affect business acquisitions, including the incentives of various
market actors to start, sell, or buy businesses.
---------------------------------------------------------------------------
\385\ Cal. Bus. & Prof. Code sec. 16601; N.D. Cent. Code sec. 9-
08-06(1); Okla. Stat. Ann. tit. 15, secs. 218 (sale of a business)
and 219 (dissolution of a partnership).
\386\ See, e.g., Fla. Stat. Ann. sec. 542.335(1)(d); Hess
Newmark Owens Wolf, Inc. v. Owens, 415 F.3d 630, 634 (7th Cir.
2005); Jiffy Lube Int'l, Inc. v. Weiss Bros., Inc., 834 F. Supp.
683, 691 (D.N.J. 1993).
\387\ See, e.g., Strategix, Ltd. v. Infocrossing West, Inc., 142
Cal. App. 4th 1068, 1072-73 (Cal. Ct. App. 4th 2006); Reed Mill &
Lumber Co., 165 P.3d at 736; Bybee, 178 P.3d at 622.
---------------------------------------------------------------------------
The Commission further notes that the evidentiary record described
above in Part II.B relates primarily to non-compete clauses that arise
solely out of employment. Unlike non-compete clauses that arise solely
out of employment, there has been little empirical research on the
prevalence of non-compete clauses between the seller and buyer of a
business. The Commission is also not aware of empirical research on the
economic effects of applying additional legal restrictions to these
types of non-compete clauses. In part, this is because all states
permit non-compete clauses between buyers and sellers of businesses to
some degree, and because the laws that apply to these types of non-
compete clauses have seen fewer changes recently than the laws that
apply to non-compete clauses that arise solely out of employment. As a
result, there have been few natural experiments that allow researchers
to assess how restricting these types of non-compete clauses may affect
competition, including any effects on business acquisitions.
For these reasons, the Commission believes it may be appropriate to
exempt non-compete clauses between the seller
[[Page 3515]]
and buyer of a business from coverage under the Rule. Proposed Sec.
910.3 would clarify, however, that these non-compete clauses would
remain subject to federal antitrust law and all other applicable law,
including state law requiring non-compete clauses to be tailored to
protect a legitimate business interest and to be limited in duration,
geographic area, and the scope of activity prohibited.
Exempting non-compete clauses between the seller and buyer of a
business from coverage under the Rule would not represent a finding
that such non-compete clauses are beneficial to competition. It would
simply reflect the Commission's view that it would be appropriate to
tailor the Rule to non-compete clauses that arise solely out of
employment--given that non-compete clauses between the seller and buyer
of a business may implicate unique interests and have unique effects,
and that the evidentiary record does not permit the Commission to
assess these potential effects as thoroughly as the potential effects
of restricting non-compete clauses that arise solely out of employment.
The exception in proposed Sec. 910.3 would only apply where the
seller of the business is a substantial owner of, or substantial member
or substantial partner in, the business at the time the person enters
into the non-compete clause. Proposed Sec. 910.1(e) would define
substantial owner, substantial member, or substantial partner as an
owner, member, or partner holding at least a 25% ownership interest in
a business entity. The exception would therefore not allow non-compete
clauses to be applied to a business's workers in connection with the
sale of a business, where those workers are not substantial owners,
members, or partners. The reasons for this proposed 25% threshold are
described above in the section-by-section analysis for proposed Sec.
910.1(e).
The Commission seeks comment on proposed Sec. 910.3.
Section 910.4 Relation to State Laws
The Supremacy Clause of the U.S. Constitution provides that the
Constitution, and the laws of the United States made pursuant to the
Constitution, ``shall be the supreme Law of the Land.'' \388\ Hence,
federal law preempts any state law that conflicts with the exercise of
federal power.\389\ Such conflict preemption occurs either ``where it
is impossible for a private party to comply with both state and federal
law'' or where state law ``stands as an obstacle to the accomplishment
and execution of the full purposes and objectives of Congress.'' \390\
Congressional intent to preempt state law can be expressed in the
statutory language itself (express preemption) or implied in the
structure and purpose of federal law (implied preemption).\391\ Federal
regulations ``have no less pre-emptive effect than federal statutes,''
\392\ and agencies themselves, implementing federal statutes, can
expressly preempt conflicting state laws and regulations.\393\
---------------------------------------------------------------------------
\388\ U.S. Const. art. VI, cl. 2.
\389\ Fid. Fed. Sav. & Loan Ass'n v. de la Cuesta, 458 U.S. 141,
153 (1982) (citing roots in the Supremacy Clause); McCulloch v. Md.,
U.S. Supreme Court, 4 Wheat 159 (1819) (citing the Supremacy Clause
and the Necessary and Proper Clause (Article I, Section 8, clause
18)).
\390\ Crosby v. Nat'l Foreign Trade Council, 530 U.S. 363, 372-
73 (2000).
\391\ Cipollone v. Liggett Grp., Inc., 505 U.S. 504, 516 (1992);
Jones v. Rath Packing Co., 430 U.S. 519, 525 (1977).
\392\ Fid. Fed. Sav. & Loan Ass'n, 458 U.S. at 153.
\393\ Id.; see also U.S. v. Shimer, 367 U.S. 374, 383 (1961).
---------------------------------------------------------------------------
In some instances, a federal law may fully preempt contrary state
laws. In others, federal law may impliedly or expressly respect the
continuing and concurrent exercise of state power, thus setting a
regulatory ``floor'' but not a ``ceiling.'' \394\ The Commission notes
that ``Congress intended the federal antitrust laws to supplement, not
displace, state antitrust remedies.'' \395\
---------------------------------------------------------------------------
\394\ See, e.g., Oneok, Inc. v. Learjet, Inc., 575 U.S. 373,
384-85 (2015).
\395\ Cal. v. ARC Am. Corp., 490 U.S. 93, 102 (1989).
---------------------------------------------------------------------------
The proposed rule would contain an express preemption provision.
Proposed Sec. 910.4 would provide that the Rule shall supersede any
state statute, regulation, order, or interpretation to the extent that
such statute, regulation, order, or interpretation is inconsistent with
the Rule.\396\ Proposed Sec. 910.4 would further provide that a state
statute, regulation, order, or interpretation is not inconsistent with
the provisions of the Rule if the protection such statute, regulation,
order, or interpretation affords any worker is greater than the
protection provided under the Rule.
---------------------------------------------------------------------------
\396\ In this Part V, we refer to state statutes, regulations,
orders, or interpretations as ``state laws'' for ease of reference.
---------------------------------------------------------------------------
This preemption provision would reflect the Commission's intent
that the Non-Compete Clause Rule establish a regulatory floor, not a
ceiling. Under the proposed preemption provision, state laws that are
inconsistent with the Rule would be preempted. One example would be a
state law providing that an employer may enforce a non-compete clause
against a worker where the non-compete clause is tailored to a
legitimate business interest and reasonably limited in duration,
geographic area, and scope of activity prohibited. Such a law would be
inconsistent with proposed Sec. 910.2(a), which would state that it is
an unfair method of competition--and therefore a violation of Section 5
of the FTC Act--for an employer to enter into, attempt to enter into,
or maintain a non-compete clause with a worker. Under proposed Sec.
910.4, proposed Sec. 910.2(a) would preempt the contrary state law to
the extent that it conflicts with proposed Sec. 910.2(a).
However, under the second sentence of proposed Sec. 910.4, a state
law would not conflict with the provisions of the Rule if the state law
afforded greater protection to the worker than the protection provided
under the Rule. For example, as noted above, proposed Sec. 910.3 would
exempt certain non-compete clauses between the seller and buyer of a
business from coverage under the Rule. If a state were to prohibit
employers from entering into, attempting to enter into, or maintaining
all non-compete clauses--including non-compete clauses between the
seller and buyer of a business--an employer could comply with both the
state law and the Rule by not entering into, attempting to enter into,
or maintaining non-compete clauses between the seller and buyer of a
business.
The Commission seeks comment on proposed Sec. 910.4.
Section 910.5 Compliance Date
The proposed rule would establish a separate effective date and
compliance date. Under proposed Sec. 910.5, the proposed rule's
effective date would be the date that is 60 days after the final rule
is published in the Federal Register. The proposed rule's compliance
date would be the date that is 180 days after the final rule is
published in the Federal Register. In this NPRM, the Commission refers
to the 180-day period between the publication of the final rule and the
compliance date as the ``compliance period.''
Compliance With Sec. 910.2(a). The Commission expects that
employers would need to undertake the following two types of tasks
during the compliance period to be prepared to comply with Sec.
910.2(a) starting on the compliance date. First, starting on the
compliance date, employers would be prohibited from maintaining
existing non-compete clauses (i.e., non-compete clauses that the
employer entered into with a worker prior to the compliance
[[Page 3516]]
date).\397\ As a result, during the compliance period, an employer
would need to assess whether to implement replacements for existing
non-compete clauses, such as NDAs; draft those covenants; and then
negotiate and enter into those covenants with the relevant workers.
Second, an employer would be prohibited from entering into new non-
compete clauses starting on the compliance date.\398\ As a result,
during the compliance period, employers would need to, for example,
remove any non-compete clauses from employment contracts that they
provide to new workers. The Commission believes that 180 days--or
approximately six months--would be enough time for employers to
accomplish each of these two tasks.
---------------------------------------------------------------------------
\397\ See proposed Sec. 910.2(a).
\398\ Id.
---------------------------------------------------------------------------
Compliance With Sec. 910.2(b)(1)-(3). To comply with Sec.
910.2(b)(1)-(3) starting on the compliance date, an employer would be
required to rescind, no later than the compliance date, any non-compete
clauses that it entered into prior to the compliance date.\399\ Where
an employer rescinds a non-compete clause, the employer would be
required to provide notice to the worker that the worker's non-compete
clause is no longer in effect and may not be enforced against the
worker.\400\ This notice may be provided in a digital format, such as
an email or text message.\401\ The Rule would require the employer to
provide the notice to the worker within 45 days of rescinding the non-
compete clause.\402\ Employers would be required to provide the notice
to current workers, as well as former workers where the employer has
the former worker's contact information readily available.\403\ To
reduce compliance costs, the Rule would provide model language that
employers may use for the notice.\404\ However, employers would have
the flexibility to use language other than the model language, provided
that it communicates to the worker that the worker's non-compete clause
is no longer in effect and may not be enforced against the worker.\405\
The Rule would also provide a safe harbor that would allow an employer
to comply with the Rule's rescission requirement by providing a
compliant notice.\406\ The Commission believes that this would
significantly reduce compliance costs. The Commission believes that the
180-day compliance period would provide employers with sufficient time
to prepare to rescind existing non-compete clauses no later than the
compliance date.
---------------------------------------------------------------------------
\399\ See proposed Sec. 910.2(b)(1).
\400\ See proposed Sec. 910.2(b)(2)(A)-(C).
\401\ See proposed Sec. 910.2(b)(2)(A).
\402\ Id.
\403\ Id.
\404\ See proposed Sec. 910.2(b)(2)(C).
\405\ Id.
\406\ See proposed Sec. 910.2(b)(3).
---------------------------------------------------------------------------
The Commission is proposing an effective date of 60 days after
publication of the final rule in the Federal Register because it
expects that the final rule would likely be a major rule under the
Congressional Review Act (CRA). Under the CRA, a ``major rule'' may not
take effect fewer than 60 days after the rule is published in the
Federal Register.\407\ The CRA further states that a rule is a ``major
rule'' if it has an annual effect on the economy of $100 million or
more.\408\ The Commission believes that the impacts of the proposed
rule, if finalized, would be large enough that the final rule would be
a major rule under the CRA.\409\
---------------------------------------------------------------------------
\407\ 5 U.S.C. 801(a)(3)(A).
\408\ 5 U.S.C. 804(2).
\409\ See infra Part VII (analyzing the costs and benefits of
the proposed rule).
---------------------------------------------------------------------------
The Commission seeks comment on proposed Sec. 910.5.
VI. Alternatives to the Proposed Rule
In this Part VI, the Commission describes alternatives to the
proposed rule.\410\ This Part VI addresses the alternatives related to
the rule's fundamental design. These alternatives flow from two key
questions: (1) whether the rule should impose a categorical ban on non-
compete clauses or a rebuttable presumption of unlawfulness, and (2)
whether the rule should apply uniformly to all workers or whether there
should be exemptions or different standards for different categories of
workers. The different permutations of the answers to each of these
questions yield the different alternatives for the rule's fundamental
design.
---------------------------------------------------------------------------
\410\ The Commission intends for this Part VI to satisfy the
requirements in Section 22 of the FTC Act that, in an NPRM, the
Commission issue a preliminary regulatory analysis that shall
contain ``a description of any reasonable alternatives to the
proposed rule which may accomplish the stated objective of the rule
in a manner consistent with applicable law'' and ``a preliminary
analysis of the effectiveness of the proposed rule and each
alternative in meeting the stated objectives of the proposed rule.''
15 U.S.C. 57b-3(b)(1)(B)-(C).
---------------------------------------------------------------------------
This Part VI does not generally address alternatives related to the
design of specific regulatory provisions. For example, proposed Sec.
910.1(e) defines a substantial owner, substantial member, or
substantial partner as an owner, member, or partner holding at least a
25% ownership interest in a business entity. In a final rule, the
Commission could set this standard at a different percentage level--for
example, 50% or 10%. The Commission seeks comment on these types of
granular questions not in this Part VI, but in the section-by-section
analysis for the relevant provision in Part V above.
A. Two Key Dimensions of Alternatives
In Part IV above, the Commission preliminarily finds that the use
of non-compete clauses by employers is an ``unfair'' method of
competition under Section 5. For workers who are not senior executives,
the Commission preliminarily finds that non-compete clauses are
``unfair'' under Section 5 in three independent ways. First, the use by
employers of non-compete clauses is restrictive conduct that negatively
affects competitive conditions. Second, non-compete clauses are
exploitative and coercive at the time of contracting while burdening a
not insignificant volume of commerce. Third, non-compete clauses are
exploitative and coercive at the time of the worker's potential
departure from the employer while burdening a not insignificant volume
of commerce.\411\
---------------------------------------------------------------------------
\411\ See supra Part IV.A.1. The Commission also preliminarily
finds that non-compete clauses are a ``method of competition.'' See
supra Part IV.A.2.
---------------------------------------------------------------------------
For workers who are senior executives, the Commission preliminarily
finds that the use by employers of non-compete clauses is ``unfair''
under Section 5 because such non-compete clauses are restrictive
conduct that negatively affects competitive conditions. Indeed, as
described above in Part IV.A.1.a.ii, the Commission preliminarily
believes that non-compete clauses for senior executives may harm
competition in product markets in unique ways. (The second and third
preliminary findings described above--that non-compete clauses are
exploitative and coercive at the time of contracting and at the time of
a worker's potential departure--do not apply to senior executives.) In
Part IV, the Commission seeks comment on whether this different
unfairness analysis should also apply to highly paid or highly skilled
workers who are not senior executives.
The objective of the proposed rule is to remedy these adverse
effects from the use of non-compete clauses. The proposed rule would
seek to accomplish this objective by prohibiting an employer from
entering into or attempting to enter into a non-compete clause with a
worker; maintaining with a worker a non-compete clause; and, under
certain circumstances,
[[Page 3517]]
representing to a worker that the worker is subject to a non-compete
clause.\412\
---------------------------------------------------------------------------
\412\ See proposed Sec. 910.2(a). For ease of reference, this
Part VI employs the term ``use of non-compete clauses'' to refer to
the specific conduct that the proposed rule would prohibit.
---------------------------------------------------------------------------
The proposed rule would ban non-compete clauses categorically, with
a limited exception for certain non-compete clauses between the seller
and buyer of a business.\413\ In Part V, the Commission explains why it
is proposing a categorical ban on non-compete clauses.\414\
---------------------------------------------------------------------------
\413\ See proposed Sec. 910.3. As described in Part V (in the
section-by-section analysis for proposed Sec. 910.1(c)), the
proposed rule would also not apply to employers to the extent they
are exempt under Section 5(a)(2) of the FTC Act, and the proposed
rule may not apply under certain circumstances due to the state
action doctrine.
\414\ See supra Part V, in the section-by-section analysis for
proposed Sec. 910.2(a).
---------------------------------------------------------------------------
There are two key dimensions of alternatives related to the rule's
fundamental design. First, instead of a categorical ban, the Commission
could adopt a rebuttable presumption of unlawfulness. Under this
approach, it would be presumptively unlawful for an employer to use a
non-compete clause, but the use of a non-compete clause would be
permitted if the employer could meet a certain evidentiary burden,
based on a standard that would be articulated in the rule. Second,
instead of applying to all workers uniformly, the Rule could include
exemptions or different standards for different categories of workers.
These exemptions or different standards could be based on a worker's
job functions, earnings, another factor, or some combination of
factors.
1. Categorical Ban vs. Rebuttable Presumption
The Commission could adopt a rebuttable presumption of unlawfulness
instead of a categorical ban. Under this approach, it would be
presumptively unlawful for an employer to use a non-compete clause.
However, the use of a non-compete clause would be permitted if the
employer could meet a certain evidentiary burden, based on a standard
that would be articulated in the rule. The rationale behind this
approach would be that prohibiting employers from using non-compete
clauses is an appropriate default rule in light of the adverse effects
on competition from their use in the aggregate; however, there may be
specific sets of facts under which their use may be justified, so it
would be appropriate to permit employers to use them in those cases.
Conceptually, the rebuttable presumption approach would be similar
to ``quick look'' analysis under antitrust law. In antitrust cases,
most restraints are analyzed under the rule of reason, which entails an
intensive, fact-specific assessment of market power and market
structure to determine a restraint's actual effect on competition.\415\
However, where ``the great likelihood of anticompetitive effects can be
easily ascertained,'' a court may also adopt a truncated, or ``quick
look,'' rule of reason analysis.\416\ Courts apply quick look analysis
where, ``based upon economic learning and the experience of the market,
it is obvious that a restraint of trade likely impairs competition.''
\417\ In such cases, ``the restraint is presumed unlawful and, in order
to avoid liability, the defendant must either identify some reason the
restraint is unlikely to harm consumers or identify some competitive
benefit that plausibly offsets the apparent or anticipated harm.''
\418\ A rebuttable presumption in the Rule would mirror this approach.
Non-compete clauses would be presumed unlawful, based on the ``economic
learning and experience of the market'' summarized in Part IV above,
but the use of a non-compete clause would be permitted if the employer
could make a showing that satisfies a certain standard.
---------------------------------------------------------------------------
\415\ See, e.g., Am. Express Co., 138 S. Ct. at 2284.
\416\ See, e.g., Calif. Dental Ass'n v. Fed. Trade Comm'n, 526
U.S. 756, 770 (1999).
\417\ Polygram Holding, Inc. v. Fed. Trade Comm'n, 416 F.3d 29,
36 (D.C. Cir. 2005).
\418\ Id.
---------------------------------------------------------------------------
The rebuttable presumption approach would also be similar in many
respects to the current common law governing non-compete clauses. In
most states, non-compete clauses are disfavored, but are permitted if
an employer can identify a legitimate business interest and if the non-
compete clause is reasonable with respect to geographic area, duration,
and the scope of activity prohibited.\419\ Similarly, under the
rebuttable presumption approach, non-compete clauses would be
presumptively unlawful but would be permitted under certain
circumstances.
---------------------------------------------------------------------------
\419\ See supra Part II.C.1.
---------------------------------------------------------------------------
One important question related to the rebuttable presumption
approach is what the test for rebutting the presumption should be. The
Commission preliminarily believes that, if it were to adopt a
rebuttable presumption in a final rule, it would adopt a test that is
more restrictive than the current common-law standard. Otherwise, the
Rule would be no more restrictive than current law, and the objective
of the Rule--to remedy the adverse effects to competition from
employers' use of non-compete clause--would not be achieved.
One option would be a test derived from the quick look test. For
example, the rule could allow an employer to rebut the presumption
where the employer ``shows by clear and convincing evidence that the
non-compete clause is unlikely to harm competition in labor markets or
product or service markets, or identifies some competitive benefit that
plausibly outweighs the apparent or anticipated harm.'' Alternatively,
the test could focus exclusively on either of these two prongs:
unlikeliness of harm to competition, or presence of a competitive
benefit that plausibly outweighs the apparent or anticipated harm to
competition. A term other than ``clear and convincing evidence,'' such
as ``preponderance of the evidence,'' could also be used.
Another option would be a test that piggybacks on state law. For
example, the rule could allow an employer to rebut the presumption
where the employer ``shows by clear and convincing evidence that a non-
compete clause is necessary to protect a legitimate business
interest.'' This would be a higher standard than the current common law
test because it would require an employer to show not only that it has
a ``legitimate business interest'' under state law, but that it cannot
protect this interest in another way--for example, through the use of
an NDA. The test could also use the term ``reasonably necessary''
instead of ``necessary,'' or a term other than ``clear and convincing
evidence, such as ``preponderance of the evidence.'' The Commission
could also establish what ``legitimate business interests'' could
justify a non-compete clause and which could not.
The Commission preliminarily believes the categorical ban in the
proposed rule would advance the proposed rule's objectives to a greater
degree than the rebuttable presumption approach. The Commission is
concerned that the rebuttable presumption approach could foster
confusion among employers and workers because the question of whether
an employer may use a non-compete clause would depend on an abstract
legal test rather than a bright-line rule. Under a categorical ban, it
would be clear non-compete clauses are prohibited. In contrast, under
the rebuttable presumption approach, it may be difficult for both
employers and workers to know whether a particular non-compete clause
meets the abstract legal test articulated in the rule. For example, it
may be difficult for an employer or worker to know whether a particular
non-compete clause is
[[Page 3518]]
``unlikely to harm competition in labor markets or product or service
markets,'' whether ``there is some competitive benefit that plausibly
outweighs the apparent or anticipated harm,'' or whether a non-compete
clause is ``necessary'' to protect a legitimate business interest.
Furthermore, because only the Commission can enforce a rule issued
under Section 6(g), the development of the law--and therefore clarity
for employers--would be slow in coming.
However, the rebuttable presumption could also have some advantages
over a categorical ban. If there were to be specific factual scenarios,
unanticipated by the Commission, in which a particular non-compete
clause did not implicate the anticompetitive concerns the Commission is
concerned about, the rebuttable presumption would allow the clause to
be used.
The Commission seeks comment on whether it should adopt a
rebuttable presumption instead of a categorical ban and what the test
for rebutting the presumption should be.
2. Uniform Rule vs. Differentiation
In addition to establishing a categorical ban on non-compete
clauses, the proposed rule would apply uniformly to all workers.
Employers covered by the rule--i.e., employers other than those exempt
from coverage under the FTC Act \420\--would be prohibited from using a
non-compete clause with a worker, except in limited scenarios where the
non-compete clause is between the seller and buyer of a business.\421\
---------------------------------------------------------------------------
\420\ See supra Part V, in the section-by-section analysis for
proposed Sec. 910.1(c), for additional discussion of this issue.
\421\ See proposed Sec. 910.3.
---------------------------------------------------------------------------
Rather than applying a rule uniformly to all workers, the
Commission could apply different rules to different categories of
workers based on a worker's job function, occupation, earnings, another
factor, or some combination of factors. For example, the rule could ban
non-compete clauses for workers generally, but could apply a rebuttable
presumption to non-compete clauses for workers whose earnings are above
a certain threshold (or could exempt such workers altogether).
This Part VI uses the term ``more-lenient standards'' to refer to
the more relaxed regulatory standards that would apply to certain
categories of workers--such as the workers above the earnings threshold
in the example above--under this approach. This Part VI also uses the
term ``more-stringent standards'' to refer to the stricter standards
that would apply to certain categories of workers, such as the workers
below the earnings threshold in the second example above.
As described above in Part II.C.1, the recent non-compete clause
statutes many states have enacted have generally differentiated among
categories of workers. Most of these states have restricted non-compete
clauses only for workers below a threshold based on the worker's
earnings or a similar factor, such as whether the worker is non-exempt
under the FLSA or whether the worker is an hourly worker.\422\
---------------------------------------------------------------------------
\422\ See supra Part II.C.1.
---------------------------------------------------------------------------
There are three main ways a rule could differentiate among workers.
First, a rule could apply different standards to workers based on the
workers' job functions or occupations. For example, a rule could apply
more-lenient standards to non-compete clauses for senior executives or
could exempt them from coverage altogether.
Second, a rule could apply different standards to workers based on
some combination of job functions/occupations and a worker's earnings.
For example, the rule could apply more-lenient standards to workers who
qualify for the FLSA exemptions for ``executives'' and ``learned
professionals.'' \423\ Workers qualify for these FLSA exemptions (which
exempt the worker from minimum-wage and overtime-pay rules) if they
earn above a certain amount and perform certain types of job
duties.\424\ Another potential alternative could be to apply more-
lenient standards to a worker who qualifies for any FLSA
exemption.\425\
---------------------------------------------------------------------------
\423\ See 29 CFR 541.100; 29 CFR 541.200.
\424\ See Dep't of Labor, Fact Sheet #17A: Exemption for
Executive, Administrative, Professional, Computer & Outside Sales
Employees Under the Fair Labor Standards Act (FLSA) (Sept. 2019).
\425\ See Dep't of Labor, Handy Reference Guide to the Fair
Labor Standards Act, entry under Exemptions, https://www.dol.gov/agencies/whd/compliance-assistance/handy-reference-guide-flsa#8.
---------------------------------------------------------------------------
Third, like the recent state statutes described above, a rule could
apply different standards based on the worker's earnings. An earnings
threshold could be relatively high (as in, e.g., the State of
Washington, where a non-compete clause is void unless the worker's
annual earnings exceed $100,000 for employees and $250,000 for
independent contractors); in the middle (as in, e.g., Virginia, where
employers may not enter into, enforce, or threaten to enforce a non-
compete clause with a worker whose average weekly earnings are less
than the Commonwealth's average weekly wage); or relatively low (as in,
e.g., Maryland, where non-compete clauses are void where a worker earns
equal to or less than $15 per hour or $31,200 per year).\426\ The
Commission also believes if it were to adopt a threshold based on
earnings, it would be appropriate to index the earnings level to
inflation, to ensure as well as possible that the threshold continues
to correspond to the Commission's justification for it.
---------------------------------------------------------------------------
\426\ See supra note 149 and accompanying text.
---------------------------------------------------------------------------
A rule could also differentiate among workers based on a different
factor, or based on some combination of factors.
The Commission preliminarily concludes applying the rule uniformly
to all workers would advance the proposed rule's objectives to a
greater degree than differentiating among workers. As described in Part
V above, non-compete clauses obstruct labor market competition in a
similar way for all workers, regardless of a worker's income or job
status.\427\ Whether a labor market includes high earners or low-wage
workers, non-compete clauses block workers in that market from
switching to jobs in which they would be better paid and more
productive--restricting the opportunities of all workers in that labor
market. The Commission estimates the proposed rule would increase
earnings for workers across the labor force, as well as for workers in
all of the subgroups of the labor force for which sufficient data are
available--from hourly workers to highly paid, highly skilled workers
such as executives.\428\ Excluding these workers from the proposed rule
would deny these workers the benefits of higher earnings through
increased competition in the market for their labor.
---------------------------------------------------------------------------
\427\ See supra Part V (in the section-by-section analysis for
proposed Sec. 910.2(a)).
\428\ See infra Part VII.B.1.a.
---------------------------------------------------------------------------
The Commission also preliminarily concludes a rule that applies
uniformly to all workers would better ensure workers are aware of their
rights under the rule. For example, the Commission believes employers
generally know whether a particular worker is exempt under the FLSA,
but many workers may not know this themselves. Therefore, if the Rule
were to prohibit non-compete clauses with FLSA non-exempt workers, and
an employer were to enter into a non-compete clause with an FLSA non-
exempt worker in violation of the Rule, the worker may not know whether
the non-compete clause is valid.
If the Commission were to adopt a final rule differentiating among
categories of workers, it may also adopt a severability clause
indicating the Commission intends for the standards to
[[Page 3519]]
be severable.\429\ If a regulatory provision is severable, and one part
of the provision is invalidated by a court, the court may allow the
other parts of the provision to remain in effect.\430\ When analyzing
whether a provision is severable, courts consider both (a) the agency's
intent and (b) whether severing the invalid parts of the provision
would impair the function of the remaining parts.\431\ Including a
severability clause would clarify the Commission's intent that, if a
court were to invalidate the standards for one category of workers, the
other standards would remain in effect. The Commission also believes if
it were to adopt a final rule differentiating between categories of
workers, and a court were to strike down the rules for one category,
that would not impair the function of the remaining provisions. If
every worker falls into only one category, and one or more (but not
all) of the standards were to be invalidated, an employer could simply
comply with the standards that remain in effect.
---------------------------------------------------------------------------
\429\ The Commission may adopt a severability clause even if it
did not apply different standards to the different categories of
workers.
\430\ See, e.g., Davis Cnty. Solid Waste Mgmt. v. EPA, 108 F.3d
1454, 1459 (D.C. Cir. 1997).
\431\ Id. at 1460.
---------------------------------------------------------------------------
The Commission seeks comment on whether it should differentiate
between workers rather than adopting a rule that applies uniformly to
all workers. In addition, the Commission seeks comment on what the
specific threshold(s) should be.
B. Discrete Alternatives
As described above, there are two key dimensions of alternatives
related to the fundamental design of the rule. The first is whether the
rule should impose a categorical ban on non-compete clauses or a
rebuttable presumption of unlawfulness. The second is whether the rule
should apply uniformly to all workers or whether there should be
exemptions or different standards for different categories of workers,
using one or more thresholds based on a worker's job functions,
earnings, some other factor, or some combination of factors. The
different permutations of the answers to each of these questions yield
the different alternatives for the rule's fundamental design. As a
result, the number of potential alternatives to the proposed rule is
nearly limitless. However, for the purpose of focusing public comment,
this Part VI.B describes four discrete alternatives to the proposed
rule. The Commission preliminarily believes each of these alternatives
may further the objectives of the proposed rule, to some degree.
For each of the alternatives described below, the Commission could
adopt a variety of different thresholds. As described above in Part
VI.A.2, a threshold could be based on job functions, the worker's
occupation, earnings, some other factor, or some combination of
factors. A threshold could be set relatively high, relatively low, or
in the middle.
1. Alternative #1: Categorical Ban Below Threshold, Rebuttable
Presumption Above
Under Alternative #1, the rule would categorically ban the use of
non-compete clauses for some workers and apply a rebuttable presumption
of unlawfulness to non-compete clauses for the other workers. For
example, the rule could ban non-compete clauses generally, but apply a
rebuttable presumption to workers who qualify for the FLSA exemptions
for executives or learned professionals.\432\ Or the rule could ban
non-compete clauses but apply a rebuttable presumption to workers who
earn more than $100,000 per year.
---------------------------------------------------------------------------
\432\ See supra note 423-424 and accompanying text.
---------------------------------------------------------------------------
The Commission is not proposing this approach due to the
preliminary concerns, described above in Parts VI.A.1 and VI.A.2, about
the rebuttable presumption approach and about differentiating among
categories of workers. However, the Commission seeks comment on this
alternative.
2. Alternative #2: Categorical Ban Below Threshold, No Requirements
Above
Under Alternative #2, the rule would categorically ban the use of
non-compete clauses for some workers and not apply any requirements to
the other workers. In effect, the other workers would simply be exempt
from coverage under the rule. This approach would be similar to the
recent non-compete clause statutes many states have enacted.\433\ For
example, like the recent State of Washington statute, the rule could
prohibit the use of non-compete clauses for employees earning $100,000
or less per year and independent contractors earning less than $250,000
or less per year. Or, like the recent Massachusetts and Rhode Island
statutes, the rule could prohibit the use of non-compete clauses for
workers who are non-exempt under the FLSA.
---------------------------------------------------------------------------
\433\ See supra note 149.
---------------------------------------------------------------------------
The Commission is not proposing this approach due to its
preliminary concerns, described above in Part VI.A.2, about
differentiating among categories of workers. However, the Commission
seeks comment on this alternative.
3. Alternative #3: Rebuttable Presumption for All Workers
Under Alternative #3, the rule would apply a rebuttable presumption
of unlawfulness to non-compete clauses for all workers. This approach
would be similar to the proposed rule in that it would apply uniformly
to all U.S. workers. However, instead of a categorical ban, the rule
would apply a rebuttable presumption. The Commission is not proposing
this approach due to its preliminary concerns with the rebuttable
presumption approach, which are described above in Part VI.A.1.
However, the Commission seeks comment on this alternative.
4. Alternative #4: Rebuttable Presumption Below Threshold, No
Requirements Above
Under Alternative #4, the rule would apply a rebuttable presumption
of unlawfulness to non-compete clauses for some workers and not apply
any requirements to the other workers. This approach would be similar
to Alternative #2, except that, instead of categorically banning non-
compete clauses for workers below the threshold, the rule would apply a
rebuttable presumption. The Commission is not proposing this approach
due to the preliminary concerns, described above in Parts VI.A.1 and
VI.A.2, about the rebuttable presumption approach and about
differentiating among categories of workers. However, the Commission
seeks comment on this alternative.
The Commission seeks comment on each of these alternatives
described in this Part VI.B, including whether the alternative would
advance the objectives of the proposed rule to a greater or lesser
degree than the proposed rule, and how the Commission should design the
rule if it were to adopt the alternative.
C. Different Standards for Senior Executives
In addition to seeking comment generally on whether the rule should
apply uniformly to all workers or differentiate between categories of
workers,\434\ the Commission seeks comment specifically on whether it
should adopt different standards for non-compete clauses with senior
executives.\435\
---------------------------------------------------------------------------
\434\ See supra Part VI.A.2.
\435\ The Commission could also define senior executives as a
separate category, but apply the same standards to senior executives
as to other workers.
---------------------------------------------------------------------------
[[Page 3520]]
The proposed rule would categorically ban non-compete clauses for
all workers, including senior executives. However, the Commission
recognizes non-compete clauses for senior executives may present
distinct concerns. As described in Part IV, the Commission
preliminarily finds that, like non-compete clauses for other workers,
non-compete clauses for senior executives negatively affect competitive
conditions in labor markets.\436\ The Commission also preliminarily
finds non-compete clauses for senior executives negatively affect
competitive conditions in product and service markets, and they may do
so in unique ways.\437\ However, unlike non-compete clauses for other
workers, the Commission does not preliminarily find non-compete clauses
for senior executives are exploitative and coercive at the time of
contracting or at the time of the worker's potential departure.\438\
---------------------------------------------------------------------------
\436\ See supra Part IV.A.1.a.i.
\437\ See supra Part IV.A.1.a.ii.
\438\ See supra Part IV.A.1.b-c.
---------------------------------------------------------------------------
Given that non-compete clauses for senior executives may present
distinct concerns, the Commission is interested in the public's views
about whether different standards for senior executives would be
appropriate. For example, the Commission could adopt a categorical ban
on non-compete clauses for workers in general, but apply a rebuttable
presumption of unlawfulness for senior executives or exempt senior
executives altogether.
The Commission seeks comment on how, if the Commission were to
adopt different standards for senior executives, this category of
workers should be defined. The Commission is not aware of a generally
accepted legal definition of ``senior executive.'' This term may be
challenging to define, given the variety of organizational structures
used by employers. The Commission could cross-reference a definition in
an existing federal regulation, such as the definition of ``named
executive officer'' in Securities and Exchange Commission (SEC)
Regulation S-K \439\ or the definition of ``executive officers'' in SEC
Rule 3b-7; \440\ adopt a definition closely based on a definition in an
existing federal regulation; adopt a new definition; define the
category according to a worker's earnings; use some combination of
these approaches; or use a different approach. The Commission seeks
comment on what definition would draw the appropriate line--with
respect to which workers should be covered by the different standards--
while providing sufficient clarity to employers and workers.
---------------------------------------------------------------------------
\439\ 17 CFR 229.402(a)(3).
\440\ 17 CFR 203.501(f).
---------------------------------------------------------------------------
In addition, the Commission seeks comment on whether these
different standards should also be applied to other highly paid or
highly skilled workers who are not senior executives, including
specifically how such a category should be defined.
D. Coverage of Non-Compete Clauses Between Franchisors and Franchisees
The proposed rule would state the term ``worker'' does not include
a franchisee in the context of a franchisee-franchisor
relationship.\441\ As a result, the proposed rule would not cover non-
compete clauses between franchisors and franchisees.\442\ As described
above in Part V, the Commission believes that, in some cases, the
relationship between a franchisor and franchisee may be more analogous
to the relationship between two businesses than the relationship
between an employer and a worker. In addition, the evidentiary record
before the Commission relates primarily to non-compete clauses that
arise solely out of employment; the Commission has surveyed the
available evidence relating to non-compete clauses and is not aware of
research on the effects of applying additional legal restrictions to
non-compete clauses between franchisors and franchisees. Therefore, the
Commission believes it is appropriate to clarify that a franchisee--in
the context of a franchisor-franchisee relationship--is not a
``worker'' for purposes of proposed Sec. 910.1(f).\443\ (Proposed
Sec. 910.1(f) would explain, however, the term ``worker'' includes a
natural person who works for the franchisee or franchisor, and non-
compete clauses between franchisors and franchisees would remain
subject to federal antitrust law as well as all other applicable law.)
---------------------------------------------------------------------------
\441\ See proposed Sec. 910.1(f).
\442\ For ease of reference, this Part VI refers to these types
of non-compete clauses as ``franchisor/franchisee non-compete
clauses.''
\443\ See supra Part V (in the section-by-section analysis for
proposed Sec. 910.1(f)).
---------------------------------------------------------------------------
While the Commission is not currently proposing to cover
franchisor/franchisee non-compete clauses for these reasons, the
Commission recognizes that, in some cases, these non-compete clauses
may present concerns under Section 5 similar to the concerns presented
by non-compete clauses between employers and workers. Many franchise
agreements may contain non-compete clauses.\444\ By restricting a
franchisee's ability to start a new business, franchisor/franchisee
non-compete clauses could potentially stifle new business formation and
innovation, reduce the earnings of franchisees, and have other negative
effects on competitive conditions similar to non-compete clauses
between employers and workers. Franchisor/franchisee non-compete
clauses could also potentially be exploitative and coercive in some
cases, such as where there is an imbalance of bargaining power between
the parties. While the relationship between franchisors and franchisees
may, in some cases, be more analogous to a business-to-business
relationship, many franchisees lack bargaining power in the context of
their relationship with franchisors and may be susceptible to
exploitation and coercion through the use of non-compete clauses.\445\
---------------------------------------------------------------------------
\444\ See, e.g., Brian Callaci, Sergio Pinto, Marshall
Steinbaum, & Matthew Walsh, Vertical Restraints and Labor Markets in
Franchised Industries (July 6, 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4155571 (finding that, in a sample of 530
franchising contracts, various types of vertical restraints were
prevalent, while not specifically addressing non-compete clauses).
The Commission has also frequently encountered non-compete clauses
in franchise agreements. See supra Part II.D (describing consent
orders that restricted a franchisor's ability to enforce non-compete
clauses).
\445\ See, e.g., Brian Callaci & Sandeep Vaheesan, Antitrust
Remedies for Fissured Work, Cornell L. Rev. (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4076274 at 21-22.
---------------------------------------------------------------------------
For these reasons, the Commission seeks comment on whether the Rule
should cover franchisor/franchisee non-compete clauses and why. The
Commission also seeks comment on whether, if the Rule were to cover
franchisor/franchisee non-compete clauses, they should be categorically
banned or subject to a rebuttable presumption of unlawfulness (and if
the latter, what the standard for rebutting the presumption should be).
The Commission further seeks comment on whether, if the rule were to
cover franchisor/franchisee non-compete clauses, the rule should apply
uniformly to all such non-compete clauses or whether certain categories
of franchisor/franchisee non-compete clauses should be exempted or
subject to different standards. The Commission encourages commenters to
submit data or other evidence that could inform the Commission's
consideration of this issue.
E. Other Alternatives
This Part VI.E describes two alternatives the Commission believes
would likely not further the objectives of the proposed rule. However,
this assessment is preliminary. Based on the public comments and the
Commission's
[[Page 3521]]
additional analysis, the Commission could potentially decide to adopt
one or both of the alternatives described below in a final rule instead
of, or in addition to, the proposed rule or one of the alternatives
described above. The Commission seeks comment on each of the two
alternatives described in this Part VI.E, as well as whether there are
other alternatives not described in Part VI that the Commission should
consider.
1. Disclosure Rule
The Commission could potentially adopt disclosure requirements
related to non-compete clauses.\446\ For example, research suggests
many workers often do not find out about non-compete clauses until
after they have accepted an employment offer.\447\ This concern could
be addressed by requiring an employer to disclose to a worker, before
making the employment offer, that the worker will be subject to a non-
compete clause. The employer could also potentially be required to
explain the terms of the non-compete clause and how the worker would be
affected by signing the non-compete clause.
---------------------------------------------------------------------------
\446\ The Commission's Franchise Rule requires non-compete
clauses to be disclosed to a franchisee. 16 CFR 436(i); 436(q).
\447\ Marx (2011), supra note 55 at 706.
---------------------------------------------------------------------------
While there is evidence disclosure of non-compete clauses to
workers prior to acceptance of a job offer may increase earnings,
increase rates of training, and increase job satisfaction for that
worker,\448\ the Commission does not believe this alternative would
achieve the objectives of the proposed rule. Merely ensuring workers
are informed about non-compete clauses would not address one of the
Commission's central concerns: that, in the aggregate, they are
negatively affecting competitive conditions in labor markets--including
impacts on workers who are not bound by non-compete clauses--and in
markets for products and services. Moreover, the benefits of a
disclosure rule may be limited due to the differential in bargaining
power between many workers and their employers, which would hamper
those workers' ability to negotiate for better employment terms.\449\
---------------------------------------------------------------------------
\448\ Starr, Prescott, and Bishara, supra note 42 at 75.
\449\ See supra Part IV.A.1.b.
---------------------------------------------------------------------------
2. Reporting Rule
The Commission could also potentially require employers to report
certain information to the Commission relating to their use of non-
compete clauses. For example, employers that use non-compete clauses
could be required to submit a copy of the non-compete clause to the
Commission. This would enable the Commission to monitor the use of non-
compete clauses. It would also potentially discourage employers from
using non-compete clauses where they are clearly not justified under
existing law.
However, the Commission does not believe a reporting rule would
achieve the objectives of the proposed rule. Merely requiring employers
to submit their non-compete clauses to the Commission may not
meaningfully reduce the prevalence of non-compete clauses. As a result,
it may not remedy the extent to which non-compete clauses adversely
affect competitive conditions in labor markets and product and service
markets. A reporting rule would also impose significant and recurring
compliance costs on employers.
The Commission seeks comment on all aspects of this Part VI,
including whether the Commission should adopt one of the alternatives
described above, or a different alternative, instead of the proposed
rule.
VII. Analysis of Benefits and Costs of the Proposed Rule and
Alternatives
The proposed rule would provide it is an unfair method of
competition--and thus a violation of Section 5 of the FTC Act--for an
employer to enter into or attempt to enter into a non-compete clause
with a worker; maintain with a worker a non-compete clause; or
represent to a worker that the worker is subject to a non-compete
clause where the employer has no good faith basis to believe the worker
is subject to an enforceable non-compete clause.\450\ The proposed rule
is targeted at increasing competition in labor markets by allowing
workers to move more freely between jobs and increasing competition in
product markets by ensuring firms are able to hire talented workers and
workers are able to found entrepreneurial ventures.
---------------------------------------------------------------------------
\450\ See proposed Sec. 910.2(a).
---------------------------------------------------------------------------
The proposed rule is intended to alleviate two primary competitive
problems. First, non-compete clauses anticompetitively interfere in the
functioning of labor markets without generating compensating benefits.
Non-compete clauses prevent firms from competing for workers' services
and increase barriers to voluntary labor mobility, obstructing the
smooth functioning of labor markets, resulting in lower wages and
diminished worker and firm productivity.
The second competitive problem is non-compete clauses create
negative spillovers in labor markets and in product and service
markets. In labor markets, non-compete clauses negatively impact
workers who are not themselves bound by non-compete clauses by
preventing the opening of vacancies and thereby creating mismatches
between labor and firms. In product and service markets, non-compete
clauses prevent entrepreneurial growth, which negatively impacts
consumers by reducing competition in those markets. Non-compete clauses
also foreclose competitors' ability to access labor market talent,
negatively affecting those competitors' ability to effectively compete
in the marketplace. Additionally, non-compete clauses impede
innovation, which may negatively impact technological growth rates.
Section 22 of the FTC Act requires the Commission to issue a
preliminary regulatory analysis when publishing a proposed rule that
would declare a practice to be an unfair method of competition under
Section 5 of the FTC Act.\451\ The preliminary regulatory analysis must
contain (1) a concise description of the need for, and objectives of,
the proposed rule; (2) a description of any reasonable alternatives to
the proposed rule which may accomplish the stated objective of the rule
in a manner consistent with applicable law; and (3) for the proposed
rule, and for each of the alternatives described in the analysis, a
preliminary analysis of the projected benefits and any adverse economic
effects and any other effects.\452\
---------------------------------------------------------------------------
\451\ 15 U.S.C. 57b-3.
\452\ 15 U.S.C. 57b-3(b)(1)(A)-(C).
---------------------------------------------------------------------------
In the preliminary analysis below, we describe the anticipated
impacts of the rule as proposed. Where possible, we quantify the
benefits and costs. If a benefit or cost is quantified, we indicate the
sources of the data relied upon. If an assumption is needed, the text
makes clear which quantities are being assumed. We measure the benefits
and costs of the rule against a baseline in which no rule regarding
non-compete clauses has been promulgated by the Commission. The
Commission solicits comments from the public to improve the assumptions
used in this preliminary analysis before promulgation of any final
rule.
This preliminary analysis attempts to include in its scope the
broadest set of economic actors possible. The Commission invites
submission of information pertaining to additional economic actors who
would be affected by the proposed rule. Several of the benefits and
costs described in this
[[Page 3522]]
analysis are either quantifiable, but not monetizable (especially with
respect to separation between transfers, benefits, and costs), or not
quantifiable at all. The Commission therefore also invites submission
of information which could be applied to quantify or monetize estimates
contained in the analysis.
For some of the economic effects of non-compete clauses,
conflicting evidence exists in the academic literature. We classify
these effects under both benefits and costs, and discuss divergences in
the evidence, as well as relative strengths and weaknesses of the
evidence.
The Commission seeks comment on all aspects of the preliminary
analysis presented in this Part VII as well as submissions of
additional data that could inform the Commission's analysis of the
benefits, any adverse economic effects, and any other effects of the
proposed rule.
A. Overview of the Effects of the Proposed Rule
In this preliminary regulatory analysis, we have quantified and
monetized those costs and benefits for which we are able and described
all other costs and benefits. The Commission finds substantial benefits
of the proposed rule: workers' earnings would likely increase by $250-
$296 billion annually (though some portion of this represents an
economic transfer from firms to workers), new firm formation and
competition would increase, health care prices would fall (and prices
in other markets may fall), and innovation would increase, though
several of these benefits overlap (e.g., increases in competition may
fully or in part drive decreases in prices and increases in
innovation). The Commission also finds some costs of the proposed rule:
direct compliance and contract updating would result in $1.02 to $1.77
billion in one-time costs, and firm investment in worker training and
capital assets would fall.
The nature of the estimates, however, creates substantial
difficulty in calculating a bottom-line present value of the net
benefit to the economy of the proposed rule. The Commission believes
the substantial labor and product market benefits of the proposed rule
would exceed the costs, and additionally would persist over a
substantially longer time horizon than some of the one-time costs of
compliance and contract updating. However, we do not present here an
estimate of the net benefit, as it would necessarily omit major
components of both costs and benefits. In particular, the numbers
reported above are not comparable in order to estimate the net benefit
of the rule: as noted, some portion of the earnings increase estimate
represents transfers rather than benefits; several benefits and costs
are unmonetized in this analysis; and several of the annualized
benefits and costs (including the portion of the earnings increase
attributable to benefit) may persist indefinitely, as compared with the
one-time compliance and contract updating costs.
B. Estimated Benefits of the Proposed Rule
In this Part VII.B, we describe the beneficial impacts of the
proposed rule; provide preliminary quantitative, monetized estimates
where possible; and describe benefits we can only assess qualitatively.
We enumerate benefits in two broad categories (further divided into
subcategories): benefits related to labor markets and benefits related
to goods and service markets.
Overall, the Commission estimates worker earnings would increase by
$250-$296 billion annually as a result of the proposed rule. While the
Commission believes some of this increase represents an economic
benefit, some portion of this increase likely represents a transfer of
income from firms to workers, or from consumers to workers if firms
pass labor costs on to consumers. The Commission also finds, however,
the proposed rule would increase the rate of new firm formation, the
rate of innovation, and the extent of competition in product and
service markets, which may lead to lower prices for consumers, though
the sizes of these effects are not quantifiable based on the estimates
in the economic literature (except in the case of healthcare).
1. Benefits Related to Labor Markets
By preventing workers from changing employers or embarking upon
entrepreneurial ventures, non-compete clauses prevent beneficial labor
market competition in two primary ways. First, non-compete clauses
prevent workers from leaving their job for higher-paying jobs, or from
leveraging such an offer to increase their earnings at their current
employer. Second, non-compete clauses reduce voluntary churn in labor
markets. While churn is not necessarily beneficial in and of itself,
voluntary churn allows workers (who would otherwise be bound by non-
compete clauses) and firms to sort into the best possible matches and
opens vacancies, which allow workers who are not necessarily bound by
non-compete clauses to find better matches. Both mechanisms exhibit, at
least in part, as earnings losses for workers when non-compete clauses
enforceability increases; however, the extent to which earnings gains
associated with the proposed rule represent benefits versus transfers
may depend on the mechanism. We describe in which cases we are and are
not able to categorize, quantify, and monetize these estimates below.
a. Earnings
The primary impact of the proposed rule is an increase in earnings
or earnings growth for workers, and more efficient functioning of labor
markets. A full analysis of this benefit would seek to quantify the
entire range of heterogeneity in the effect of the proposed rule on
earnings. In other words, for any given worker, the likely impact on
that worker's earnings is based on whether that worker has a non-
compete clause, whether non-compete clauses are broadly used in their
occupation/industry/local area, how much that worker earns, that
worker's demographics, and much more. While some studies have sought to
quantify heterogeneous impacts of non-compete clauses and their
enforceability on subgroups of workers, this accounting is limited to
fairly small sectors of the population. For this reason, we focus
primarily on estimates of average effects across the American labor
force, though we provide details on what heterogeneity has been
analyzed below.
The study containing the most direct estimate of the increase in
workers' earnings given a prohibition on non-compete clauses finds that
earnings would increase across the labor force by an average of 3.3-
13.9%.\453\ For several reasons, we primarily focus on the low end of
this range: in addition to generating the most conservative estimate,
this range represents an out-of-sample approximation and is furthermore
based on enforceability in 2014. Since then, some states have passed
legislation causing non-compete clauses to be more difficult to enforce
for subsets of their workforces, therefore causing a prohibition on
non-compete clauses today to have a slightly lesser effect than a
prohibition would have had in 2014.\454\ Using total annual wage
earnings in the United States for private employers in 2020 (the most
recent year with finalized numbers) as a baseline,\455\ we estimate a
total annual earnings
[[Page 3523]]
increase of $250.05 billion. We also report the total annual earnings
increase that is associated with other levels of the percentage
increase in earnings that fall within the range reported in the study
in Table 1, in addition to 10-year discounted earnings increases using
both 3% and 7% discount rates.
---------------------------------------------------------------------------
\453\ Johnson, Lavetti, & Lipsitz, supra note 63 at 2.
\454\ See supra Part II.C.1.
\455\ National annual earnings are taken from Bureau of Labor
Statistics, Employment and Wages Data Viewer (last visited Dec. 9,
2022), https://data.bls.gov/cew/apps/data_views/data_views.htm#tab=Tables.
Table 1
----------------------------------------------------------------------------------------------------------------
Total 10-year Total 10-year
Total annual earnings earnings
Percentage increase in earnings (%) earnings increase, 3% increase, 7%
increase ($ discount rate discount rate
billion) ($ billion) ($ billion)
----------------------------------------------------------------------------------------------------------------
3.3............................................................. 250.05 2,132.97 1,756.24
5.0............................................................. 378.86 3,231.78 2,660.98
7.0............................................................. 530.41 4,524.49 3,725.37
9.0............................................................. 681.95 5,817.20 4,789.76
11.0............................................................ 833.50 7,109.91 5,854.15
13.0............................................................ 985.04 8,402.63 6,918.54
13.9............................................................ 1,053.24 8,984.35 7,397.51
----------------------------------------------------------------------------------------------------------------
Another study estimates decreased non-compete clause enforceability
would increase earnings by approximately 1%. This study uses, as a
control group, occupations which use non-compete clauses at a low rate:
the estimate therefore represents the differential effect on
occupations which use non-compete clauses at a high rate, relative to
the control group. While the study does estimate the separate impact of
non-compete clause enforceability for each group, there is no way to
disentangle this effect from state-specific effects (e.g., that
California does not typically enforce non-compete clauses, and also
differs from other states in many ways).\456\ Since workers in
occupations which use non-compete clauses at a low rate may also be
affected by changes in non-compete clause enforceability, the reported
increase in earnings likely underestimates the impact on the entire
labor force. The change in enforceability which generates this estimate
is a one standard deviation change, as measured using non-compete
clause enforceability scores \457\ for all 50 states and the District
of Columbia in 1991. Applying the 1% earnings effect estimate to each
state (based on the scores in 2009), we calculate that each state
moving to non-enforceability (as would be the case under the proposed
rule) would result in an overall annual earnings increase of $295.9
billion.\458\
---------------------------------------------------------------------------
\456\ Starr, supra note 66 at 792-93.
\457\ Non-compete clause enforceability scores, used for this
estimate as well as several others, are calculated using various
methods based on legal descriptions provided in various editions of
``Non-Compete Clauses: A State-by-State Survey'' by Brian M.
Malsberger.
\458\ The total earnings increase is calculated as the sum over
all states of:
(e
0.0099*(State's Enforceability Score--Lowest State Enforceability Score)
-1)*(Total Annual Wages of the State)
This calculation assumes that all workers benefit from the
increase in earnings, as opposed to calculating the benefits to
those in high-use occupations versus those in low-use occupations.
The benefit of this approach is that it yields a total predicted
earnings increase for the economy as a whole, rather than a
comparison between different types of workers. However, it is likely
an overestimate for workers in low-use occupations, and an
underestimate for those in high-use occupations.
---------------------------------------------------------------------------
The Commission's preliminary finding is therefore the proposed rule
would increase workers' earnings workforce-wide by $250-$296 billion
annually. We discuss in Part VII.B.1.b the extent to which the
Commission believes this increase represents a benefit of the proposed
rule versus a transfer.
Four broad classes of workers merit specific attention, as
researchers have generated empirical estimates of the effects of non-
compete clause enforceability based specifically on those sectors.
These classes are (a) high-tech workers; (b) physicians; (c) workers
paid on an hourly basis; and (d) CEOs. We clarify that the effects we
present on each of these specific classes of workers are contained
within the broader estimates presented above: that is, the estimates
above contain each of these classes of workers, plus the rest of the
labor force. The specific estimates for each class of workers are
therefore presented to indicate the range of effects observed in the
labor market and to illustrate the scope of empirical work that has
been performed on the topic.
i. High-Tech Workers
One study examines the impact of non-compete clause enforceability
on high-tech workers in Hawaii.\459\ That study includes estimates for
the entirety of the high-tech work force, as well as for newly hired
workers. Since the ban in Hawaii did not void previously signed non-
compete clauses, while the proposed rule would, we use the estimate for
newly hired workers. This is because that estimate reflects the effects
on those workers who were subject to a regime with no non-compete
clause enforceability. Extrapolating from the estimates for Hawaii to
the average impact on high-tech workers in each state, a prohibition
such as the one in this proposed rule would increase earnings of high-
tech workers in the average state by 4.8%.\460\ Caution is recommended
in interpreting this extrapolation, however, since results from one
sector within one state may not necessarily inform outcomes that would
occur in the rest of the country.
---------------------------------------------------------------------------
\459\ Balasubramanian et al., supra note 68 at S349.
\460\ The increase in earnings in each state is calculated as
e
(0.0441*(State's Enforceability Score-Lowest State Enforceability Score)/(Hawaii's Enforceability Score-Lowest State's Enforceability Score)
-1, where 0.0441 represents the impact of Hawaii's prohibition on
log earnings for newly hired high-tech workers (Table 2, Panel A,
Column 5).
---------------------------------------------------------------------------
ii. Physicians
One study reports the effects of non-compete clause use and
enforceability on the earnings growth of physicians.\461\
---------------------------------------------------------------------------
\461\ Lavetti, Simon, & White, supra note 53 at 1025.
---------------------------------------------------------------------------
Due to the limitations of the study design, the main estimate
concerns the impact of non-compete clause use on earnings growth,
rather than the level of earnings.\462\ However, assuming physicians
begin at an identical level of earnings, a physician with a non-compete
clause would have an estimated 89% earnings growth over a ten-year
period, versus an estimated 36% for a physician without a non-compete
clause. In other words, the physician with a non-compete clause would
have earnings approximately
[[Page 3524]]
39% greater than the physician without.\463\
---------------------------------------------------------------------------
\462\ In Table 4 of the study, the table which reports earnings
effects, the authors include a ``job-match'' fixed effect, which
rules out several alternate explanations for the authors' findings
but leaves the authors unable to estimate the base effect of having
a non-compete clause on earnings.
\463\ Calculated as 1.89/1.36-1 = 39%.
---------------------------------------------------------------------------
This estimate, however, is based solely on non-compete clause use,
and does not consider the impact of enforceability changing. Use of
non-compete clauses is likely determined by several characteristics of
an employer (e.g., the value of trade secrets or client attraction,
productivity gains associated with training, nearness of potential
competitors), some of which may also cause changes in earnings levels
or earnings growth. Taking the separate effect of non-compete clause
enforceability into account, it is possible that the estimated effect
on earnings growth would differ from the estimates reported above.
The combined effect of enforceability and use on earnings growth
may separately be estimated using another model in the same study.\464\
We note that the authors state this model presents only ``suggestive
evidence.'' Furthermore, while this model does estimate the effect of
non-compete clause use on physicians' earnings (in contrast to that
reported above, which only examines earnings growth), as well as the
interaction between use and enforceability, it does not report the
baseline effect of non-compete clause enforceability, independent of
use.\465\ Using those estimates, nonetheless, allows for estimation of
the impact of simultaneously removing non-compete clause enforceability
and non-compete clause use on earnings at various levels of experience
(omitting the baseline effect of enforceability, which is not
reported). For a physician with 10 years of experience in the state
which enforces non-compete clauses most readily, the estimates suggest
a prohibition on non-compete clauses and removing that physician's non-
compete clause would lead to a 12.7% increase in earnings, in contrast
with the results of the model reported above.\466\ For the identical
situation for a physician with just 1 year of experience, the increase
in earnings would be 37.4%. We emphasize, however, that if the baseline
effect of enforceability (which the authors are unable to estimate) is
large, it could qualitatively change the effect on earnings of a
simultaneous change in enforceability and use that we report.
---------------------------------------------------------------------------
\464\ The estimates are presented in Table 6, Column 2.
\465\ In Table 6 of the study, the authors use local market
fixed effects: again, these fixed effects are necessary to rule out
alternate explanations for their findings, but prevent estimation of
the baseline impact of non-compete clause enforceability on
earnings.
\466\ The increase in earnings are calculated as e\B\-1, where B
is the sum of each of the coefficients on NCA, NCA*Log Exp, Bishara
Score*NCA, and Bishara Score*NCA*Log Exp, each multiplied by the
relevant variable.
---------------------------------------------------------------------------
iii. Workers Paid on an Hourly Basis
One study analyzed how Oregon's 2008 prohibition on non-compete
clauses for hourly workers impacted their wages.\467\ The study
estimates Oregon's prohibition increased hourly workers' earnings by
2.3%, with twice the effect (4.6%) on workers in occupations which use
non-compete clauses at a relatively high rate.\468\ Extrapolating from
the estimates for Oregon to the average impact on hourly workers in
each state, a prohibition such as the one in this proposed rule would
increase earnings of hourly workers in the average state by 2.3%.\469\
Caution is recommended in interpreting this extrapolation, however,
since results from one segment of the workforce within one state may
not necessarily inform outcomes that would occur in the rest of the
country.
---------------------------------------------------------------------------
\467\ Lipsitz & Starr, supra note 46 at 143.
\468\ Id. at Table 3, columns 3 and 4, respectively; percent
changes are calculated as e\b\-1, where b is the relevant reported
coefficient.
\469\ The increase in earnings in each state is calculated as
e
(0.023*(State's Enforceability Score-Lowest State Enforceability Score)/(Oregon's Enforceability Score-Lowest State's Enforceability Score)
-1, where 0.023 represents the impact of Oregon's prohibition on log
earnings for hourly workers (Table 3, Column 3).
---------------------------------------------------------------------------
iv. CEOs
One estimate of the impact of non-compete clause enforceability
finds that moving from full enforceability of non-compete clauses to a
prohibition would increase earnings growth by 8.2% and the level of
earnings by 12.7% for CEOs.\470\ Again ignoring heterogeneity and
implementing a linear extrapolation using 2009 enforceability scores,
the average CEO would experience a 9.4% increase in earnings due to the
prohibition in the proposed rule.\471\
---------------------------------------------------------------------------
\470\ Garmaise, supra note 69 at 376-425. We assume the average
level of in-state competition for the estimate of the effect on the
level of earnings, as reported in Table 1.
\471\ We first calculate the difference between each state's
score and the lowest score (which represents a full prohibition)
after normalizing scores to a 0 to 1 scale. Then, we find the
average of that difference (0.742) and multiply by the estimated
change of 12.7% to arrive at 9.4%.
---------------------------------------------------------------------------
Another study simultaneously examines the effect of use of a non-
compete clause and the enforceability thereof.\472\ This study finds
that decreased enforceability of non-compete clauses led to lower
earnings for CEOs when use of non-compete clauses is held constant.
However, this study also finds that, when non-compete clause
enforceability decreases (as it would under the proposed rule), non-
compete clause use does not stay constant; it decreases.\473\ As a
result, the Commission believes the appropriate way to extrapolate
based on the findings of this study is to take into account both the
impact of non-compete clause enforceability decreasing and the effect
of non-compete clause use decreasing.
---------------------------------------------------------------------------
\472\ Kini, Williams, & Yin, supra note 52 at 4701.
\473\ The study estimates that an increase in enforceability of
1 on a 0 to 12 scale increases CEO noncompete use by 10.2 percentage
points in their sample. Id. at 4718.
---------------------------------------------------------------------------
When this relationship is taken into account, decreases in non-
compete clause enforceability (as would occur under the proposed rule)
result in greater earnings for CEOs. The study estimates an increase in
enforceability of 1 on a 0 to 12 scale increases CEO noncompete use by
10.2 percentage points in their sample: therefore, a prohibition on
non-compete clauses would affect CEOs' earnings via the effect the
study attributes to enforceability alone, as well as by changing the
use of non-compete clauses by CEOs, which has its own effect on
earnings, according to the study.\474\
---------------------------------------------------------------------------
\474\ Id.
---------------------------------------------------------------------------
Assuming a baseline level of enforceability, it is possible to use
the estimates from this study to calculate the impact on CEOs' earnings
of simultaneously decreasing enforceability and non-compete clause use
to zero (which would mirror the effect of the proposed rule). At the
highest level of enforceability (9; Florida from 1997-2014), setting
enforceability to zero and eliminating non-compete clauses from
contracts would increase CEOs' earnings by 11.4%, based on this study.
From a lower baseline level of enforceability (for example, 3, as in
New York from 1992 to 2014), setting enforceability to zero and
eliminating non-compete clauses from contracts would increase earnings
by 14.1%.\475\
---------------------------------------------------------------------------
\475\ The estimated impact of an increase in enforceability on
CEOs with non-compete clauses is calculated as the effect of the sum
of the coefficients on CEO noncompete x HQ Enforce and HQ enforce
(i.e., 0.4% = e(0.047-0.043)-1).
---------------------------------------------------------------------------
Based on the results of these two studies, the Commission therefore
believes total compensation for CEOs would increase by 9.4% as a result
of the proposed rule. This estimate is based on the first study
discussed: while the results from the second study are qualitatively
similar, the extent to which its results can be extrapolated are
murkier due to the reliance on the secondary estimate of how non-
compete clause use changes with non-compete clause enforceability.
Ultimately, this finding is in accordance with findings
[[Page 3525]]
in other segments of the labor force. Similar to typical workers, non-
compete clauses prevent employers from competing for the labor of CEOs,
including by offering better remuneration. Therefore, CEOs, like other
workers, are locked into jobs in ways that prevent them from taking
advantage of positive changes in labor market conditions.
b. Discussion of Transfers Versus Benefits
It is difficult to determine the extent to which the earnings
effects discussed above represent transfers versus benefits. In the
context of this analysis, transfers refer to ``monetary payments from
one group to another that do not affect total resources available to
society.'' \476\ In other words, transfers do not represent a net
benefit or cost to the economy as a whole.
---------------------------------------------------------------------------
\476\ Off. of Mgmt. & Budget, Circular A-4 (Sept. 17, 2003) at
38.
---------------------------------------------------------------------------
Broad increases in earnings when non-compete clauses are prohibited
may simply represent a transfer of income from firms to workers (or, if
firms pass labor costs on to consumers, from consumers to workers).
There may, however, be a related benefit if the earnings increase of
workers is related to market power or efficiency in the labor market.
In other words, if a prohibition on non-compete clauses leads to a more
efficient allocation of labor in the market, perhaps due to a
rebalancing of power between workers and employers which decreases
monopsony power, then the resulting earnings increases may represent a
net benefit to the economy.
Additionally, if earnings increases are due to higher quality
matching which results from increased labor market churn, then
increased pay reflects a benefit to the economy, since workers' higher
pay reflects higher productivity.
Several pieces of evidence support the idea that at least part of
the increase in earnings represents a social benefit, rather than just
a transfer. As described above in Part II.B.1.c, two studies have
sought to estimate the external impact of non-compete clause use or
enforceability: that is, the effect of use or enforceability on
individuals other than those directly affected by use or
enforceability.
First, one study demonstrates when the use of non-compete clauses
by employers increases, that decreases wages for workers who do not
have non-compete clauses but who work in the same state and industry.
This study also finds this effect is stronger where non-compete clauses
are more enforceable.\477\ Since the affected workers are not bound by
non-compete clauses themselves, the differential in earnings does not
completely represent a transfer due to a change in bargaining power
between a worker bound by a non-compete clause and their employer,
though available data does not allow for an estimate of the magnitude
of transfers versus the total increase in economic benefit.
---------------------------------------------------------------------------
\477\ Starr, Frake, & Agarwal, supra note 76 at 961-80.
---------------------------------------------------------------------------
A second study directly estimates the external impact of a change
in non-compete clause enforceability.\478\ While use of non-compete
clauses is not observed in the study, the impacts of changes in a
state's laws are assessed on outcomes in a neighboring state. Since the
enforceability of the contracts of workers in neighboring states are
not affected by these law changes, the effect must represent a change
related to the labor market, which workers in both states share. The
estimate suggests workers in the neighboring state experience impacts
on their earnings that are 87% as large as workers in the state in
which enforceability changed.\479\ In other words, two workers who
share a labor market would experience nearly the same increase in their
earnings due to a prohibition on non-compete clauses, even if the
prohibition only impacts one worker. While the study does not directly
estimate the differential effects by use, the effects on workers
unaffected by a change in enforceability may be similar to the effects
on workers not bound by non-compete clauses.
---------------------------------------------------------------------------
\478\ Johnson, Lavetti, & Lipsitz, supra note 63 at 26.
\479\ Calculated as -0.181/-0.207=87%. Coefficients taken from
id. at Table 6, Column 2.
---------------------------------------------------------------------------
Overall, these two studies suggest there are market-level dynamics
governing the relationship between earnings and the enforceability of
non-compete clauses: that restrictions on the enforceability of non-
compete clauses impact competition in labor markets by alleviating
frictions and allowing for more productive matching. Changes in
enforceability or use of non-compete clauses affect earnings of workers
who do not have non-compete clauses or who work in local labor markets
near, but not in, locations which experience changes in enforceability.
If non-compete clauses simply changed the relative bargaining power of
workers and firms, without affecting market frictions or competition,
then these patterns would not be observed.
With a full accounting of all other costs and benefits, one could
perform a ``sensitivity analysis'' to estimate how much the percentage
of earnings increases that represent benefits, rather than transfers,
would affect the net impact of the proposed rule. However, as
discussed, we are unable to fully monetize, or even quantify, several
costs and benefits associated with the proposed rule. We present,
instead, a partial sensitivity analysis which answers the question: for
a given level of costs, what percentage of the earnings increases would
offset those costs? The costs may be interpreted as the overall net
cost of the rule, excluding benefits associated with earnings
increases: that is, the costs listed in the table are the direct
compliance and contract updating costs, plus the nonquantifiable and
nonmonetizable costs, minus all benefits, excluding benefits associated
with earnings increases.
The estimates are presented in Table 2. In order to present the
most conservative estimates possible, we assume the earnings increase
represents the lowest end of the range we estimate from the empirical
literature ($250.05 billion). We discount annually at the rate of 7%
(which is more conservative than a 3% discount rate, given that the
costs are more front-loaded than the benefits due to the upfront
compliance costs and costs of contract updating), and assume that
annualized benefits and costs persist for 10 years. The first estimate,
for zero or negative net cost, demonstrates that, if the non-earnings-
related benefits of the proposed rule outweigh the total costs of the
proposed rule, then the costs are already offset, and no portion of the
earnings increase must be a benefit. The next estimate for costs is the
midpoint of the estimates presented for direct compliance and contract
updating costs, as estimated in Part VII.C: if the costs of the
proposed rule (excluding direct compliance and contract updating costs)
exactly offset the benefits (excluding earnings-related benefits), then
if 0.08% of the earnings increases are benefits, they would exactly
offset the estimated $1.394 billion costs of direct compliance and
contract updating (where that estimate is the midpoint of the estimated
range). While the Commission does not have detailed or complete enough
quantifiable and monetizable estimates to determine whether net costs
are positive or negative, the rest of Table 2 presents estimates for
the portion of the earnings increase which would offset net costs
greater than $1.394 billion, should they exist.
[[Page 3526]]
Table 2
------------------------------------------------------------------------
Portion of
earnings
Net cost estimate ($ million) increase that
offsets the cost
estimate (%)
------------------------------------------------------------------------
0 or Negative......................................... 0.00
1,394................................................. 0.08
5,000................................................. 0.28
10,000................................................ 0.57
15,000................................................ 0.85
20,000................................................ 1.14
25,000................................................ 1.42
30,000................................................ 1.71
35,000................................................ 1.99
40,000................................................ 2.28
45,000................................................ 2.56
50,000................................................ 2.85
------------------------------------------------------------------------
2. Benefits Related to Product and Service Markets
There is evidence the proposed rule would positively impact the
markets for products and services in multiple ways. Studies show that
new firm formation would rise under a prohibition on non-compete
clauses, for two primary reasons: first, workers would be free to form
spin-offs which compete with their employers, contributing to increased
competition and growth. Second, firms are more willing to enter markets
in which they know there are potential sources of skilled and
experienced labor, unhampered by non-compete clauses.
Another possible benefit of the proposed rule related to markets
for products and services is that worker flows across employers
contribute to knowledge sharing, resulting in increased levels of
innovation.
We note that, to the extent productivity increases of firms may be
shared with workers, some of the benefits outlined in this Part VII.B.2
may overlap with the earnings estimates outlined above in Part
VII.B.1.a. Similarly, to the extent harms to incumbent firms (due to,
e.g., increased competition) may negatively impact workers, those would
also be reflected in the earnings estimates.
a. Increased Firm Formation and Competition
Intra-industry employee spinoffs (i.e., firms formed by
entrepreneurs who previously worked for a firm against which they now
compete--also known as within-industry spinouts or WSOs) have been
shown to be highly successful, on average, when compared with typical
entrepreneurial ventures.\480\ Non-compete clauses typically reduce the
prevalence of intra-industry spinoffs, and therefore prevent
entrepreneurial activity that is likely to be highly successful. One
estimate implies that a one-standard-deviation increase in non-compete
clause enforceability decreases the rate of WSOs by 0.13 percentage
points (against a mean of 0.4%).\481\ The proposed prohibition, by
extrapolation, would result in an overall increase in the rate of WSOs
by 0.56 percentage points, which would more than double the rate of
WSOs. We note this is a linear approximation and cannot account for
heterogeneous effects of enforceability across states, nor can it
account for nonlinearities in the impact of enforceability (as neither
analysis is reported in the study).
---------------------------------------------------------------------------
\480\ For reviews of the literature, see, e.g., Steven Klepper,
Spinoffs: A Review and Synthesis, 6 European Mgmt. Rev. 159-71
(2009) and April Franco, Employee Entrepreneurship: Recent Research
and Future Directions, in Handbook of Entrepreneurship Research
(2005) 81-96.
\481\ Starr, Balasubramanian, & Sakakibara, supra note 87 at
561.
---------------------------------------------------------------------------
The study also estimates the impact on the entry rate of non-WSOs
(i.e., spinoffs into other industries), and calculates a coefficient
statistically indistinguishable from zero (0.07 percentage point
increase associated with a one standard deviation increase in
enforceability).\482\
---------------------------------------------------------------------------
\482\ Id. at 561.
---------------------------------------------------------------------------
Another study similarly estimates the impacts of non-compete clause
enforceability on departures of employees to found new firms, as well
as on all new firm entry.\483\ These outcomes differ slightly from the
ones previously reported: for employee departures to found new firms,
the target industry of the employee spinoff is not reported (so the
effect encompasses both within-industry and out-of-industry spinoffs).
The latter outcome encompasses all new firm entry, not just spinoffs.
There are pros and cons of this approach, relative to studying only
spinoffs. On the one hand, it examines an outcome less likely to be
directly impacted by non-compete clauses. On the other hand, if firms
are encouraged to enter when non-compete clauses are more easily
enforceable (due to, e.g., greater projected protection of knowledge
assets), then this approach will likely identify effects that may
appear only weakly when looking just at spinoffs.
---------------------------------------------------------------------------
\483\ Jeffers (2019), supra note 92 at 1.
---------------------------------------------------------------------------
For each outcome, the estimated effect of an increase in non-
compete clause enforceability (which is, in this study, measured by a
collection of discrete legal changes) is negative: an increase in non-
compete clause enforceability decreases the rate at which employees
leave to become founders of firms by 0.78 percentage points, against a
mean in the sample of 5% (though the result is statistically
indistinguishable from zero),\484\ and decreases the rate of new firm
entry by 0.06 firms per million people (against a mean of 0.38) for
firms in the knowledge sector, compared with firms in other sectors
(for which there is no statistically significant effect). Due to the
design of the study, the change in legal enforceability is not
quantified, and therefore no extrapolation is possible to the country
as a whole.
---------------------------------------------------------------------------
\484\ The estimated effect is statistically significant at the
10% level, and nearly doubles to 0.014, when attention is focused on
firms which employ at least 40% of workers in the state in which
their headquarters resides. This is important because it ensures
that a greater portion of the workforce is subject to the local non-
compete clause policy regime: a broadly dispersed company has
workers subject to many different legal policies surrounding non-
compete clauses, and it is therefore not surprising that the
estimate is unable to distinguish a large impact of the policy
changes.
---------------------------------------------------------------------------
Three more estimates related to firm entry exist in the literature.
One examines the differential impacts of venture capital (``VC'')
funding on firm entry: it finds a 1% increase in VC funding increases
business formation by 2.3% when non-compete clauses are not
enforceable, and by 0.8% when non-compete clauses are enforceable.\485\
Another study examined the extent to which a legal enforceability
increase in Michigan affected firm entry, and found that, among all
sectors, there was no change in the entry rate of new firms (none of
the estimated coefficients were statistically significant).\486\ Among
high-tech firms, the increase in enforceability was associated with a
40.3% increase in entry when compared with states that did not enforce
non-compete clauses. However, the study also notes that, compared with
its neighbors, or using a statistical technique to match Michigan's
trend in firm entry (synthetic control method), the estimated effect
was statistically indistinguishable from zero. Finally, a study
examining the effect of an increase in enforceability in Florida found
small firm (fewer than 50 employees) entry fell by 5.6%, while large
firm (greater than 1,000 employees) entry increased by 8.5%. Similarly,
employment at large businesses rose by 15.8% following the change,
while employment at smaller businesses effectively did not change
\.487\ The net effect was a 4.4% increase in concentration, as measured
by a Herfindahl-Hirschman Index, due to the overall increase in the
size of
[[Page 3527]]
firms. It is important to note that firm entry, in this study, is not
necessarily new business formation. Indeed, the authors describe many
business entries into Florida are existing businesses which are seeking
to move or establish new franchises. The observed effects may therefore
be due to relocations across state lines, which would likely not occur
under the proposed rule.
---------------------------------------------------------------------------
\485\ Samila & Sorenson, supra note 112 at 425-38.
\486\ Carlino, supra note 86.
\487\ Kang & Fleming, supra note 120 at 674.
---------------------------------------------------------------------------
For the previously mentioned three sets of estimates, it is again
difficult to extrapolate to a population-wide measure of impact, since
the ``size'' of the enforceability change is not quantified.
In Part II.B.2.c above, the Commission states the weight of the
evidence demonstrates new firm formation would increase under the
proposed rule; however, the Commission is unable to extrapolate from
the studies which examine this outcome in order to quantify or monetize
the effect.
b. Innovation
Scholars have posited that a lack of non-compete clause
enforceability led Silicon Valley to become a hub of technological
innovation. One paper theorizes that, as workers freely flowed between
knowledge firms, those workers shared ideas and generated innovations
greater than what a fixed set of workers, not interacting with outside
workers, could have generated.\488\ Studies have shown labor mobility
is greater when non-compete clauses are more difficult to enforce.\489\
However, those same studies did not directly show innovation is aided
by the free flow of knowledge workers.
---------------------------------------------------------------------------
\488\ Gilson, supra note 88.
\489\ See, e.g., Fallick, Fleischman, & Rebitzer, supra note 89
at 472-81; Johnson, Lavetti, & Lipsitz, supra note 42.
---------------------------------------------------------------------------
If non-compete clauses inhibit innovation by creating barriers to
knowledge-sharing, then a prohibition on non-compete clauses, by
alleviating those barriers, would increase innovation. Studies have
sought to directly quantify this effect, primarily focused on patenting
activity.
One study examined the impact of non-compete clause enforceability
on venture capital's relationship with innovation. The study found
that, when non-compete clauses are enforceable, venture capital induced
less patenting, by 6.6 percentage points.\490\ Two other studies
directly focused on the relationship between non-compete clause
enforceability and patenting. One, examining seven changes in non-
compete clause enforceability, finds a 26.6% decline in the value of
patents (as measured by changes in stock prices surrounding the date a
patent is granted) associated with increases in non-compete clause
enforceability.\491\ The other, examining the impact of a legal change
in enforceability in Michigan, finds an increase in non-compete clause
enforceability leads to an increase in the number of patents per 10,000
residents of 0.054 (against a mean of 2.20 in Michigan prior to the
legal change).\492\ There is no clear reason for this discrepancy in
findings. It may be due to the setting being studied: the study finding
a 26.6% decline in patent value considers several legal changes in non-
compete clause enforceability, rather than just using one (as in the
Michigan study) or relying on cross-sectional differences (as in the
study of venture capital).
---------------------------------------------------------------------------
\490\ Samila & Sorenson, supra note 112 at 432.
\491\ He, supra note 124 at 22.
\492\ Carlino, supra note 86 at 40.
---------------------------------------------------------------------------
While the Commission believes the strongest evidence (due to the
robustness of the findings across several legal changes) indicates
innovation would likely increase under the proposed rule, as described
above in Part II.B.2.d, the Commission is unable to extrapolate from
the relevant studies to quantify or monetize this benefit.
c. Prices
Several of the effects discussed above, as well as costs of the
proposed rule on products and service markets, may possibly filter
through to consumer prices. Prices, therefore, may act as a summary
metric for the impacts on consumers. We note this metric is highly
imperfect: for example, increased innovation due to the proposed rule
could cause quality increases in products, which drives prices up.
Consumers may be better off, even though prices increased. For this
reason, as well as to avoid double-counting (since prices may take into
account changes in innovation, investment, market structure, wages, and
other outcomes), we consider evidence on prices to be corroborating
evidence, rather than a unique cost or benefit on its own.
One study estimates the impact of non-compete clause enforceability
on consumer prices in the market for physician services.\493\ The study
estimates moving from the lowest observed non-compete clause
enforceability score to the highest would increase prices by 53.3%.
Extrapolating to the effect of the proposed prohibition nationwide
(using 2009 enforceability scores), and applying percentage price
decreases to state-level physician spending,\494\ we estimate health
spending would decrease by $148.0 billion annually. We note, again,
this is a large (linear) extrapolation from the estimate provided in
the study. Furthermore, this amount is partially a transfer from
physician practices to consumers, and additionally, we reiterate this
estimate likely encompasses some of the prior estimates (i.e., those
regarding new firm formation or innovation), and we therefore do not
count it as a standalone benefit of the proposed rule.
---------------------------------------------------------------------------
\493\ Hausman & Lavetti, supra note 101 at 258.
\494\ The latest available numbers are from 2014. See Ctrs. for
Medicare & Medicaid Servs., National Health Expenditure Data, Health
Expenditures by State of Provider, 1980-2014 (last visited Dec. 9,
2022), https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsStateHealthAccountsProvider. We use physician
and clinical spending in 2014 by state of provider.
---------------------------------------------------------------------------
With respect to other industries, if the relationship between non-
compete clause enforceability and prices observed in healthcare markets
holds, the Commission believes prices would decrease, product and
service quality would increase, or both under the proposed rule.
Insofar as such effects may be driven by increases in competition (see
Part VII.B.2.a), it is likely output would also increase. However, the
evidence in the economic literature is solely based on healthcare
markets (which do comprise a large portion of spending in the United
States, but are far from all consumer spending), and while there is
evidence that there are relationships between non-compete clause
enforceability and concentration, innovation, new firm formation, and
other product market outcomes, the Commission cannot say with certainty
similar effects would be present for other products and services.
In many settings, it is theoretically plausible increases in worker
earnings from restricting non-compete clauses may increase consumer
prices by raising firms' costs (though there is countervailing
evidence, especially in goods manufacturing).\495\ We note an absence
of empirical evidence that this mechanism persists in practice, as well
as countervailing forces, such as the impacts on concentration
described above and positive impacts on innovation (see Part II.B.2.d).
Additionally, greater wages for workers freed from non-compete clauses
may be due to better worker-firm matching, which could simultaneously
increase wages and increase productivity, which
[[Page 3528]]
could lead to lower prices. Finally, as described in Part II.B.2.a,
increases in healthcare prices are not due to pass-through of greater
labor costs.
---------------------------------------------------------------------------
\495\ Sebastian Heise, Fatih Karahan, & Ay[scedil]eg[uuml]l
[Scedil]ahin The Missing Inflation Puzzle: The Role of the
Wage[hyphen]Price Pass[hyphen]Through, 54 J. Money, Credit & Banking
7 (2022).
---------------------------------------------------------------------------
C. Estimated Costs of the Proposed Rule
In this Part VII.C, we describe the costs associated with the
proposed rule; provide preliminary quantitative, monetized estimates
where possible; and describe costs we can only assess qualitatively. We
welcome public comment regarding the scope of the costs outlined in
this Part VII.C, especially with respect to direct compliance costs and
the costs of updating contractual practices.
The Commission estimates firms' direct compliance costs and the
costs of firms updating their contractual practices would total $1.02
to $1.77 billion. The Commission also finds worker training and firm
investment in capital assets would likely decrease under the proposed
rule. Finally, the Commission finds inconclusive evidence that the job
creation rate would diminish under the proposed rule. Given the
evidence available, the Commission is unable to monetize the estimates
of worker training, firm investment in capital assets, and job
creation, however.
1. Direct Compliance Costs
In order to comply with the proposed rule, firms must remove non-
compete clauses from workers' contracts in two ways. First, to comply
with proposed Sec. 910.2(a), which states it is an unfair method of
competition to maintain with a worker a non-compete clause, firms would
need to no longer include non-compete clauses in the contracts of
incoming workers, which may include revising existing employment
contracts. Second, to comply with proposed Sec. 910.2(b)(1) and (2),
firms would need to rescind existing non-compete clauses no later than
the compliance date and provide notice to workers that the worker's
non-compete clause is no longer in effect and may not be enforced
against the worker.
In order to reduce compliance costs and increase compliance
certainty, proposed Sec. 910.2(b)(3) would provide that an employer
complies with the rescission requirement in proposed Sec. 910.2(b)(1)
where it provides notice to a worker pursuant to Sec. 910.2(b)(2).
Furthermore, proposed Sec. 910.2(b)(2)(C) includes model language
which may be provided to the worker in order to inform the worker that
their non-compete clause is no longer in effect. We estimate composing
and sending this message in a digital format to all of a firm's workers
and applicable former workers would take 20 minutes of a human
resources specialist's time. According to the Bureau of Labor
Statistics, the median wage for a human resources specialist was $29.95
per hour in 2021.\496\ The cost of compliance for currently employed
workers is therefore $29.95/3=$9.98 per firm. According to the U.S.
Census Bureau's Statistics of U.S. Businesses database, in 2019 (the
most recent year with data available), there were 6.10 million firms
and 7.96 million establishments in the United States.\497\ We estimate
the percentage of firms using non-compete clauses in the U.S. at 49.4%.
This estimate is based on Colvin and Shierholz's 2017 survey of
business establishments. Colvin and Shierholz estimate 49% of
establishments of more than 50 employees use non-compete clauses for at
least some of their employees, and 32% of establishments use non-
compete clauses for all of their employees.\498\
---------------------------------------------------------------------------
\496\ See Bureau of Lab. Stats., Occupational Outlook Handbook,
Human Resources Specialists, https://www.bls.gov/ooh/business-and-financial/human-resources-specialists.htm.
\497\ The dataset is available at U.S. Census Bureau, 2019 SUSB
Annual Data Tables by Establishment Industry, https://www.census.gov/data/tables/2019/econ/susb/2019-susb-annual.html
(last visited Dec. 9, 2022).
\498\ Alexander J.S. Colvin & Heidi Shierholz, Econ. Pol'y
Inst., Noncompete Agreements (2019) at 1.
---------------------------------------------------------------------------
Conservatively assuming each establishment must engage in its own
communication (i.e., that a firm's headquarters does not have the
ability to send a company-wide email, for example), this means the
total direct compliance cost for rescinding existing non-compete
clauses and providing notice is $9.98*7.96 million*0.494=$39.25
million.
To ensure incoming workers' contracts do not include non-compete
clauses and they fully comply with the proposed rule, firms may employ
in-house counsel, outside counsel, or human resource specialists
(depending on the complexity of the relevant non-compete clause). For
many firms, this process would likely be straightforward (i.e., simply
not using non-compete clauses or removing one section from a
boilerplate contract). For other firms, it may be more difficult and
require more time. We assume that, on average, ensuring contracts for
incoming workers do not have non-compete clauses would take the
equivalent of one hour of a lawyer's time (valued at $61.54),\499\
resulting in a total cost of $61.54*7.96 million*0.494=$241.96 million.
We acknowledge there may be substantial heterogeneity in the costs for
individual firms; however, we believe this number is conservative. For
firms whose costs of removing non-compete clauses for incoming workers
is greater, the work of ensuring contracts comply with the law would
overlap substantially with the costs of updating contractual practices,
described in the next section.
---------------------------------------------------------------------------
\499\ Bureau of Lab. Stats., Occupational Outlook Handbook:
Lawyers, https://www.bls.gov/ooh/legal/lawyers.htm.
---------------------------------------------------------------------------
2. Costs of Updating Contractual Practices
Firms may seek to update their contractual practices by expanding
the scope of non-disclosure agreements (NDAs) or other contractual
provisions to ensure they are expansive enough to protect trade secrets
and other valuable investments. To do so, firms may use in-house
counsel or outside counsel to examine and amend current contracts or
enter into new contracts with workers.
The Commission is not aware of empirical evidence on how much it
costs firms to update their contractual practices when they can no
longer use non-compete clauses. However, there is evidence indicating
firms that use non-compete clauses are already using other types of
restrictive employment provisions. Firms may be doing so because, among
other things, they are uncertain whether a non-compete clause will be
enforceable, or because they desire the additional protections NDAs and
other types of restrictive employment provisions can offer.
Balasubramanian et al. find that 97.5% of workers with non-compete
clauses are also subject to a non-solicitation agreement, non-
disclosure agreement, or a non-recruitment agreement, and 74.7% of
workers with non-compete clauses are also subject to all three other
types of provisions.\500\ Firms that are already using multiple layers
of protection may not need to expand the scope of existing restrictive
employment provisions or enter into new ones.
---------------------------------------------------------------------------
\500\ Balasubramanian, Starr, & Yamaguchi, supra note 40 at 35.
We calculate 97.5% as (1-0.6%/24.2%), where 0.6% represents the
proportion of workers with only a non-compete clause, and no other
post-employment restriction, and 24.2% represents the proportion of
workers with a non-compete clause, regardless of what other post-
employment restrictions they have.
---------------------------------------------------------------------------
Among the approximately one half of firms that use non-compete
clauses,\501\ we assume the average firm employs the equivalent of four
to eight hours of a lawyer's time to update their contractual
practices. We emphasize this is an average to underline the fact that
there would likely be large differences in the extent to which firms
update their contractual practices. Many firms, including those which
use non-compete clauses only with workers who do not
[[Page 3529]]
have access to sensitive information, or those which are already using
other types of restrictive employment provisions to protect sensitive
information, may opt to do nothing. Other firms may employ several
hours or multiple days of lawyers' time to arrive at a new
contract.\502\ Our estimated range of four to eight hours represents an
average taken across these different possibilities. For example, if
two-thirds of firms that currently use non-compete clauses opt to make
no changes to their contractual practices (for example, because they
are one of the 97.5% of firms which already implement other post-
employment restrictions, or because they will rely on trade secret law
in the future, or because they are using non-compete clauses with
workers who do not have access to sensitive information), and one-third
of such firms spend (on average) the equivalent of 1.5 to 3 days of an
attorney's time, this would result in the estimate of 4-8 hours on
average reported above.
---------------------------------------------------------------------------
\501\ Colvin & Shierholz, supra note 498 at 1.
\502\ These estimates are derived from outreach to employment
attorneys active in assisting firms in writing their non-compete
clauses.
---------------------------------------------------------------------------
We further emphasize this estimate is an average across all
employers that would be covered by the rule. There is likely
substantial heterogeneity in the amount of time firms would use to
update contractual practices; very large firms that use non-compete
clauses extensively would likely incur greater costs.
Under the assumption the average firm that uses a non-compete
clause employs the equivalent of four to eight hours of a lawyer's
time, we calculate the total expenditure on updating contractual
practices to range from $61.54*4*49.4%*6,102,412=$742.07 million to
$61.54*8*49.4%*6,102,412=$1.48 billion. Note that we assume decisions
regarding protection of sensitive information and contract updating are
made at the firm, rather than establishment, level, since sensitive
information is likely shared across business establishments of a firm.
The Commission seeks comment on this estimate.
3. Firm Investment
Non-compete clauses may impact investments made by firms in
multiple ways.\503\ First, a firm may anticipate a greater return on
investment in a worker with a non-compete clause--since the worker is
unable to take the skills they attain to a competitor--and may
therefore provide greater levels of training. Second, since non-compete
clauses increase worker training, firms may increase investment that
complements human capital when they are able to use non-compete
clauses. Third, non-compete clauses decrease competition, which
increases returns on investment at the firm level, inducing additional
investment at the firm level. This increased investment at the firm
level does not necessarily mean, however, investment would increase at
the market level, since decreased competition may also decrease output,
decreasing employed capital stock and investment in that capital stock.
---------------------------------------------------------------------------
\503\ For more discussion, see Jeffers (2019), supra note 92;
Starr (2019), supra note 66 at 783-817.
---------------------------------------------------------------------------
Once again, the costs described in this section may overlap with
estimates reported in preceding sections. For example, if increased
enforceability of non-compete clauses increases training of workers,
and increased training results in higher wages for workers, then the
estimate of the wage decrease when enforceability increases already
takes into account the extent to which increased training increases
wages. That is, if training were held constant, the earnings increase
associated with the proposed rule would likely be even larger.
With respect to worker training, one study finds that an increase
in the non-compete clause enforceability index of one standard
deviation (across states) results in an increase in the number of
workers who reported receiving training of 14.7% for workers in
occupations which use non-compete clauses at a high rate, relative to
those in which non-compete clauses are used at a low rate.\504\
Extending this estimate to the U.S. workforce implies that, on average,
3.1% fewer workers would receive training in a given year, as a result
of the proposed rule.\505\
---------------------------------------------------------------------------
\504\ Starr (2019), supra note 66 at 796. Estimates are taken
from Table 4, Column 4.
\505\ The total training decrease is calculated as the weighted
average (where weights are equal to employment in 2020, the latest
year available, taken from https://data.bls.gov/cew/apps/table_maker/v4/table_maker.htm) over all states of:
(e
-0.0077*(State's Enforceability Score--Lowest State Enforceability Score)
-1)
This calculation assumes that all workers are subject to the
decrease in training, as opposed to calculating the decrease to
those in high-use occupations versus those in low-use occupations.
The benefit of this approach is that it yields a total predicted
training decrease for the economy as a whole, rather than a
comparison between different types of workers. However, it is likely
an overestimate for workers in low-use occupations, and an
underestimate for those in high-use occupations. It is the same
methodology used to calculate earnings increases in Part VII.B.1.a
for the estimate drawn from the same study.
---------------------------------------------------------------------------
An estimate of the impact of non-compete clause enforceability on
firm investment in capital assets implies that an increase in
enforceability leads to an increase in firms' net investment to asset
ratio of 1.3 percentage points (against a mean of 3.5%). The magnitude
of the enforceability increase which is associated with this change is
not quantified according to the scale above, however, so it is not
possible to extend this estimate to the population. Additionally, the
estimate is constructed at the firm level, and it is not possible to
extrapolate the estimate to the market level, given potential changes
in the composition of the market associated with changes in non-compete
clause enforceability.
The proposed rule may also impact the extent to which trade secrets
are shared with workers. Non-compete clauses are commonly justified as
a means by which firms are able to protect trade secrets, which may
allow those trade secrets to be shared more freely with workers,
positively impacting productivity. However, to the best of our
knowledge, there is no available evidence on this topic which would
allow us to quantify or monetize the cost, or identify whether it
exists in practice.
4. Job Creation Rates
While non-compete clauses may, in theory, incentivize firms to
create jobs by increasing the value associated with any given worker
covered by a non-compete clause, the evidence is inconclusive. One
estimate indicates the job creation rate at startups increased by 7.8%
when Michigan increased non-compete clause enforceability.\506\
However, the job creation rate calculated in this study is the ratio of
jobs created by startups to overall employment in the state: therefore,
the job creation rate at startups may rise either because the number of
jobs created by startups rose, or because employment overall fell. The
study does not investigate which of these two factors drives the
increase in the job creation rate at startups.
---------------------------------------------------------------------------
\506\ Carlino, supra note 86 at 16.
---------------------------------------------------------------------------
Another study finds that several increases in non-compete clause
enforceability were associated with a 1.4% increase in average
employment at new firms.\507\ However, the authors attribute the
increase in average employment to a change in the composition of newly
founded firms. The increases in enforceability prevented the entry of
relatively small startups which would otherwise have existed. The
remaining firms which entered were therefore larger on average: this
increases the average job creation
[[Page 3530]]
rate at new firms, because the average entering firm is relatively
larger. However, in terms of total jobs created, it means that
increases in enforceability generate fewer total jobs, if the mechanism
identified by the authors is correct. A similar mechanism may explain
the results in both studies above. If that is indeed the case, then an
increased job creation rate among startups is not a cost of the
proposed rule. Instead, it could actually be a benefit (albeit
unquantifiable), since non-compete clauses prevent small firms from
existing in the first place. The Commission therefore believes that,
with respect to job creation rates, the evidence is inconclusive: it is
unclear whether the negative results have causes which are actually
benign, or even positive.
---------------------------------------------------------------------------
\507\ Starr, Balasubramanian, & Sakakibara, supra note 87 at
561.
---------------------------------------------------------------------------
5. Litigation Costs
The proposed rule would likely reduce litigation costs associated
with non-compete clauses, since there would be little to no uncertainty
that the vast majority of those clauses are prohibited. However, it is
also possible that costs associated with trade secret claims or other
post-employment restrictions, such as non-disclosure agreements or non-
solicitation agreements, would increase. The Commission is not aware of
any evidence indicating the magnitude of the change in litigation costs
associated with any of these claims, and it is therefore not clear
whether the net impact on litigation costs would be a benefit or a cost
of the proposed rule. The Commission seeks comment on the impact the
rule would have on litigation costs.
D. Discussion of Alternatives
In Part VI of this NPRM, the Commission describes several
alternatives to the proposed rule. Here, we discuss the extent to which
implementation of each of these alternatives would change the analysis
of benefits and costs presented above.
We treat Alternatives 1 and 3 first. Under Alternative 1, the rule
would categorically ban the use of non-compete clauses for some workers
and apply a rebuttable presumption of unlawfulness to non-compete
clauses for other workers. For example, the rule could ban non-compete
clauses generally, but apply the rebuttable presumption to workers who
qualify for the FLSA exemptions for executives or learned
professionals.\508\ Or the rule could ban non-compete clauses but apply
the rebuttable presumption to workers who earn more than $100,000 per
year. Under Alternative 3, non-compete clauses for all workers would be
subject to a rebuttable presumption of illegality.
---------------------------------------------------------------------------
\508\ See supra notes 423-424 and accompanying text.
---------------------------------------------------------------------------
There are two primary ways in which a rebuttable presumption of
illegality, rather than a prohibition, could affect the benefits and
costs associated with the proposed rule. First, a rebuttable
presumption may decrease costs associated with the proposed rule by
allowing employers to use non-compete clauses in situations in which
the true benefits of non-compete clauses exceed the costs. In other
words, the non-compete clauses which survive a rebuttable presumption
may contribute to economic efficiency to the extent a court is able to
identify efficiency-enhancing non-compete clauses.
Second, a rebuttable presumption could increase costs by forcing
cases involving non-compete clauses to be litigated more frequently,
since the line defining a permissible non-compete clause would be less
bright. Additionally, there may be situations in which the presumption
would likely hold (i.e., a given non-compete clause is likely
prohibited under the presumption), but which are not fought by workers,
fearing they might lose the case. In such cases, any costs and benefits
associated with non-compete clauses (such as those outlined in the
preceding sections) would accrue to the economy.
The two impacts of a change from a prohibition to a rebuttable
presumption would likely be more drastic for workers above the
threshold (for whom the presumption would be rebuttable under
Alternative 1), as compared with those additional workers for whom the
presumption would be rebuttable under Alternative 3. For the latter set
of workers, there are fewer plausible cases in which the presumption
would be rebutted, since higher-paid workers typically have access to
greater levels of sensitive information. This means there is a smaller
efficiency gain to be had from allowing non-compete clauses which could
plausibly rebut the presumption; however, it also means there would
likely be fewer litigated cases since there would be fewer marginal
non-compete clauses. Therefore, the effect of moving from the proposed
rule to Alternative 1 is likely more substantial than the effect of
moving from Alternative 1 to Alternative 3.
The effects of Alternatives 2 and 4 may be analyzed similarly.
Under Alternative 2, the rule would categorically ban the use of non-
compete clauses for some workers and not apply any requirements to
other workers. For example, like the recent State of Washington
statute, the rule could prohibit the use of non-compete clauses for
employees earning $100,000 or less per year and independent contractors
earning less than $250,000 or less per year. Or, like the recent
Massachusetts and Rhode Island statutes, the rule could prohibit the
use of non-compete clauses for workers who are non-exempt under the
FLSA.\509\ Under Alternative 4, the rule would apply a rebuttable
presumption of unlawfulness to non-compete clauses for some workers and
not apply any requirements to other workers. Workers above the
threshold are most likely to be those workers for whom firm investment
and training are valuable, but they are also often uniquely positioned
to found new firms, since they hold knowledge gained by working in
their industry. Therefore, a large portion of the benefits associated
with the proposed rule would be lost if workers above the threshold
were not covered; however, a large portion of the costs would also be
lost, since the need to restructure contracts to protect sensitive
information would no longer be present for those workers, and firms
would continue to train and invest in those workers in the same way
they currently do. Additionally, the earnings effects for relatively
lower-wage workers appear to be less, based on empirical work, though
the legal changes analyzed were not perfectly comparable. This could
indicate, again, there are more substantial benefits to be had from
prohibiting non-compete clauses for workers above the threshold based
on harms to labor markets, compared with workers below the threshold.
---------------------------------------------------------------------------
\509\ See supra Part VI.B.2.
---------------------------------------------------------------------------
The alternative under which the rule would use a different standard
for senior executives, discussed in Part VI.C, would yield similar
effects to the analyses discussed above. If a rebuttable presumption
were applied to senior executives, if there are some non-compete
clauses that are efficient, and if courts are able to appropriately
identify efficient non-compete clauses, then some non-compete clauses
would likely be used (and may survive challenges) which are indeed
efficient. On the other hand, costs associated with legal challenges
would likely increase due to an increased frequency of legal challenges
associated with a less bright line. If no requirement is applied to
senior executives, then a large portion of the benefit of the proposed
rule, as it applies to senior executives, would be lost: benefits
associated with increased
[[Page 3531]]
product market competition and benefits associated with increased labor
market competition. The costs of restructuring contracts, however,
would be lost, as well.
Another alternative, discussed in Part VI.D, concerns whether non-
compete clauses between a franchisor and a franchisee would be covered
by the proposed rule. As noted in Part VI.D, evidence concerning the
impact of prohibiting non-compete clauses between franchisors and
franchisees does not exist. The Commission is therefore unable to
estimate the extent to which the costs and benefits which would result
from the proposed rule covering those parties would be similar to those
resulting from prohibiting worker non-compete clauses.
E. Other Major Effects
There are two substantial equity concerns associated with the
proposed rule which are not captured above. The first relates to the
economic outcomes of women and racial and ethnic minorities. Non-
compete clauses may affect women and racial and ethnic minorities more
negatively than other workers. For example, firms may use the monopsony
power which results from use of non-compete clauses as a means by which
to wage discriminate, or women (who may exhibit greater risk aversion,
in practice \510\) may be more reluctant to start businesses when non-
compete clauses are enforceable. One estimate indicates that gender and
racial wage gaps would close by 3.6-9.1% under a nationwide prohibition
on non-compete clauses.\511\ Another estimate indicates the negative
impact of non-compete clause enforceability on within-industry
entrepreneurship is 15% greater for women than for men.\512\
---------------------------------------------------------------------------
\510\ See, e.g., Catherine C. Eckel & Philip J. Grossman, Men,
Women and Risk Aversion: Experimental Evidence, Handbook of
Experimental Economics Results 1 (2008) 1061-073 and Gary Charness &
Uri Gneezy, Strong Evidence For Gender Differences in Risk Taking,
83 J. Econ. Behavior & Org. 50-58 (2012).
\511\ Johnson, Lavetti, & Lipsitz, supra note 63 at 38.
\512\ Marx (2021), supra note 118 at 8.
---------------------------------------------------------------------------
The second equity concern related to non-compete clauses is that
workers may not be willing to file lawsuits against deep-pocketed
employers to challenge their non-compete clauses, even if they predict
a high probability of success. The proposed rule would substantially
mitigate this concern by enacting a bright-line prohibition, which the
Commission could enforce. This would mitigate uncertainty for workers
and would be especially helpful for relatively low-paid workers, for
whom access to legal services may be prohibitively expensive.
VIII. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), as amended by the Small
Business Regulatory Enforcement Fairness Act of 1996, requires an
agency to either provide an Initial Regulatory Flexibility Analysis
(IRFA) with a proposed rule or certify that the proposed rule would not
have a significant impact on a substantial number of small
entities.\513\ The Commission does not expect the proposed rule, if
adopted, would have a significant impact on a substantial number of
small entities.
---------------------------------------------------------------------------
\513\ 5 U.S.C. 603-605.
---------------------------------------------------------------------------
Although small entities across all industrial classes--i.e., all
North American Industry Classification System (NAICS) codes--would be
affected, the estimated impact on each entity would be relatively
small. The Small Business Administration (SBA) states that, as a rule
of thumb, the impact of a proposed rule could be significant if the
cost of the proposed rule (a) eliminates more than 10% of the
businesses' profits; (b) exceeds 1% of the gross revenues of the
entities in a particular sector, or (c) exceeds 5% of the labor costs
of the entities in the sector.\514\ As calculated in Part VIII.D, the
Commission estimates direct compliance costs and the costs of updating
contractual practices would result in costs of $317.68 to $563.84 for
single-establishment firms. These costs would only exceed these sample
limits if the average profit of regulated entities is $3,177 to $5,638,
average revenue is $31,768 to $56,384, or average labor costs are
$6,353 to $11,276, respectively. Furthermore, while there are
additional nonmonetizable costs associated with the proposed rule,
there are also nonmonetizable benefits which would at least partially
offset those costs, as explained above in Part VII.
---------------------------------------------------------------------------
\514\ Small Bus. Admin., A Guide for Government Agencies: How to
Comply With the Regulatory Flexibility Act (August 2017)
(hereinafter RFA Compliance Guide) at 19.
---------------------------------------------------------------------------
Although the Commission certifies under the RFA that the proposed
rule would not have a significant impact on a substantial number of
small entities, and hereby provides notice of that certification to the
SBA, the Commission has determined it is appropriate to publish an IRFA
in order to describe the impact of the proposed rule on small entities.
The Commission seeks comment on all aspects of the IRFA in this Part
VIII.
A. Reasons for the Proposed Rule
The Commission describes the reasons for the proposed rule above in
Part IV.
B. Statement of Objectives and Legal Basis
The Commission describes the objectives and legal basis for the
proposed rule above in Part IV and the legal authority for the rule
above in Part III.
C. Description and Estimated Number of Small Entities to Which the Rule
Would Apply
The proposed rule would impact all small businesses, across all
industry classes, that use non-compete clauses. The Commission does not
expect there are classes of businesses that would face disproportionate
impacts from the proposed rule.
For the vast majority of industries, there is no granular data
regarding the percentage of firms that use non-compete clauses (which
could then be used to calculate the number of small entities in that
industry using non-compete clauses). Due to this data limitation and
given the relatively stable percentage of firms using non-compete
clauses across the size distribution,\515\ we estimate the total number
of small firms across all industries in the U.S. economy. We then
calculate the number of firms estimated to use non-compete clauses by
applying an estimate of the percentage of firms using non-compete
clauses to that total. Using the size standards set by the SBA,\516\ we
calculate that there are 5.95 million small firms and 6.24 million
small establishments in the U.S.\517\ Assuming
[[Page 3532]]
49.4% of firms or establishments use non-compete clauses,\518\ we
estimate 2.94 million small firms, comprising 3.08 million small
establishments, would be affected by the proposed rule. Since our
estimate ignores differential use of non-compete clauses across
industries (in the absence of more detailed data), these firms span all
industries and various sizes below the standards set in the SBA's size
standards.
---------------------------------------------------------------------------
\515\ See Colvin & Shierholz, supra note 498 at 5. We emphasize
that, since smaller firms generally use non-compete clauses at a
lower rate, based on the numbers reported in Table 1, our estimate
of the number of affected small entities is likely larger than is
true in practice.
\516\ See Small Bus. Admin., Table of Size Standards, https://www.sba.gov/document/support-table-size-standards.
\517\ We use the latest data available from the U.S. Census
Bureau's Statistics of U.S. Businesses database, available based on
firm revenue and firm size. U.S. Census Bureau, Statistics of U.S.
Businesses (SUSB), https://www.census.gov/programs-surveys/susb.html
(last visited Dec. 9, 2022). We deflate to current dollars using
Historical Table 10.1. Off. of Mgmt. & Budget, Historical Tables,
https://www.whitehouse.gov/omb/budget/historical-tables/ (last
visited Dec. 9, 2022). As used in this analysis, per the U.S. Census
Bureau, ``a firm is a business organization consisting of one or
more domestic establishments in the same geographic area and
industry that were specified under common ownership or control.'' On
the other hand, ``an establishment is a single physical location at
which business is conducted or services or industrial operations are
performed.'' See U.S. Census Bureau, Glossary, https://www.census.gov/programs-surveys/susb/about/glossary.html.
\518\ See Colvin & Shierholz, supra note 498 at 1.
---------------------------------------------------------------------------
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
As calculated in Parts VIII.D.1 and VIII.D.2, the Commission
estimates the direct compliance costs and the costs of updating
contractual practices would total $246.16 to $492.32 for each small
firm, plus an additional $71.52 for each establishment owned by that
firm. A single-establishment firm, for example, would bear estimated
costs of $317.68 to $563.84, for example.
As described in greater detail in Part VII.C.3, the Commission also
finds worker training and firm investment in capital assets would
likely decrease under the proposed rule. Finally, as described in
greater detail in Part VII.C.4, the Commission finds mixed evidence
that the job creation rate would diminish under the proposed rule.
Given the evidence available, the Commission is unable to monetize the
estimates of worker training, firm investment in capital assets, and
job creation, however.
1. Direct Compliance Costs
In order to comply with the proposed rule, small entities must
remove non-compete clauses from workers' contracts in two ways. First,
to comply with proposed Sec. 910.2(a), which states it is an unfair
method of competition to maintain with a worker a non-compete clause,
small entities would need to no longer include non-compete clauses in
the contracts of incoming workers, which may include revising existing
employment contracts. Second, to comply with proposed Sec. 910.2(b)(1)
and (2), small entities would need to rescind existing non-compete
clauses no later than the compliance date and provide notice to workers
that the worker's non-compete clause is no longer in effect and may not
be enforced against the worker.
In order to reduce compliance costs and increase compliance
certainty, proposed Sec. 910.2(b)(3) would provide that an employer
complies with the rescission requirement in proposed Sec. 910.2(b)(1)
where it provides notice to a worker pursuant to Sec. 910.2(b)(2).
Furthermore, proposed Sec. 910.2(b)(2)(C) includes model language
which may be provided to the worker in order to inform the worker that
their non-compete clause is no longer in effect. We estimate composing
and sending this message in a digital format to all of a firm's workers
and applicable former workers would take 20 minutes of a human
resources specialist's time. According to the Bureau of Labor
Statistics, the median wage for a human resources specialist was $29.95
per hour in 2021.\519\ The cost of compliance for currently employed
workers is therefore $29.95/3=$9.98 per firm. As calculated in Part
VIII.C, we estimate there are 2.94 million small firms, comprising 3.08
million small establishments, in the United States which use non-
compete clauses.\520\ Conservatively assuming that each establishment
must engage in its own communication (i.e., a firm's headquarters does
not have the ability to send a company-wide email, for example), this
means the total direct compliance cost for workers who are already
employed is $9.98*3.08 million=$30.74 million.
---------------------------------------------------------------------------
\519\ See U.S. Bureau of Lab. Stats., Occupational Outlook
Handbook, Human Resources Specialists, https://www.bls.gov/ooh/business-and-financial/human-resources-specialists.htm.
\520\ The dataset is available at U.S. Census Bureau, 2019 SUSB
Annual Data Tables by Establishment Industry, https://www.census.gov/data/tables/2019/econ/susb/2019-susb-annual.html,
(last visited Dec. 9, 2022).
---------------------------------------------------------------------------
To ensure incoming workers' contracts do not include non-compete
clauses and they fully comply with the proposed rule, firms may employ
in-house counsel, outside counsel, or human resource specialists
(depending on the complexity of the relevant non-compete clause). For
many firms, this process would likely be straightforward (i.e., simply
not using non-compete clauses or removing one section from a
boilerplate contract). For other firms, it may be more difficult and
require more time. We assume that, on average, ensuring contracts for
incoming workers do not have non-compete clauses would take the
equivalent of one hour of a lawyer's time (valued at $61.54),\521\
resulting in a total cost of $61.54*3.08 million=$189.54 million. We
acknowledge there may be substantial heterogeneity in the costs for
individual firms; however, we believe this number is conservative. For
firms whose costs of removing non-compete clauses for incoming workers
is greater, the work of ensuring that contracts comply with the law
would overlap substantially with the costs of updating contractual
practices, described in the next section.
---------------------------------------------------------------------------
\521\ U.S. Bureau of Lab. Stats., Occupational Outlook Handbook,
Lawyers, https://www.bls.gov/ooh/legal/lawyers.htm.
---------------------------------------------------------------------------
For each establishment of each firm, we estimate direct compliance
costs would total $9.98+$61.54=$71.52.
2. Costs of Updating Contractual Practices
Firms may seek to update their contractual practices by expanding
the scope of non-disclosure agreements (NDAs) or other contractual
provisions to ensure they are expansive enough to protect trade secrets
and other valuable investments. To do so, firms may use in-house
counsel or outside counsel to examine and amend current contracts or
enter into new contracts with workers.
The Commission is not aware of empirical evidence on how much it
costs firms to update their contractual practices when they can no
longer use non-compete clauses. However, there is evidence indicating
firms that use non-compete clauses are already using other types of
restrictive employment provisions. Firms may be doing so because, among
other things, they are uncertain whether a non-compete clause will be
enforceable, or because they desire the additional protections NDAs and
other types of restrictive employment provisions can offer.
Balasubramanian et al. find that 97.5% of workers with non-compete
clauses are also subject to a non-solicitation agreement, non-
disclosure agreement, or a non-recruitment agreement, and 74.7% of
workers with non-compete clauses are also subject to all three other
types of provisions.\522\ Firms already using multiple layers of
protection may not need to expand the scope of existing restrictive
employment provisions or enter into new ones.
---------------------------------------------------------------------------
\522\ Balasubramanian, Starr, & Yamaguchi, supra note 40 at 35.
We calculate 97.5% as (1-0.6%/24.2%), where 0.6% represents the
proportion of workers with only a non-compete clause, and no other
post-employment restriction, and 24.2% represents the proportion of
workers with a non-compete clause, regardless of what other post-
employment restrictions they have.
---------------------------------------------------------------------------
Among the approximately one half of firms that use non-compete
clauses,\523\ we assume the average firm employs the equivalent of four
to eight hours of a lawyer's time to update their contractual
practices. We emphasize this is an average to underline the likelihood
of large differences in the extent to which firms update their
contractual practices. Many firms, including those which use non-
compete clauses only with workers who do not have access to sensitive
information, or those which are already using other types of
restrictive employment provisions to protect
[[Page 3533]]
sensitive information, may opt to do nothing. Other firms may employ
several hours or multiple days of lawyers' time to arrive at a new
contract.\524\ Our estimated range of four to eight hours represents an
average taken across these different possibilities. For example, if
two-thirds of firms that currently use non-compete clauses opt to make
no changes to their contractual practices (for example, because they
are one of the 97.5% of firms which already implement other post-
employment restrictions, or because they will rely on trade secret law
in the future, or because they are using non-compete clauses with
workers who do not have access to sensitive information), and one-third
of such firms spend (on average) the equivalent of 1.5 to 3 days of an
attorney's time, this would result in the estimate of 4-8 hours on
average reported above.
---------------------------------------------------------------------------
\523\ Colvin & Shierholz, supra note 498 at 1.
\524\ These estimates are derived from outreach to employment
attorneys active in assisting firms in writing their non-compete
clauses.
---------------------------------------------------------------------------
We further emphasize this estimate is an average across all
employers that would be covered by the rule. There is likely
substantial heterogeneity in the amount of time firms would use to
update contractual practices; very large firms that use non-compete
clauses extensively would likely incur greater costs.
Under the assumption the average firm that uses a non-compete
clause employs the equivalent of four to eight hours of a lawyer's
time, we calculate the total expenditure on updating contractual
practices to range from $61.54*4*2.94 million=$723.7 million to
$61.54*8*2.94 million=$1.45 billion. Note that we assume decisions
regarding protection of sensitive information and contract updating are
made at the firm, rather than establishment, level, since sensitive
information is likely shared across business establishments of a firm.
The Commission seeks comment on this estimate.
For each firm, we estimate the cost of updating contractual
practices would be $61.54*4=$246.16 to $61.54*8=$492.32.
E. Identification of Duplicative, Overlapping, or Conflicting Federal
Rules
The Commission is not aware of any duplicative, overlapping, or
conflicting federal rules. As described above in Part II.C.1, the
enforceability of a non-compete clause currently depends on state law.
Non-compete clauses are also subject to federal antitrust law. However,
the Commission is not aware of any federal regulations that would
duplicate, overlap, or conflict with the proposed rule.
F. Discussion of Significant Alternatives
In Part VI above, the Commission discusses significant alternatives
to the proposed rule. Part VI also includes a preliminary assessment of
whether each of the significant alternatives would accomplish the
objectives of the proposed rule. In addition, the Commission's analysis
of benefits and costs in Part VII includes an assessment of the
benefits and costs of various alternatives.\525\
---------------------------------------------------------------------------
\525\ See supra Part VII.D.
---------------------------------------------------------------------------
The Commission is not proposing an exemption for small entities or
different regulatory requirements for small entities. The proposed rule
would provide it is an unfair method of competition for an employer to
enter into or attempt to enter into a non-compete clause with a worker;
maintain with a worker a non-compete clause; or, under certain
circumstances, to represent to a worker that the worker is subject to a
non-compete clause.\526\ For the reasons described above in Part IV,
the Commission is proposing to provide these practices are an unfair
method of competition under Section 5. Based on the available evidence,
the Commission does not believe the analysis in Part IV above is
fundamentally different for non-compete clauses imposed by small
entities. For this reason, the Commission is not proposing an exemption
for small entities or different regulatory requirements for small
entities. The Commission seeks comment on whether it should propose a
small entity exemption or different requirements for small entities,
including whether non-compete clauses used by small entities are less
likely to have the anticompetitive effects described in Part IV.A
above, and whether employers that are small entities are less likely
than other employers to have alternatives available for protecting
their investments, as described in Part IV.B above.
---------------------------------------------------------------------------
\526\ See proposed Sec. 910.2(a).
---------------------------------------------------------------------------
The Commission is also not proposing a delayed compliance date for
small entities. Under proposed Sec. 910.5, compliance with the
proposed rule would be required as of the proposed compliance date,
which would be 180 days after publication of the final rule in the
Federal Register.\527\ In the Commission's preliminary view, this
proposed compliance period would afford small entities a sufficient
period of time to comply with the proposed rule.\528\ The Commission
seeks comment on whether this is the case.
---------------------------------------------------------------------------
\527\ See proposed Sec. 910.5.
\528\ See supra Part V, in the section-by-section analysis for
proposed Sec. 910.5.
---------------------------------------------------------------------------
IX. Paperwork Reduction Act
Under the Paperwork Reduction Act of 1995 (PRA),\529\ federal
agencies must obtain approval from the Office of Management and Budget
(OMB) for each collection of information they conduct or sponsor. The
term ``collection of information'' includes any requirement or request
for persons to obtain, maintain, retain, report, or publicly disclose
information.\530\ Under the PRA, the Commission may not conduct or
sponsor, and, notwithstanding any other provision of law, a person is
not required to respond to, an information collection unless the
information collection displays a valid control number assigned by
OMB.\531\
---------------------------------------------------------------------------
\529\ 44 U.S.C. 3501 et seq.
\530\ 44 U.S.C. 3502(3); 5 CFR 1320.3(c).
\531\ 44 U.S.C. 3506(c)(1)(B); 5 CFR 1320.5(a)(3).
---------------------------------------------------------------------------
The Commission believes the proposed rule would contain a
disclosure requirement that would constitute a collection of
information requiring OMB approval under the PRA. Proposed Sec.
910.2(a) would state it is an unfair method of competition for an
employer to enter into or attempt to enter into a non-compete clause
with a worker; maintain with a worker a non-compete clause; or, under
certain circumstances, represent to a worker that the worker is subject
to a non-compete clause. Proposed Sec. 910.2(b)(1) would state that,
to comply with Sec. 910.2(a), an employer that entered into a non-
compete clause with a worker prior to the compliance date must rescind
the non-compete clause no later than the compliance date.
Proposed Sec. 910.2(b)(2)--the provision that would contain the
disclosure requirement that would require OMB approval--would require
employers to provide a notice to workers in certain circumstances.
Specifically, proposed Sec. 910.2(b)(2)(A) would require an employer
that rescinds a non-compete clause pursuant to Sec. 910.2(b)(1) to
provide notice to the worker that the worker's non-compete clause is no
longer in effect and may not be enforced against the worker. Proposed
Sec. 910.2(b)(2)(A) would also state the employer must provide the
notice to the worker in an individualized communication and the
employer must provide the notice on paper or in a digital format such
as, for example, an email or text message. Proposed Sec.
910.2(b)(2)(B) would state the employer must provide the notice to a
[[Page 3534]]
worker who currently works for the employer. Proposed Sec.
910.2(b)(2)(B) would also state that the employer must also provide the
notice to a worker who formerly worked for the employer, provided the
employer has the worker's contact information readily available.
Finally, proposed Sec. 910.2(b)(2)(C) would provide model language
that would satisfy the notice requirement. Proposed Sec.
910.2(b)(2)(C) would also state that an employer may also use different
language, provided the notice communicates to the worker that the
worker's non-compete clause is no longer in effect and may not be
enforced against the worker.
The Commission estimates composing and sending this message in a
digital format to all workers would take 20 minutes of a human
resources specialist's time. According to the Bureau of Labor
Statistics, the median wage for a human resources specialist in 2021
was $29.95 per hour.\532\ The cost of compliance for currently employed
workers is therefore $29.95/3 = $9.98 per firm. According to the U.S.
Census Bureau's Statistics of U.S. Businesses database, in 2019 (the
most recent year for which data are available), there were 6.10 million
firms and 7.96 million establishments in the United States.\533\ The
Commission estimates the percentage of firms using non-compete clauses
in the United States at 49.4%.\534\ This yields an estimated 3,932,240
covered establishments. Conservatively assuming that each establishment
must engage in its own communication--i.e., a firm's headquarters does
not have the ability to send a company-wide email, for example--this
means covered employers would incur an estimated labor cost burden of
1,310,747 hours to comply with this requirement (3,932,240
establishments x 20 minutes). The Commission estimates the associated
labor cost for notifying affected workers who are already employed is
$9.98 x 7.96 million x 0.494 = $39,243,755.
---------------------------------------------------------------------------
\532\ U.S. Bureau of Lab. Stats., Occupational Outlook Handbook:
Human Resources Specialists, https://www.bls.gov/ooh/business-and-financial/human-resources-specialists.htm.
\533\ U.S. Census Bureau, 2019 SUSB Annual Data Tables by
Establishment Industry (February 2022), https://www.census.gov/data/tables/2019/econ/susb/2019-susb-annual.html (last visited Dec. 9,
2022).
\534\ See Colvin & Shierholz, supra note 498 at 4.
---------------------------------------------------------------------------
The proposed rule would impose only de minimis capital and non-
labor costs. The Commission anticipates covered employers already have
in place existing systems to communicate with and provide employment-
related disclosures to workers. While the proposed rule would require a
one-time disclosure to some workers subject to a rescinded non-compete
clause, the Commission anticipates this one-time disclosure would not
require substantial investments in new systems or other non-labor
costs. Moreover, many establishments are likely to provide the
disclosure electronically, further reducing total costs.
The Commission invites comments on: (1) Whether the proposed
collection of information is necessary for the proper performance of
the functions of the agency, including whether the information would
have practical utility; (2) the accuracy of the agency's estimate of
the burden of the proposed collection of information, including the
validity of the methodology and assumptions used; (3) ways to enhance
the quality, utility, and clarity of the information to be collected;
and (4) ways to minimize the burden of these information collections on
respondents. The Commission seeks comment on all aspects of this Part
IX.
Comments on the proposed reporting requirements subject to
Paperwork Reduction Act review by OMB should additionally be submitted
to www.reginfo.gov/public/do/PRAMain. Find this particular information
collection by selecting ``Currently under 30-day Review--Open for
Public Comments'' or by using the search function. The reginfo.gov web
link is a United States Government website operated by OMB and the
General Services Administration (GSA). Under PRA requirements, OMB's
Office of Information and Regulatory Affairs (OIRA) reviews federal
information collections.
X. Request for Comment
You can file a comment online or on paper. For the Commission to
consider your comment, we must receive it on or before March 20, 2023.
Write ``Non-Compete Clause Rulemaking, Matter No. P201200'' on your
comment. Your comment--including your name and your state--will be
placed on the public record of this proceeding, including the https://www.regulations.gov website.
Because of the public health emergency in response to the COVID-19
outbreak and the agency's heightened security screening, postal mail
addressed to the Commission will be subject to delay. We strongly
encourage you to submit your comments online through the https://www.regulations.gov website. To ensure the Commission considers your
online comment, please follow the instructions on the web-based form.
If you file your comment on paper, write ``Non-Compete Clause
Rulemaking, Matter No. P201200'' on your comment and on the envelope,
and mail your comment to the following address: Federal Trade
Commission, Office of the Secretary, 600 Pennsylvania Avenue NW, Suite
CC-5610 (Annex C), Washington, DC 20580.
Because your comment will be placed on the publicly accessible
website at https://www.regulations.gov, you are solely responsible for
making sure your comment does not include any sensitive or confidential
information. In particular, your comment should not include any
sensitive personal information, such as your or anyone else's Social
Security number; date of birth; driver's license number or other state
identification number, or foreign country equivalent; passport number;
financial account number; or credit or debit card number. You are also
solely responsible for making sure your comment does not include any
sensitive health information, such as medical records or other
individually identifiable health information. In addition, your comment
should not include any ``trade secret or any commercial or financial
information which . . . is privileged or confidential''--as provided by
15 U.S.C. 46(f) and 16 CFR 4.10(a)(2)--including, in particular,
competitively sensitive information such as costs, sales statistics,
inventories, formulas, patterns, devices, manufacturing processes, or
customer names.
Comments containing material for which confidential treatment is
requested must be filed in paper form, must be clearly labeled
``Confidential,'' and must comply with 16 CFR 4.9(c). In particular,
the written request for confidential treatment that accompanies the
comment must include the factual and legal basis for the request, and
must identify the specific portions of the comment to be withheld from
the public record. Your comment will be kept confidential only if the
General Counsel grants your request in accordance with the law and the
public interest. Once your comment has been posted publicly at https://www.regulations.gov--as legally required by 16 CFR 4.9(b)--we cannot
redact or remove your comment, unless you submit a confidentiality
request that meets the requirements for such treatment under FTC Rule
4.9(c) and the General Counsel grants that request.
Visit the Commission's website, www.ftc.gov, to read this NPRM and
the fact sheet describing it. The FTC Act and other laws the Commission
administers permit the collection of
[[Page 3535]]
public comments to consider and use in this proceeding as appropriate.
The Commission will consider all timely and responsive public comments
that it receives on or before March 20, 2023. For information on the
Commission's privacy policy, including routine uses permitted by the
Privacy Act, see https://www.ftc.gov/site-information/privacy-policy.
XI. Communications by Outside Parties to Commissioners or Their
Advisors
Written communications and summaries or transcripts of oral
communications respecting the merits of this proceeding, from any
outside party to any Commissioner or Commissioner's advisor, will be
placed on the public record, per 16 CFR 1.26(b)(5).
List of Subjects in 16 CFR Part 910 Antitrust
0
For the reasons set forth above, the Federal Trade Commission proposes
to add a new subchapter J, consisting of part 910, to chapter I in
title 16 of the Code of Federal Regulations to read as follows:
Subchapter J--Rules Concerning Unfair Methods of Competition
PART 910--NON-COMPETE CLAUSES
Sec.
910.1. Definitions.
910.2. Unfair methods of competition.
910.3. Exception.
910.4. Relation to State laws.
910.5. Compliance date.
Authority: 15 U.S.C. 45 and 46(g).
Sec. 910.1 Definitions.
(a) Business entity means a partnership, corporation, association,
limited liability company, or other legal entity, or a division or
subsidiary thereof.
(b) Non-compete clause, as used in this part:
(1) Means a contractual term between an employer and a worker that
prevents the worker from seeking or accepting employment with a person,
or operating a business, after the conclusion of the worker's
employment with the employer.
(2) The term non-compete clause includes a contractual term that is
a de facto non-compete clause because it has the effect of prohibiting
the worker from seeking or accepting employment with a person or
operating a business after the conclusion of the worker's employment
with the employer. For example, the following types of contractual
terms, among others, may be de facto non-compete clauses:
(i) A non-disclosure agreement between an employer and a worker
that is written so broadly that it effectively precludes the worker
from working in the same field after the conclusion of the worker's
employment with the employer.
(ii) A contractual term between an employer and a worker that
requires the worker to pay the employer or a third-party entity for
training costs if the worker's employment terminates within a specified
time period, where the required payment is not reasonably related to
the costs the employer incurred for training the worker.
(c) Employer means a person, as defined in 15 U.S.C. 57b-1(a)(6),
that hires or contracts with a worker to work for the person.
(d) Employment means work for an employer, as the term employer is
defined in paragraph (c) of this section.
(e) Substantial owner, substantial member, and substantial partner
mean an owner, member, or partner holding at least a 25 percent
ownership interest in a business entity.
(f) Worker means a natural person who works, whether paid or
unpaid, for an employer. The term includes, without limitation, an
employee, individual classified as an independent contractor, extern,
intern, volunteer, apprentice, or sole proprietor who provides a
service to a client or customer. The term worker does not include a
franchisee in the context of a franchisee-franchisor relationship;
however, the term worker includes a natural person who works for the
franchisee or franchisor. Non-compete clauses between franchisors and
franchisees would remain subject to Federal antitrust law as well as
all other applicable law.
Sec. 910.2 Unfair methods of competition.
(a) Unfair methods of competition. It is an unfair method of
competition for an employer to enter into or attempt to enter into a
non-compete clause with a worker; maintain with a worker a non-compete
clause; or represent to a worker that the worker is subject to a non-
compete clause where the employer has no good faith basis to believe
that the worker is subject to an enforceable non-compete clause.
(b) Existing non-compete clauses.
(1) Rescission requirement. To comply with paragraph (a) of this
section, which states that it is an unfair method of competition for an
employer to maintain with a worker a non-compete clause, an employer
that entered into a non-compete clause with a worker prior to the
compliance date must rescind the non-compete clause no later than the
compliance date.
(2) Notice requirement.
(i) An employer that rescinds a non-compete clause pursuant to
paragraph (b)(1) of this section must provide notice to the worker that
the worker's non-compete clause is no longer in effect and may not be
enforced against the worker. The employer must provide the notice to
the worker in an individualized communication. The employer must
provide the notice on paper or in a digital format such as, for
example, an email or text message. The employer must provide the notice
to the worker within 45 days of rescinding the non-compete clause.
(ii) The employer must provide the notice to a worker who currently
works for the employer. The employer must also provide the notice to a
worker who formerly worked for the employer, provided that the employer
has the worker's contact information readily available.
(iii) The following model language constitutes notice to the worker
that the worker's non-compete clause is no longer in effect and may not
be enforced against the worker, for purposes of paragraph (b)(2)(i) of
this section. An employer may also use different language, provided
that the notice communicates to the worker that the worker's non-
compete clause is no longer in effect and may not be enforced against
the worker.
Figure 1 to Paragraph (b)(2)(iii)--Model Language
BILLING CODE 6750-01-P
[[Page 3536]]
[GRAPHIC] [TIFF OMITTED] TP19JA23.000
BILLING CODE 6750-01-C
(3) Safe harbor. An employer complies with the rescission
requirement in paragraph (b)(1) of this section where it provides
notice to a worker pursuant to paragraph (b)(2) of this section.
Sec. 910.3 Exception.
The requirements of this part 910 shall not apply to a non-compete
clause that is entered into by a person who is selling a business
entity or otherwise disposing of all of the person's ownership interest
in the business entity, or by a person who is selling all or
substantially all of a business entity's operating assets, when the
person restricted by the non-compete clause is a substantial owner of,
or substantial member or substantial partner in, the business entity at
the time the person enters into the non-compete clause. Non-compete
clauses covered by this exception would remain subject to Federal
antitrust law as well as all other applicable law.
Sec. 910.4 Relation to State laws.
This part 910 shall supersede any State statute, regulation, order,
or interpretation to the extent that such statute, regulation, order,
or interpretation is inconsistent with this part 910. A State statute,
regulation, order, or interpretation is not inconsistent with the
provisions of this part 910 if the protection such statute, regulation,
order, or interpretation affords any worker is greater than the
protection provided under this part 910.
Sec. 910.5 Compliance date.
Compliance with this part 910 is required as of [DATE 180 DAYS
AFTER DATE OF PUBLICATION OF THE FINAL RULE].
By direction of the Commission, Commissioner Wilson dissenting.
April J. Tabor,
Secretary.
Note: the following statements will not appear in the Code of
Federal Regulations.
Statement of Chair Lina M. Khan Joined by Commissioner Rebecca Kelly
Slaughter and Commissioner Alvaro M. Bedoya
Today the Federal Trade Commission is proposing a rule that would
prohibit businesses from using noncompete clauses in contracts with
workers. Noncompete clauses generally restrict a company's workers from
working for--or launching--a competitor for a period of time even after
they have stopped working for that company. Researchers estimate that
about one in five American workers is bound by a noncompete clause.
By design, noncompetes often close off a worker's most natural
alternative employment options: jobs in the same geographic area and
professional field. These restrictions can undermine core economic
liberties, burdening Americans' ability to freely switch jobs.\1\
---------------------------------------------------------------------------
\1\ Pollock v. Williams, 322 U.S. 4, 17-18 (1944) (describing
the ``right to change employers'' as a critical ``defense against
oppressive hours, pay, working conditions, or treatment'').
---------------------------------------------------------------------------
[[Page 3537]]
A recent Commission action illustrates the real-life stakes:
Prudential, a security company in Michigan, enforced noncompetes
against its workers, including security guards earning near-minimum
wage.\2\ These noncompetes included a $100,000 liquidated damages
clause. On multiple occasions, Prudential sued former employees who
left for competitors offering higher wages. In one case, Prudential
successfully pressured a competitor to fire one of those new hires.
Media reports document countless other instances in which Americans who
wish to change jobs--be it to pursue a better opportunity, to escape
harassment, or to express disagreement with new workplace policies--are
trapped in place by noncompete clauses.
---------------------------------------------------------------------------
\2\ Complaint, In re Prudential Security, Inc., File No. 221-
0026 (Jan. 4, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/2210026prudentialsecuritycomplaint.pdf; see Press Release, Fed.
Trade Comm'n, FTC Cracks Down on Companies That Impose Harmful
Noncompete Restrictions on Thousands of Workers (Jan. 4, 2023),
https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers.
---------------------------------------------------------------------------
Notably, the aggregate economic impact of noncompete clauses goes
beyond any individual worker. Initiatives by several states to limit
the use of noncompetes has given researchers the opportunity to closely
study their effects. The Notice of Proposed Rulemaking (NPRM) published
today carefully reviews the empirical evidence available to date and
highlights several key findings.\3\
---------------------------------------------------------------------------
\3\ Notice of Proposed Rulemaking for Non-Compete Clause Rule
(``NPRM''), Part II.B (Jan. 5, 2023).
---------------------------------------------------------------------------
First, noncompete clauses reduce competition in labor markets,
suppressing earnings and opportunity even for workers who are not
directly subject to a noncompete. When workers subject to noncompete
clauses are blocked from switching to jobs in which they would be
better paid and more productive, unconstrained workers in that market
are simultaneously denied the opportunity to replace them. This
collective decline in job mobility means fewer job offers and an
overall drop in wages, as firms have less incentive to compete for
workers by offering higher pay, better benefits, greater say over
scheduling, or more favorable conditions. The FTC estimates that the
proposed ban on noncompetes would increase workers' total earnings by
close to $300 billion per year.\4\
---------------------------------------------------------------------------
\4\ See NPRM Part VII.B.1 (describing the Commission's
assessment of the benefits of the proposed rule).
---------------------------------------------------------------------------
Second, the existing evidence indicates that noncompete clauses
reduce innovation and competition in product and service markets.
Studies show that locking workers in place reduces innovation, likely
by decreasing the flow of information and knowledge among firms. By
preventing workers from starting their own businesses and limiting the
pool of talent available for startups to hire, noncompetes also limit
entrepreneurship and new business formation. This in turn reduces
product quality while raising prices. Indeed, existing evidence from
the health care sector suggests that the proposed ban would decrease
consumer prices, potentially to the tune of $150 billion a year.\5\
---------------------------------------------------------------------------
\5\ Drawing from a study on the financial industry, Commissioner
Wilson suggests that suspending noncompetes here caused higher
prices and more employee misconduct. See Umit G. Gurun, Noah
Stoffman & Scott E. Yonker, Unlocking Clients: The Importance of
Relationships in the Financial Advisory Industry, 141 J. Fin. Econ.
1218 (2021). Notably, under the proposed rule, firms will still have
contractual methods to protect their client lists, unlike the firms
observed in this study, which were prohibited from using non-
solicitation agreements in addition to noncompete clauses.
Furthermore, the change in the financial industry may have curtailed
beneficial entrepreneurship, since it only covered mobility of
workers between member firms, and therefore continued to permit some
noncompete clauses which could prevent workers from starting their
own businesses.
---------------------------------------------------------------------------
A recent Commission action shows how depriving new businesses of
access to skilled workers can thwart competition. In the highly
concentrated glass manufacturing sector, incumbent firms imposed
noncompetes on thousands of employees. These noncompetes locked up
highly specialized workers, tending to impede the entry and expansion
of rivals by depriving them of access to qualified employees.\6\
---------------------------------------------------------------------------
\6\ Complaint, In re O-I Glass, Inc., File No. 211-0182 (Jan. 4,
2023), https://www.ftc.gov/system/files/ftc_gov/pdf/2110182o-iglasscomplaint.pdf; Complaint, In re Ardagh Group S.A., File No.
211-0182 (Jan. 4, 2023), https://www.ftc.gov/system/files/ftc_gov/pdf/2110182ardaghcomplaint.pdf; see Press Release, Fed. Trade
Comm'n, FTC Cracks Down on Companies That Impose Harmful Noncompete
Restrictions on Thousands of Workers (Jan. 4, 2023), https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers.
---------------------------------------------------------------------------
The empirical evidence available to date, coupled with the
Commission's years of work on noncompetes, forms the basis for the
proposed rule.\7\ The proposal determines that employers' use of
noncompetes is an unfair method of competition under Section 5 of the
FTC Act. It recognizes that noncompetes may be unlawful in different
contexts for different reasons; for example, employers' use of
noncompetes to bind low-wage workers may be coercive and unfair in ways
that the use of noncompetes to bind senior executives is not. Still,
the proposal concludes that, in the aggregate, employers' use of
noncompetes undermines competition across markets in ways that are
harmful to workers and consumers and warrant a prohibition.
---------------------------------------------------------------------------
\7\ The Commission has conducted extensive public outreach
relating to noncompete clauses. See, e.g., Fed. Trade Comm'n,
Hearings on Competition and Consumer Protection in the 21st Century,
https://www.ftc.gov/enforcement-policy/hearings-competition-consumer-protection (including discussion of noncompete agreements
during the Oct. 15-17, 2018 and June 12, 2019 hearings, and inviting
public comment on topics including ``the use of non-competition
agreements and the conditions under which their use may be
inconsistent with the antitrust laws''); Fed. Trade Comm'n, Non-
Competes in the Workplace: Examining Antitrust and Consumer
Protection Issues (Jan. 9, 2020), https://www.ftc.gov/news-events/events/2020/01/non-competes-workplace-examining-antitrust-consumer-protection-issues; Fed. Trade Comm'n, Making Competition Work:
Promoting Competition in Labor Markets (Dec. 6-7, 2021), https://www.ftc.gov/news-events/events/2021/12/making-competition-work-promoting-competition-labor-markets; Fed. Trade Comm'n, Solicitation
for Public Comments on Contract Terms that May Harm Competition (Aug
5, 2021), https://www.regulations.gov/document/FTC-2021-0036-0022.
The FTC has also focused on noncompete clauses in connection with
its merger review work. See Press Release, Fed. Trade Comm'n, FTC
Approves Final Order Restoring Competitive Markets for Gasoline and
Diesel in Michigan and Ohio (Aug. 9, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/08/ftc-approves-final-order-restoring-competitive-markets-gasoline-diesel-michigan-ohio; Press
Release, Fed. Trade Comm'n, FTC Approves Final Order Imposing Strict
Limits on Future Mergers by Dialysis Service Provider DaVita, Inc.
(Jan. 12, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/01/ftc-approves-final-order-imposing-strict-limits-future-mergers-dialysis-service-provider-davita-inc; Press Release,
Fed. Trade Comm'n, FTC Approves Final Order Requiring Divestitures
of Hundreds of Retail Gas and Diesel Fuel Stations Owned by 7-
Eleven, Inc. (Nov. 10, 2021), https://www.ftc.gov/news-events/news/press-releases/2021/11/ftc-approves-final-order-requiring-divestitures-hundreds-retail-gas-diesel-fuel-stations-owned-7.
---------------------------------------------------------------------------
The proposed rule also draws on key lessons learned from state
efforts to limit or ban the use of noncompetes. For example, research
shows that some employers continue to use noncompetes even in states
that have declared them null and void. As a result, workers in states
where noncompetes are unenforceable are about as likely to have one in
their contract as workers in other states.\8\ In practice this causes
confusion and uncertainty for workers about whether they are bound by
an enforceable noncompete, which can dissuade them from seeking or
accepting another job. To address this, the proposed rule would both
prohibit employers from representing to workers
[[Page 3538]]
that they are covered by a noncompete clause and require them to
actively notify workers presently covered that these clauses are now
void and cannot be enforced.
---------------------------------------------------------------------------
\8\ Evan P. Starr, James J. Prescott, & Norman D. Bishara,
Noncompete Agreements in the U.S. Labor Force, 64 J.L. & Econ. 53,
81 (2021).
---------------------------------------------------------------------------
Action by federal enforcers is particularly appropriate here given
that the harms from noncompetes flow across state lines. Many labor
markets are spread across more than one state, and product markets are
typically multistate as well, so the use of noncompetes in one state
can harm workers and consumers in others. Moreover, employers may seek
to circumvent state laws restricting noncompetes through the use of
choice-of-law provisions and forum selection clauses, so that one
state's lenient approach to noncompetes may have spillover effects into
other states.\9\
---------------------------------------------------------------------------
\9\ Non-compete clauses often contain choice-of-law provisions
designating a particular state's law for resolution of any future
disputes. See Gillian Lester & Elizabeth Ryan, Choice of Law and
Employee Restrictive Covenants: An American Perspective, 31 Comp.
Lab. & Pol'y J. 389, 396-402 (2010). Some non-compete clauses
include forum selection clauses, which specify the court and
location where any dispute will be heard. Id. at 402-04. When
contracting with workers in states with relatively stringent non-
compete laws, companies may include choice-of-law and forum-
selection provisions that designate jurisdictions with less
stringent non-compete laws. The default rule under conflict-of-laws
principles is that the court honors the parties' choice of law,
meaning that the burden is on the worker to argue that the law of a
different forum should apply. Id. at 394.
---------------------------------------------------------------------------
The Federal Trade Commission is particularly well suited to this
task. Congress designed the FTC to be an expert administrative agency
that could enforce the prohibition against unfair methods of
competition through rulemaking as well as through case-by-case
adjudication. Although the Commission has primarily pursued antitrust
enforcement through adjudication, rulemaking can deliver several
benefits--including greater legal clarity and predictability, greater
administrability and efficiency of enforcement, and greater public
participation and airing of a maximally broad range of viewpoints and
criticisms.\10\
---------------------------------------------------------------------------
\10\ See, e.g., Rohit Chopra & Lina Khan, The Case for ``Unfair
Methods of Competition'' Rulemaking, 87 U. Chi. L. Rev. 357 (2020);
Nat'l Petroleum Refiners Ass'n v. FTC, 482 F.2d 672, 683 (D.C. Cir.
1973) (noting that ``utilizing rule-making procedures opens up the
process of agency policy innovation to a broad range of criticism,
advice and data that is ordinarily less likely to be forthcoming in
adjudication'').
---------------------------------------------------------------------------
Several factors seem to make noncompetes especially ripe for
enforcement through rulemaking rather than adjudication, including the
magnitude and scope of the apparent harms. Private litigation in this
area may also be limited, given that there is no private right of
action under Section 5 of the FTC Act--and that arbitration clauses and
class action waivers in employment contracts often can functionally
preclude lawsuits by workers.
Moreover, the FTC has notable expertise in this area. The
Commission began deepening its work on noncompetes under Chairman
Joseph Simons four years ago. Since then, the agency has held multiple
workshops and sought and received public comments on three separate
occasions. Our staff have closely studied the available economic
research and reviewed hundreds of comments from employers, advocates,
trade associations, members of Congress, state and local officials,
unions, and workers.
In her dissent, Commissioner Wilson questions the Commission's
authority to engage in ``unfair methods of competition''
rulemaking.\11\ But the rulemaking authority we are exercising today is
firmly rooted in the text and structure of the FTC Act and supported
both by judicial precedent interpreting the scope of the law as well as
further statutory language from the 1970s.\12\ Commissioner Wilson also
suggests that the Commission's authority for the NPRM will be
challenged under the major questions doctrine, which the Supreme Court
recently applied in West Virginia v. EPA. Here, however, the FTC is
operating under clear statutory authority. Identifying and addressing
unfair methods of competition is central to the mandate that Congress
gave the Commission in the text of our authorizing statute. Indeed, a
greater threat to the ``vesting of federal legislative power in
Congress'' would be for this Commission to repudiate or ignore
Congress's clear direction to the Commission to consider rules to
address unfair methods of competition.\13\
---------------------------------------------------------------------------
\11\ Commissioner Wilson argues that our enforcement actions are
in direct tension with a Seventh Circuit decision, Snap-On Tools
Corp. v. FTC, 321 F.2d 825 (7th Cir. 1963). Snap-On Tools is
distinguishable on several fronts, including the fact that it
concerned noncompetes used in the business-to-business context, not
those used by an employer to restrict its workers. Additionally,
while the majority stated that it is ``not prepared to say that [the
termination restriction] is a per se violation of the antitrust
laws,'' id. at 837, the Commission did not argue for a per se rule
and so the issue was not litigated. Id. at 830-31; id. at 839
(Hastings, C.J., dissenting). Notably, the question before the
Seventh Circuit was not whether the noncompete clause itself
constituted an unfair method of competition. The Commission had held
that the termination restriction provision was unlawful because it
was used as an enforcement mechanism to ensure compliance with the
other provisions. Id. at 836-37. Thus, once the court found that the
other restrictive provisions in the agreement were lawful, it also
held that the clause restricting competition upon termination did
not violate the FTC Act. Id. at 837.
\12\ The plain text of the FTC Act clearly authorizes the
Commission to issue rules. Specifically, Section 6(g) enables the
agency to ``make rules and regulations for the purpose of carrying
out the provisions'' of the law. Several other provisions support
the conclusion that Section 6(g) confers substantive rulemaking
authority. For instance, Section 18 explicitly preserves ``any
authority of the Commission to prescribe rules (including
interpretive rules), and general statements of policy, with respect
to unfair methods of competition in or affecting commerce.'' The
D.C. Circuit endorsed this plain reading of 6(g) in Petroleum
Refiners, 482 F.2d at 698, when it considered and rejected an
argument that Section 6(g) only authorized the FTC to promulgate
procedural or interpretive rules. Petroleum Refiners is the only
case that directly addresses the FTC's Section 6(g) rulemaking
authority. This holding--that the FTC may ``promulgate rules
defining the meaning of the statutory standards of the illegality
[the agency was] empowered to prevent,'' id. at 698--represents the
current state of the law.
\13\ West Virginia v. EPA, 142 S. Ct. 2587, 2617 (2022)
(Gorsuch, J., concurring).
---------------------------------------------------------------------------
This proposal is the first step in the FTC's rulemaking process. It
identifies several potential alternative rules, including those that
would cover only a subset of workers or that would apply different
legal standards to different categories of workers. Receiving input
from a broad set of market participants, including those who have
experienced firsthand the effects of noncompete clauses, will be
critical to our efforts. I urge members of the public to review our
proposal and submit comments.
A few topics are especially worthy of close consideration. First,
should the rule apply different standards to noncompetes that cover
senior executives or other highly paid workers? As the NPRM notes,
these workers may be less vulnerable to coercion, but restraining them
through noncompetes may still harm competition--for example, by making
it harder and more expensive for potential entrants to recruit
individuals for leadership positions. I am keen for input on this
question, including on how any such category of workers should be
defined and what standards should be applied. For example, if the
Commission were to adopt a ``rebuttable presumption'' of illegality for
noncompetes affecting these workers, what showing should be required to
overcome the presumption?
Second, should the rule cover noncompetes between franchisors and
franchisees? The current proposal does not cover noncompetes used by
franchisors to restrict franchisees, but we recognize that in some
cases they may raise concerns that are analogous to those raised by
noncompetes between employers and workers. We welcome the public's
views on this topic, as well as data or other evidence that could
inform our consideration of this issue.
Third, what tools other than noncompetes might employers use to
[[Page 3539]]
protect valuable investments, and how sufficient are these
alternatives? The proposal identifies several potential mechanisms that
employers may use--including trade secrets law and confidentiality
agreements--and we preliminarily find that these alternatives
reasonably achieve the goal of protecting investments without unduly
burdening competition. We welcome feedback on the Commission's
preliminary analysis of this issue.
I am deeply grateful to staff in the Office of Policy Planning, the
Bureau of Competition, the Bureau of Economics, and the Office of
General Counsel for their careful and thorough work on this proposal. I
am also grateful to the many scholars, advocates, and journalists whose
work in recent years has shed light on the proliferation of noncompetes
and the resulting harms that can manifest.
While the NPRM is just the first step toward a final rule, it marks
the Commission's commitment to exercising the full set of tools and
authorities that Congress gave us and to ensuring that our work is
protecting all Americans. I look forward to working closely with my
colleagues to continue this critical effort.
Statement of Commissioner Slaughter Joined by Commissioner Alvaro M.
Bedoya
One of the great privileges of working at the Federal Trade
Commission is the opportunity--and responsibility--we have to help real
people in their everyday lives. We offer that help not only when we
challenge massive mergers but also when we tackle the myriad smaller
ways in which people are denied agency and autonomy. When we fight
fraud, manipulative business opportunities, anticompetitive schemes,
and bogus fees, we help restore meaningful choice and dignity to
consumers and workers. These principles are the bedrock of a democratic
society, but too often they are denied to Americans who are not rich
and powerful. Addressing the scourge of noncompete clauses that
restrict the job mobility of workers advances our mission by ensuring
that workers have the chance to compete to earn a fair wage and family-
supporting benefits.
I am therefore pleased to support the Commission's Notice of
Proposed Rulemaking (``NPRM'') on the Noncompete Clause Rule under
Sections 5 and 6(g) of the Federal Trade Commission Act. I am grateful
to the cross-agency team who worked on this NPRM and thank them for
their hard work and collaborative drafting process.
I also want to thank the civil-society organizations and academics
who filed a petition with the FTC in 2019 calling for a rulemaking to
address noncompetes in employment contracts.\1\ This petition increased
the awareness of and knowledge about the issue not only within the
agency but also with the public more broadly. That heightened focus was
on display in the FTC's noncompete workshop in January 2020.\2\ As I
did at that workshop, I again thank the labor community for engaging
with the competition community to tackle the pocketbook issues that sit
at the intersection of labor and antitrust law and that have profound
effects on workers.\3\ Several years of activity by the Commission
related to noncompete clauses in employment contracts have culminated
in this NPRM, which is another milestone in our effort to more
thoroughly incorporate labor competition and effects on workers into
our antitrust law analyses.
---------------------------------------------------------------------------
\1\ Open Markets Inst. et al., Petition for Rulemaking to
Prohibit Worker Non-Compete Clauses (March 20, 2019), https://static1.squarespace.com/static/5e449c8c3ef68d752f3e70dc/t/5eaa04862ff52116d1dd04c1/1588200595775/Petition-for-Rulemaking-to-Prohibit-Worker-Non-Compete-Clauses.pdf.
\2\ Fed. Trade Comm'n, Non-Competes in the Workplace: Examining
Antitrust and Consumer Protection Issues, https://www.ftc.gov/news-events/events/2020/01/non-compete clauses-workplace-examining-
antitrust-consumer-protection-issues.
\3\ Remarks of FTC Commissioner Rebecca Kelly Slaughter, New
Decade, New Resolve to Protect and Promote Competitive Markets for
Workers, FTC Workshop on Non-Compete Clauses in the Workplace (Jan.
9, 2020), https://www.ftc.gov/system/files/documents/public_statements/1561475/slaughter_-_noncompete_clauses_workshop_remarks_1-9-20.pdf.
---------------------------------------------------------------------------
I write separately to emphasize two points. First, noncompete
clauses, and the restrictions they place on workers regarding their
future employment or business creation, are deeply troubling. Based on
the research discussed in the NPRM, they have serious ramifications for
individual workers and labor competition broadly, as well as for
consumers. Although sometimes referred to as noncompete ``agreements,''
they rarely represent actual agreements. Instead, they are often
imposed on workers with no ability to bargain as a condition of
employment. Even when noncompetes have been ruled unenforceable by
courts or outlawed by legislation, firms continue to use them, as was
alleged in a recent case the FTC settled over noncompetes imposed on
minimum wage-earning security guards.\4\
---------------------------------------------------------------------------
\4\ In the Matter of Prudential Security, Inc., a corporation;
Prudential Command Inc., a corporation; Greg Wier, a natural person;
and Matthew Keywell, FTC Matter/File Number 2210026 (January 4,
2023), Complaint ] 22, https://www.ftc.gov/legal-library/browse/cases-proceedings/2210026-prudential-security-et-al-matter;
Statement of Chair Lina M. Khan Joined by Commissioner Rebecca Kelly
Slaughter and Commissioner Alvaro M. Bedoya In the Matters of
Prudential Security, O-I Glass Inc., and Ardagh Group S.A, January
4, 2023, https://www.ftc.gov/legal-library/browse/cases-proceedings/public-statements/statement-chair-lina-m-khan-joined-commissioners-slaughter-bedoya-matters-prudential-security-o-i.
---------------------------------------------------------------------------
Workers restrained by noncompetes are unable to pursue certain job
opportunities and are therefore deprived of higher wages and more
favorable working conditions and benefits. Similarly, businesses that
need to hire workers are inhibited from attracting and hiring
noncompete-restrained workers through better working conditions, pay,
and benefits.\5\ Even more alarming is the evidence that shows
noncompetes reduce earnings for workers not individually bound by
them.\6\ Studies also show reduced entrepreneurship, new-business
formation, or both when workers are inhibited by noncompetes.\7\
Finally, American consumers can suffer from noncompete clauses through
paying higher prices for lower-quality goods and services.\8\ For all
these reasons, it is clear that it is more than appropriate for the FTC
to use our rulemaking authority under Sections 5 and 6(g) to address
noncompete clauses in employment contracts.
---------------------------------------------------------------------------
\5\ Notice of Proposed Rulemaking, Non-Compete Clause Rule, Part
II.B.1.
\6\ See Matthew S. Johnson, Kurt Lavetti, & Michael Lipsitz, The
Labor Market Effects of Legal Restrictions on Worker Mobility 2
(2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3455381;
Evan Starr, Justin Frake, & Rajshree Agarwal, Mobility Constraint
Externalities, 30 Org. Sci. 961, 6 (2019).
\7\ See Sampsa Samila & Olav Sorenson, Noncompete Covenants:
Incentives to Innovate or Impediments to Growth, 57 Mgmt. Sci. 425,
432 (2011); Jessica Jeffers, The Impact of Restricting Labor
Mobility on Corporate Investment and Entrepreneurship 22 (2019),
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3040393; Evan
Starr, Natarajan Balasubramanian, & Mariko Sakakibara, Screening
Spinouts? How Noncompete Enforceability Affects the Creation,
Growth, and Survival of New Firms, 64 Mgmt. Sci. 552, 561 (2018).
\8\ See Naomi Hausman & Kurt Lavetti, Physician Practice
Organization and Negotiated Prices: Evidence from State Law Changes,
13 a.m. Econ. J. Applied Econ. 258, 284 (2021); Michael Lipsitz &
Mark Tremblay, Noncompete Agreements and the Welfare of Consumers 6
(2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3975864.
---------------------------------------------------------------------------
Second, I strongly encourage the public to share their lived
experiences and perspectives with the Commission. I have heard
personally about how noncompete clauses can strike fear into workers
and make them anxious about their livelihoods. These stories come from
a variety of different industries and
[[Page 3540]]
professions, from fast-food workers to family physicians.\9\ Public
input from individuals who are or who have been bound by noncompetes
and from firms that use them is a critically important step in the
rulemaking process, and it will help the Commission weigh the proposed
broad ban on noncompete clauses as well as the alternative approaches
discussed in the NPRM. I look forward to working with my fellow
Commissioners to achieve a just outcome that promotes fair competition.
---------------------------------------------------------------------------
\9\ See People of the State of Ill. v. Jimmy John's Enters.,
LLC, No. 2016-CH-07746 (Cook County Cir. Ct. filed June 8, 2016);
See also Kurt Lavetti, Carol Simon, & William D. White, The Impacts
of Restricting Mobility of Skilled Service Workers Evidence from
Physicians, 55 J. Hum. Res. 1025, 1042 (2020).
---------------------------------------------------------------------------
Dissenting Statement of Commissioner Christine S. Wilson
Today, the Commission announced a notice of proposed rulemaking
(``NPRM'') for a Non-Compete Clause Rule. ``The proposed rule would
provide that it is an unfair method of competition--and therefore a
violation of Section 5--for an employer to enter into or attempt to
enter into a non-compete clause with a worker; [or to] maintain with a
worker a non-compete clause . . .'' \1\ For the many reasons described
below, on the current record, I do not support initiating the proposed
rulemaking and consequently dissent.
---------------------------------------------------------------------------
\1\ Notice of Proposed Rulemaking for Non-Compete Clause Rule
(``NPRM'') Part I (Jan. 5, 2023).
---------------------------------------------------------------------------
The proposed Non-Compete Clause Rule represents a radical departure
from hundreds of years of legal precedent that employs a fact-specific
inquiry into whether a non-compete clause is unreasonable in duration
and scope, given the business justification for the restriction. The
Commission undertakes this radical departure despite what appears at
this time to be a lack of clear evidence to support the proposed rule.
What little enforcement experience the agency has with employee non-
compete provisions is very recent (within the last week) and fails to
demonstrate harm to consumers and competition. Lacking enforcement
experience, the Commission turns to academic literature--but the
current record shows that studies in this area are scant, contain mixed
results, and provide insufficient support for the scope of the proposed
rule. And one study illustrates clearly, in the financial services
sector, the negative unintended consequences of suspending non-compete
provisions, including higher fees and broker misconduct. The suspension
of non-competes across all industry sectors in the U.S. undoubtedly
will impose a much larger raft of unintended consequences.
Setting aside the substance of the rule, the Commission's
competition rulemaking authority itself certainly will be challenged.
The NPRM is vulnerable to meritorious challenges that (1) the
Commission lacks authority to engage in ``unfair methods of
competition'' rulemaking, (2) the major questions doctrine addressed in
West Virginia v. EPA applies, and the Commission lacks clear
Congressional authorization to undertake this initiative; and (3)
assuming the agency does possess the authority to engage in this
rulemaking, it is an impermissible delegation of legislative authority
under the non-delegation doctrine, particularly because the Commission
has replaced the consumer welfare standard with one of multiple goals.
In short, today's proposed rule will lead to protracted litigation in
which the Commission is unlikely to prevail.
The NPRM invites public comment on both a sweeping ban on non-
competes and various alternatives pursuant to the Administrative
Procedure Act, not the Magnuson-Moss Act. Stakeholders should note that
this solicitation for public comment is likely the only opportunity
they will have to provide input not just on the proposed ban, but also
on the proposed alternatives. For this reason, I encourage all
interested parties to respond fully to all parts of the NPRM's
solicitation of public comments.
Non-Compete Clauses Merit Fact-Specific Inquiry
Based on the current record, non-compete clauses constitute an
inappropriate subject for rulemaking. The competitive effects of a non-
compete agreement depend heavily on the context of the agreement,
including the business justification that prompted its adoption. But
don't take my word for it--the need for fact-specific inquiry aligns
with hundreds of years of precedent. When assessing the legality of
challenged non-compete agreements, state and federal courts (and
English courts before them) have examined the duration and scope of
non-compete clauses, as well as the asserted business justifications,
to determine whether non-compete clauses are unreasonable and therefore
unenforceable.\2\
---------------------------------------------------------------------------
\2\ See, e.g., United States v. Addyston Pipe & Steel Co., 85 F.
271, 281 (6th Cir. 1898) (Taft, J.), aff'd in relevant part, 175
U.S. 211 (1899); Mitchel v. Reynolds, 1 P. Wms. 181 (1711).
---------------------------------------------------------------------------
The NPRM itself acknowledges, at least implicitly, the relevance of
the circumstances surrounding adoption of non-compete clauses. For
example, the NPRM proposes an exception to the ban on non-compete
clauses for provisions associated with the sale of a business,
acknowledging that these non-compete clauses help protect the value of
the business acquired by the buyer.\3\ Recognizing that senior
executives typically negotiate many facets of their employment
agreements, the NPRM distinguishes situations in which senior
executives are subject to non-compete provisions.\4\ And to stave off
potential legal challenges, the NPRM proposes more carefully tailored
alternatives to a sweeping ban on non-compete clauses that instead
would vary by employee category.
---------------------------------------------------------------------------
\3\ NPRM Part V, Section 910.3.
\4\ Accordingly, the Commission seeks comments on whether senior
executives should be treated differently from the proposed ban on
non-compete clauses. See NPRM Parts IV.A.1.b, IV.A.1.c. In a similar
vein, recent consent agreements issued for public comment that
prohibit the use of non-compete agreements in the glass container
industry do not prohibit non-compete clauses for senior executives
and employees involved in research and development. See O-I Glass,
Inc., File No. 211-0182, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182o-iglassdraftorderappxa.pdf (Jan. 4, 2023) (Decision and
Order Appendix A); Ardagh Glass Group S.A., File No. 211-0182,
https://www.ftc.gov/system/files/ftc_gov/pdf/2110182ardaghdraftorderappxa.pdf (Jan. 4, 2023) (Decision and Order
Appendix A); Christine S. Wilson, Comm'r, Fed. Trade Comm'n,
Dissenting Statement regarding In the Matter of O-I Glass, Inc. and
In the Matter of Ardagh Group S.A. (Jan. 4, 2023), https://www.ftc.gov/legal-library/browse/cases-proceedings/public-statements/dissenting-statement-commissioner-christine-s-wilson-regarding-matters-o-i-glass-inc-ardagh-group-sa.
---------------------------------------------------------------------------
Despite the importance of context and the need for fact-specific
inquiries, the Commission instead applies the approach of the newly
issued Section 5 Policy Statement \5\ to propose a near-complete ban on
the use of non-compete clauses. Pursuant to this approach, the
Commission invokes nefarious-sounding adjectives--here, ``exploitive
and coercive''--and replaces the evaluation of actual or likely
competitive effects with an unsubstantiated conclusion about the
``tendency'' for the conduct to generate negative consequences by
``affecting consumers, workers or other market participants.'' \6\
---------------------------------------------------------------------------
\5\ Fed. Trade Comm'n, Policy Statement Regarding the Scope of
Unfair Methods of Competition Under Section 5 of the Federal Trade
Commission Act (Nov. 10, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/p221202sec5enforcementpolicystatement_002.pdf.
\6\ Id. at 9.
---------------------------------------------------------------------------
Using the approach of the Section 5 Policy Statement that enables
the majority summarily to condemn conduct it finds distasteful, the
Commission today proposes a rule that prohibits conduct 47 states have
chosen
[[Page 3541]]
to allow.\7\ Similarly, the Commission's proposed rule bans conduct
that courts have found to be legal,\8\ a concern the Commission
dismisses with a claim that the Section 5 prohibition on ``unfair
methods of competition'' extends beyond the antitrust laws. But the
majority's conclusions and today's proposed rule forbid conduct
previously found lawful under Section 5 of the FTC Act. Specifically,
applying FTC Act Section 5, the Seventh Circuit found that
``[r]estrictive [non-compete] clauses . . . are legal unless they are
unreasonable as to time or geographic scope[.]'' \9\ In other words,
the Seventh Circuit found that a fact-specific inquiry is required
under Section 5.
---------------------------------------------------------------------------
\7\ NPRM Part II.C.1. Further, the NPRM explains ``[s]tates have
been particularly active in restricting non-compete clauses in
recent years.'' Id. The Commission's rulemaking will end states'
varying approaches to address non-compete agreements. The
Commission's preemption of states' approaches is premature to the
extent that the Commission admits that it does not know where to
draw lines regarding the treatment of non-compete provisions (i.e.,
the Commission seeks comments on alternatives to the proposed ban
based on earnings levels, job classifications, or presumptions). The
Commission ignores the advice of Justice Brandeis and instead
proposes to end states' experimentation to determine the optimal
treatment of non-compete clauses. See New State Ice Co. v. Liebmann,
285 U.S. 262, 311 (1932) (``To stay experimentation in things social
and economic is a grave responsibility. Denial of the right to
experiment may be fraught with serious consequences to the nation.
It is one of the happy incidents of the federal system that a single
courageous state may, if its citizens choose, serve as a laboratory;
and try novel social and economic experiments without risk to the
rest of the country.'').
\8\ See United States v. Empire Gas Corp., 537 F.2d 296, 307-08
(8th Cir. 1976); Lektro-Vend Corp. v. Vendo Co., 660 F.2d 255, 267
(7th Cir. 1981); Newburger, Loeb & Co., Inc. v. Gross, 563 F.2d
1057, 1081-83 (2d Cir. 1977); Bradford v. New York Times Co., 501
F.2d 51, 57-59 (2d Cir. 1974).
\9\ Snap-On Tools Corp. v. Fed. Trade Comm'n, 321 F.2d 825, 837
(7th Cir. 1963).
---------------------------------------------------------------------------
The NPRM announced today conflicts not only with the Seventh
Circuit's holding, but also with several hundred years of precedent.
With all due respect to the majority, I am dubious that three unelected
technocrats \10\ have somehow hit upon the right way to think about
non-competes, and that all the preceding legal minds to examine this
issue have gotten it wrong. The current rulemaking record does not
convince me otherwise.
---------------------------------------------------------------------------
\10\ This characterization is not an insult, but a fact. I, too,
am an unelected technocrat.
---------------------------------------------------------------------------
I. Non-Compete Agreements--the First Application of the Section 5
Policy Statement
The proposed Non-Compete Clause Rule ``would provide that it is an
unfair method of competition--and therefore a violation of Section 5--
for an employer to enter into or attempt to enter into a non-compete
clause with a worker; [or] to maintain with a worker a non-compete
clause . . .'' \11\ The proposed ban on non-compete clauses is based
only on alleged violations of Section 5 of the FTC Act; it is not
premised on the illegality of non-compete clauses under the Sherman or
Clayton Acts.
---------------------------------------------------------------------------
\11\ NPRM Part I.
---------------------------------------------------------------------------
When the Commission issued the Policy Statement Regarding the Scope
of Unfair Methods of Competition Under Section 5 of the Federal Trade
Commission Act (``Policy Statement'') in November 2022, I warned that
the approach described by the Policy Statement would enable the
Commission majority to condemn conduct it disfavors, even when that
conduct repeatedly has been found lawful.\12\ I predicted that the
approach to Section 5 enforcement contained in the Policy Statement
would facilitate expansive enforcement, often without requiring
evidence of anticompetitive effects. And I cautioned that subjects of
investigations would not be able to defend their conduct because
procompetitive justifications would not be credited. The Non-Compete
Clause Rule NPRM provides a graphic illustration of these concerns.
---------------------------------------------------------------------------
\12\ See Christine S. Wilson, Comm'r, Fed. Trade Comm'n,
Dissenting Statement Regarding the ``Policy Statement Regarding the
Scope of Unfair Methods of Competition Under Section 5 of the
Federal Trade Commission Act'' (Nov. 10, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/P221202Section5PolicyWilsonDissentStmt.pdf.
---------------------------------------------------------------------------
A. The NPRM's Determination That Non-Compete Clauses Are Unfair
The NPRM states that there are 3 independent ways for classifying
non-compete clauses as an ``unfair'' method of competition.\13\ In
November, I objected to the enforcement approach described in the
Section 5 Policy Statement--specifically, permitting the Commission
majority to condemn conduct merely by selecting and assigning to
disfavored conduct one or more adjectives from a nefarious-sounding
list.\14\ Here, two of the three explanations the Commission provides
for concluding that non-compete clauses are unfair rely on invocation
of the adjectives ``exploitive and coercive.'' \15\ The third
explanation for the illegality of non-compete clauses demonstrates how
little evidence the majority requires to conclude that conduct causes
harm.
---------------------------------------------------------------------------
\13\ NPRM Part IV.A.1.
\14\ See Wilson, supra note 12.
\15\ The Policy Statement claimed that determinations of
unfairness would be based on a sliding scale. Here, the NPRM
identifies independent ways to determine that non-compete clauses
are unfair; no sliding scale is applied.
---------------------------------------------------------------------------
According to the NPRM, ``non-compete clauses are exploitive and
coercive at the time of contracting.'' \16\ The NPRM explains that the
``clauses for workers other than senior executives are exploitive and
coercive because they take advantage of unequal bargaining power[.]''
\17\ The business community will be surprised to learn that ``unequal
bargaining power'' can lead to a conclusion that any negotiated outcome
may be condemned as ``exploitive and coercive,'' which then can be
parlayed into a finding that the conduct violates Section 5. Indeed,
this assertion is particularly troubling not merely because it presages
an approach that is literally limitless, but also because the imbalance
of bargaining power, as in this setting, arises wholly apart from any
conduct by the business.\18\ The reader may note that the NPRM cites
legal decisions to support the assignment of adjectives. Yet, a careful
reading of the courts' discussions of the imbalance of bargaining power
between employers and employees reveals that while the imbalance may
provide a reason to scrutinize non-compete clauses, it is not used to
condemn or invalidate them.\19\ Remarkably, in each case cited in
footnote 253 of the NPRM, the court found the non-compete clauses to be
enforceable.
---------------------------------------------------------------------------
\16\ NPRM Part IV.A.1.b The NPRM explains that this conclusion
does not apply to senior executives and also seeks comment on
whether there is a broader category of highly paid or highly skilled
employees for whom the conclusion is inappropriate. Id.
\17\ Id.
\18\ According to the NPRM, unequal bargaining power arises
because employees depend on job income to pay bills, job searches
entail significant transaction costs, the prevalence of unions has
declined, employers outsource firm functions, employers have more
experience negotiating because they have multiple employees,
employees typically do not hire lawyers to negotiate agreements, and
employees may not focus on the terms of their contracts. Id.
\19\ See Alexander & Alexander, Inc. v. Danahy, 488 NE2d 22, 29
(Mass. App. Ct. 1986) (finding injunction to enforce non-compete
agreement proper); Diepholz v. Rutledge, 659 NE 989, 991 (Ill. Ct.
App. 1995) (finding non-compete agreement enforceable, but also
finding no violation of terms of non-compete agreement); Palmetto
Mortuary Transp., Inc. v. Knight Sys., Inc., 818 SE2d 724, 731 (S.C.
2018) (finding non-compete agreement enforceable).
---------------------------------------------------------------------------
Next, the NPRM finds that ``non-compete clauses are exploitive and
coercive at the time of the worker's potential departure from the
employer[.]'' \20\ The NPRM reaches this conclusion regardless of
whether the clauses are enforced. This conclusion is
[[Page 3542]]
contrary to legal precedent, which requires enforcement of non-compete
provisions before finding harm.\21\
---------------------------------------------------------------------------
\20\ NPRM Part IV.A.1.c. Again, the NPRM explains that this
conclusion does not apply to senior executives and also invites
comments on whether there is a broader category of highly paid or
highly skilled employees for whom the conclusion is inappropriate.
Id.
\21\ See, e.g., O'Regan v. Arbitration Forums, Inc., 121 F.3d
1060, 1065-66 (7th Cir. 1997) (``to apply antitrust laws to
restrictive employment covenants, there must be some attempted
enforcement of an arguably overbroad portion of the covenant in
order for there to be a federal antitrust violation.''); Lektro-Vend
Corp. v. Vendo Co., 660 F.2d 255, 267 (7th Cir.1981) (``a section 1
violation requires proof that the defendant knowingly enforced the
arguably overbroad section of the ancillary noncompetition
covenant'').
---------------------------------------------------------------------------
Finally, the NPRM finds that ``non-compete clauses are restrictive
conduct that negatively affects competitive conditions.'' \22\ Although
this basis for concluding that non-compete provisions are unfair does
not rely solely on the selection of an adjective, here, the NPRM
demonstrates how little evidence the majority requires before finding
that conduct is unfair pursuant to the Section 5 Policy Statement.
---------------------------------------------------------------------------
\22\ NPRM Part IV.A.1.a.
---------------------------------------------------------------------------
Until yesterday, the Commission had announced no cases (and
therefore had no experience and no evidence) to conclude that non-
compete clauses harm competition in labor markets. In fact, the only
litigated FTC case challenging a non-compete clause found that a non-
compete provision covering franchise dealers did not violate Section 5
of the FTC Act.\23\ Notably, the NPRM omits any reference to this case.
The Commission has accepted settlements regarding non-compete clauses
in contracts between businesses,\24\ but the majority itself has
distinguished those cases from non-compete clauses in labor
contracts.\25\ And in those B2B cases, the non-compete clauses were
associated with the sale of a business, a situation that falls within
the narrow exception to the ban provided in the proposed Non-Compete
Clause Rule.
---------------------------------------------------------------------------
\23\ See Snap-On Tools Corp. v. Fed. Trade Comm'n, 321 F.2d at
837.
\24\ See ARKO Corp., FTC File No. 211-0187, https://www.ftc.gov/system/files/ftc_gov/pdf/2110087C4773ArkoExpressComplaint.pdf (Aug.
5, 2022); DTE Energy Co., FTC File No. 191-0068, https://www.ftc.gov/system/files/documents/cases/191_0068_c-4691_dte-enbridge_complaint.pdf. (Dec. 13, 2019).
\25\ See Lina M. Khan, Chair, Fed. Trade Comm'n, Joined by
Rebecca Kelly Slaughter and Alvaro M. Bedoya, Comm'rs, Fed. Trade
Comm'n, Statement regarding In the Matter of ARKO Corp./Express
Stop, https://www.ftc.gov/system/files/ftc_gov/pdf/2110187GPMExpressKhanStatement.pdf (June 10, 2022) (distinguishing
non-compete clauses in labor contracts and effects on workers from
non-compete clause in merger agreement where both parties remain in
market).
---------------------------------------------------------------------------
Just yesterday, though, the Commission rushed out the announcement
of three consent agreements that resolve allegations that non-compete
provisions constitute an unfair method of competition.\26\ The first
consent involves security guard services, and the other two involve the
manufacturing of glass containers. These consents undoubtedly were
designed to support assertions that the FTC now has experience with
non-compete agreements in employee contracts. But even a cursory read
of the complaints reveals the diaphanous nature of this ``experience.''
---------------------------------------------------------------------------
\26\ On December 28, 2022, the Commission voted to accept for
public comment three consent agreements involving non-compete
agreements. For two of those matters, the Commission vote occurred
less than a week after the Commission received the papers. See
Ardagh Glass Group S.A., File No. 211-0182, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182ardaghacco.pdf (Jan. 4, 2023)
(Agreement Containing Consent Order (signatures dated Dec. 21,
2022)).
---------------------------------------------------------------------------
Remarkably, none of these cases provides evidence showing the
anticompetitive effects of non-compete clauses beyond the conclusory
allegations in the complaints. The complaints in the glass container
industry assert that non-compete provisions may prevent entry or
expansion by competitors, but contain no allegations regarding firms
that have tried unsuccessfully to obtain personnel with industry-
specific skills and experience.\27\ Regarding the effects on employees,
the complaints make no allegations that the non-compete clauses were
enforced by respondents \28\ and the Analysis to Aid Public Comment
accompanying the consent agreements points only to studies not tied to
the glass container industry. These cases provide no evidence that the
non-compete provisions limited competition for employees with industry-
specific expertise, thereby lowering wages or impacting job quality.
Similarly, in the case against Prudential Security, Inc.,\29\ the
complaint alleges that individual former employees were limited in
their ability to work for other firms in the security guard
industry,\30\ but contain no allegations that the firm's non-compete
provisions had market effects on wages or effects in a properly defined
market for security guard services.
---------------------------------------------------------------------------
\27\ See O-I Glass, Inc., File No. 211-0182, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182o-iglasscomplaint.pdf
(Jan. 4, 2023) (complaint ]] 6, 8); Ardagh Glass Group S.A., File
No. 211-0182, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182ardaghcomplaint.pdf (Jan. 4, 2023) (complaint ]] 6, 8).
\28\ See Wilson, Dissenting Statement regarding In the Matter of
O-I Glass, Inc. and In the Matter of Ardagh Glass Group S.A., supra
note 4.
\29\ Prudential Security, Inc., File No. 221-0026, https://www.ftc.gov/system/files/ftc_gov/pdf/2210026prudentialsecuritycomplaint.pdf (Dec. 28, 2022) (consent
agreement accepted for public comment).
\30\ Id. (complaint at ]] 23, 25).
---------------------------------------------------------------------------
The NPRM also asserts FTC experience with non-compete provisions by
pointing to Commission merger consent agreements that restrict the use
of non-compete agreements. The complaints in those cases did not allege
harm from non-compete clauses and the provisions in the consent
agreements were included to ensure that the buyers of divestiture
assets could obtain employees familiar with the assets and necessary
for the success of the divestitures at issue.
Finally, the NPRM claims Commission experience with non-compete
agreements to support the Non-Compete Clause Rule from a Commission
workshop in January 2020.\31\ But the NPRM fails to reflect the variety
of views expressed during that workshop, including testimony that the
economic literature is ``[s]till far from reaching a scientific
standard for concluding [that non-compete agreements] are bad for
overall welfare . . . Also [we] don't yet fully understand the
distribution of effects on workers . . . Welfare tradeoffs are likely
context-specific, and may be heterogeneous.'' \32\
---------------------------------------------------------------------------
\31\ Fed. Trade Comm'n, Non-Competes in the Workplace: Examining
Antitrust and Consumer Protection Issues, https://www.ftc.gov/news-events/events/2020/01/non-compete-clauses-workplace-examining-
antitrust-consumer-protection-issues.
\32\ Kurt Lavetti, Economic Welfare Aspects of Non-Compete
Agreements, Remarks at the Fed. Trade Comm'n Workshop on Non-Compete
Clauses in the Workplace (Jan. 9, 2020), https://www.ftc.gov/system/files/documents/public_events/1556256/non-compete=workshop-slides.pdf.
---------------------------------------------------------------------------
Indeed, the NPRM ignores that testimony and instead focuses on
economic literature that purportedly demonstrates that non-compete
clauses are unfair because they negatively affect competitive
conditions. But an objective review of that literature reveals a mixed
bag. For example, the first study described in the NPRM \33\ finds that
``decreasing non-compete clause enforceability from the approximate
enforceability level of the fifth-strictest state to that of the fifth-
most-lax state would increase workers' earnings by 3-4%.'' Yet, this
study also finds that these effects vary strongly across different
groups of individuals. For example, the authors find that
``enforceability has little to no effect on earnings for non-college
educated workers'' and instead find that enforceability primarily
impacts college-educated workers. Similarly, it finds that strict non-
compete clause enforceability has very different effects for different
demographic groups: it has little to no effect on men, and much
[[Page 3543]]
larger effects on women and Black men and women. The NPRM interprets
these differential effects as facts in favor of the Non-Compete Clause
Rule, as it would diminish race and gender wage gaps, but there is no
corresponding discussion of the Rule's effect on the wage gap based on
education. An alternative interpretation of these findings is that the
scientific literature is still muddled as to who is helped and who is
harmed by non-compete clauses, and that it would be better for the
Commission to tailor a rule to those settings where a scientific
consensus exists.
---------------------------------------------------------------------------
\33\ Matthew S. Johnson, Kurt Lavetti, & Michael Lipsitz, The
Labor Market Effects of Legal Restrictions on Worker Mobility 2,
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3455381 (2020).
---------------------------------------------------------------------------
Similarly, the NPRM often bases its conclusions about the effects
of non-compete clauses on limited support. For example, the NPRM
contends that increased enforceability of non-compete clauses increases
consumer prices. Yet, under the current record, this conclusion is
based on only one study in healthcare markets and another study that
considers the relationship between non-compete clauses and
concentration.\34\ The NPRM does not provide a basis to conclude that
findings with respect to the market for physicians and healthcare are
generalizable, instead acknowledging that no comparable evidence exists
for other markets.\35\ Also, the study that considers the effects of
non-compete clauses on concentration does not draw conclusions about
prices; the NPRM's conclusion that non-compete provisions lead to
higher prices requires assumptions about a relationship between
concentration and prices. Moreover, the NPRM omits studies showing that
reducing the enforceability of non-compete restrictions leads to higher
prices for consumers. A study by Gurun, Stoffman, and Yonker finds that
an agreement not to enforce post-employment restrictions among
financial advisory firms that were members of the Broker Protocol led
brokers to depart their firms, and consumers to follow their brokers,
at high rates. The study found, however, that clients of firms in the
Broker Protocol paid higher fees and experienced higher levels of
broker misconduct.\36\ In other words, suspending non-competes resulted
in higher prices and a decrease in the quality of service provided.
These unintended consequences illustrate the inevitably far-reaching
and unintended consequences that today's NPRM will visit upon
employees, employers, competition, and the economy.
---------------------------------------------------------------------------
\34\ NPRM Part II.B.2.a.
\35\ NPRM Part VII.B.2.c.
\36\ Umit G. Gurun, Noah Stoffman, & Scott E. Yonker, Unlocking
Clients: The Importance of Relationships in the Financial Advisory
Industry, 141 J. Fin. Econ. 1218 (2021).
---------------------------------------------------------------------------
B. The NPRM's Treatment of Business Justifications
The NPRM explains that ``the additional incentive to invest (in
assets like physical capital, human capital, or customer attraction, or
in the sharing of trade secrets and confidential commercial
information) is the primary justification for use of non-compete
clauses.'' \37\
---------------------------------------------------------------------------
\37\ NPRM Part II.B.2.e.
---------------------------------------------------------------------------
It acknowledges that ``there is evidence that non-compete clauses
increase employee training and other forms of investment,'' \38\ and
describes two studies demonstrating that increased non-compete clause
enforceability increased firm-provided training and investment.\39\ It
also describes studies that examine non-compete clause use and
investment.\40\ Despite the studies, the NPRM concludes, ``the evidence
that non-compete clauses benefit workers or consumers is scant.'' \41\
In other words, the NPRM treats asymmetrically the evidence of harms
(mixed evidence given great credence) and benefits (robust evidence
given no credence). These early examples of cherry-picking evidence
that conforms to the narrative provide little confidence in the
integrity of the rulemaking process or the ultimate outcome.
---------------------------------------------------------------------------
\38\ Id.
\39\ Evan Starr, Consider This: Training, Wages, and the
Enforceability of Non-Compete Clauses, 72 I.L.R. Rev. 783, 799
(2019) (moving from mean non-compete enforceability to no non-
compete clause enforceability would decrease the number of workers
receiving training by 14.7% in occupations that use non-compete
clauses at a high rate); Jessica Jeffers, The Impact of Restricting
Labor Mobility on Corporate Investment and Entrepreneurship 22
(2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3040393
(knowledge-intensive firms invest 32% less in capital equipment
following decreases in the enforceability of non-compete clauses).
\40\ Matthew S. Johnson & Michael Lipsitz, Why Are Low-Wage
Workers Signing Noncompete Agreements?, 57 J. Hum. Res. 689, 700
(2022) (finding firms that use non-compete clauses in hair salon
industry train employees at 11% higher rate and increase investment
in particular customer-attraction device by 11%); Evan P. Starr,
James J. Prescott, & Norman D. Bishara, Noncompete Agreements in the
U.S. Labor Force, 64 J.L. & Econ. 53, 53 (2021) (finding no
statistically significant impact on training and trade secrets from
use of non-compete clauses, but unable to examine other types of
investments).
\41\ NPRM Part IV.B.3.
---------------------------------------------------------------------------
Implicitly, though, the NPRM credits some business justifications
for non-compete provisions. It excludes from the ban those non-compete
clauses associated with the sale of a business, implicitly
acknowledging that these non-compete clauses are necessary to protect
the goodwill of the transferred business. Also, the NPRM likely credits
business justifications when it seeks comment on whether senior
executives should be covered by the rule. Nonetheless, on its face, the
NPRM expressly discounts business justifications and makes no effort to
distinguish and determine circumstances where investment incentives are
important.
The NPRM also discounts procompetitive business justifications by
asserting that trade secret law, non-disclosure agreements, and other
mechanisms can be used to protect firm investments. While the NPRM
explains that these mechanisms may protect investments, the existing
record provides no evidence that these mechanisms are effective
substitutes for non-compete agreements.\42\ The NPRM cites no instances
where these mechanisms have been used effectively in lieu of non-
compete clauses, even though natural experiments exist and could be
studied (e.g., when states have changed the enforceability of non-
compete clauses). ``[M]erely identifying alternative mechanisms to
solve a potential employee investment problem does not provide . . .
guidance as to which mechanism achieves the objective at the lowest
social cost.'' \43\ Moreover, the NPRM's observation that firms
successfully operate in states where non-compete clauses are not
enforceable is unpersuasive; the NPRM offers no meaningful cross-state
comparisons and the observation does not show that firms and
competition are equally or even more successful in those states than in
states where non-compete clauses are permissible.
---------------------------------------------------------------------------
\42\ There is a limited literature regarding the efficacy of
trade secret protection and non-disclosure agreements. See Jie Gong
& I.P.L. Png, Trade Secrets Law and Inventory Efficiency: Empirical
Evidence from U.S. Manufacturing, https://ssrn.com/abstract=2102304
(July 8, 2012) (investigating effects of operational know-how
information spillovers under various levels of enforcement of trade
secret law).
\43\ Camila Ringeling, Joshua D. Wright, et. al, Noncompete
Clauses Used in Employment Contracts, Comment of the Global
Antitrust Institute 6 (Feb. 7, 2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3534374.
---------------------------------------------------------------------------
II. The Proposed Non-Compete Clause Rule Will Trigger Numerous and
Likely Successful Legal Challenges Regarding the Commission's Authority
To Issue the Rule
This section describes the numerous, and meritorious, legal
challenges that undoubtedly will be launched against the Non-Compete
Clause Rule. Defending these challenges will entail lengthy litigation
that will consume
[[Page 3544]]
substantial staff resources. I anticipate that the Rule will not
withstand these challenges, so the Commission majority essentially is
directing staff to embark on a demanding and futile effort. In the face
of finite and scarce resources, this NPRM is hardly the best use of FTC
bandwidth.
There are numerous paths for opponents to challenge the
Commission's authority to promulgate the Non-Compete Clause Rule.
First, I question whether the FTC Act provides authority for
competition rulemaking. The NPRM states that the Commission proposes
the Non-Compete Clause Rule pursuant to Sections 5 and 6(g) of the FTC
Act. Section 6(g) of the FTC Act authorizes the Commission to ``make
rules and regulations for the purpose of carrying out the provisions of
the subchapter'' where Section 6(g) otherwise provides that the
Commission may ``from time to time classify corporations.'' \44\
Section 6(g) was believed to provide authority only for the Commission
to adopt the Commission's procedural rules. For decades, consistent
with the statements in the FTC Act's legislative history, Commission
leadership testified before Congress that the Commission lacked
substantive competition rulemaking authority.\45\
---------------------------------------------------------------------------
\44\ 15 U.S.C. 46(g). Section 6 of the FTC Act provides
Sec. 46. Additional powers of Commission
The Commission shall also have power . . .
(g) Classification of corporations; regulations
From time to time classify corporations and (except as provided
in section 57a(a)(2) of this title) to make rules and regulations
for the purpose of carrying out the provisions of this subchapter.
\45\ See Nat'l Petroleum Ref'rs Ass'n v. FTC, 482 F.2d 672, 696
nn. 38, 39 (D.C. Cir. 1973). See also Noah Joshua Phillips, Against
Antitrust Regulation, American Enterprise Institute Report 3,
https://www.aei.org/research-products/report/against-antitrust-regulation/ (Oct. 13, 2022) (``[T]he Conference Committee
[considering legislation that created the Federal Trade Commission]
was between two bills, neither of which contemplated substantive
rulemaking. . . . The legislative history does not demonstrate
congressional intent to give the FTC substantive rulemaking power:
The House considered and rejected it, the Senate never proposed it,
and neither the Conference Committee's report nor the final debates
mentioned it.''); 51 Cong. Rec. 12916 (1914), reprinted in The
Legislative History of the Federal Antitrust Laws and Related
Statutes 4368 (Earl W. Kintner ed., 1982) statement of Sen. Cummins)
(``[I]f we were to attempt to go further in this act and to give the
commission the authority to prescribe a code of rules governing the
conduct of the business men of this country for the future, we would
clash with the principle that we can not confer upon the commission
in that respect legislative authority; but we have not made any such
attempt as that, and no one proposes any attempt of that sort.'');
id. at 14932, reprinted in The Legislative History of the Federal
Antitrust Laws and Related Statutes 4732 (Earl W. Kintner ed., 1982)
(statement of Rep. Covington) (``The Federal trade commission will
have no power to prescribe the methods of competition to be used in
the future. In issuing orders it will not be exercising power of a
legislative nature . . . The function of the Federal trade
commission will be to determine whether an existing method of
competition is unfair, and, it is finds it to be unfair, to order
the discontinuance of its use. In doing this it will exercise power
of a judicial nature.''); id. at 13317, reprinted in The Legislative
History of the Federal Antitrust Laws and Related Statutes 4675
(Earl W. Kintner ed., 1982) (statement of Sen Walsh) (``We are not
going to give to the trade commission the general power to regulate
and prescribe rules under which the business of this country shall
in the future be conducted; we propose simply to give it the power
to denounce as unlawful a particular practice that is pursued by
that business.'').
---------------------------------------------------------------------------
Ignoring this history, the Commission embarked on a substantive
rulemaking binge in the 1960s and 1970s.\46\ The vast majority of these
substantive rules pertained to consumer protection issues. Only one
substantive rule was grounded solely in competition; \47\ that rule was
not enforced and subsequently was withdrawn.\48\ Another substantive
rule was grounded in both competition and consumer protection
principles, and prompted a federal court challenge. There, the D.C.
Circuit in 1973 held in National Petroleum Refiners \49\ that the FTC
did have the power to promulgate substantive rules.
---------------------------------------------------------------------------
\46\ See Timothy J. Muris & Howard Beales, III, The Limits of
Unfairness Under the Federal Trade Commission Act 13 (1991).
\47\ FTC Men's and Boy's Tailored Clothing Rule, 16 CFR 412
(1968).
\48\ Notice of Rule Repeal, 59 FR 8527 (1994).
\49\ Nat'l Petroleum Ref'rs Ass'n v. FTC, 482 F.2d 672 (D.C.
Cir. 1973).
---------------------------------------------------------------------------
Two years later, however, Congress enacted the Magnuson-Moss
Act,\50\ which required substantive consumer protection rules to be
promulgated with heightened procedural safeguards under a new Section
18 of the FTC Act. Notably, the Magnuson-Moss Act expressly excluded
rulemaking for unfair methods of competition from Section 18. FTC
Chairman Miles Kirkpatrick (1970-73) explained that it was not clear
whether Congress in the Magnuson-Moss Act sought to clarify existing
rulemaking authority or to grant substantive rulemaking authority to
the FTC for the first time.\51\ If the latter, then the FTC only has
substantive consumer protection rulemaking power, and lacks the
authority to engage in substantive competition rulemaking. This
uncertainty about the language of the statute will be a starting point
for challenges of the Non-Compete Clause Rule.
---------------------------------------------------------------------------
\50\ Magnuson-Moss Warranty--Federal Trade Commission
Improvement Act, Public Law 93-637, 88 Stat. 2183 (1975).
\51\ See Miles W. Kirkpatrick, FTC Rulemaking in Historical
Perspective 48 Antitrust L.J. 1561, 1561 (1979) (``One of the most
important aspects of the Magnuson-Moss Act was its granting, or
confirmation, depending upon your reading of the law at that time,
of the FTC's rulemaking powers.'').
---------------------------------------------------------------------------
Second, the Commission's authority for the Rule likely will be
challenged under the major questions doctrine, which the Supreme Court
recently applied in West Virginia v. EPA.\52\ Under the major questions
doctrine, ``where a statute . . . confers authority upon an
administrative agency,'' a court asks ``whether Congress in fact meant
to confer the power the agency has asserted.'' \53\ The Supreme Court
explained in West Virginia v. EPA that an agency's exercise of
statutory authority involved a major question where the ``history and
the breadth of the authority that the agency has asserted, and the
economic and political significance of that assertion, provide a reason
to hesitate before concluding that Congress meant to confer such
authority.'' \54\
---------------------------------------------------------------------------
\52\ West Virginia v. EPA, 142 S. Ct. 2587 (2022).
\53\ Id. at 2608.
\54\ Id.
---------------------------------------------------------------------------
Challengers will ask a court to determine whether today's NPRM
constitutes a major question. Using Justice Gorsuch's concurrence as a
guide, agency action will trigger the application of the major
questions doctrine if the agency claims, among other things, the power
to (1) resolve a matter of great political significance, (2) regulate a
significant portion of the American economy, or (3) intrude in an area
that is the particular domain of state law.\55\ First, the regulation
of non-compete clauses is a question of political significance;
Congress has considered and rejected bills significantly limiting or
banning non-competes on numerous occasions,\56\ a strong indication
that the Commission is trying to ``work around'' the legislative
process to resolve a question of political significance.\57\ Second,
the Rule proposes to regulate a significant portion of the American
economy through a ban on non-competes. According to the NPRM, the
``Commission estimates that approximately one in five American
workers--or approximately 30 million workers--is bound by a non-compete
clause.\58\ Thus, the Non-Compete Clause Rule indisputably will negate
millions of private contractual agreements and impact employer/employee
relationships in a wide variety of
[[Page 3545]]
industries across the United States. Third, regulation of non-compete
agreements has been the particular domain of state law. As the NPRM
explains, 47 states permit non-competes in some capacity, while three
states have chosen to prohibit them entirely, and state legislatures
have been active in this area recently.\59\
---------------------------------------------------------------------------
\55\ Id. at 2600-01 (Gorsuch, J. concurring).
\56\ Russell Beck, A Brief History of Noncompete Regulation,
Fair Competition Law (Oct. 11, 2021), https://faircompetitionlaw.com/2021/10/11/a-brief-history-of-noncompete-regulation/.
\57\ West Virginia v. EPA, 142 S.Ct. at 2600 (Gorsuch, J.
concurring).
\58\ NPRM Part II.B.1.a.
\59\ Id. Part II.C.1.
---------------------------------------------------------------------------
If a court were to conclude that the Non-Compete Clause Rule is a
major question, the FTC would be required to identify clear
Congressional authorization to impose a regulation banning non-compete
clauses. Yet, as discussed above, that clear authorization is
unavailable. The language in Section 6(b) is far from clear, and
largely discusses the Commission's classification of corporations. I do
not believe that Congress gave the FTC authority to enact substantive
rules related to any provision of the FTC Act using this ``oblique''
and unclear language. In addition, the decision by Congress to omit
unfair methods of competition rulemaking in the Magnuson-Moss Act,
which immediately followed the decision in National Petroleum Refiners,
is additional evidence that Congress has not clearly authorized the FTC
to make competition rules that may have significant political or
economic consequences. Moreover, Congress did not remove the known
ambiguity when it enacted the FTC Improvements Act of 1980.\60\
---------------------------------------------------------------------------
\60\ See H.R. Rep. No. 96-917, 96th Cong., 2d sess. 29-30
(1980), reprinted in The Legislative History of the Federal
Antitrust Laws and Related Statutes 5862 (Earl W. Kintner ed., 1982)
(conference report on FTC Improvements Act of 1980 explaining that
when adopting a restriction on standards and certification
rulemaking brought as an unfair or deceptive act or practice,
conferees were not taking a position on the Commission's authority
to issue a trade regulation rule defining `unfair methods of
competition' pursuant to section 6(g). ``The substitute leaves
unaffected whatever authority the Commission might have under any
other provision of the FTC Act to issue rules with respect to
`unfair methods of competition.' '').
---------------------------------------------------------------------------
Third, the authority for the Non-Compete Clause Rule may be
challenged under the non-delegation doctrine. The doctrine is based on
the principle that Congress cannot delegate its legislative power to
another branch of government, including independent agencies.\61\
---------------------------------------------------------------------------
\61\ Five Supreme Court justices have expressed interest in
reconsidering the Court's prior thinking on the doctrine, which
increases the risk that a challenge may be successful. See Gundy v.
United States, 139 S. Ct. 2116, 2131 (2019) (Alito, J. concurring)
(stating with respect to the nondelegation doctrine that ``[i]f a
majority of this Court were willing to reconsider the approach we
have taken for the past 84 years, I would support that effort'');
id. at 2131 (Gorsuch, J., dissenting, joined by Chief Justice
Roberts and Justice Thomas) (expressing desire to ``revisit'' the
Court's approach to the nondelegation doctrine); Paul v. United
States, 140 S. Ct. 342, 342 (2019) (statement of Kavanaugh, J,
respecting the denial of certiorari); Amy Coney Barrett, Suspension
and Delegation, 99 Cornell L. Rev. 251, 318 (2014).
---------------------------------------------------------------------------
Since the 1920s, the Supreme Court has found that Congress has not
made an improper delegation of legislative power so long as Congress
has set out ``an intelligible principle to which the person or body
authorized to fix [rules] is directed to conform.'' \62\ Applying this
principle in Schechter Poultry,\63\ the Supreme Court approved
Congressional authorization for the FTC to prohibit unfair methods of
competition, relying on the Commission's administrative enforcement
proceedings where the Commission acts as ``a quasi judicial body'' and
that ``[p]rovision was made for formal complaint, for notice and
hearing, for appropriate findings of fact supported by adequate
evidence, and for judicial review . . .'' \64\ The Court simultaneously
found that provisions of the National Industrial Recovery Act to issue
``codes of fair competition'' were improper delegations of legislative
power, distinguishing the impermissibly broad fair competition codes
from the FTC Act's approach to address unfair methods of competition
that are ``determined in particular instances, upon evidence, in light
of particular competitive conditions[.]'' \65\
---------------------------------------------------------------------------
\62\ J.W. Hampton, Jr., & Co. v. United States, 276 U.S. 394,
409 (1928).
\63\ A.L.A. Schechter Poultry Corp. v. United States, 295 U.S.
495 (1935).
\64\ Id. at 533.
\65\ Id.
---------------------------------------------------------------------------
Notably, the Commission's proposed ban on non-compete clauses
abandons the Commission's procedures that led the Supreme Court in
Schechter Poultry to find that the Commission's enforcement of ``unfair
methods of competition'' does not constitute an improper delegation of
legislative power. In addition, to the extent that the Commission's
Section 5 Policy Statement (which provides the basis for determining
that non-compete clauses are an unfair method of competition) abandons
the consumer welfare standard to pursue multiple goals, including
protecting labor, the Commission's action more closely resembles the
National Industrial Recovery Act codes that also sought to implement
multiple goals under the guise of codes of fair competition.
III. Comments Are Encouraged
The NPRM invites public comment on many issues. I strongly
encourage the submission of comments from all interested stakeholders.
After all, unlike rulemaking for consumer protection rules under the
Magnuson-Moss process, this is likely the only opportunity for public
input before the Commission issues a final rule. For this reason, it is
important for commenters to address the proposed alternatives to the
near-complete ban on non-compete provisions. To the extent that the
NPRM proposes alternatives to the current proposed rule, if the
Commission were subsequently to adopt one of the alternatives, which
would be a logical outgrowth of the current proposed rulemaking,\66\
there would be no further opportunity for public comment. Moreover, the
Commission believes that if it were to adopt alternatives that
differentiate among categories of workers, the various rule provisions
would be severable if a court were to invalidate one provision.
Consequently, it is important for the public to address each of the
alternatives proposed in the NPRM because the comment period on the
proposed rule is the only opportunity for public input on those
alternatives.
---------------------------------------------------------------------------
\66\ See Owner-Operator Indep. Drivers Ass'n v. Fed. Motor
Carrier Safety Admin., 494 F.3d 188, 210 (D.C. Cir. 2007); see also
Agape Church, Inc. v. FCC, 738 F.3d 397, 412 (2013) (holding that
FCC ``sunset'' rule was a logical outgrowth when proposed rule gave
public notice that a viewability rule was in danger of being phased
out, i.e., a sunset provision).
---------------------------------------------------------------------------
In addition to the issues for which the NPRM invites comments, I
encourage stakeholders to address the following points:
The NPRM references some academic studies regarding non-
competes. What other academic literature addresses the issues in the
NPRM, including the procompetitive justifications for non-compete
provisions?
The NPRM describes papers that exploit natural experiments
to estimate the effects of enforcing non-compete clauses. While this
approach ensures that the estimates are internally valid, it reflects
the causal effects of non-compete agreements only in the contexts
within which they are estimated. What should the Commission consider to
understand whether and when these estimates are externally valid? How
can the Commission know that the estimates calculated from the contexts
of the literature are representative of the contexts outside of the
literature?
The NPRM draws conclusions based on ``the weight of the
literature,'' but the literature on the effects of non-compete
agreements is limited, contains mixed results, and is sometimes
industry-specific. Which conclusions in the NPRM are supported by the
weight
[[Page 3546]]
of the literature? Which conclusions in the NPRM contradict the weight
of the literature? Which conclusions in the NPRM require additional
evidence before they can be considered substantiated?
Where the evidence provided in the NPRM is limited, is the
evidence sufficient to support either the proposed ban on non-compete
clauses or the proffered alternative approaches to the proposed ban?
What are the benefits and drawbacks of the currently
proposed ban compared to the proposed alternative rule that would find
a presumption of unlawfulness, including the role of procompetitive
justifications in rebutting a presumption?
[FR Doc. 2023-00414 Filed 1-18-23; 8:45 am]
BILLING CODE 6750-01-P