Rule faces legal pushback as industries and associations brace for change
By: David Bland
“Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.” – Lina Khan, Chair, FTC
The Federal Trade Commission (FTC) has enacted a sweeping ban on noncompete agreements nationwide, a measure aimed at enhancing labor market competition and promoting worker mobility. In an April 23, 2024, announcement, FTC Chair Lina Kahn said that the rule is intended to eliminate barriers that prevent employees from moving between jobs, potentially fostering innovation and encouraging the formation of new businesses.
According to Khan, the prohibition of noncompetes could catalyze the creation of approximately 8,500 new startups each year by removing constraints that currently inhibit economic activity.
According to FTC projections, the new rule is expected to offer substantial economic benefits. These include an average annual increase in worker earnings by $524 and a potential reduction in healthcare costs of up to $194 billion over the next decade. Additionally, the FTC estimates a significant boost in innovation, with an increase of 17,000 to 29,000 patents expected annually.
The rule also outlines specific provisions for the ongoing enforcement of noncompetes for senior executives and establishes a compliance framework for employers adapting to the new regulations.
FTC Chair Lina Khan said in a statement at the time the rule was first introduced, “The freedom to change jobs is core to economic liberty and to a competitive, thriving economy. Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.”
Commissioners Vote Along Party Lines
The rule’s enactment aligns with the Biden administration’s broader economic objectives of enhancing labor mobility and encouraging fair market competition. The FTC’s approval of the rule underscored the sharp partisan divide on the issue, as evidenced by the 3-2 party line vote.
Democrat Commissioners Rebecca Kelly Slaughter, Alvaro Bedoya, and Chair Khan supported the measure, aligning with the administration’s policy goals. Republican Commissioners Melissa Holyoak and Andrew Ferguson dissented, reflecting deep divisions on the regulatory approach to employer-employee agreements and their impact on the economic environment.
Commissioner Holyoak firmly dissented from the Commission’s decision, raising constitutional and authority concerns. She argued in an oral statement that the FTC’s broad action oversteps the limited legislative powers delegated by Congress, which are meant for filling specific statutory gaps, not for expansive rulemaking. This, she contended, challenges the separation of powers.
Holyoak also questioned the FTC’s authority under Sections 5 and 6(g) of the FTC Act, deeming the Commission’s rulemaking interpretation as overly expansive and lacking historical or legislative support. She cited the Magnuson-Moss Warranty Act’s strict requirements as indicative of the intended limits on the FTC’s powers. Holyoak suggested that the FTC should instead focus on enforcing laws against specific anti-competitive noncompetes, rather than broad, potentially unauthorized rulemaking likely to face legal opposition.
Holyoak’s Republican colleague Ferguson grounded his objections to the new rule in constitutional concerns and statutory interpretation. He argued that such rulemaking usurps Congress’s legislative role and lacks explicit authorization to nullify contracts and override state laws. Emphasizing the major questions doctrine, his oral dissent contended that sweeping regulations with profound economic impacts necessitate clear congressional approval, which is not present.
Ferguson also questioned the constitutional validity of the FTC’s expansive interpretation under the major questions doctrine and critiqued the rule as arbitrary under the Administrative Procedure Act. He argued that the rule fails to consider the diverse impacts of noncompete agreements and oversteps the FTC’s authority, deeming the rule unlawful due to the lack of a direct congressional mandate.
Key Changes in Finalized Rule
The final rule retains the core elements of the initially proposed rule but incorporates several adjustments based on feedback received during the rulemaking process. One notable change is the substantial expansion of the “sale of business” exception. Originally, this exception was limited to scenarios where a seller/worker owned at least 25% of the business entity.
The revised rule broadens this to include noncompete agreements made in the context of a legitimate sale of a business entity, a person’s ownership interest, or a significant portion of a business entity’s operational assets. Despite this expansion, the FTC emphasizes that such noncompetes must still comply with applicable state laws and federal antitrust regulations.
Additionally, the final rule modifies the approach to noncompete agreements with senior executives. While the proposed rule considered whether such clauses should be evaluated differently due to the negotiated value they represent for senior employees, the final rule maintains existing noncompete clauses with senior executives but prohibits new ones moving forward.
Furthermore, the FTC shifted from requiring the rescission of existing noncompetes to simply mandating that employers notify employees subject to such agreements that they will no longer be enforced.
Existing Noncompetes
The final rule sets distinct guidelines for handling existing noncompete agreements based on the status of the employee. For senior executives, who are defined as those earning over $151,164 annually and holding policy-making positions, existing noncompete clauses will remain valid and enforceable. These executives account for less than 1% of the workforce.
The rule defines policy-making authority as “final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.”
In contrast, for the vast majority of workers who are not senior executives, existing noncompetes will become unenforceable once the rule takes effect. This differentiation underscores a targeted approach in the regulation of noncompete agreements, prioritizing the retention of such agreements only for top-level executives.
Business Groups Plan to Fight New Rule
The finalized rule marks a pivotal shift in employment regulations, potentially reshaping the landscape for U.S. companies and their employees. As noted by the FTC, an estimated 30 million workers, or about one in five, are currently restricted by noncompetes, which limit their ability to seek better opportunities or start competing ventures.
Critics argue that these agreements have broadened in scope over the years, affecting not only high-level executives in sectors like technology and finance but also lower-wage workers in roles as varied as security personnel and food service employees.
However, the noncompete ban faces significant opposition and is expected to encounter legal challenges. Business groups, including the U.S. Chamber of Commerce (USCC), assert that the FTC’s sweeping prohibition oversteps its regulatory authority and undermines state laws that have traditionally governed the enforceability of noncompete clauses.
The Chamber has announced plans to sue, arguing that the decision by three FTC commissioners to implement the ban disregards established legal norms and encroaches on what they consider legitimate business practices. This legal pushback highlights the contentious nature of the rule and the potential hurdles it faces in becoming a definitive law.
In a strongly worded statement, USCC President and CEO Suzanne P. Clark criticized the FTC, arguing that this action represents an unlawful extension of the Commission’s powers and a detrimental overreach into business practices traditionally governed by state laws.
“The Federal Trade Commission’s decision to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive.”
She further contested the authority of the FTC to regulate noncompete rules, stating, “Since its inception over 100 years ago, the FTC has never been granted the constitutional and statutory authority to write its own competition rules.”
Highlighting her disapproval of the decision made by “three unelected commissioners,” Clark declared that the USCC would take legal action: “The Chamber will sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked.”
Less than a day following the issuance of the final rule, the USCC, along with other stakeholders, initiated a lawsuit in the U.S. District Court for the Eastern District of Texas. They are seeking both a declaratory judgment and an injunction aimed at halting the enforcement of the new rule.
DSA Raises Concerns
Brian Bennett, senior vice president, government affairs and policy for the Direct Selling Association (DSA), highlights the wide-reaching implications of the FTC’s new rule banning noncompete agreements, emphasizing its extensive impact across various industries. He underscored the DSA’s efforts to clarify non-solicitation clauses and advised businesses to reassess their existing agreements.
“This is a very broad sweeping rule that touches nearly every business and industry in the United States including direct selling. DSA filed comments on the Notice of Proposed Rulemaking that asked for clarity on non-solicitation clauses,” Bennett says. “Unfortunately, the final rule did not provide that and potentially even broadened the impact.
“Companies should review their non-compete and non-solicitation clauses to see if they would survive scrutiny under this rule. The association has provided guidance to our members as well as been involved with coalition efforts raising legal concerns with the rule. As the advocate for direct selling, we remain actively engaged in this issue,” Bennett says.
Effect on Direct Selling Companies
The effect of the new rule on direct selling companies, and in particular the restrictive covenants contained in many companies’ policies and procedures, is uncertain but potentially far-reaching.
Such restrictive covenants vary widely from company to company. They can include explicit clauses prohibiting distributors from competing, which might be limited to competing products or broadly defined to cover any network marketing company. Non-solicitation provisions may also vary, sometimes forbidding any solicitation of a company’s distributors while often allowing solicitation of those personally enrolled by a distributor.
Larry Steinberg, chair of the Buchalter law firm’s Multi-level Marketing Industry Group, suggests that companies would be well advised to start preparing for a world where non-competition restrictions are the exception rather than the norm.
“Regardless of the ultimate fate of the FTC’s new rule, there is a clear trend at both the national and state levels to restrict the scope and effect of non-competition agreements, particularly as they apply to persons who are not in policy-making positions.”
Steinberg points out that companies have tools other than non-competition agreements that they can use to protect their businesses. The commentary that the FTC released along with the new rule explicitly states that the new restrictions do not apply to non-solicitation agreements unless they are so restrictive that they function to prevent a worker from seeking or accepting other work or starting a new business after their employment.
“The most powerful tool in a company’s arsenal, the ability to prevent a distributor from revealing or utilizing a company’s trade secrets, remains unaffected by the new rule,” Steinberg concludes.
Noncompete Rule Faces Uncertain Future
With legal challenges to the noncompete ban already underway, the fate of the rule remains uncertain, signaling an ongoing debate over the balance between economic freedom and regulatory oversight in the labor market. While proponents argue that the rule will spur innovation, promote fair competition, and enhance worker mobility, critics raise concerns about the FTC’s authority and the potential impact on certain business practices, including direct selling.
The court battles will likely shape the final outcome and set precedents for future regulatory efforts. As the controversy unfolds, stakeholders from various sectors will be closely watching to gauge how the new rule might redefine the employment landscape.
David Bland is the publisher of Social Selling News.
