Brokerage Ops the April 2023 issue

All or Nothing?

The FTC’s proposed non-compete rule is likely to fail expected legal challenges.
By Scott Sinder, Ashelen Vicuña Posted on April 2, 2023

The idealists who champion the all-or-nothing approach will rightly note that the D.C. policy agenda is bottomless and you have to seize the moment when you have it because you never know if or when it will come again. The pragmatic incrementalists want the whole loaf too but are willing to take half if that is all that is in the offing.

The latest episode in this ongoing saga is the Federal Trade Commission’s proposed rule to ban non-compete agreements.

The FTC defines a “non-compete agreement” as any agreement that prevents an employee from working for a competitor. The proposed rule would exempt non-solicitation agreements, non-service agreements, non-disclosure agreements and other post-employment restrictive covenants from the ambit of the prohibition, provided those restrictions do not functionally bar an employee from working for a competitor. The FTC also would create an exemption to the prohibition for business sales but only for “material” owners, defined as individuals owning or controlling at least 25% of the business being sold.

If the FTC finalizes the proposed rule more or less in its current form, I think the odds of its losing the lawsuits that undoubtedly will be filed are almost 100%.

In explaining the need for the rule, the FTC focuses heavily on the extensive use of non-compete agreements for hourly and other lower-income workers. The commission asserts, for example, that over half of all the non-compete agreements currently in place in the United States apply to this lower-wage employee population. The vast majority of cases the commission cites as examples of the misuse of non-compete covenants also are focused on these populations—challenges, for example, brought by security guards, fast-food workers, line employees at manufacturing companies, and warehouse workers against provisions prohibiting them from working for any competitor.

The FTC anchors its authority to bar the use of non-compete agreements in Section 5 of the FTC Act, which generally prohibits “unfair or deceptive acts or practices.” The preliminary hurdle for the FTC is that, in the 109 years since the provision was initially enacted in 1914, the FTC has never issued a rule declaring a specific category of “acts or practices” either “unfair or deceptive” and instead has enforced Section 5 exclusively through claims asserted in litigation proceedings against individual company practices. The U.S. Chamber of Commerce has announced its intention to challenge any rule the FTC ultimately issues here and will assert that the FTC has no rulemaking authority at all under Section 5.

Legal Scrutiny

The broad reach of the rule—the FTC itself estimates that it will impact as many as 40% of all U.S. workers—also will subject it to scrutiny under the Supreme Court’s West Virginia v. EPA “major questions doctrine.” In essence, under that decision, an agency can promulgate a rule that has such a broad and material impact only if Congress clearly directed the agency to do so.

If the FTC finalizes the proposed rule more or less in its current form, I think the odds of its losing the lawsuits that undoubtedly will be filed are almost 100%. Even if it can get over the authority hurdle, the broad impact of the rule, which the commission itself touts, will almost certainly require the “major questions doctrine” analysis, and there is no evidence of which I am aware that Congress ever directed the agency to regulate the permissibility of non-compete agreements.

Challengers will be aided by the fact that covenants not to compete are expressly regulated by the states. In every state, such covenants are disfavored, but most states generally permit them to be enforced provided the requirements they have established—in most circumstances through case law—have been satisfied.

There are three notable exceptions: California, North Dakota and Oklahoma all have statutes that generally deem covenants not to compete as legally impermissible. The North Dakota restriction initially was enacted in 1865, the California restriction in 1872, and the Oklahoma restriction in 1890.

Since 2017, and apparently in response to some of the same concerns flagged by the FTC with respect to the growing abuse of covenants not to compete, the District of Columbia and 11 states (Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia and Washington) have enacted bans on the use of non-compete agreements. Those bans, however, apply only to lower-income workers—either only to hourly workers or to those who make below a specified income threshold (e.g., under $100,000).

The FTC itself admits that the data on which it is relying to support the rule are very limited with respect to higher-income wage earners and that there is little evidence related to the significance of non-competes in the business sale context.

Importance to Market Value

The FTC itself admits that the data on which it is relying to support the rule are very limited with respect to higher-income wage earners and that there is little evidence related to the significance of non-competes in the business sale context. In the insurance brokerage firm space, allowing non-competes to be used in conjunction with a business sale but only for those who own 25% or more of the business being sold likely would significantly decrease the market value of those firms, and, for firms of any size, there are generally no individual owners who would meet the 25% ownership threshold.

The proposed rule’s retrospective application also would nullify existing covenants not to compete that are included in broader negotiated agreements while presumably leaving in place the consideration that was paid for the non-compete provision.

There is an old expression: bad facts make bad law. If the FTC were to pare the rule back to bar the use of non-competes only for lower-wage earners, which in essence would be a nationalization of the more recent state initiatives, you could imagine a scenario under which the courts would work harder to uphold the rule given the perceived egregiousness of the underlying practices.

The Chamber’s primary interest is in ensuring that the FTC does not have Section 5 rulemaking authority at all, and a limiting of the application of the rule to lower-income workers would therefore make its challenge a little more difficult. The majority of the FTC commissioners appear to be idealists though, not pragmatists. It is therefore more likely that the commission will keep the vast majority of the proposed rule intact in its effort to have it all, thus ensuring that it is most likely to achieve exactly nothing when all is said and done.

Scott Sinder Chief Legal Officer, The Council; Partner, Steptoe Read More
Ashelen Vicuña Senior Associate, Government Affairs and Public Policy Practice Group, Steptoe & Johnson Read More

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