Biden Noncompete Order Risks Legal Disputes Over FTC Overreach

Federal limits on employee noncompete agreements are poised to set the Federal Trade Commission up for legal challenges, especially if it broadly bans the contracts that the Biden administration says hurt workers and stifle competition.

President Joe Biden called on the FTC to ban or limit employee noncompetes as part of a broad executive order issued July 9 aimed at improving competition within the economy. The order stops short of specifying how to limit the pacts, which prohibit employees from working for a competitor as a way to protect company trade secrets and investment in employee training. A complete ban could raise questions about the FTC’s power to limit contracts, which are governed by state law.

“The real question is, how big of a group are they going to try to exempt from noncompetes?” said Evan Starr, an assistant professor of management and organization at the University of Maryland. “There’s a lot of conflicting views on that point. If they went the most extreme they could go—which is not unprecedented— it would be to just ban them entirely.”

That would likely invite legal challenge, attorneys say. If the FTC follows the lead of state legislatures, its enforcement could range anywhere from banning most or all employee non-competes, as California and the District of Columbia do, to imposing a less-stringent ban for low-wage workers as a handful of states have enacted in the last five years.

The executive order, which includes a range of policy initiatives that aim to give workers more power and suppress anti-competitive activity, follows calls in recent years from labor unions, Democratic leaders, and state governments that say the contracts hobble workers’ rights and fair competition. Courts in the past year have been skeptical of enforcing the contracts for workers facing historic unemployment during the Covid-19 pandemic.

In the U.S., one out of every five workers is bound by noncompetes, according to a 2019 study from the Economic Innovation Group. Companies such as Amazon.com Inc. and Jimmy John’s have come under public pressure to limit the use of these contracts for low-wage workers.

“The executive order speaks to the fundamental needs in the economy right now, and the problems we carried with us into the pandemic that threatened to bog us down on the other side of it,” said Kenan Fikri, the Economic Innovation Group’s director of research.

‘Unprecedented Expansion’

The use of noncompetes is limited by a broad range of state-level policies—some enacted into statutes specific to noncompetes and others enforced by courts based on common law.

Employers looking to enforce the contracts against a former employee often must prove there’s a legitimate business interest at stake and that the noncompete clause isn’t overly broad in terms of duration, geographic reach, or the types of restricted employment activities.

Biden’s order for the FTC to restrict noncompetes is an unprecedented federalization of state employment law, said John Siegal, co-head of BakerHostetler’s national noncompete and trade secrets practice group. He authored a recent report on the need for laws to regulate noncompetes for lower-salary employees.

“A Biden administration executive order on noncompetes would be an unprecedented expansion of the federal role in an area that has always been governed by state law, and whether it is tailored to curb abuses of noncompetes for lower-salary employees or reaches more broadly throughout the economy will be a critical piece of economic policymaking with ramifications for every industry in America,” Siegal said.

While the executive order doesn’t have immediate impact as it simply signals the FTC should look into the issue, any FTC action will have implications, said Chris Marquardt, leader of the labor and employment group at Alston & Bird.

“There will be federalism and rulemaking authority questions of the FTC, and it won’t be surprising if someone challenges on appropriate grounds,” Marquardt said. “Where we are sitting now it will be hard to see where those challenges will be.”

Business Concern

A full ban on noncompetes would be problematic because there are legitimate reasons to have them in place, said Carson Sullivan, a partner with Paul Hastings LLP, who represents employers.

“There has been an increased hostility toward noncompetes coming out of a number of states,” she said. “Most disputes in courts are not over low-wage workers.”

A number of business groups and lawyers, including the U.S. Chamber of Commerce, previously urged the FTC to avoid federal rulemaking to limit noncompetes, in public comment letters that the commission solicited in early 2020.

Like the chamber, the American Bar Association’s Antitrust Law Section and others questioned the wisdom of creating a broad new federal rule to govern an area that traditionally has been the domain of state contract law. The chamber and ABA letters also raised doubts about the FTC’s legal authority for rulemaking to govern noncompetes.

The toughest option for employers to manage would be a full ban on noncompetes that also limits businesses’ ability to use customer or employee nonsolicitation contracts, as California law does, said Michael Elkon, an employment lawyer with Fisher Phillips LLP in Atlanta.

“The number of legal challenges and the intensity of legal challenges will depend on how broad the FTC’s rule is. If the FTC goes full California, there will be lots of legal challenges,” he said.

Worker Harm

Other groups—such as a coalition including the Open Markets Institute and the AFL-CIO—previously urged the FTC to move ahead with rulemaking to broadly restrict the use of employee noncompetes, stressing the harm to workers because of limited job mobility as well as larger constraints on the economy and entrepreneurship.

Noncompetes are overly used and some would argue they shouldn’t be used at all, said Eric Meyer, an attorney with FisherBroyles, who represents workers. He said he has represented manual laborers who face multi-year agreements that would have no geographic limitations.

“A lot of people especially at the lower level as part of onboarding don’t realize what they’ve signed. Sometimes even higher-level executives don’t appreciate what they’ve signed,” he said.

He said a flat-out ban on noncompetes would likely invite a legal challenge over the FTC’s ability to take such action.

“As a pragmatic matter, states are the ones who set up the framework for enforcement and legality of noncompetes,” he said.

While it’s still unclear how far the executive order and FTC-issued regulations will go, Biden’s order could have a chilling effect on pending noncompete litigation, said Don Schroeder, a partner at Foley & Larder LLP.

“It will require private businesses, most notably technology companies, to re-examine their legal strategy for protecting confidential, proprietary information,” he said.

—With assistance from Claire Hao