Cutting the Legal Ties That Bind
Cutting the Legal Ties That Bind
Exploring the implications of the FTC’s ban on noncompetes.
If you’ve been formally employed, chances are you’ve dealt with a noncompete. Either knowingly or unknowingly. Noncompetes are post-employment agreements not to compete - either by working for a competitor or starting a new business. Around 30 million workers, or about one in five American workers, are bound by a noncompete clause. Most employees don’t negotiate these provisions and even fewer get outside advice during the process. They extend to nearly all corners of the labor market and can apply to anyone from top-level executives to software engineers, salespeople, and even hair stylists and fast food workers.
In April 2024, the Federal Trade Commission (FTC) enacted an outright ban on noncompetes. And it applies retroactively, meaning all existing noncompetes are invalid as well. This was an unprecedented move by the agency and the rule was set to take effect on September 4. However, such a sweeping ban was bound to face legal challenges, and it has. Last week, a Texas federal judge ruled that the FTC lacked the authority to impose such a broad ban. While that decision is final, the broader legal battle is far from over. This article unpacks the legacy of noncompetes in the US, explores why the FTC’s ban may have been too expansive for its own good, and considers the necessity of noncompetes in today’s labor market.
A Brief History of Noncompetes
From Prohibition to Regulation (and Back?) 🔄
While the FTC’s recent rule may seem new and unprecedented, noncompetes have been banned in the past. Under English common law, noncompete agreements were not enforced because they were considered restraints on trade. The first known case involving a noncompete, Dyer’s Case in 1414, involved an apprentice named John Dyer who agreed not to practice his trade for six months in the town where he was trained. When his master tradesman attempted to enforce this restriction, the court found that the agreement was presumptively invalid. Dyer’s case became a symbol of individual freedom to work, and several courts interpreted it broadly to prohibit restrictive guild practices.
As the popularity of guilds waned, the strict prohibition of noncompetes gave way to more nuanced regulation. In 1711, Mitchel v. Reynolds introduced a more modern framework, allowing noncompetes if they were reasonably limited in scope and intended to promote beneficial transactions. Essentially, enforcement became more context-dependent. Against this more permissive historical backdrop, the FTC’s blanket ban appears to be a significant departure from tradition.
Traditionally, A State-By-State Issue 🧩
Noncompetes are creatures of contract, which means they are primarily governed by state law. This has led to a patchwork of regulations across the country because each state makes unique policy decisions tailored to its citizens and economies. Some states, like California, North Dakota, Minnesota, and Oklahoma, have long-standing bans on noncompetes. Others impose restrictions based on income thresholds, industry, and the scope of the agreement. Recent efforts to ban noncompetes in New York and Rhode Island have gained momentum but ultimately failed. In New York, Governor Kathy Hochul vetoed a proposed ban, citing the need for exceptions for high-wage earners. Similarly, Rhode Island Governor Dan McKee vetoed a bill that would have prohibited most noncompete agreements.
These decisions and policies ultimately come down to incentives. If a single state enacts restrictive legislation on noncompetes, it risks making its businesses less competitive in the national market. Although employee mobility fosters innovation, individual companies often prefer noncompetes to prevent losing their talent. At the government level, a state might favor a complete ban on noncompetes, but if it's the only one to do so, it could effectively drive businesses away. The map below illustrates the varying legislative restrictions by state.
The Sandwich That Spurred Federal Action 🥪
The federal government’s focus on noncompetes sharpened in response to the high-profile abuse of noncompetes by Jimmy John’s. In 2016, the fast-food franchise made headlines for requiring low-wage sandwich workers to sign overly restrictive noncompetes as part of their hiring process. These contracts prohibited employees from working at any business within three miles of a Jimmy John’s that derived at least 10% of its revenue from “submarine, hero-type, deli-style, pita, and/or wrapped or rolled sandwiches” during their employment and for two years afterward. Eventually, Jimmy John’s reached a settlement in which they agreed not to enforce the noncompetes and provided $100,000 to fund public awareness programs about noncompetes (note: this is mere pennies to the franchise that snagged first place on the Franchise 500 list in 2016).
Following the Jimmy John’s saga, the Obama Administration issued a State Call to Action, urging states to limit the use of noncompetes. The administration also lobbied Congress to pass a federal ban. These efforts didn’t work. Recognizing the limitations of traditional lawmaking, President Biden took a different approach. In 2021, he signed an Executive Order on Promoting Competition in the American Economy and started urging the FTC to take decisive action. And act, they did.
The FTC’s Bold Move
On April 23, 2024, the FTC issued a landmark rule banning noncompetes nationwide. In a 3-to-2 vote, the FTC determined that noncompetes constitute an unfair method of competition, violating Section 5 of the FTC Act. This rule overrides all state laws, regulations, and interpretations that conflict with the federal mandate. Specifically, it bans all new noncompetes and imposes different rules for existing ones. Existing noncompetes with senior executives can remain in force, while the rest are no longer enforceable. The rule was set to take effect on September 4, but has faced immediate legal challenges. Several cases are currently in litigation, including Ryan LLC v. FTC, ATS Tree Services, and Properties of the Villages. The Ryan case is the furthest along, and Tuesday’s ruling makes it the first final decision from the federal courts on this issue.
It’s Overreach, not Empowerment 💥
Ryan’s main argument is that the FTC exceeded its statutory authority by issuing a nationwide ban on noncompete agreements. After reviewing the text, structure, and history of the FTC Act, Judge Brown held that (1) the FTC lacked statutory authority to issue substantive rules (versus procedural rules) and (2) even if it did have the authority, this particular rule was unreasonably overbroad and didn't have a reasonable justification. Ryan is significant because it means that businesses that were preparing to comply with the new FTC rule no longer need to do so. At least for now. Most likely, the FTC will appeal. This case is teeing up a significant legal debate that some speculate may reach the Supreme Court: what authority does the FTC have, and what is the appropriate role of federal agencies in shaping regulations that affect the entire nation?
The Rise of the FTC and Its Authority 🪜
At the heart of this debate is the tension between agencies and the courts in determining how laws are interpreted and enforced. The FTC is an independent federal agency that derives its authority from the Federal Trade Commission Act, which Congress enacted to protect consumers and promote competition. Section 5 of the Act empowers the FTC to prevent unfair methods of competition and unfair deceptive acts or practices, primarily through administrative proceedings. Section 6 grants additional investigatory and ministerial powers to support its broader goals. But the extent of the FTC's substantive rulemaking authority is where the controversy lies. (For more on agency dynamics, I wrote about the rise of the regulatory state in a prior article here.)
The FTC is composed of five appointed Commissioners, who are selected by the President, confirmed by the Senate, and serve seven-year terms. At least, that’s how it’s supposed to work. This structure was upended in 2023 when Commissioner Christine Wilson announced her early resignation. In a Wall Street Journal op-ed, Wilson openly criticized Chair Lina Khan's leadership, and accused her of disregarding the rule of law and due process.
Wilson's resignation left the FTC with just three members: Chair Lina Khan, and Commissioners Rebecca Slaughter and Alvaro Bedoya - all of whom are Democrats. According to FTC rules, no more than three Commissioners can belong to the same political party, and for nearly a year, the Commission operated with only three members. In 2024, the two vacancies were filled by Republican Commissioners Andrew Ferguson and Melissa Holyoak, both former Solicitor Generals. Both new members voted against the controversial noncompete ban. Partisan perception complicates the ongoing debate about the FTC’s authority and the proper role of federal agencies.
Zooming Out: The Death of Chevron Shifts Power Back to Courts ☠️
Lurking behind the headlines about noncompetes is a quiet but significant SCOTUS decision: Loper Bright Enterprises v. Raimondo. In June, the Supreme Court issued a landmark decision that eliminated the so-called Chevron doctrine as established in Chevron v. NRDC. Under Chevron, courts were required to defer to a federal agency's interpretation of a statute if the law was silent or ambiguous. The death of Chevron shifts the balance of power back to the courts. It means that courts, not agencies, will be the ultimate arbiters of statutory meaning. This shift has profound implications for the ongoing controversy over noncompetes. It suggests that the FTC may not have the authority to impose a blanket ban on noncompete agreements, and rulings like Ryan take on added significance. In light of Loper Bright, it seems unlikely that the FTC’s noncompete ban will survive in its current form.
Rethinking Noncompetes: Are They Really Necessary?
Noncompetes are contentious because they encompass a wide range of scenarios, from the clearly unjust to the somewhat defensible. While there are undeniably abusive noncompetes, like those imposed on low-wage workers at Jimmy John’s, there are also cases where these agreements could serve a legitimate business purpose—especially for high-level knowledge workers. Although most people would agree that preventing a sandwich maker from making sandwiches elsewhere is an unfair business practice, many also believe that companies have a right to stop their CEO from jumping ship to a competitor with valuable insider information. It’s this perceived dichotomy that makes the issue of a noncompete ban so divisive across industries and interest groups. However, the debate often overlooks two key points: (1) noncompetes have not been historically necessary for innovation to thrive, and (2) they are far from the only tool companies can use to protect their interests.
Silicon Valley > Route 128 🍀
For the former, it is illustrative to consider the case of Silicon Valley and Route 128. While Silicon Valley is synonymous with groundbreaking tech innovation and immense business success, far fewer people are familiar with Route 128, Boston's major innovation hub. Though there are countless reasons for these varying degrees of success and impact, one important factor is that California does not enforce noncompetes. This allowed for unusually high employee mobility, fostering intense competition between companies and a work culture focused on employee retention (think ping pong tables and cushy Big Tech perks). As a result, innovation flourished, and the employees responsible for this innovation managed to capture a substantial amount of benefit. This outcome seems to align well with the FTC's goals of promoting competition and business development. While Boston remains a key hub for American innovation — home to companies like Moderna, which pioneered the COVID-19 vaccine, and Akamai Technologies, a leader in cloud computing — the region has been unable to keep pace with Silicon Valley's dynamic ecosystem.
Just One Tool in the Toolbox 🔨
Finally, conversations about noncompetes often assume that without these contracts, employees would be free to exploit their former employers' business secrets and customer base. However, even without noncompetes, businesses have other legal tools at their disposal, such as NDAs, non-solicitation agreements, and confidentiality agreements to ensure that their intellectual property is preserved in the face of employee turnover. These alternatives are more narrowly tailored, preserving the key elements of competitive advantage without placing undue restrictions on talent. As the conversation around noncompetes continues on the national stage, it's worth considering whether these agreements are truly the best tool for the job.