Marina Lao: "FTC Rulemaking on Noncompetes"

Dear readers, the Network Law Review is delighted to present you with this month’s guest article by Marina Lao, Edward S. Hendrickson Professor of Law at Seton Hall University School of Law.

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In early 2023, the U.S. Federal Trade Commission (FTC) proposed a rule that would ban virtually all noncompete clauses as “unfair methods of competition” (UMC) under section 5 of the FTC Act.¹ This was the agency’s first modern foray into competition rulemaking after decades of relying almost exclusively on case-by-case adjudications to enforce section 5, a provision that simply declares UMC to be unlawful and charges the FTC with identifying and prohibiting such practices.²

The FTC’s rulemaking initiative generated significant controversy. Whether the agency has statutory authority to promulgate substantive, as opposed to merely procedural, rules in the first place has been the subject of debate for some time.³ The debate widened after the Supreme Court handed down its decision in West Virginia in 2022.⁴ Critics of the FTC’s rulemaking intentions contend that even if the statutory provision on which the agency based its rulemaking, section 6(g),⁵ can be read to authorize the issuance of substantive rules, West Virginia was a game-changer.⁶ Some claim, more specifically, that a rule on noncompetes would almost certainly not survive a “major questions doctrine” (MQD) challenge after West Virginia.⁷

In a recent article,⁸ I explained why I believe section 6(g) should be interpreted to grant the FTC authority to promulgate substantive competition rules and why West Virginia should have no major implications on that basic issue; I will not repeat those arguments here. As to the specific claim that rulemaking on noncompetes would be problematic under West Virginia, I argued that the issuance of a rule to assist in the agency’s enforcement efforts against that practice (a vertical restraint) should not, categorically, be deemed to involve a major question.

In this essay, I will expand on this last point and then discuss a question that I had left open in that article: whether the FTC’s rule as proposed—an across-the-board ban on all noncompetes—might trigger the MQD, even if rulemaking on the subject, alone, would not. I will begin with a summary of the major questions doctrine.

West Virginia, and the Major Questions Doctrine (MQD)

The thrust of the MQD, as articulated in West Virginia, is that any agency action relating to a “major question” required “clear congressional authorization”.⁹ The Court’s reasoning was that Congress intends to make major policy decisions itself and, therefore, if an agency attempts to act with respect to a major question, it must show that Congress clearly authorized it. What exactly would be considered a “major” question is not, however, entirely clear. The majority spoke of the magnitude of the policy’s impact,¹⁰ the “unprecedented power over American industry” it would give the agency,¹¹ and the novelty and ambitiousness of the agency’s statutory interpretation,¹² as important indicators. Justice Gorsuch’s concurrence would consider the policy’s political or economic significance.¹³

Despite its importance, the doctrine should not be a game-changer on the basic question of whether section 6(g) may be interpreted to grant the FTC competition rulemaking authority as a general matter. As I explained in my article, the FTC has been adjudicating competition cases for over a century, under its mandate from Congress to identify and prohibit “unfair methods of competition”. The authority to issue substantive rules to help define what constitutes a UMC simply gives the agency a supplemental tool, in addition to adjudication, to carry out its statutory mandate. It is hard to see how that, in itself, could be viewed as presenting a major question.

Rulemaking on Noncompetes

However, the doctrine could place limits on the subject matter of a substantive rule. This raises the question of whether the issuance of a UMC rule on noncompetes by the FTC would necessarily be deemed “major”, irrespective of the content and scope of the Final Rule. While it is not clear yet how courts will apply the MQD going forward, based on the indicators discussed in the opinion, I argue that the promulgation of a rule on noncompetes should not automatically raise a “major question” for several reasons.

First, the legal theory of an antitrust claim against noncompetes is not novel at all. While antitrust authorities have indeed overlooked them until quite recently,¹⁴ noncompete clauses, by their express terms, restrict competition in labor markets and so are properly subject to competition law under Section 1 of the Sherman Act¹⁵ and Section 5 of the FTC Act,¹⁶ over which the agency clearly has jurisdiction. Noncompetes operate to diminish competition for workers in labor markets and artificially suppress wages, and are undoubtedly “contract[s] . . . in restraint of trade” subject to the antitrust laws. There is no need to even wrestle with these claims to have them fit within an ordinary reading of existing antitrust law. Thus, a rule on noncompetes would not effectuate a “fundamental revision” of a statute, which was one of the Supreme Court’s concerns in West Virginia.¹⁷

Second, a rule banning noncompete clauses would not give the FTC “the magnitude of […] ‘unprecedented power over American industry’” that Chief Justice Roberts feared in West Virginia.¹⁸ Nor would it allow an agency to restructure any American market. Even the strictest rule banning noncompetes would do no more than bar employers from interfering with their workers’ freedom to work for a competitor upon leaving.

Third, as for political salience, a factor important to Justice Gorsuch, the issue of noncompetes is not inherently polarizing. Notably, of the three states that currently impose a complete ban on noncompete clauses,¹⁹ one state (California) is solidly blue while two (North Dakota and Oklahoma) are solidly red. While there is substantial criticism of the currently proposed rule, the disapproval may be attributable to the specifics of the rule as proposed, which is very broad.²⁰

Noncompete clauses, in fact, present an ideal subject for UMC rulemaking. From a non-economic perspective, noncompetes are unfair to workers and they exacerbate the problem of rising income and wealth disparity in the United States.²¹ Noncompetes cut off employees’ job opportunities with those very firms where their experience and skills would likely be most valued—firms in the employer’s line of business and, therefore, likely considered their competitors. This increases the employer’s bargaining leverage vis-à-vis the employee and tends to depress employee pay.²²

From an economic perspective, there is now a growing body of scholarship, including empirical studies, that would support prohibiting most noncompetes. These surveys and studies document the widespread use of noncompetes in this country, even for low-pay, hourly workers.²³ Many credible studies also consistently find a strong correlation between the use of noncompetes and lower wages,²⁴ as well as reduced labor mobility.²⁵ And some studies suggest a correlation between noncompetes and innovation: that is, increased enforcement of noncompete clauses tends to be linked to decreased innovation.²⁶

As to the economic rationale most often offered for noncompetes—that they are needed to encourage employer investment in their workers and innovations—the vitality of California, which has had a complete ban on noncompetes for decades, seems to refute this theory. It has been noted that labor mobility is particularly high in California’s technology sector, probably because of the state ban on noncompetes. Yet no one would seriously argue that the state is lagging in innovations or that companies there are unwilling to invest in employee training. There is, in fact, research positing that the rise and success of Silicon Valley was aided by labor mobility made possible by the unenforceability of noncompetes in that state.²⁷ Informed by these studies and empirical evidence, the FTC is particularly well-suited to formulate administrable rules (as a complement to adjudication) to tackle the social and economic problems caused by noncompetes.

However, the current proposed rule would absolutely ban virtually all noncompete clauses.²⁸ Would such a rule (assuming its adoption as proposed) be deemed to involve a “major question” that would not survive a MQD challenge because of the absence of express congressional authority? I had left that question unanswered in my earlier paper and will address it here.

Rulemaking Categorically Banning Noncompetes

A rule that categorically bans all noncompetes (except those that accompany the sale of a business) as violations of section 5 of the FTC Act would effectively treat the practice as per se unlawful. Noncompetes, however, are vertical restraints as they involve the employer and employee, who are in a vertical relationship. And vertical restraints are, of course, not per se unlawful under the Sherman Act but are evaluated under the rule of reason.

I realize that section 5 of the FTC Act was intended to have a broader reach than the Sherman Act and, therefore, applying a per se approach to noncompetes under section 5 does not truly conflict with established antitrust doctrine.²⁹ However, for reasons that are outside the scope of this short essay, federal courts customarily treat section 5 as coextensive with the Sherman Act, and apply Sherman Act standards to similar claims brought under the FTC Act.³⁰ In other words, a claim involving a restriction of competition between vertical parties brought under section 5 of the FTC Act would be judged under the same rule of reason standard that applies to vertical restraint claims brought as Sherman Act violations.

That being the case, promulgating a rule that treats noncompete agreements—i.e., vertical restraints of trade—as per se unlawful under the FTC Act would be a departure from decades of legal precedents. Given West Virginia and particularly this Supreme Court’s skepticism of agency powers, it is doubtful that such a rule would survive an inevitable MQD challenge. The Supreme Court would likely find that the FTC had engaged in policymaking that raises a major question, for which it must show sufficiently clear statutory authority in support of its regulatory effort.

A Slight Tweak

There are strong policy reasons, both social and economic, to ban noncompetes in most contexts. However, this Supreme Court is extremely unlikely to uphold an agency rule that seemingly defies well-established antitrust law. Perhaps it may be better for the agency to retreat from a per se approach and, instead, promulgate a rule that applies a rebuttable presumption that noncompete clauses are anticompetitive. That would shift the burden of production and proof to employers to justify the restraints, which they probably would be unable to do in most cases. This approach would also fit within the concept of the “quick look”, an analysis much less demanding of the plaintiffs, that the Supreme Court has endorsed in certain contexts.³¹ This more limited approach, analogous to the quick-look and informed by new economic studies that were not available twenty years ago, may well be viewed as more acceptable under a MQD analysis.

Marina Lao

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Citation: Marina Lao, FTC Rulemaking on Noncompetes, Network Law Review, Fall 2023.

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