The Federal Trade Commission Should Reconsider its Proposed Ban on Employee Noncompete Agreements

        In January, 2023, the Federal Trade Commission issued a Notice of Proposed Rulemaking ("NPRM"), proposing to ban all employee noncompete agreements ("NCAs"), with the exception of a small portion of those that arise out the sale of a business.      The proposed rule would ban even those agreements that state courts have found to be reasonable, after employers demonstrate that the agreement is necessary to produce significant benefits that exceed harms.  The Commission issued the proposed ban more than three years after receiving a 2019 petition from Chair Khan's former employer requesting that the Commission ban all NCAs as unfair methods of competition and thus violations of Section 5 of the FTC Act.  The Commission, in existence since 1914, has never assessed an NCA in an on-the-record adjudication. 

            This blogger filed lengthy comments with the Commission in April, 2023 identifying various errors of fact and analysis in the NPRM.  Among other things, the NPRM:

• Overstated the extent of labor market concentration; 

•  Understated the extent to which such agreements are disclosed to employees in advance;

• Mischaracterized state court opinions describing the prevalence of employer bargaining power;

• Ignored advances in economic theory relating to the voluntary formation of contracts that produce cognizable benefits;

• Misapplied the less restrictive alternative standard; 

• Erroneously rejected the regulatory alternative, proposed by this blogger and others, that would mandate pre-agreement disclosure of such contracts and thus reduce the information imbalance that the NPRM identified;

• Incorrectly concluded that mandate disclosure would have no impact on the number and content of NCAs.     

• Relied on "aggregate" or "average" effects of NCAs and refusing to discriminate between those that produce benefits and those that are harmful.

•  Incorrectly assumed that fully disclosed and beneficial NCAs are the result of a coercive process of contract formation with the result that any benefits necessarily coexist with coercive harm.  

        In addition to the Comments mentioned above, this blogger has also authored four publications on this subject between 2022 and 2024.   The first replied to a 2019 Petition requesting that the Commission ban all NCAs, including those that are reasonable. See Don't Abolish Employee Noncompete Agreements, 57 Wake Forest L. Rev. 631 (2022).  The three more recent publications criticize various aspects of the reasoning of the NPRM.  See New Vision Old Model: How the FTC Exaggerated Harms When Assessing Business Justifications for Employee Noncompete Agreements, 109 Cornell L. Rev. Online _____ (2024) (forthcoming); Regulation by (bad) Proxy: How Selective Application of Transaction Cost Economics Tainted the FTC’s Proposed Ban of Employee Noncompete Agreements, 100 Indiana L. J. Supp. _____ (2024)  (forthcoming); Are Employee Noncompete Agreements Coercive?  Why the FTC's Wrong Answer Disqualifies It from Rulemaking (For Now), 18 Va Law & Bus. Rev. 245 (2024).   Like the 2022 article in the Wake Forest Law Review, these papers draw on my prior work regarding the intersection of Transaction Cost Economics (TCE) and antitrust policy.  See e.g.:

• The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine, 88 Notre Dame L. Rev. 1291 (2013);

• Reframing Antitrust in Light of Scientific Revolution: Accounting for Transaction Costs in Rule of Reason Analysis, 62 Hast. L. J. 457 (2010) 

• Market Failure and Non-Standard Contracting: How the Ghost of Perfect Competition Still Haunts Antitrust, 1 J. Competition L & Econ. 21 (2005);

• Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77; 

• Tying Meets the New Institutional Economics: Farewell to the Chimera of Forcing, 146 U. Penn. L. Rev. 1 (1997);

    The four recent articles (2022-2024) cited above identify various errors and shortcomings in the case for abolishing NCAs.  Perhaps most notably, these papers take issue with the claim, made by the 2019 Petition and the NPRM, that NCAs, whether or not they produce benefits, are the result of a coercive process of contract formation.  The Petition contended that NCAs are always the result of unequal bargaining power and thus contracts of adhesion and can never produce cognizable benefits.  To its credit, the NPRM implicitly rejected the second contention, instead finding that NCAs could protect trade secrets and facilitate employer investments in employee training.  Unfortunately, the Commission embraced the claim that all NCAs result from employers' use of a "particularly acute" bargaining power advantage coercively to impose NCAs on unwilling employees.  (The only exception was for the tiny category of "Senior Executives.").   

    This finding of what I call "procedural coercion" informed several other aspects of the NPRM's rationale.  For instance, the NPRM treated such procedural coercion as a necessary condition for "substantive coercion," which it treated as an independent source of harm.  The Commission also assumed that, even if NCAs are fully disclosed in advance, employers will still use coercive bargaining power to impose them, with the result that disclosure will not impact the number and content of NCAs.  Finally, the NPRM invoked the supposed near-universal presence of procedural and substantive coercion to justify imposing a "high bar" on efforts to establish business justifications for NCAs, over and above the requirement that defendants bear the burden of proving the factual basis for such justifications.

     Each of the papers authored between 2022 to 2024 refutes the claim that NCAs are necessarily the result of unequal bargaining power.  The NPRM adduced no evidence that all or even most employees subject to NCAs work in concentrated markets.  Moreover, evidence in the record the NPRM ignored established the opposite, namely, that most employees work in unconcentrated markets.  Also, the Commission ignored several decades of economic learning to the effect that firms with market power generally will not use such power to impose a fully-disclosed nonstandard agreement, including an NCA but will instead exercise that power to increase prices or reduce wages.  While such exercises of power are cognizable harms, they are inconsistent with the use of such power coercively to impose NCAs.

      As noted above, the Commission found that NCAs sometimes produce cognizable benefits.  Evidence in the record also reported that 61 percent of employees subject to NCAs know of such agreements in advance, a figure generated before several states mandated pre-agreement disclosure of NCAs.  These facts raise the prospect that a significant proportion of NCAs are both beneficial and known to employees in advance, thereby refuting the finding that such agreements are always coercive in either respect.  Such refutation also undermines that Commission's assertion that mandatory disclosure will have no impact on the number and content of NCAs, undermining the Commission's rationale for rejection of the mandatory disclosure requirement.  Finally, such refutation undermines the Commission's assumption that benefits of NCAs always coexist with coercive harms, thereby eliminating the basis for applying a "high bar" to efforts to justify all NCAs.  The Commission's erroneous assumption that harms and benefits coexist, which echoed price theory's partial equilibrium trade-off model, resulted in a distorted assessment of business justifications that was unduly biased against NCAs.

        More fundamentally, the various errors identified above suggest to this blogger that, regardless of legal authority to issue such rules, the Commission lacks the capacity to gather and evaluate information regarding the impact of the entire universe of NCAs.  The Commission should thus withdraw the NPRM and start over.