In a new nationwide rule, Joe Biden’s Federal Trade Commission has discarded its legal restraints.
In a new nationwide rule, Joe Biden’s Federal Trade Commission has discarded its legal restraints.
O n April 23, the Federal Trade Commission voted 3–2 to issue a new nationwide rule banning most noncompete clauses in employment contracts. The rule, following a 2021 directive from President Biden, is controversial as both a legal and policy matter for its sweeping scope, its vast preemption of more permissive state laws, and its break with the FTC’s traditional case-by-case approach to “unfair” competition. It was doubts about the commission’s statutory authority to make itself the nation’s regulator of employee–employer relations that led two of the commissioners to dissent.
But the most drastic aspect of the rule is that, through it, the FTC doesn’t just prohibit employers from demanding noncompete clauses in future contracts; it also purports to void tens of millions of existing contracts, thus depriving employers of the benefit of bargains they already struck. That’s outrageous and may be unconstitutional.
Free Labor and Retroactivity
Freedom of contract in employment is vital to free markets and has been a principle of the free-labor Republican Party since its foundation. The sanctity of contracts was also crucial to the Framers, which is why the Constitution contains the contracts clause: “No State shall . . . pass any . . . Law impairing the Obligation of Contracts.” That said, noncompete clauses test the limits of that principle because they can constrain the free movement of labor and prevent workers from leaving to start their own businesses.
As a result, there have long been legal limits on when courts can order an employee to keep working for an employer whom he wishes to leave or effectively preclude him from practicing his profession. Some of those limits derive from common-law rules from as far back as the 1850s, and some come from the 13th Amendment’s ban on involuntary servitude, which outlawed even voluntary contracts for indentured servitude on the ground that they would promote abusive working conditions.
Aside from the outer limits placed by the 13th Amendment, the enforcement or non-enforceability of noncompete clauses has generally been left to the states, which have reached their own decisions through the common law and statutes. There has been a good amount of state legislative activity in this area in recent decades, not all of it going in the same direction. State policy decisions can balance the legitimate interests employers have in protecting their trade secrets and their investment in training workers against the legitimate interests of employees in remaining free to leave. They can also take into account the justification that the FTC now uses as an excuse to invade the employment-law area: that noncompete agreements also have some stifling effect on competition.
The contracts clause, however, properly constrains states from retroactively ripping up existing contracts. Historically, that’s why, before the 13th and 14th Amendments, states could ban slavery immediately if they wanted to (and the federal government likely couldn’t because of the takings clause of the Fifth Amendment) but the contracts clause limited their actions against indentured servitude (which a number of states banned) to prospective bans.
Can the federal government abrogate existing private contracts? The courts have typically analyzed this as a question of property rights on the theory that a vested interest in an existing contract is a form of property. Thus, if Congress acts within its powers (or clearly empowers an agency to do so), the federal government can eliminate existing contract rights but may have to pay compensation. For example, in Cienega Gardens v. United States (2003), Congress abrogated the rights of real-estate developers to prepay mortgages from private lenders; by doing so, it prevented the developers from escaping regulatory obligations to provide low-income housing. The Federal Circuit found that this altered the terms of vested contract rights in a way that took the developers’ property.
The law in this area has a lot of wrinkles: For example, there’s no taking if contracts are frustrated by some rule (unlike this one) that doesn’t target the contracts directly, or if neither side has started to perform under the contracts. Neither of these is true here. Employers might have a hard time quantifying exactly how much value they would lose by the feds’ rewriting their employment contracts. Also, most of the cases in this area, such as Cienega Gardens, arose out of some sort of government regulatory program by which the government essentially changed the deal on people who did business with it. But if we can’t quite predict how a takings claim would come out in this case, it’s at least clear that the FTC is on thin constitutional ice.
More fundamentally, the rule is unfair. Noncompetes are unpopular with workers, so employers quite reasonably believe that they need to compensate people to accept them — especially in any job for which compensation or a severance package is negotiated. Pulling the rug out from under employers is a raw deal.
The Lawsuits Begin
The U.S. Chamber of Commerce, the Business Roundtable, the Texas Association of Business, and the local chamber of commerce in Longview, Texas, fired the first shot by filing suit immediately in the Eastern District of Texas. Because they are trying to get the FTC’s rule enjoined rather than seeking compensation for any particular business, they’re not asserting a constitutional takings claim. But the suit argues that the FTC either exceeded its statutory authority or was unconstitutionally delegated too much vague power so that it violated the traditional presumption that lawmaking won’t be retroactive (a sound principle, although the Federal Trade Commission Act of 1914 itself long predates anybody’s current employment contract) and that it otherwise violated the Administrative Procedure Act by being arbitrary, capricious, and failing to consider alternatives.
As the U.S. Chamber of Commerce notes, the FTC’s rule breaks with precedent in two ways. First, it’s the first time the federal government has tried to wrest authority over noncompete agreements away from the states. The FTC has left these agreements in place, regulated only by state law under its authorizing statute, for 110 years, which suggests that these agreements don’t violate the statute and that nobody in Congress in 1914 thought they did. Second, the FTC has long taken enforcement actions against specific unfair-competition practices rather than issue broadly applicable rules, which, the commission itself had admitted, it lacks the authority to do.
The Federal Trade Commission Act, after all, speaks of the need to curb “unfair methods of competition” — not unfair labor practices, which are regulated by the Labor Department under a completely different statutory scheme. It’s apparent that concern for harm to consumers is a pretext used by the administration to make what it sees as a pro-worker move; and by crafting a rule that applies so broadly, the FTC is dodging an enforcement proceeding’s usual requirement that it show harm to competition from a particular agreement or practice.
But, hey, since when has this administration let little things like laws or long-standing norms get in the way of broad assertions of executive power over everyday American life?