FTC Chair Lina Khan, Citing Wage and Innovation Concerns, Takes on Non-Compete Clauses

January 9, 2023

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In a New York Times opinion piece by Lina Khan, “Noncompetes Depress Wages and Kill Innovation”, Ms. Kahn, a high-ranking federal official, mounts a broad-based assault against non-compete provisions, sending shockwaves across the employee-employer legal landscape.

Ms. Khan argues that non-competes promote economic liberty, stating that “[y]ou’re not really free if you don’t have the right to switch jobs or choose what to do with your labor. But millions of American workers can’t fully exercise that choice because of a provision that bosses put into their contracts: a noncompete clause.”

In theory, employees are not powerless when executing employment contracts with non-compete provisions.  Employees do frequently have less leverage than their employer counterparts.  At a time of very low unemployment, they can push back against the terms on offer from a potential employer or walk away from it and search for other opportunities.  Other employees, however, may lack the leverage to resist signing a non-compete agreement.

Ms. Kahn also describes the problems that non-competes present at an individual level:

[w]hen you’re subject to a noncompete clause, you lose your right to go work for a competing company or start your own, typically within a certain geographic area and for a certain period of time. Unless you’re willing to move hundreds of miles away or take a huge pay cut to restart your career from scratch, a noncompete can effectively lock you into a job. That’s a clear restriction of individual liberty.

Here, there may be a difference between the “black letter law” of such agreements and what actually happens on the ground, from an individual workplace-by-workplace perspective.  Indeed, the cost of actually enforcing a non-compete provision may be a deterrent that is “a bridge too far” for many employers, when it comes to actual costs.  If that is the case, then this issue may not be as significant as it seems.

For Ms. Khan, the problems with non-competes creates an aggregate price tag that acts to drag down the productive capacities of the entire US economy: “[a] body of empirical research shows that they also inflict major harm across the economy. In fact, even if you aren’t personally bound by one, noncompetes may be costing you money.”

From here, Ms. Khan engages with the roots of such provisions, describing non-competes as being:

long assumed to apply mainly to high-level executives with access to sensitive corporate information. But their use has exploded in the past few decades, extending far beyond the boardroom. Today, experts estimate that one out of every five American workers or about 30 million people, is bound by a noncompete. Studies and media reports have found noncompetes routinely invoked against fast-food workers, arborists and manual laborers, to name a few examples. Just this week, the Federal Trade Commission, where I am chair, settled allegations against a company in Michigan that prohibited its workers — security guards earning at or near the minimum wage — from going to work for a competitor within a 100-mile radius of their job location for two years. Each worker who violated the noncompete would have been liable for $100,000.

Here, there is a lot to untangle.  But it is difficult to quibble with the basic premise of the argument, which is that non-competes are overused.  At the same time, there may be specific situations where their utilization is justified.

Ms. Khan goes on to argue that:

[i]n theory, noncompete clauses promote investment and innovation by assuring companies that their employees can’t run off with valuable secrets. And, again in theory, workers should be paid more in exchange for agreeing to sign a contract that restricts their autonomy. But the reality looks very different. We know this because over the past few decades, several states restricted the enforceability of noncompete clauses to various degrees, usually because of court decisions. This created natural experiments, allowing researchers to draw causal inferences about their impact.

A basic problem with non-compete clauses is that “workers should be paid more in exchange for agreeing to sign a contract that restricts their autonomy.”

But, what does “more” mean?  For participants in the debate over “non-compete” provisions, it is critical to establish “baselines”.  Otherwise, “more” takes on a concept with no precise meaning, when parties to a specific workplace-related dispute may be searching for an exact measure of the actual damages in play.

According to Ms. Khan:

[t]heir most staggering finding: Noncompete clauses systemically drive down wages, even for workers who aren’t bound by one. Every worker stuck in a job represents a position that isn’t opening up for someone else. And if employers know their workers can’t leave, they have less incentive to offer competitive pay and benefits, which puts downward pressure on wages for everyone.

The perspective shared by Ms. Khan as to employees “stuck in job” is a refreshing one.  That should be the subject of more research.

As part of Kahn’s argument, there is the following:

[s]urvey data backs up what most people know through experience: Only a small percentage of workers actually bargain over noncompete clauses. In fact, employers often spring them on workers after they’ve accepted a job, when their bargaining power is effectively zero. Surveying the literature, F.T.C. economists conservatively estimate that noncompetes suppress American workers’ income by roughly 3 percent to 4 percent or $250 billion to $296 billion.

There’s validity to Khan’s claim that “[i]n fact, employers often spring them on workers after they’ve accepted a job, when their bargaining power is effectively zero”. When advising as to non-compete provisions, I make it a point to emphasize that many clients look back with profound regret on their decision to become legally bound by such clauses.

Ms. Khan goes on to argue that

[p]erhaps this would be more forgivable if noncompetes really did spur innovation, helping companies take big swings and bold risks. But here, too, the real-world evidence reviewed by the F.T.C. undermines the theory. As the name implies, noncompete clauses tend to make markets less competitive. Rather than encouraging dynamism and new ideas, they can enable stale incumbents to lock out new rivals.

“Start-ups,” according to Khan, “are historically a key driver of job creation and innovation, but several studies have found that noncompetes reduce entrepreneurship and start-up formation. How can a new business break into the market if all of the qualified workers are locked in? Or if the would-be founder is bound by a noncompete?”

Here, the founder may need to confront the risk of violating the non-compete, regardless of what may lay on the other side of that. Obviously, that is a tough decision no one wants to confront. Additionally, there may be ambiguities in the language of the non-compete that actually permits, on closer inspection, what was thought to be prohibited. If the language of the non-compete is itself vague, then there is a case that the provision is unenforceable. In that case, a court may enforce it selectively or simply rip the entire clause to shreds.

For Khan, “[w]hen you add it up, the evidence to date suggests that noncompetes suppress wages, reduce competition and keep innovative ideas from breaking into the market. One study even found that noncompetes lead to higher prices for consumers by reducing competition in the heavily concentrated health care sector.”

Khan contends:

Noncompetes are the type of restriction that Section 5 of the F.T.C. Act, a federal law passed by Congress more than a century ago, is supposed to prevent. That’s why the F.T.C. last week proposed a rule forbidding companies to subject workers to noncompetes. Under the proposal, noncompetes would be designated an ‘unfair method of competition,’ which the law prohibits. The rule would apply to professions across the board — janitors, nurses, engineers, journalists. Because employers often try to use noncompetes even when they’re unenforceable, the rule would require companies to proactively notify employees currently subject to noncompetes that those restrictions are now void.

In theory, this development could fundamentally revolutionize the American workplace. However, the impact of such a ban could be subdued, to the extent that employees—and even employers—don’t realize that their utilization has been prohibited. Without the assistance of counsel, various workplace actors might be starved of fresh information. Having been advised in the distant past that a given employment contract or offer letter “works”, an employer may be on automatic pilot as to the utilization of an agreement with unenforceable terms. For the employee, they may rush into the arrangement and willingly agree to execute such agreement just to get a “deal done” and embark on a new chapter in their career.

For Khan, “[p]eople might worry that eliminating noncompetes would make it impossible for companies to hold on to their secrets. But there is good reason to believe that more-targeted alternatives, such as nondisclosure agreements and trade secret law, would get the job done without imposing such a burden on the economy.”

In a sense, this is an excellent argument on Khan’s part. Non-competes are often too broad. Ironically, both sides to a non-compete agreement may be ill-served by it.

Khan then imagines what the United States as a whold would look like if it followed the lead of California on non-compete policy:

[w]e have already seen what life looks like without noncompetes because they have been legally unenforceable in California since the 19th century. Somehow, that hasn’t kept the California economy — the world’s fifth-largest — stuck in the Stone Age. Some observers have even suggested that Silicon Valley became the epicenter of America’s tech industry precisely because noncompetes were unenforceable there. As the law professor Ronald Gilson and others have argued, technological progress benefits from the free flow of workers — and knowledge — between companies and start-ups. Tying down workers through noncompetes risks blocking this progress.

In California, policy-makers have struggled to inform labor market participants that non-competes are not enforceable. Indeed, many employers and employees operate as if non-competes are a natural part of the workplace landscape. What can be done to address this situation?

Khan has the following to say about how non-competes ripple through the broader economy:

[i]n the wake of the economic recovery from the pandemic, we continue to see a strong labor market and unusually high turnover, with employers complaining that they can’t hire qualified workers. These circumstances only underscore the importance of allowing workers to freely match with the jobs that are right for them. Noncompetes prevent that from happening. Removing them would unlock a tremendous pool of talent, helping employers find and hire the workers they need.

For employers, non-competes are relatively cheap to insert into employment, independent contractor and consulting agreements. From their perspective, there is really no downside to doing so. If policymakers are sincere about disincentivizing their use, they will need to explore stronger measures for countering their use. Until this takes place, there will be little to signal that the American workplace, from a regulatory perspective, has entered a post-non-compete era.

Khan goes on to argue:

[a]t this stage, the F.T.C.’s proposed rule is just that — a proposal. The public is invited to weigh in during the open commenting period. Hearing from a broad range of voices — including entrepreneurs, employers and workers who have been subject to noncompetes — will help ensure that our efforts are based in reality, not abstract theories.

For keen observers of the debate on non-compete provisions, the ensuing comment period should be fascinating, although it may be difficult to discern whether authentic voices on the employee side of the debate are weighing in on it.

Ms. Kahn’s conclusion: “[a] thriving, dynamic economy depends on fair competition — not just for consumers, but also for workers. We should be skeptical of any methods designed to prevent it.”

From the employer’s perspective on this aspect of workplace relations, this may be the real question: “whether or not your non-compete in enforceable, do you really want the drama of enforcing such provision by supervising employees who really don’t want to be working there?”

Have you been asked to execute an offer letter or other legal instrument with a non-compete provision? Does your business plan to make use of agreements with restrictive covenants?  If so, contact us to schedule an introductory consultation with Castle Garden Law.

Ted Amley

Managing Attorney

With more than two decades of experience, Ted Amley has advised on hundreds of complex business, finance, and employment matters. His background includes roles at Cravath, Richards Kibbe, and Dentons, along with in-house experience at Morgan Stanley, Blackstone, and UBS. Now leading his own practice, Ted represents individuals, companies, funds, and institutions across sectors such as tech, real estate, healthcare, AI, ecommerce, and finance – offering strategic counsel on
equity, governance, contracts, lending, cross-border deals, and more.

Years of experience: 23+

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