FTC Proposes Banning Noncompete Clauses. What Does It Mean for Manufacturers?

A former antitrust prosecutor and manufacturing consultant weigh in on the proposed rule.

In the early 2000s, courts ruled that at least two franchise sandwich shops—Subway and Jimmy John’s—used non-compete clauses in employment contracts to prevent former employees from working at rival sandwich shops. The courts found both clauses to be overly restrictive of employees’ rights to work.

Three out of the four members on the Federal Trade Commission’s board may have had proprietary sandwiches on their mind last month when they proposed a rule that would outright ban noncompete clauses in employee contracts.

“Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand,” said FTC Chair Lina Khan. Getting rid of them, she added, would increase innovation and foster “healthy competition.”

The proposed rule could not just ban new contracts with noncompete clauses, but revoke existing clauses for U.S. employees entirely, depending on how broad the final rule turns out to be. 

According to FTC estimates, there are about 30 million noncompete orders in the U.S. economy, spread out roughly evenly through all sectors: If the rule passes (the FTC is collecting public comments on it through March 20), all of those noncompete orders could be nullified. 

Proposals eliminating noncompete clauses came as a “pleasant surprise” to Alex Martin, an expert in industrial manufacturing and talent searches for manufacturers. He noted that the FTC appeared poised to increase companies’ competition for workers as well as undo a certain application of noncompete orders.

“The logic I saw in the proposed rulings made sense to me.” Martin said. “The FTC is arguing that [the proposed rule is] principally about encouraging competition. And the notion that noncompetes, in an obvious way, prevent competition.”

Martin also read another target into the FTC’s proposed rules: Noncompete clauses used not as protection against intellectual property leaving the company but a strategy to hang on to employees by making finding a new job harder. 

“What the FTC might be arguing here is that it’s been more of an indirect retention strategy, to try to prevent people from leaving companies to some degree,” Martin said.

That use would be anathema to the FTC’s stated agenda to promote competition—historical cases, like those of the sandwich shops, seem to bear out noncompetes’ use as a way to keep workers from finding new work elsewhere.

At the same time, the plan in its current form may do little to free up new workers in manufacturing. According to Martin, the plan should increase employee mobility generally, but, because noncompete clauses for manufacturing workers are often highly specialized to certain industries, eliminating them may do little to increase the number of free manufacturing employees.

Manufacturing noncompetes, Martin says, are usually “specific to a very short list of direct competitors, or to a very specific market, or to a very specific set of intellectual property or technology. And the broader ones, frankly, have been considered either unenforceable or difficult to enforce because of the premise that the employee always has the right to work.”

Shortly before the FTC announced its proposal, it ruled that at least two manufacturing companies—glass companies O-I Glass Inc. and Ardagh Group—had imposed unacceptably strict noncompete laws on its employees, something the FTC said squashed competition by preventing employees from joining potential competitors. 

On Jan. 4, the FTC ordered both glass companies, as well as a private security firm, to void and nullify their existing noncompete requirements and ban them from imposing any new ones.

While the FTC’s rule is liable to change following the period of public comment, the cases against the glass manufacturers and the private security company could show the outer bounds of how the FTC expects the rule to look, said Carsten Reichel, a former federal prosecutor for the Department of Justice’s antitrust division and now partner at Norton Rose Fulbright US LLP. He said that the very different cases show how far the FTC could go in defining what counts as a banned noncompete.

“The FTC still has some work to do on what counts as a noncompete,” Reichel said. “There are things you would see in a contract that are literally labeled ‘noncompete clause,’ or an agreement not to compete, and certainly those are envisioned by the rule.” 

But the FTC has signaled it aims to go further and ban language that operates as a functional noncompete as well, complicating the issue for employers and their lawyers. 

But the cases of the glass and private security companies, despite having similar outcomes, featured markedly different circumstances. The security company in the judgements, Prudential Inc., imposed a very severe noncompete ban: Employees, many of whom worked near or at minimum wage according to the FTC, were prohibited for two years after leaving the company from working for competitors within a 100-mile radius of their former Prudential job site, on pain of a $100,000 fine. 

Meanwhile, in the glass companies, salaried workers in production, engineering, and quality assurance roles were prohibited from working for similar companies for up to two years without the consent of their former employer. Despite that the workers involved in the glass companies almost certainly had access to more privileged information than the Prudential employees, the FTC handed down broadly similar judgements against both.

Taken together, the cases show that the FTC’s current intention with the proposed rule is to condemn non-compete agreements—perhaps barring some extraordinary cases raised in the public comment period—to history.

For companies that are still concerned about security, Reichel says, the FTC has anticipated their complaints. 

“What the FTC has said on that is, ‘There are better ways to do this than a noncompete,’” he said. The major difference for companies, Reichel says, is that they’ll have to respond to specific violations of trade secret law rather than preventing possible violations by former employees hired by competitors.

“In a certain way, you’ve already incurred the problem if you’re using a trade secret law,” said Reichel. 

In a similar vein, Martin noted that some countries practice “garden leave,” especially for executives or high-skilled workers, which operates similarly to ongoing severance payments made to a former employee as long as they don’t go to work for a competitor—a more transactional version of a noncompete. 

“When it comes down to sensitive information, there are already things you can do to protect that without having to have a noncompete,” he said.

While the public comment period for the rule is long, and it’s not clear what the ban on noncompetes when—or if—the FTC goes through with the move, Martin expressed hope that it could push some companies using noncompete clauses improperly to adopt more employee-focused means of retaining employees.

“You can try to put barriers up to having people leave,” said Martin, “but the best thing to do is to give them a reason to stay.”

Written by:  Ryan Secard, associate editor, for Industry Week.