A justifiable ban on US non-compete clauses

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How should companies protect trade secrets? In the US and elsewhere, companies have long used non-compete clauses in employment contracts, which prevent employees from moving to rivals in a particular region or starting a new business for a period of time. But such clauses have, over time, extended from high-powered professionals to millions of low-wage employees, from fast-food workers to bartenders or security staff. The Federal Trade Commission this week voted to ban them. Its move is long overdue.

Nearly one in five American workers is estimated to be subject to a non-compete clause. This often exploits the most vulnerable workers, who may either be trapped in poor-paying jobs, or forced to switch to even lower paying industries or relocate to avoid financial penalties and legal action. Many individuals do not even realise they are subject to such a curb until they try to move jobs, then lack the means to challenge it.

Lina Khan, FTC chair, said non-compete clauses “keep wages low, suppress new ideas, and rob the American economy of dynamism”. Its five commissioners voted 3-2 to pass a proposed final rule banning such provisions. Senior executives — defined as individuals earning more than $151,164 who are in a “policy-making position” — will still be subject to non-compete clauses in agreements already signed. But the rule, due to take effect in 120 days, would ban new non-competes for all workers.

Legal challenges seem set to stretch the timeline, though. Workers and labour rights activists have backed the ban, but business lobby groups, led by the US Chamber of Commerce, are rushing to block it through the courts.

Supporters of non-compete clauses, including plaintiffs in a lawsuit filed in a federal court in Texas, argue they are essential to protect intellectual property, workforce investments and client relationships. Critics also maintain Khan’s FTC is straying far beyond its statutory antitrust and consumer protection mandates. Even the two dissenting commissioners said they believed the rule was “unlawful” and “won’t survive legal challenge”.

Yet targeting clauses called “non-compete” seems well within the purview of a regulator whose job in part is to ensure fair competition. There are good reasons the rule ought to proceed.

There may be some justification for restrictions for top executives in certain sectors, including strategic industries. But writing such clauses into contracts as a matter of course disproportionately hurts the least well-off, who do not negotiate their agreements in return for compensation but are usually presented with them on their first day. Non-compete timeframes can last for two years and result in tens of thousands of dollars in financial penalties even for a hospital or warehouse worker — which is why so many are compelled to stay in environments that may even be discriminatory or hostile.

When it comes to keeping hold of senior executives and business-critical employees, there are other ways of structuring contracts and compensation packages to encourage retention, including longer notice periods and non-solicitation clauses. There are alternative means, too, to protect trade secrets and inside information, including through intellectual property laws and non-disclosure agreements — even though the latter can be problematic in other contexts.

California made non-compete contracts unenforceable in the late 1800s, and also has one of the world’s most dynamic economies. Yet state-by-state enforcement, which is confusing to navigate, is in itself an argument for a nationwide approach. While dozens of states have some limitations, only four have banned such clauses entirely.

Academic researchers have long noted the impact of non-compete contracts on wages, and pushed for reform as a way of boosting pay, innovation and new business formation. Doing away with them should be seen not as overreaching regulation, but as liberalisation of employment practices.