FTC Plan to Ban Noncompete Clauses Shifts Companies’ Focus

“Employers have operated with an understanding that they can protect their interests through noncompetes,” said Matthew Durham, a Salt Lake City-based attorney with Dorsey & Whitney LLP who advises companies on employment matters. “What you’re seeing, reflected in the FTC proposal and elsewhere, is a growing hostility to the idea that there should be those kinds of restrictions, and it’s changing the environment that employers have been comfortable with in the last number of years.”

The FTC proposed a ban this month on nearly all noncompetes, saying that the clauses—which typically prohibit workers from moving to a new employer or starting new ventures of their own—hamper competition in the labor market, suppress wages and hold back innovation and entrepreneurship. The proposal came in response to an executive order from President Biden in 2021.

Businesses say they impose noncompete clauses on employees to protect trade secrets and other confidential information, including customer lists and financial data.

Mr. Durham and others say they believe the FTC may narrow its rule after hearing comments from the public, including employers and business organizations that have already signaled their opposition to the current proposal. The agency could, for example, allow noncompetes for highly compensated workers.

Noncompetes are common in employment contracts for senior employees like software engineers, sales representatives and top executives. Over time, they have been applied to many parts of the U.S. workforce, including some janitors, baristas, schoolteachers and entry-level workers. According to the FTC, one in five U.S. workers is currently subject to a noncompete clause.

Noncompetes are regulated at the state level, and many states have already taken action to limit use of the clauses by, in some cases, forbidding employers from imposing them on people earning under a particular wage threshold or for certain types of workers. 

“The vast majority of people in America can’t afford a lawyer to defend a noncompete case,” said Jonathan Pollard, an attorney in Florida who represents workers whose employers are trying to enforce noncompete clauses. “Just the threat of enforcement is often enough to restrain talent in the labor market.”

Some states, such as California and Oklahoma, hold that the clauses are unenforceable in all or nearly all employment contracts. 

A number of studies suggest noncompetes suppress wages and innovation. A review of Oregon’s 2008 ban on noncompetes for hourly workers found that wages rose an average of 2% to 3%. Another study, examining Hawaii’s 2015 ban on noncompete agreements for high-tech workers, found an 11% increase in job moves and a 4% increase in new-hire salaries.

The clauses restrain not just pay and entrepreneurship, but also professional development, workers and some attorneys say. 

Daniel Bachhuber had worked as a software consultant for years when he decided to take an in-house job in the fall of 2018. His new employer required that he sign a one-year noncompete agreement, which he said was so broad it would have prevented him from practicing his core skills if he were to leave the company or be fired.

Mr. Bachhuber balked. Earlier in his career, he had been laid off a few weeks into a new job, just after his first child was born. If that happened at the new job, he recalled thinking, he would be unable to earn a living for a year. “I’m always thinking, worst case scenario, what kind of downstream protection do I have?” the 35-year-old said. “Even if I was employed just one day, I couldn’t go back to the same clients I had.”

He consulted a lawyer and tried to renegotiate the contract, hoping to salvage a role that would have expanded his skills and given him a chance to work directly with the chief technology officer on special projects. The company declined to change the noncompete clause and, reluctantly, Mr. Bachhuber turned down the position. 

Employers have other tools to protect information besides noncompete agreements, including nondisclosure agreements, trade secret laws and nonsolicitation agreements, which prohibit workers from poaching customers or employees of their prior firm. 

But those tools generally can only be used after an employee violates the agreement, said Julie Levinson Werner, who represents employers as a partner with law firm Lowenstein Sandler LLP. “Once someone goes to another company, you’re really on the honor system. You have no way to monitor what information is being disclosed or not,” she said.

Observers on both sides say that limitations on the clauses will compel employers to get more creative about how they retain talent, using everything from compensation to career advancement to keep workers engaged and loyal to the company. Some companies use deferred compensation—such as retention bonuses or rolling stock options that vest after, say, three years—to give people incentives to stay.

“Do you get better results with honey or vinegar?” said Ms. Werner. “If you want to motivate people and have them happy to stay, you have to look at compensation, the overall environment, how you treat them.”

The fate of the FTC’s final rule is up in the air. After a 60-day comment period, the commissioners will consider potential changes to the initial proposal and then issue a final rule. That rule will likely be challenged by business groups or individual companies, and courts will determine its trajectory, attorneys say.

Write to Lauren Weber at Lauren.Weber@wsj.com