Notice & Comment

FTC’s Proposed Rule on Non-Competes May Present Commerce Clause Issue, by Eli Nachmany

The Federal Trade Commission (“FTC”) is in the news for a recent Notice of Proposed Rulemaking (“NPRM”) that would outlaw non-compete agreements. The FTC on Thursday proposed a new regulation, deeming it “an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.” The proposed agency rule would also mandate that employers rescind any existing non-compete clauses with current employees. This brief essay analyzes a potential Commerce Clause issue with the FTC’s proposed rule.

In a non-compete agreement, an employee agrees not to “compete” with her employer for a period of time after separating from her employment with that employer. Non-competes come in all shapes and sizes, and under the common law or statutory law of most states, employers must draw non-competes carefully to avoid courts invalidating or modifying the agreements. Courts often invalidate non-compete agreements that are too broad—for example, those providing that an employee may never work again in a particular industry or may not work anywhere else in the country.

Typically, the question is whether the non-compete is narrowly tailored to advance the legitimate interest of an employer. Consider the hypothetical example of a local HVAC company—call it “Company X”—in south Texas. Company X hires employees and sends those employees to the homes of its clients in the area for heating and air conditioning installations and repairs. Company X makes its employees sign non-compete agreements because it is concerned that an employee would use her affiliation with Company X to build up relationships with Company X’s clients (by virtue of the in-home installations), then start her own business and poach the clients. Thus, Company X might narrowly tailor the non-compete to protect its goodwill (and hard-earned client base) by preventing its employees from working in the HVAC industry in south Texas for one year after separating from the company. A Texas court might deem that sort of agreement appropriate. Under the proposed rule, however, the FTC would not.

FTC Chair Lina Khan argues that a flat ban on noncompete agreements—without regard to how narrowly an employer has drawn the conditions—advances economic liberty. In her telling, “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.” The FTC’s action aligns with a recent statement from the agency that laid out a robust vision of the agency’s authority under Section 5 of the FTC Act and a series of non-compete enforcement actions announced the day before the NPRM. Section 5 empowers the FTC to prevent businesses “from using unfair methods of competition”—the law declares those methods of competition to be “unlawful.” In addition, the proposed rule reflects a burgeoning philosophy at the FTC that sees the agency’s mandate in part as fighting for workers’ rights.

Policy questions aside, the FTC’s new rule might present a constitutional issue. The Commerce Clause of the U.S. Constitution provides that “Congress shall have Power … [t]o regulate Commerce … among the several States.” Because the federal government is a government of limited powers, the text of the Constitution seems to indicate that Congress’s commercial regulation power (as executed by the FTC—a federal agency—under Section 5 of the FTC Act) does not extend to the regulation of intrastate commerce. At the same time, a series of Supreme Court decisions has interpreted federal power under the Commerce Clause quite broadly, including the Court’s 1942 decision in Wickard v. Filburn that recognized federal power to regulate intrastate economic activity that would have “a substantial economic effect on interstate commerce.” The Court expanded on Wickard in Gonzales v. Raich, a 2005 opinion in which the Court opined that the Commerce Clause permitted federal regulation of the intrastate production of a commodity when such production “has a substantial effect on supply and demand in the national market for that commodity.”

Still, there are limits. And it appears likely that a non-compete agreement like the one described above—a Texas employee agreeing to a non-compete with a Texas company not to work in the HVAC industry for a full year in a circumscribed geographic area in Texas—would constitute strictly intrastate commerce that does not substantially affect interstate commerce. The FTC might argue in response that any non-compete, even this hypothetical one, substantially impacts the national labor market. Perhaps the government would say that because non-competes work such a detrimental impact on the American labor market, the regulation cannot admit of exceptions. Per this theory, the HVAC employee cannot work at another firm in south Texas, and so the firm at which the employee was going to work would hire someone else—maybe someone from out of state. Eventually, the ripple effects would mean that the non-compete would impact the national labor market, which is significantly more interconnected today than it was when the Constitution was ratified.

Still, such an argument might be a bit of a stretch, especially as applied to a non-compete in a significantly circumscribed geographic area. It admits of a nearly limitless understanding of the Commerce Clause’s scope—which, to be sure, the Supreme Court has flirted with from time to time. But there are undoubtedly non-competes whose impact on the interstate labor market is too attenuated to constitute even a substantial indirect effect. Thus, the agreement described above probably would not be regulable consistent with the federal Commerce Clause. Surely, states are free to ban non-compete agreements within their own states, but an underlying assumption of the federal Constitution is that the federal government’s power is more limited than that of the states.

Suppose an employer entered into a strictly intrastate non-compete agreement—whose operation did not significantly impact the national labor market, which is a question of fact—with an employee. In this hypothetical, the FTC then took action against that employer under the proposed rule when finalized. A challenge by the employer might look something like the following: The employer would raise two arguments. First, it would describe the regulation as ultra vires—the argument here would be that the regulation was promulgated in excess of statutory authority, because Section 5 of the FTC Act could not have possibly meant to proscribe purely intrastate commerce. Second, the employer would say that if a court disagreed with its analysis of the regulation’s fit with the statutory text, then Section 5 of the FTC Act would be unconstitutional as applied to the commercial activity at issue, as a regulation of intrastate commerce that goes beyond the limits of the Commerce Clause. And because—under the doctrine of constitutional avoidance—federal courts are usually loath to declare federal statutes unconstitutional, the “excess of statutory authority” argument would probably get some serious consideration.

Chair Khan has taken a particularly active role at the FTC, but the agency must stay within the guardrails of the Constitution. With this latest proposed rule, it may have ventured past the boundaries of the Commerce Clause.

Eli Nachmany is a law clerk to Judge Steven J. Menashi of the U.S. Court of Appeals for the Second Circuit. This essay represents the views of the author alone.

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