To understand why a proposed rule could spark a Supreme Court battle over the Federal Trade Commission’s powers to regulate the American economy requires revisiting the agency’s past.
On January 5, 2023, the Federal Trade Commission proposed a new rule that would ban most non-compete agreements. Non-compete agreements are contracts that limit the ability of an individual to compete with another firm under specified circumstances. A retiring doctor selling her practice to a recent medical school graduate might agree to a non-compete to boost the sale price for her business, as the purchaser might fear that the doctor’s patients would continue to see the original doctor if she continued to work. A tech firm might insist on a non-compete agreement as a tool for helping it keep safe its trade secrets. And, a little bit more surprisingly, a sandwich chain—call it Jimmy John’s—might use a non-compete to insist that new employees agree that they will not leave to take their sandwich-making skills elsewhere.
State laws limit the enforceability of noncompete agreements, though different states run at this differently. Dealing with an issue at the state level allows for that type of choice and, thus, competition between states. In her great 1994 book Regional Advantage, AnnaLee Saxenian argued that Silicon Valley prospered with a strong shared culture and rapid employee movement between firms, something made possible, in part, as Ron Gilson argued in 1999, by the fact that California didn’t enforce covenants not to compete. And once the Jimmy John’s noncompete clause received public attention, the company dropped them in response to actions by state attorneys general. As that suggests, state law has long played role in regulating the exact extent of non-competes. Even the proposed FTC rule would allow some non-competes in the connection with the sale of a business.
The natural question, of course, is exactly where does the FTC fit in to these state laws? The proposed rule represents a dramatic effort by the FTC to regulate contracts that it believes currently affect 20% of the United States workforce. The rule, if implemented, is likely to set off an extended fight over the scope of the FTC’s authority that will eventually reach the Supreme Court. The FTC is acting under the authority that it believes that it has under Sections 5 and 6(g) of the relevant statute. The latter gives the FTC some authority to make rules though the full range of that power is part of what will likely be contested here.
Section 5 is extensive and a couple of pieces of it are relevant here, but start with the core set out in 5(a)(1): “Unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful.” The FTC wants to characterize the proposed non-compete ban as a regulation of an unfair method of competition and not as regulation of an unfair or deceptive act or practice. Those might seem like small differences but given the history of the statute and how it has evolved, quite a bit turns on those distinctions and the scope of the authority that the FTC has.
The FTC was created as part of new legislation enacted on September 26, 1914. Section 5 of the new law only gave the FTC the power to address unfair methods of competition (the rest of the current statute, see below, would arrive in 1938). There had been a fight over how much power should be given to the new agency. An early version of the bill would have limited the FTC to an agency with mainly administrative powers to investigate “any unfair competition or practice.” But a vocal minority wanted more and Rep. Stevens pushed a bill that would empower the new agency to “prevent corporations from using unfair or oppressive methods of competition.” Stevens was clear that he wanted that language to be open-ended rather than to try to specify in advance exactly what practices would be condemned. Indeed, Rep. Lafferty had proposed exactly such a bill with nine practices barred followed by an open-ended formulation.
But Rep. Stevens also had in mind a clear set of situations that he was trying to address:
“The history of the most successful business combinations shows that the chief means these combinations have used to acquire a monopoly or partial control of the business field has been by unfair methods of competition. They have been able to drive their competitors out of business not by superior efficiency in the manufacturing of their product but by securing special advantages and contracts in the buying of their raw materials and in the distribution and selling of their products. Any advantage large corporations have over small corporations or individuals through lower costs of production they are entitled to, but they should be prevented from an unfair use of the power that comes from their size alone.”
Unfair methods of competition were to be judged based on how the method in question shaped competition, especially between large enterprises and smaller firms.
Unsurprisingly this was, to the FTC’s growing dismay, exactly how the Supreme Court understood the idea of an unfair method of competition. The FTC wanted to claim a broad power to protect the public against certain practices. In the Raladam case in 1931 (283 U.S. 643), the FTC confronted a purported “obesity cure” which the FTC thought was deceptive (as presumably it was). But the Supreme Court noted that Section 5 didn’t convey upon the FTC a broad authority to protect the public but instead created a more limited authority that focused on “unfair methods [that] threaten to drive their competitors out of business.” The method in question had to be considered by its impact on competition, not its impact on the broader public.
Unhappy with that outcome, the FTC pursued and obtained new powers. On March 21, 1938, Congress declared “unfair or deceptive acts or practices” unlawful. In a speech on May 17, 1938, less than two months after the new law had been passed, FTC Commissioner R.E. Freer explained that the point of the new language was to free the FTC of the need to “offer evidence establishing injury to an actual or potential competitor” in the fashion that the Raladam decision required.
Jumping back today, the natural thing for the FTC to do as to non-compete agreements is to issue a rule declaring them an unfair act or practice. That would the let the FTC sidestep the harm-to-competition framing of the original 1914 statute as understood by the Supreme Court heading into the 1938 amendments. But the FTC isn’t doing that and is instead trying to implement the non-compete ban as an unfair method of competition rulemaking. Why?
We need a little more history—two more amendments—to clear the fog. In 1975, Congress passed what is known to the trade as the Magnuson-Moss Act. Tucked in the back of that were amendments to the FTC Act that limited the FTC’s rulemaking authority regarding unfair or deceptive acts or practices. That came on the heels of a 1973 appellate decision (482 F.2d 672) that had confirmed that the FTC did have a substantive rulemaking authority. At the same time, the 1975 law left in place whatever rulemaking authority the FTC had regarding unfair methods of competition. And in 1994, Congress passed more amendments to the FTC Act, creating a new subjection (n) to Section 5 that further limited the FTC’s authority regarding unfair practices.
The long and short of all of that is that developments since 1938 have undercut the effect of those amendments regarding unfair practices, sufficiently so it seems, that the FTC would prefer to try to justify the non-compete ban as a regulation of an unfair method of competition rather than as just a regulation of an unfair practice. And that suggests that there is a meaningful chance that we are back in the pre-1938 understanding of what the Supreme Court required the FTC to address in declaring something to be an unfair method of competition, namely, what does it mean for competitive conditions, especially as to whether the practice advantages large firms over small firms.
All of that is likely to be contested and there is subsequent caselaw to wrangle with (though not here today) to understand how much of the pre-1938 understanding survives. The draft rule is short, but the justification for the rule and the FTC’s authority to implement it is quite extensive (200+ pages). But the FTC’s press release makes clear right off the bat what the focus is: “[T]he agency estimates that the new proposed rule could increase wages by nearly $300 billion per year and expand career opportunities for about 30 million Americans.” The focus is on wages and much less so on how non-competes shape competition among large and small firms.
There is one other important issue that is worth flagging and that is how the Supreme Court will approach assertions of agency authority. Last June, on the very last day of the Court’s term, the Court issued its decision in West Virginia v. EPA. This was the blockbuster environmental law decision that addressed the extent of the EPA’s authority to issue new rules. The EPA had promulgated rules to control greenhouse gas emissions, but the Court concluded that the EPA had failed to demonstrate “clear congressional authorization” for the power that it was claiming. The lingo for this is now the “major questions doctrine” and it is something of a sliding scale: the broader the power an agency is claiming, the more demanding the showing is that Congress really intended the agency to have that authority.
We are at the beginning of what is likely to be an extended process of comments, an updated rulemaking document and likely court challenges. There are some broad and interesting questions about freedom of contract versus the freedom to change jobs and about the respective roles of states, Congress and agencies like the FTC. And this is likely just the first of what could be more rules by the FTC to regulate the economy. A critical issue as to this rule and those that are coming will be about how much power the FTC has to regulate the American economy and sorting through that is likely to require us to dust off some very old congressional documents and caselaw.