Earlier this week, the Federal Trade Commission (FTC) barred for-profit US employers from using noncompete clauses for most employees (and nullified most existing noncompetes). It was a split decision with three of its commissioners voting for the measure while two voting against it. Here’s everything you need to know about these noncompete clauses and what impact banning these could have on the startup space – if the change isn’t overturned in the courts.

What are Noncompete Clauses

Noncompete clauses are contractual agreements between a worker and their employer that bar them from working with a competitor (generally within a set geographical area) for a certain amount of time after the employment term ends.

Companies claim that these clauses existed so that they could protect their trade secrets. Through these clauses, employers could bar employees from working for their competitors (or even becoming one with their own startup). Companies would restrict the flow of information and knowledge to competitors through these clauses.

However, noncompete clauses are a win-lose proposition as while the employer stands to benefit, the employee is at the losing end as they are forbidden from seeking employment at competing firms. This also negatively impacts their earnings. Some companies, like fast food chains such as Jimmy John’s, seem to use noncompetes simply to keep workers from quitting to work a higher-paying job in another competing company so that they can keep wages low.

The FTC previously estimated that if the non-compete clauses are done away with it could increase American workers’ annual earnings by between $250 billion and $296 billion – no small sum by any means.

FTC Expects the Ban to Spur Innovation

While announcing the ban on noncompete clauses, FTC Chair Lina M. Khan said, “Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned.”

She added, “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

The FTC has long been talking against these noncompete clauses and has been working to ban them. In January 2023, the FTC put out a proposed rule for public comment which was even more stringent than what’s passed now.

The new rules are a somewhat toned-down version and allow for the continuance of noncompete agreements for senior executives to remain in force. These by definition are workers who earn over $151,164 annually and are in a “policy-making position.”

There could have been lobbying from corporates who stand to lose if these clauses are done away with. States have also been reluctant to enforce a ban fearing losing out on startups registering in the state. For instance, New York State Governor Kathleen Hochul last year vetoed a bill to ban noncompete agreements completely in the state despite it being passed by the state legislature.

Would Banning Noncompete Clauses Be a Game Changer?

While banning noncompete clauses might seem like a game changer, it might not really be so. Firstly, these clauses were already on the wane and were mostly difficult to enforce.

According to Ryan Vann, a partner focused on employment law at Cooley, “Even without this ban, it is really, really hard in virtually every court in America to enforce a noncompete unless you have something added that are bad facts, like theft of confidential information, soliciting customers before you go, trying to set up competing business before you go.”

However, most people working under noncompetes don’t know that and probably don’t want to risk getting sued for an extra $2-$3 per hour.

Secondly, California which is home to many startup companies already has a state law restricting noncompete clauses. Also, high-paid senior executives who might account for a large portion of these noncompete clauses have been left out of its purview, making the rule less stealthy than it otherwise would have been.

Finally, the bill is set to face legal scrutiny and The US Chamber of Commerce has said it would take legal recourse to block the rule.

The lobbying group’s President and CEO Suzanne Clark termed FTC’s ban on noncompete clauses “a blatant power grab that will undermine American businesses’ ability to remain competitive.” It’s important to note that the US Congress directly gave the FTC the power to make this decision, so it’s hard to call it a power grab in good faith. It is true that this administration’s FTC is much more powerful than the last few but that is more because the others have been mostly impotent due to Reagen-era policies.

According to Clark, “This decision sets a dangerous precedent for government micromanagement of business and can harm employers, workers, and our economy.”

She added, “The Chamber will sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked.”

Overall, the move to ban noncompete clauses for most workers is a double-edged sword for startups. While on the one hand, it would increase the talent pool that they could hire from, it might also lead to higher attrition. Companies would also need to come up with alternate ways to protect their confidential information and trade secrets from falling into the hands of competitors.

The latter might not be tough as companies could still incorporate nondisclosure and confidentiality agreements in employment contracts to prevent proprietary and confidential information from being passed on to their competitors.

Perhaps the biggest positive is for workers who see a place in the market to fill who couldn’t start their own company before because of a noncompete. Now they can create their own business as they wish.

Nonetheless, the move to ban noncompete clauses could be a welcome break for employees who were struck with their companies and would now be free to seek alternate employment.