Potential Impacts of FTC’s Near-Blanket Ban on Noncompetes

This post is part of a series sponsored by AgentSync.

A proposed Federal Trade Commission (FTC) rule would enact a near-blanket ban on noncompete clauses within employment contracts, even for gig-workers and freelancers.

So, what drives the FTC’s rule? And what impacts might such a wide-reaching rule have on – yes of course this is our question – the insurance industry?

Today we’ll examine first the basics of noncompete clauses, the FTC’s proposed Rule to Ban Noncompete Restrictions, and commentary on why the federal agency believes such a rule is necessary, as well as the potential downstream consequences. As always, if this is an issue you need particular guidance on, you should call a lawyer because this blog is for nerdy commentary and not legal advice.

Contents

What is a noncompete agreement?

Noncompetes are legal clauses a business includes in its terms of employment or as part of a severance package that prevents their current employees from taking positions with the employer’s competitors.

The intention of a noncompete is to protect a business from pouring training and education into an employee, only to have that employee take all that information and experience to start their own competing business or take that knowledge to a competitor. So, when you take a position with a company, you may need to sign a noncompete, or, if you’re leaving a business and they offer you a severance package, that severance may come with a noncompete contract attached.

Noncompetes, also known as a “covenant not to compete” generally last six months to two years – although some can be for much longer. They also have quite varied enforcement; some states explicitly outlaw businesses from enforcing noncompetes, others simply make it difficult via disparate court interpretation of state right-to-work laws (holla Kansas), and others still are very diligent in enforcing noncompete clauses to the fullest extent possible.

People who advocate to preserve noncompetes argue that noncompete covenants are part of a negotiation process for sophisticated business leaders, such as C-suite executives, who may agree to a noncompete in exchange for more stock options, a higher salary, or better severance packages. Opponents, however, argue noncompetes are rarely negotiated and often don’t need full enforcement – merely the threat of noncompete enforcement is enough to keep workers in a detested role or force them into different industries or career tracks if they decide to leave a company.

What makes a noncompete enforceable?

As long as you don’t live in a state that bans noncompetes, current U.S. law comes down to a judge ruling that a noncompete contract is enforceable (or not) based on whether it is “reasonable,” something that is very subjective based on a person’s role, knowledge level, and the company’s standing. Some states have noncompete laws that make it illegal to use these contract tools, while others limit their use but don’t ban them outright.

Much of what makes a noncompete unenforceable is tied up in state case laws, and whether state precedent or general jurisprudence finds a situation to have a legitimate business purpose.

Which states prohibit noncompete agreements?

California, North Dakota, Oklahoma, and Washington, D.C. have laws explicitly nullifying the enforceability of noncompete agreements. Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, and Washington prohibit noncompetes for employees under these states’ respective income thresholds.

What would the FTC rule do?

The Federal Trade Commission’s Rule to Ban Noncompete Restrictions would (unsurprisingly) abolish noncompetes in most contracts moving forward, from entry-level up through executive employees. Not only would businesses be forbidden from including noncompetition agreements or negotiating noncompete terms with employees, the rule would be retroactive, nullifying noncompete agreements in existing contracts and making all noncompete covenants unenforceable.

FTC guidelines about the proposed rule also make clear that it would make it illegal for a business to tell a worker that they are subject to a noncompete. The FTC would require businesses to rescind existing noncompete contracts by the rule’s compliance deadline, and actively inform their workers that they aren’t subject to noncompete covenants.

Exceptions to the FTC rule

The Rule to Ban Noncompete Restrictions has a few exceptions. Franchisees, for example, would still be subject to noncompete restrictions, giving a franchise business the assurance that a franchisee won’t change restaurant chains at a whim. Additionally, noncompete covenants would still be legal and applicable for people who are selling their business or their business’s property, or who maintain substantial ownership in a business.

In lay terms, under the new rule, anyone who is functionally an employee would never be subject to a noncompete, but someone who is a business owner might be.

FTC jurisdictional authority

Critics of the law complain that the FTC is overstepping its legal authority in banning noncompetes for employees across the nation. However, the FTC asserts that, under Section 5 of the Federal Trade Commission Act, the FTC is tasked with stopping unfair trade practices and unfair competition. The FTC has taken the stance that noncompetes are an unfair method of competition as they stymie job growth and innovation, wage growth, and business startups in numerous industries, and therefore fall under its jurisdictional direction.

“The freedom to change jobs is core to economic liberty and to a competitive, thriving economy,” said FTC Chair Lina M. Khan in one news release. “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. By ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.”

Why is the FTC seeking to abolish noncompete clauses?

The FTC’s proposed rule is based on four free-market economic principles, all of which turn on the idea of a more robust and competitive capital market:

Noncompetes drive down wages
Noncompetes stifle businesses and innovation
Noncompetes exploit workers and hinder individual economic liberty
Noncompetes are unnecessary given employers’ other legal options

To point to the cumulative effects of each of these individual principles, the FTC estimates ending noncompetes for the medical field could save Americans up to $148 billion in health costs. FTC testimonial points to a few reasons for this cost savings: Doctors could have more room to compete, opening their own practices and trying innovative care models. Health care employers that maintain toxic environments would have a higher incentive to change working conditions. And, perhaps the most impactful benefit, more doctors would stay in the medical field instead of being forced out by aggressive noncompetes.

Using the testimonial provided in the FTC’s February Forum Examining Proposed Rule to Ban Noncompete Clauses, let’s take a look at these four key premises underpinning the rule, and the pros and cons that those who testified raised as discussion points.

1. Noncompete clauses and wages

According to an FTC fact sheet, ending the practice of noncompete restrictions would increase workers’ earnings by nearly $300 billion a year. The data set cited one study that said “banning noncompetes nationwide would close racial and gender wage gaps by 3.6 to 9.1 percent.”

Noncompetition agreements by their nature bar employees from seeking employment elsewhere, a condition that often traps that employee at a job that isn’t handing out wage increases. At a personal level, this restricts an individual with a skill set to one employer.

In the FTC’s forum where people across different industries and market sectors gave testimony, many health care professionals – surgeons and other highly educated medical professionals – testified against the practice. One testified that she had moved her family of five to different states multiple times because of geographically broad health facility systems that said they would enforce their noncompete covenant with her. Another doctor testified noncompetes drive unsafe conditions in the medical field.

“I mean, these noncompetes don’t just ban you from that hospital or the city. Sometimes the entire region or the state, depending on your specialty. And so it really creates a safety concern, not only for obviously the patients but also the well-being of doctors,” said Dr. Sameer Baig. “I personally know a physician who committed suicide. And this was not at some smaller hospital. This was at a prestigious institution and it shook everyone that knew her. And I have no doubt that it was the working conditions that she was under. So I think it has a real impact on safety for workers and by nature of what we do, safety for patients.”

One couple testified that, as property managers, they were locked into noncompetes that would cost them their housing if they chose to leave. Year after year, the company paid them incremental wage increases, yet they watched as new hires were hired at salaries tens of thousands of dollars above their pay, despite their years of experience and established service records.

Opponents of the noncompete Clause Rule point out that noncompetes could be leveraged in severance and employment negotiations to actually increase wages.

“I think this rule goes too far in prohibiting private parties, employers and employees, from bargaining over a noncompete, which may be in both of their interests,” said Emily Glendenning, Vice President and Associate General Counsel for Employment and the Chief Privacy Officer for BAE Systems. “You may have a worker who is delighted to accept the equity grant or the additional consideration, or to take the job in the first place fully agreeing to a noncompete with eyes wide open.”

Glendenning and other noncompete advocates pointed that, by making noncompetes unenforceable nationwide, some employees, particularly at the executive level, could wind up with disproportionately high salaries or benefits as a result of having negotiated a noncompete that no longer exists.

2. Noncompete covenants stifle new business and innovation

The FTC has data that suggests noncompete restrictions are holding back innovation and competition. Some estimates project the number of new businesses in any given industry could double in the event of a nationwide ban on noncompetes.

Scott Shewcraft, Vice President of Policy at the Economic Innovation Group, testified in support of the noncompete ban. While some testifiers proposed a potential income threshold that would allow companies to use noncompetes against senior knowledge workers at a company and not against their entry-level employees, he resisted this idea altogether.

“In many cases it’s those knowledge workers at a firm that are most likely to be the entrepreneurs of tomorrow and the innovators that bring dynamism to their local economy and new jobs,” said Shewcraft.

noncompetes are essentially supposed to keep workers from leaving to start competing businesses or take their ideas and experience to an existing competitor. This captive approach means many startups never start, many businesses never change, and knowledge that could be shared across industries remain siloed.

“Nearly 100 percent of net new jobs come from new businesses according to the Kauffman Foundation. If you look at census data, we’re in a startup or new business slump. There have been an uptick over the last couple years, but business formation is around a 50-year low and a large part of that is businesses are not able to access capital or the talent to grow,” said Ross Baird, Founder and CEO of Blueprint Local. “Historically, the demise of large companies and the creation of smaller companies has been a natural part of our economic growth. …I think extending that right to anybody in America who wants to start and grow a company will cause more capital to flow, more jobs to be created and ultimately be a huge net benefit for our society.”

3. Noncompetes exploit workers and hinder individual economic liberty

The exploitative nature of noncompetes was hotly contested by testimonials before the FTC. Although 18 percent of full-time workers are subject to noncompete agreements, those agreements aren’t tailored to senior leadership, knowledge workers, or those who are dealing in proprietary knowledge. Instead, they cover a range of employees.

Yes, these agreements cover senior researchers and executive leadership. But they also cover gas station attendants, teachers, veterinarians, hair stylists, house cleaners, call center staffers, and more. The reality is, even with employers that are very unlikely to enforce the noncompetes they have with millions of minimum-wage employees, it’s not just the enforceability of a noncompete that matters.

As Daniel Kalish, founder of HKM Employment Attorneys, testified, his white-collar, sophisticated clients often chose to stay at companies they dislike or to leave their respective industries altogether rather than violating a noncompete clause. The reason comes down to a simple calculation. It’s not about whether a noncompete is legally enforceable, but instead is about whether the person is willing to go through the process of proving it’s unenforceable. Even a moderate case, he said, could amount to more than $100,000 in attorney’s fees.

“Even for our employees who win a lawsuit against an invalid noncompete, it will bankrupt them,” Kalish said.

Dr. Baig echoed that sentiment, expressing that, while noncompetes for low-wage employees are particularly predatory, even workers with higher incomes and education were losing in the current system.

“I think aside from being part of the 1 percent, nobody can afford prolonged, protracted litigation in the United States,” said Dr. Baig. “I am triple-specialized in internal medicine, hematology and oncology. I still cannot understand my employment contract without an attorney. And I think even at higher education levels to say, ‘Well, you’re smart enough, you can understand this legalese,’ that’s not fair.”

Glendenning pushed back on the idea that noncompetes are exploitative or overly complicated. Instead, Glendenning posited that, while it’s important for companies to stay focused on their protectable interests, that doesn’t mean it should be limited to senior executives, since proprietary knowledge could exist at any level of the company.

“We trust people to enter into all kinds of contracts all the time. And a mortgage agreement may be confusing for someone, but that doesn’t mean we’ve banned mortgage agreements. So I think we can focus on providing information, providing education. But I think to say no one can have a noncompete because there may be some workers who are confused by them, to me is just too Draconian a response,” said Glendenning.

4. Noncompetes are unnecessary given employers’ other legal options

One of the primary arguments against noncompete covenants comes down to the fact that companies wishing to protect their “secret sauce” have a few different levers at their disposal. Employees often sign nondisclosure agreements to prevent them from sharing company secrets. Nonsolicitation agreements can keep sales people from dragging clients with them to a new service provider. Many trade laws and corporate espionage laws prevent employees from walking away and disseminating proprietary information across the industry already.

But is that enough to negate the need for a noncompete contract?

Dr. Baig said yes.

“You want to keep your people? Pay them. Create an environment that is nice to be around. Don’t create toxic environments. I wholeheartedly disagree with noncompetes on any level. I think even at an executive level, if somebody wants to leave, who are you to tell them that, “You’re too smart? You can’t go to this company for a period of two years and use your brain.” Find a way to keep them,” said Dr. Baig. “They have nonsolicitation agreements, they have nondisclosure agreements, they have patents and they have an army of lawyers. You don’t necessarily need the noncompete there.”

As a counterpoint, Chenai Kirkpatrick, Director for Global Policy and Regulatory Affairs at the Society for Human Resource Management (SHRM), countered that noncompetes preserve a business’s incentive to educate its employees.

“With an economy that is more knowledge-based than ever, there are more and more circumstances where employers need to protect information. We also believe the broadly drafted regulation would jeopardize the ability of HR professionals to require the repayment of education or training benefits, and it would also endanger the use of nondisclosure and nonsolicitation clauses,” said Kirkpatrick.

Kirkpatrick and other pro-noncompete testimonials noted that some businesses pay for training, testing, re-skilling, and other educational expenses on behalf of employees. Things like paid-for college courses or work-endorsed training certifications could, they theorized, become relics of the past if an employer couldn’t guarantee that the educational opportunities would be put to work on their behalf.

“SHRM believes the FTC should differentiate between agreements designed to limit labor market mobility and those designed to protect confidential trade secrets or strategic planning,” said Kirkpatrick. “SHRM supports a well functioning labor market and the ability of workers to secure good paying jobs, and we believe that this proposed rule will limit the ability of employers to create workplaces where everyone thrives.”

How would abolishing noncompete clauses affect the insurance industry?

With 30 million workers subject to noncompetes, there’s no shortage of them in insurance.

While other industries have taken aim against the practice, with the American Bar Association and American Medical Association declaring noncompetes unethical (despite their continued widespread use), people who work in insurance are likely to encounter them at some point or another.

Yet, the potential repercussions specific to insurance are likely to track with the FTC’s other projections. If a noncompete contract is all that holds you to your job, then your employer isn’t getting an enthusiastic, innovative, driven worker. Their main benefit at that point comes down to merely preventing you from joining a competitor and thwarting true capitalism.

Noncompetes as they work in insurance

In insurance, noncompete restrictions certainly work to limit competition. (You know, putting the NON in noncompete.)

For instance, captive agents who want to become independent and start their own firms often face noncompetes that prevent them from leaving, or that allow them to leave but prevent them from communicating with former colleagues or clients for years. These terms are far more punitive than nonsolicitation agreements.

Nonsolicitation agreements: Nonsolicitation agreements may be part of noncompete covenants, or may be stand alone agreements. In a nonsolicitation agreement, an employee agrees not to actively recruit their employers’ clients, vendors, or other employees if they leave the company. However, nonsolicitation agreements often don’t prevent those clients or ex-colleagues from seeking out the ex-employee in their new venture.

Noncompetition agreements lock people out of geographies and industries, and many of them don’t distinguish the circumstances under which an employee left.

Fired? Layed off? Company collapsed? Starting a new firm? Joining your friends for a new venture? noncompetes don’t care. Regardless of the reason for the departure, voluntary or not, employees subject to noncompetes can be intimidated enough to keep them from pursuing their own interests in their area of expertise. For the insurance industry, where the freedom to be self-employed and control your own destiny is an oft-touted benefit, a noncompete can discourage and prevent people from doing just that.

The truth of noncompetes in insurance is that, without a noncompete agreement in place, an unhappy employee has options. They could renegotiate compensation and benefits to improve the situation. Or, they can leave and find a more fulfilling position, joining a competitor, moving into an adjacent area of the industry, or starting their own business. In every situation, the industry (not just the individual) would benefit. Sure, a freer flow of ideas, experience, and talent between competitors could lead to stiffer competition. But it also could lead to more innovation and changes that improve certain aspects of the industry as a whole. A rising tide lifts all boats, after all!

Instead, noncompetes give people the options of staying stuck with a job that they resent, moving to a new locale, or leaving the industry entirely. During a time when talent recruitment and retention are essential for the insurance industry, these are unwelcome options.

Benefits of the FTC rule against noncompetes

Each state takes a different approach to regulation for insurance, but the basics of solvency, underwriting, and actuarial design are fundamentally repeatable. So, in that respect, carriers wouldn’t see much change – there are strict limits to how “innovative” you can get with product development, and there’s not much “secret sauce” to solvency.

In other ways, the industry would see the kind of competitive innovation we pride ourselves on in the American capital market. We could see exchanges in technology, digitization, customer service, internal culture expectations – the things that make carriers and agencies different beyond their product ratings.

But an incredible positive for our industry could come down to retention. Young workers subject to noncompetes who leave jobs due to downsizing, toxic leadership, or other changes are currently forced to reconsider the city or even state they live in or leave the industry altogether. Particularly if you’re starting a family or are early in a career, an industry switch is far more likely!

Further, without noncompetes in place, many gig workers, part-timers, temporary employees, and contractors could find themselves staying in insurance and contributing to a robust American economy. Currently, if you have a noncompete agreement, you might do contract work for a gig and then have to wait 6 months or a year before you take another insurance gig. With gig jobs and temp labor often serving as an entry-point to the broader industry, noncompetes are a strong deterrent to new recruits just developing a taste for insurance. It doesn’t have to be this way.

Regardless of whether the FTC implements the ban on noncompete agreements, ending the practice of noncompetes in the insurance industry could ensure our businesses collectively stay competitive, collaborative, and staffed for decades to come.

Potential Impacts of FTC’s Near-Blanket Ban on Noncompetes