Regulate Non-Competes by Administrative Adjudication

The Federal Trade Commission (FTC) held a workshop last month on the topic of non-compete clauses in employment contracts. Presenters discussed whether and how to regulate these clauses, which prohibit employees from competing with the employer—perhaps by working for a different employer in the same industry—during and for a time after employment. The FTC also opened up a docket on Regulations.gov to allow the public to comment, asking several questions, including whether it should use its rulemaking authority, law enforcement, advocacy, or guidance to regulate the use of non-compete clauses.

The answer to the FTC’s question is clear: It should consider regulating non-competes by administrative adjudication. Regulating these clauses through adjudication is about as ideal a use of policymaking by adjudication as an agency can get; a new policy would not impose an affirmative duty on private actors, would likely receive Chevron deference, and would not be subject to OIRA review.

Policymaking by adjudication is a key source of administrative agencies’ authority but it seems to have fallen out of favor in all but a few. In 1947, the Supreme Court declared in SEC v. Chenery Corp. (Chenery II) that “not every principle essential to the effective administration of a statute can or should be cast immediately into the mold of a general rule” and that “an administrative agency must be equipped to act either by general rule or by individual order.” Chenery II opened the door to agencies making regulatory policy by individual adjudications, developing policy incrementally rather than through a codified rule all at once. Since then, however, courts have limited when and how agencies may make policy by adjudication.

One such limitation is that agencies cannot use adjudications to issue prospective legislative rules. In NLRB v. Wyman-Gordon, the Supreme Court prohibited the National Labor Relations Board (NLRB) from using an adjudication—separately known as the Excelsior case—to articulate a new rule requiring all employers facing a union election to file with the NLRB a list of employees eligible to vote. The Court held this rule invalid, as it applied prospectively and had not been issued in the procedurally correct way under the rulemaking provision of the Administrative Procedure Act. The Wyman-Gordon principle—that prospective rules cannot be issued through adjudications—is a significant limitation on agencies’ authority, and it stops agencies from implementing a wide range of policies by adjudication. The U.S. Securities and Exchange Commission, for example, likely could not use adjudication to require broker-dealers to file Form BD.

When the Supreme Court closes a door, however, it opens a window. In Wyman-Gordon, the Court still upheld the NLRB’s ability to require the Wyman-Gordon Company to provide the list subject to the Excelsior rule. That is to say, the NLRB could enforce its Excelsior rule in future adjudications; it just could not enforce the rule absent an adjudication.

What this situation means for the FTC and non-compete clauses in employment contracts is that although the FTC could not use an adjudication to impose an affirmative duty on a company, such as requiring it to use specific language in employment contracts, it could declare that it will consider non-competes to be an unfair method of competition whenever it adjudicates a case. After articulating this policy and bringing stringent penalties against a large company or two, more companies will likely begin to remove these clauses from their contracts for fear of the FTC bringing an action against them.

Of course, since the FTC can achieve this result by rulemaking or adjudication—and would likely obtain Chevron deference to its policy under either—it must weigh the costs and benefits of both. Rulemakings cannot be overturned as easily by a future Commission as may policies articulated in adjudications, and a single codified rule can more clearly demarcate the line between permissible and impermissible conduct than a principle that must be extracted from the prose of an adjudicatory order can.

Making policy by adjudication, however, exempts the FTC from having to comply with various legal requirements applicable only to rulemakings, such the Regulatory Flexibility Act, Paperwork Reduction Act, Unfunded Mandates Reform Act, and Congressional Review Act (CRA). Perhaps most importantly, acting via adjudication would allow the Commission to avoid submitting its rule to the Office of Information and Regulatory Affairs (OIRA) for review.

Last April, the Office of Management and Budget (OMB), which houses OIRA, issued a memorandum governing agencies’ compliance with the CRA. The CRA requires agencies to submit to Congress every rule issued before the rule can become effective, as well as a statement as to whether the rule is a “major rule.” The CRA also grants OIRA the responsibility of making the major rule determination. For the first time, OMB’s memo required all independent agencies, including the FTC, to conduct a regulatory impact analysis according to OMB’s Circular A-4, quantify costs and benefits as wholly as possible, and submit each rule and regulatory impact analysis to OIRA for the major-rule determination before sending it to Congress.

This new additional step—drafting a regulatory impact analysis and sending a rule to OIRA—is not innocuous. Not only does creating a regulatory impact analysis take extensive time, manpower, and provide another path for a policy’s opponents to sue claiming any of the analysis’s decisions were arbitrary and capricious, but OIRA could also delay its major rule determination by months or years.

More dangerously, OIRA could opt not to make a determination at all (and thus preventing the rule from becoming effective) unless the issuing agency implements significant changes to its rule, much as how OIRA may require non-independent agencies to change their rules under Executive Order 12,866. Although the legal bounds of the CRA have not been fully tested in court, it is unlikely that a rule issued by the FTC could be sent to Congress without a major-rule determination, and the FTC’s rule cannot become effective without being first sent to Congress. FTC commissioners, removable by the president only for cause, should be very wary of giving authority over the agency regulatory policies to the White House.

I am a strong proponent of policymaking by adjudication as it allows for greater agency independence, responsiveness to changing circumstances, and contains fewer procedural hurdles than does rulemaking. Although this method of making policy will not work for every agency in every instance, the FTC would be wise to consider adjudications to regulate non-compete clauses in employment contracts.

Todd Phillips is a government lawyer in Washington, DC.