Final Word on Final Rule? Texas District Court Eviscerates FTC’s Non-Compete Ban
On July 3, 2024, Judge Ada Brown of the U.S. District Court for the Northern District of Texas entered a limited, preliminary injunction barring the Federal Trade Commission (“FTC”) from enforcing its controversial Final Rule (“Rule”) which purports to ban almost all non-compete agreements. Importantly, Judge Brown’s preliminary order only enjoined enforcement of the Final Rule against the named plaintiffs who opposed it. On August 20, 2024 – just two weeks before the Rule’s effective date – Judge Brown greatly expanded the scope of her initial ruling by granting summary judgment for the plaintiffs and ordering the Rule be completely “set aside” and “not be enforced or otherwise take effect on September 4, 2024[.]” Judge Brown’s order may be the fatal blow for the Rule, and should end a months-long saga of uncertainty for employers.
Relevant Background
As discussed in our prior blog, on April 23, 2024, the FTC voted 3-2 along party lines to issue the Rule banning employers from imposing almost all noncompete clauses against their workers. The Rule defined “non-competes” broadly – such that nearly any type of agreement that penalized or prohibited future, competitive employment would be void. The Rule, as drafted, banned not only post-employment non-compete provisions, but also “forfeiture for competition” provisions and similar provisions typically found in equity grant agreements. Narrow exceptions to the ban included restraints in the context of asset purchase agreements and existing – but not future – non-compete obligations between employers and a narrow class of highly paid senior executives.
The Rule was immediately challenged via two complaints filed in the Northern District of Texas by tax services firm Ryan, LLC and the U.S. Chamber of Commerce and other industry groups. On July 3, 2024, Judge Brown granted a preliminary injunction enjoining enforcement of the Rule as to named plaintiffs in the Ryan case, holding that the FTC lacked the substantive authority to promulgate the Rule under Section 6(g) and, alternatively, that the Rule was invalid under the Administrative Procedures Act (“APA”), because it was arbitrary and capricious since it was “unreasonably overbroad.”
All parties subsequently filed competing motions for summary judgment with their arguments focused on the FTC’s authority to issue the Rule. For its part, the FTC asserted that because non-competes are “unfair methods of competition under Section 5 of the FTC Act,” it had authority to issue the Rule pursuant to Section 6(g) of the Act.
Judge Brown’s Decision
In her August 20 decision setting aside the Rule, Judge Brown adopted the summary judgment arguments made by Ryan and the Chamber. Specifically, Judge Brown concluded the text and structure of the FTC Act “reveal the FTC lacks substantive rulemaking authority with respect to unfair methods of competition, under Section 6(g).” While noting that the FTC had the authority to promulgate procedural rules under Section 6(g) to preclude unfair methods of competition (see 15 U.S.C. SS 57a), Judge Brown concluded that, after reviewing the text, structure, and history of the FTC Act, the FTC did not have the authority to create substantive rules under Section 6(g). Specifically, Judge Brown found that Section 6(g) is “a ‘housekeeping statute,’ authorizing what the APA terms ‘rules of agency organization procedure or practice’ as opposed to ‘substantive rules[,]'” citing the fact that Section 6(g) contains no penalty provision as evidence that the Section does not include substantive rulemaking power.
Much like her preliminary injunction ruling, however, Judge Brown did not stop there. She also held that the FTC’s action in enacting the Rule was arbitrary and capricious under the APA. Judge Brown concluded the FTC’s action in promulgating the Rule was “unreasonably overbroad without a reasonable explanation.” In support of her determination, Judge Brown found that the Rule imposed “a one-size-fits-all approach with no end date” and failed “to establish a ‘rational connection between the facts found and the choice made.'”
In holding the FTC’s efforts to implement the Rule to be arbitrary and capricious, Judge Brown condemned the Commission’s choice “to impose such a sweeping prohibition–that prohibits entering or enforcing virtually all non-competes – instead of targeting specific, harmful non-competes[.]” Moreover, Judge Brown found that the basis for the Rule failed “to consider the positive benefits of non-compete agreements, and disregard[ed] the substantial body of evidence supporting these agreements.” Judge Brown determined the record reflected that the FTC failed to sufficiently address alternatives to issuing the Rule.
Having found the Rule invalid, Judge Brown then “set[] aside the Non-Compete Rule” in its entirety on grounds that “the APA does not contemplate party-specific relief” and thus, “setting aside agency action . . . has ‘nationwide effect[.]'” Accordingly, Judge Brown’s order sets aside the Rule everywhere and for everyone – not just the plaintiffs.
The Rule’s Future
Judge Brown’s decision eviscerated the Rule in no uncertain terms. But the Ryan litigation was not the only challenge to the Rule. After Ryan was filed, two additional actions were brought shortly thereafter: one by ATS Tree Services LLC in the Eastern District of Pennsylvania and another by Properties of the Villages, Inc. in the Middle District of Florida. On July 23, 2024, Judge Kelley Hodge of the Eastern District of Pennsylvania declined to issue a preliminary injunction for the employer ATS Tree Services, finding “that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition”–without citing Judge Brown’s preliminary injunction decision in Ryan. And on August 15, 2024, Judge Timothy Corrigan in the Middle District of Florida enjoined enforcement of the Rule as to the plaintiff in that case. Judge Corrigan’s opinion – which cited Ryan and ATS – struck a middle ground between the two, holding that while the FTC has some substantive rulemaking authority to regulate unfair methods of competition under Section 6(g), the Rule was nonetheless invalid under the major questions doctrine, which requires that an agency point to clear congressional authorization when issuing rules that have extraordinary economic and political significance.
These conflicting district court rulings have teed up a burgeoning split in authority. The FTC has already announced that it is considering an appeal of Judge Brown’s decision, and that it intends to continue to address non-competes though “case-by-case enforcement actions.” The likelihood of such appeal is questionable, however, particularly in light of the United States Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, which overturned over forty years of deference afforded to federal agencies under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc. Given the current Supreme Court’s skepticism of agencies’ regulatory authority, the FTC may be leery of asking this Court to clarify the scope of the FTC’s substantive rulemaking authority with regard to unfair methods of competition. Additionally, any appeal of the Ryan decision would go to the Fifth Circuit – which also has a track record of taking a conservative approach in evaluating federal agencies’ rulemaking authority. Thus, asking the Fifth Circuit to overturn Judge Brown’s decision in Ryan is, at best, a long shot.
Regardless of whether the FTC pursues an appeal, the FTC’s response to the Ryan decision indicates that we may see a continued trend of the FTC filing Section 5 enforcement actions against employers, which would be consistent with the FTC’s announcement in November 2022 that it would “reactivate Section 5” as outlined in an accompanying Policy Statement. Following the announcement, the FTC has pursued a spate of actions targeting non-compete practices, which have largely resulted in settlements voiding the employers’ noncompete agreements and required the employers to inform their employees that such agreements were no longer enforceable. Even assuming the FTC continues to bring individual battles, however, it has–at least for now–lost the war.
Considerations for Employers
Although the Rule’s future is undoubtedly grim, nothing is certain, and the ultimate outcome of any appeal is impossible to guarantee. Given the uncertain status of the Rule and the FTC’s emphasis that it maintains the authority to bring “case-by-case” enforcement actions, employers should keep the following, high-level recommendations in mind:
- Employers who have not already done so should hold off on delivering “non-enforcement” or “voiding of non-compete” notices to employees contemplated by the Final Rule. Employers who have sent such notices based on a belief that the Rule would be implemented should consult outside counsel on efforts to potentially ‘claw back’ these proclamations.
- Employers should keep and maintain a census of all employees who presently have non-compete agreements and, in addition, former employees whose non-competes are still in term.
- Work with outside counsel to ensure existing non-competes are not overly broad in terms of time, geography, and scope – and are otherwise enforceable in the relevant jurisdictions.
- Related to point “3”, employers, in conjunction with outside counsel, should ensure that non-competes are being rolled out only to employees who need them, likely by virtue of their access to confidential information, trade secrets, and sensitive customer relationships or data.
- Review and revise other restrictive covenants – such as non-disclosure and customer non-solicit provisions – to ensure compliance and effectiveness.
- Ensure in-house or outside counsel are monitoring the ever-changing legal landscape in this area. Regardless of the Rule’s fate, many states are adopting a more skeptical posture towards non-competes. Multi-state employers must take care to ensure their agreements are enforceable in the relevant jurisdictions based on current state law.
We will continue to monitor this important issue and provide updates as they become available.
