Final Word on the Final Rule? Texas District Court eviscerates FTC’s non-competition ban
On the 3rd of July 2024, Judge Ada Brown of the U.S. District Court for the Northern District of Texas issued a limited preliminary injunction prohibiting the Federal Trade Commission (FTC) from enforcing the controversial Final Rule (Rule), which purports, to ban almost every non-compete agreement. Judge Brown’s preliminary injunction only prohibited enforcement of the Final Rule by the named plaintiffs. 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 “noncompetes” in a broad sense, so that any agreement that penalized or prohibited competitive employment in the future would be invalid. The Rule as written prohibited not only post-employment provisions of non-compete, but also “forfeiture of competition” provisions or similar provisions found in equity grant contracts. 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. Judge Brown granted a preliminary order on July 3, 2024, preventing enforcement of the Rule against named plaintiffs. She held that the FTC lacked substantive authority to promulgate it under Section 6(g), and that it was invalid under the Administrative Procedures Act (APA) because it was “unreasonably broad.” The FTC argued that non-competes were “unfair methods” of competition under Section 5, and therefore, it had the authority to issue the rule pursuant to Section 6, of the Act. Judge Brown found that the text and structure in the FTC Act revealed the FTC lacked substantive rulemaking authority for unfair methods of competing under Section 6 (g). She noted, however, that the FTC was authorized to promulgate procedural regulations under Section 6 (g) to prevent unfair methods of competing (15 U.S.C. 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
,” and citing the fact that Section 6(g) contains no penalty provision as evidence that the Section does not include substantive rulemaking power. Judge Brown determined that Section 6 (g) was “a housekeeping statute’ that authorized what the APA calls ‘rules or agency organization procedure or practices’ as opposed to substantive rules
“. She cited the fact that Section 6 (g) contained no penalty provision as proof that the Section did not have substantive rulemaking powers. She also found that the FTC acted arbitrarily and capriciously in enacting this Rule. 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
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[ed]'” 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. The Ryan litigation was not, however, the only challenge to this Rule. Two additional actions were filed shortly after Ryan: 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. Judge Timothy Corrigan of the Middle District of Florida, on August 15, 2024 enjoined the enforcement of the Rule for the plaintiff in this 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 conflicting district court rulings have sparked a growing split in authority. The FTC might be hesitant to ask the Supreme Court to clarify its substantive rulemaking authority in relation to unfair competition methods, given the Supreme Court’s current skepticism about agencies’ regulatory authority. The Fifth Circuit is also known for its conservative approach to evaluating the rulemaking authority of federal agencies. 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. The FTC pursued a series of actions against non-compete practices following the announcement. These actions have resulted in settlements that have voided the employers’ non-compete agreements and forced the employers to notify their employees about the non-competition agreements no longer being 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. Many states are becoming more skeptical of non-competes, regardless of the fate of the Rule. Employers with multiple states must ensure that their agreements are enforceable based on state law in the relevant jurisdictions.
