As we reported last year, the Federal Trade Commission ("FTC") proposed a broad-sweeping rule that would ban virtually all non-competition agreements in employment contracts. The FTC enacted the Rule because it believes that noncompetition agreements are unfair methods of competition. The FTC's Rule became final in April 2024 and was set to be effective starting September 4, 2024. However, on August 20, 2024, the FTC Rule was set aside by the federal court in the Northern District of Texas. Therefore, the Rule (for now) is invalid and unenforceable.
The FTC's Rule is codified in 16 C.F.R. §§ 910.1-910.6. 16 C.F.R. § 910.2 states:
"(a) Unfair methods of competition —
(1) Workers other than senior executives. With respect to a worker other than a senior executive, it is an unfair method of competition for a person:
(i) To enter into or attempt to enter into a non-compete clause; (ii) To enforce or attempt to enforce a non-compete clause; or (iii) To represent that the worker is subject to a non-compete clause.
(2) Senior executives. With respect to a senior executive, it is an unfair method of competition for a person:
(i) To enter into or attempt to enter into a non-compete clause; (ii) To enforce or attempt to enforce a non-compete clause entered into after the effective date; or (iii) To represent that the senior executive is subject to a non-compete clause, where the noncompete clause was entered into after the effective date."
A non-compete clause is defined in § 910.1 to mean:
"(1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:
(i) Seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or
(ii) Operating a business in the United States after the conclusion of the employment that includes the term or condition.
(2) For the purposes of this part, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral."
Employers also had a notice requirement for existing non-competes, meaning that by the effective date of the Rule (September 4, 2024), the employer had to provide the worker with written "clear and conspicuous" notice that the worker's non-compete clause "will not be, and cannot legally be, enforced against the worker." 16 C.F.R. § 910.2(b)(1).
In addition, the FTC Rule supersedes all state laws that would "permit or authorize" non-compete agreements. 16 C.F.R. § 910.4(a).
As soon as the FTC's Rule became final in April 2024, lawsuits were filed to challenge the validity and enforceability of the Rule. In Texas, on April 23, 2024, Ryan LLC filed a lawsuit against the FTC, Ryan LLC v. FTC, N.D. Tex. No. 3:24-CV-00986-E, and in Pennsylvania, on April 25, 2024, ATS Tree Services LLC filed its lawsuit against the FTC, ATS Tree Services, LLC v. FTC, E.D. Pa. No. 2:24-cv-01743. Both lawsuits sought to enjoin enforcement of the FTC's Rule banning noncompetes, and both wanted the court to declare that the Rule was invalid and unenforceable because, among other reasons, the FTC exceeded its statutory authority and the Rule is arbitrary and capricious.
The Eastern District of Pennsylvania was first to issue a decision on the matter. On July 23, 2024, the court denied the plaintiff's motion to stay the effective date of the Rule and for a preliminary injunction. In reaching its decision, the court reviewed the history of the Federal Trade Commission Act (15 U.S.C. §§ 41-58) and found that Sections 5 and 6 of the Act (15 U.S.C. § 45) gave the FTC did have statutory authority to make substantive (as opposed to merely procedural) rules to prevent unfair methods of competition. "When taken in the context of the goal of the Act and the FTC's purpose, the Court finds it clear that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition." Opinion, p. 26. The Court homed in on the word "prevent" – Section 5 of the Act empowers and directs the FTC "to prevent persons, partnerships, or corporations,…from using unfair methods of competition…. Prevent is an inherently forward-looking directive, requiring the FTC to take action to avoid or avert a future occurrence in addition to remediating or stopping past harm. Plaintiff asks the Court to cabin the FTC's power as solely adjudicatory, and therefore reactionary and backward-looking, only arising once unfair methods of competition have already occurred. The Court declines to do so." Opinion, p. 28. Finding that the plaintiffs were unlikely to succeed on the merits (in addition to failure to show irreparable harm), the court refused to grant a preliminary injunction or stay the effective date of the Rule.
On August 20, 2024, however, the Northern District of Texas rendered its decision, and it granted the plaintiffs' motion for summary judgment, holding that the FTC's Rule is invalid and unenforceable. "The Court sets aside the Non-Compete Rule. Consequently, the Rule shall not be enforced or otherwise take effect on its effective date of September 4, 2024 or thereafter." Opinion, p. 2.
In reaching its decision that the Rule is invalid, the Texas court began explaining that under the Administrative Procedure Act ("APA") (5 U.S.C. § 706(2)), the court is empowered to hold unlawful and set aside agency actions that have been taken without statutory authority or that are based on findings and conclusions that are arbitrary and capricious. Under Section 706 of the APA, "courts must hold unlawful and set aside agency action, findings, and conclusions found to be … arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law, contrary to constitutional right, power, privilege, or immunity; or in excess of statutory jurisdiction, authority, or limitations, or short of statutory right." Opinion, p. 12. The Texas court (like its Pennsylvania counterpart) reviewed the FTC's Non-Compete Rule and the bases for it, and the FTC Act's statutory language and purpose, including Sections 5 and 6. The Texas court, however, agreed with the plaintiffs that the FTC Act does not authorize the FTC to issue substantive unfair-competition rules, such as the broad categorical ban on virtually all non-competes. "[A]fter reviewing the text, structure, and history of the Act, the Court concludes the FTC lacks the authority to create substantive rules…. Section 6(g) is indeed a 'housekeeping statute' authorizing what the APA terms rules of agency organization procedure or practice as opposed to substantive rules." Opinion, p. 17. As further support for its conclusion that there is no authority to make substantive rules, the court highlighted the location of the provision on which the FTC relies (Section 6(g)) as seventh in a list of twelve almost entirely investigative powers and the fact that there is no statutory penalty for violating rules promulgated under Section 6(g) – "Section 6(g) contains no penalty provision—which indicates a lack of substantive force." Opinion, pp. 18-19.
The Texas court next concluded that the Rule "is arbitrary and capricious because it is unreasonably overbroad without a reasonable explanation. The Rule imposes a one-size-fits-all approach with no end date, which fails to establish a 'rational connection between the facts found and the choice made.'" Opinion, p. 24. The Texas court first found that
"[t]he record does not support the Rule. In enacting the Rule, the Commission relied on a handful of studies that examined the economic effects of various state policies toward noncompetes. The record shows no state has enacted a non-compete rule as broad as the FTC's Rule. The FTC's evidence compares different states' approaches to enforcing non-competes based on specific factual situations—completely inapposite to the Rule's imposition of a categorical ban. As to this latter point, the FTC provides no evidence or reasoned basis. The Commission's lack of evidence as to why they chose to impose such a sweeping prohibition—that prohibits entering or enforcing virtually all non-competes—instead of targeting specific, harmful non-competes, renders the Rule arbitrary and capricious….In sum, the Rule is based on inconsistent and flawed empirical evidence, fails to consider the positive benefits of non-compete agreements, and disregards the substantial body of evidence supporting these agreements." Opinion, p. 24.
The court also found that "the FTC failed to sufficiently address alternatives to issuing the Rule." Opinion, p. 25. In justifying its decision for not considering alternatives, the FTC simply concluded that case-by-case adjudication of enforceability of non-competes has an in terrorem effect and that "either the pro-competitive justifications [for an outright ban of all non-competes] outweighed the harms, or that employers had other avenues to protect their interests." Opinion, p. 25. The court was not persuaded, finding the Rule not reasonably explained. Thus, because the FTC lacked statutory authority and the Rule is arbitrary and capricious, the Court held the Rule is unlawful and unenforceable.
Importantly, the Texas court's setting aside the Rule has nationwide effect. Thus, for now the Rule cannot be enforced anywhere.
But the saga is not over yet. While the plaintiffs in the Pennsylvania case have dismissed their complaint, the FTC is appealing the Texas court's Ryan decision in the Fifth Circuit Court of Appeals. The FTC's first brief is due on January 2, 2025.
One final caveat. It is important to remember that it is only the FTC's federal rule banning non-competes that has been set aside. Employers must remain cognizant of the various states' laws pertaining to non-competes as these laws remain in full force and effect. Indeed, four states currently have full bans on non-competes – California, Oklahoma, Minnesota, and North Dakota. Among the other states are a plethora of various restrictions or legislation currently pending addressing non-competes.
