A Texas federal district court held on Aug. 20, 2024, that the Federal Trade Commission’s rule banning most employer-employee non-compete agreements is unlawful. This decision — unlike earlier preliminary decisions — orders that the rule shall not be enforced against any employers nationwide.
The FTC originally issued the rule on April 23, 2024, and companies — including the litigants in the Texas case — immediately challenged the rule. While courts issued conflicting preliminary decisions on the likelihood of success of the challenges, no court previously had precluded the FTC from enforcing the rule on a nationwide basis. The Texas district court’s decision setting aside the rule makes it the first court to reach a final decision, two weeks before the rule was to take effect.
What was the Texas district court’s decision, and why is it important? The plaintiff in the Texas case filed a lawsuit challenging the non-compete rule as unlawful on the same day that the FTC issued the final rule. In a July 3, 2024, preliminary ruling, the Texas district court agreed with the plaintiff and additional intervenors that they were likely to succeed in their challenge to the legality of the rule, and enjoined the FTC from enforcing the rule against those challengers during their litigation. Notably, that preliminary ruling was limited in that it only prevented the FTC from enforcing the rule against the litigants in the Texas case. Other courts reviewing challenges to the rule have likewise limited their decisions to the litigants before them or have disagreed with the Texas district court’s initial decision and declined to enjoin the rule at all. Accordingly, prior to the Aug. 20 decision, the FTC’s non-compete rule was set to go into effect for most employers on its effective date, Sept. 4, 2024, but the Aug. 20 decision set aside the rule as unlawful and held the rule will not take effect on Sept. 4.
The Texas district court’s reasons for declaring the rule unlawful in its Aug. 20 ruling largely follow those set forth in its preliminary decision. The court first concluded that the FTC lacked the statutory authority to issue the non-compete rule. It reasoned that the FTC’s cited grant of rulemaking authority in the FTC Act is limited to “procedural” rules that “aid in the administration” of the FTC’s adjudicatory framework for determining whether a party has engaged in unfair methods of competition. The court rejected the FTC’s argument that it has “substantive” rulemaking authority related to unfair methods of competition — i.e., that the FTC can issue rules substantively regulating forms of conduct as unfair methods of competition. While the court observed that the FTC Act does give the FTC authority to issue substantive rules related to “unfair or deceptive practices,” it held there is no parallel authority for substantive rules related to “unfair methods of competition.”
The court also held that the rule was arbitrary and capricious in violation of the Administrative Procedure Act, concluding that the rule “is unreasonably overbroad without a reasonable explanation.” The court noted the lack of empirical basis for the “sweeping prohibition” that the FTC adopted, barring “entering or enforcing virtually all non-competes.” And the court criticized the FTC for failing to consider the benefits of non-compete agreements.
In light of these fundamental problems with the rule, the court concluded it was required to “ ‘hold unlawful’ and ‘set aside’ the FTC’s Rule.” The decision made clear that this holding applied nationwide, relying on prior Fifth Circuit authority to hold that its ruling is “not party-restricted” and “affects persons in all judicial districts equally.” In short, the court ordered the FTC may not enforce the rule against any party.
What’s next? The Aug. 20 decision offers much needed clarity but likely will not be the final word on the rule. As of now, companies will not be required by the FTC to comply with the rule starting Sept. 4.
The FTC is likely to appeal the decision to the U.S. Court of Appeals for the Fifth Circuit and may seek a stay of the decision pending that appeal. Among other potential issues for appeal, there is an ongoing debate about the ability of district courts to enter nationwide relief under the Administrative Procedure Act. If the FTC is successful on appeal, the FTC could obtain at least a temporary reinstatement of the final rule. The Fifth Circuit, however, has not been a favorable venue in recent years for the federal government in regulatory litigation similar to this case, and the U.S. Supreme Court has also expressed skepticism about major new regulations based on novel interpretations of longstanding statutory authority.
Where does this leave employers? For now, employers should no longer feel the need to comply with the rule by Sept. 4. Nor should they plan to send out the notices envisioned by the rule or otherwise rescind non-competes because of the rule.
Employers should, however, continue to monitor developments in this space. This litigation is not over. The FTC will likely appeal and other cases challenging the rule are pending. The FTC could also still bring individual actions against employers for unfair methods of competition on a case-by-case basis, utilizing the same arguments and data cited by the FTC in the now set-aside final rule. And multiple states have pursued or enacted laws restricting or banning the use of non-competes, and this litigation will not impact those laws.
McGuireWoods will continue to monitor these developments and is ready to assess the effect the litigation and related existing and pending state legislation may have on businesses.