On July 3, 2024, the U.S. District Court for the Northern District of Texas, in a challenge to the validity of the Federal Trade Commission's (the "FTC") new non-compete rule, granted the plaintiffs' motion for a preliminary injunction and stayed the rule's effective date as to the plaintiffs only, concluding that the plaintiffs were likely to succeed in showing that the FTC overstepped its authority when issuing the non-compete rule. Subsequently, on July 23, 2024, in a similar challenge to the rule's validity, the U.S. District Court for the Eastern District of Pennsylvania denied the plaintiff's motion for a preliminary injunction to stay the rule's effective date, concluding that plaintiff was unlikely to succeed in challenging the non-compete rule and that plaintiff had failed to show that it would suffer irreparable harm absent an injunction. Subject to further judicial developments, the non-compete rule remains scheduled to come into effect for all parties other than the plaintiffs in the Texas case on September 4, 2024.
This memorandum addresses, in a question-and-answer format, recent judicial developments involving the FTC's non-compete rule, as well as several nuances and ambiguities employers should keep in mind when assessing employee non-competes and other restrictive covenants in the event the FTC's non-compete rule ultimately comes into effect.
Legal Challenges to the Rule
What is the current status of the legal proceedings?
Following the FTC's issuance of its final non-compete rule (the "Rule") on April 23, 2024,1 multiple lawsuits have been filed challenging the validity of the Rule and seeking a preliminary injunction and stay of the September 4, 2024 effective date (the "Effective Date"). Ryan LLC, a tax services company, filed first in the U.S. District Court for the Northern District of Texas, and the U.S. Chamber of Commerce, along with other pro-business organizations, filed a similar suit a day later in the U.S. District Court for the Eastern District of Texas. The U.S. Chamber case has been stayed, and the plaintiffs have been allowed to intervene in the Ryan case.2 Separately, ATS Tree Services, LLC filed a lawsuit challenging the Rule in the U.S. District Court for the Eastern District of Pennsylvania.3 More recently, Properties of the Villages, Inc., a residential community in Florida, filed another challenge to the Rule in the U.S. District Court for the Middle District of Florida.4 The plaintiffs in these cases generally are asserting that the Rule is invalid because it (i) exceeds the FTC's statutory authority, (ii) is based on an unconstitutional delegation of Congressional authority, and/or (iii) is arbitrary and capricious. The lawsuit filed by Properties of the Villages also alleges that the Rule violates the U.S. Constitution's Commerce Clause, emphasizing that plaintiff's non-competes at issue "only temporarily restrict former Sales Associates from selling homes within a small area in central Florida" and therefore have no impact on interstate commerce.
As noted above, the Northern District of Texas court issued a preliminary injunction in Ryan and stayed the Effective Date as to the plaintiffs only. The court's rationale for limiting the injunction to the plaintiffs was based largely on the fact that the plaintiffs "offered virtually no briefing (or basis) that would support 'universal' or 'nationwide' injunctive relief."
What was the court's reasoning for granting a preliminary injunction in Ryan?
The court granted a preliminary injunction as to the plaintiffs because it concluded that plaintiffs had shown a likelihood of success in demonstrating that: (i) the FTC exceeded its statutory authority under the Federal Trade Commission Act (the "FTC Act") in promulgating the Rule and (ii) the Rule is arbitrary and capricious under the Administrative Procedure Act.
In ruling that the FTC exceeded its statutory authority, the court determined that Section 6(g) of the FTC Act does not empower the FTC to promulgate substantive rules about unfair methods of competition, but is rather limited to "housekeeping rules," i.e., interpretive or procedural rules. The court specifically noted that "the structure and the location of Section 6(g) show that Congress did not explicitly give the [FTC] substantive rulemaking authority under Section 6(g)."
n finding the Rule to be arbitrary and capricious, the court focused on the broad nature of the Rule's ban on non-competes. The court described the Rule as "unreasonably overbroad without a reasonable explanation" and a "one-size-fits-all approach with no end date." The court emphasized that the FTC failed to provide evidence explaining why it chose to impose a "sweeping prohibition," rather than taking a more targeted approach and that the FTC did not sufficiently consider alternative, and less-disruptive, approaches.
Why did the court in Ryan limit the preliminary injunction and only stay the Effective Date as to the named plaintiffs?
While the plaintiffs had sought a nationwide injunction, the court found that the plaintiffs had offered no briefing or basis to support nationwide injunctive relief, and, as it relates to the U.S. Chamber of Commerce, et al. as plaintiff-intervenors, the court emphasized that the "associational standing" argument had not been briefed, and therefore the court could not extend the injunction beyond the plaintiff-intervenors themselves. Since then, however, the parties have provided full briefing on the merits that includes the bases for a nationwide injunction. The court is scheduled to issue a final decision on the merits of the case by August 30, 2024, and it is therefore possible that the court will expand its ruling before the Rule's implementation.
Why did the court in ATS Tree Services deny the plaintiff's motion for a preliminary injunction and refuse to stay the Effective Date?
In sharp contrast to Ryan, the court in ATS Tree Services determined, based on its examination of the text and history of the FTC Act, that Section 6(g) provides the FTC with substantive rulemaking authority over unfair methods of competition. The court found that "the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition." The court further rejected the plaintiff's arguments that the FTC lacked authority to issue the Rule by holding that the FTC is empowered under Section 5 of the FTC Act to "prevent" unfair methods of competition, which 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 a past harm."
As to the plaintiff's constitutional argument, the court held that Congress had articulated an "intelligible principle" to guide the FTC and therefore properly delegated its authority.
Although the plaintiff had initially also challenged the Rule as arbitrary and capricious, it excluded this count from its preliminary injunction motion, and the court therefore did not address that claim at this stage of the proceedings. While the court did not formally address whether the Rule is arbitrary and capricious, it did tip its hand somewhat on this point, e.g., by describing the FTC's research and rule-making process for the Rule as "extensive" and "thorough."
Overview of the FTC's Non-Compete Ban
What does the Rule say about prohibiting non-competes?
The Rule provides that it is an unfair method of competition to enter into (or attempt to enter into), enforce (or attempt to enforce), or represent that a worker is subject to a "non-compete clause," subject to the sale of business and narrow senior executive exceptions discussed below. The Rule defines "non-compete clause" broadly to encompass any term or condition of employment that "prohibits," "penalizes," or "functions to prevent" a worker from seeking or accepting work in the United States that would begin after (or from operating a business after) the conclusion of an employment or service relationship.
As further discussed below, it is clear from the FTC's commentary accompanying the Rule (the "Commentary") that the FTC intends to apply the Rule to arrangements that would not necessarily be viewed as traditional non-competes.
What types of arrangements could be deemed to violate the Rule because they "penalize" workers for competing?
The Commentary specifically identifies forfeiture-for-competition clauses and liquidated damages provisions as terms or conditions of employment that penalize workers for competing if they are triggered by post-employment competition. A worker's voluntary decision not to compete in order to retain compensation earned from a prior employer is irrelevant to the FTC's analysis of the applicability of the Rule, as the FTC only considers that the worker would experience adverse financial consequences as a direct result of competing. Severance contingent on a worker not competing is also provided as an example of a term that "penalizes" post-employment competition. The Commentary does not address severance subject to an off-set against compensation received by a worker from any subsequent employment (rather than being forfeited for competitive employment).
If a non-compete in exchange for severance isn't compliant with the Rule, are "garden leave" arrangements and fixed-term employment contracts permissible?
Yes, BUT it is unclear if "garden leave" arrangements would need to conform precisely to the concept of "garden leave," as discussed in the Commentary. The FTC describes garden leave as an arrangement in which a worker remains employed and continues to receive the same total annual compensation and benefits as they had been receiving (on a pro rata basis), but the worker's access to coworkers and the employer's premises are restricted. This type of arrangement would therefore not be considered a non-compete, because there is no post-employment restriction. The FTC similarly noted that fixed-term employment contracts are arrangements that do not restrict post-employment work.
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Footnotes
1. See our memorandum, dated May 20, 2024, for an overview of the Rule.
2. See Ryan, LLC v. Federal Trade Commission, Case No. 3:24-cv-00986 (N.D. Tex.); Chamber of Commerce of the United States of America, et al. v. Federal Trade Commission, Case No. 6:24-cv-00148 (E.D. Tex.) (Tyler Division). The plaintiff-intervenors consist of the Chamber of Commerce of the United States of America, Business Roundtable, Texas Association of Business and Longview Chamber of Commerce.
3. See ATS Tree Services, LLC v. Federal Trade Commission, et al., Case No. 2:24-cv-01743 (E.D. Pa.).
4. See Properties of the Villages, Inc. v. Federal Trade Commission, Case No. 5:24-cv-000316 (M.D. Fla) (Ocala Division).
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