In a significant and sweeping move, the Federal Trade Commission (FTC) adopted a rule in April 2024, the "Non-Compete Rule," effectively banning the use of all non-compete clauses for many workers starting on September 4, 2024. The rule is embroiled in a battle between two U.S. District Courts. The Northern District Court of Texas granted a motion for preliminary injunction preventing the FTC from moving forward with the rule, but only for plaintiffs of that case while the Eastern District Court of Pennsylvania recently denied a plaintiff's motion for preliminary injunctive relief. The recent rulings guarantee continued uncertainty regarding the future of non-compete clauses. It is important that employers understand what to expect in anticipation of the rule becoming effective and are aware of the rationale articulated in each court.
The FTC's Ban on Non-Competes
The FTC's Non-Compete Rule prohibits employers from entering into (or attempting to enter into), non-compete clauses with workers starting on the rule's compliance date, currently set for September 4, 2024, and requires employers to rescind existing non-compete clauses no later than that same date with notification to current and former employees. The Non-Compete Rule defines a "non-compete clause" as 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 a term or condition." 16 C.F.R Section 910.1(1)(i)-(ii).
Texas Court Issues Limited Injunction Against FTC Ban
Several groups, including the United States Chamber of Commerce and other Texas businesses filed an action in the United States District Court for the Northern District of Texas seeking injunctive relief to block the Non-Compete Rule from going into effect (Ryan LLC, et al. v. FTC). In support of the rule, the FTC argued that non-compete clauses are "unfair methods of competition" in violation of Section 5 of the Federal Trade Commission Act (the "Act"), and that the FTC has the requisite rulemaking authority to issue the rule pursuant to Section 6(g) of the Act, which authorizes the FTC "to make rules and regulations for the purpose of carrying out the provisions of [the Act]." The Texas Court was not persuaded by the FTC's argument and granted the plaintiff's motion for preliminary injunction, but applicable only to the plaintiff. The Court's analysis offers a glimpse into a possible final disposition in the matter.
The Court held that the plaintiff's action has a likelihood of success holding that the "FTC lacks substantive rulemaking authority with respect to unfair methods of competition, under Section 6(g)," concluding that the FTC "exceeded its statutory authority in promulgating the Non-Compete Rule." Specifically, the Court reasoned that although Section 6(g) grants the FTC some rulemaking power with respect to methods of competition, Section 6(g) is a "housekeeping statute," authorizing the FTC to adopt rules of "organization procedure or practice, as opposed to substantive rules." The Court highlighted the lack of statutory penalty in Section 6(g), as compared to Section 5 to support its finding relative to Section 6(g).
The Court recognized the D.C. Circuit Court's holding in National Petroleum Refiners v. FTC, 482 F.2d 672, 673 (D.C. Circuit, 1973), declaring that Section 6(g) should be construed to permit the FTC to promulgate substantive rules. However, the Texas Court reasoned that the FTC had not enacted a single substantive rule under Section 6(g) from 1978 until the enactment of the Non-Compete Rule and refused to follow this holding.
The Texas Court also determined that there is a substantial likelihood that the Non-Compete Rule is "arbitrary and capricious stating that the rule is "unreasonably overbroad without a reasonable explanation," and "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." For instance, the Court highlights the FTC's review of specific factual scenarios involving non-competes occurring across different states as a basis to support a wide sweeping, categorical ban of virtually all non-competes. The Court's analysis suggests that a narrowly tailored approach targeting "specific, harmful non-competes" would be more appropriate. The Court was also critical of the FTC for not considering some of the positive benefits of non-compete clauses and the FTC's failure to consider an alternative, less disruptive approach.
Pennsylvania Court Declines to Block FTC Ban
More recently, the Eastern District of Pennsylvania in ATS Tree Services v. FTC issued a ruling on a plaintiff's motion for preliminary injunction to bar the Non-Compete Rule from going into effect. Like the case in the Northern District of Texas, the FTC argued that the Act authorized the FTC to make substantive rules to prevent unfair competition. However, unlike the Texas court, the motion was denied finding that the plaintiff was unable to show "that there is a reasonable probability that the FTC lacked authority under the Act to issue the final rule, or that Congress's delegation of such authority under the [Act] was unconstitutional."
The Court's analysis supporting this holding sharply disagreed in almost all respects with the ruling issued in Ryan. Both Sections 5 and 6 were found to empower the FTC "to make both procedural and substantive rules as is necessary to prevent unfair methods of competition," and that "the plaint text of the [Act] provides not express limitations on the FTC's rulemaking authority..." In fact,the ATS Tree Service ruling interpreted the Act to mandate the FTC to take steps to prevent unfair competition before it occurs. Importantly, the Court declared that Congress intended to provide broad and flexible authority to the FTC in preventing unfair methods of competition such that a complete ban on all non-competes is within the agency's authority ("Court finds the FTC acted within its authority under the Act in designating all non-compete clauses as unfair methods of competition" (emphasis added)). In a direct clash with the rationale in Ryan, the ATS Tree Services Court found that the FTC had "determined through extensive and thorough research and rule-making process...that non-compete clauses are not justified by legitimate business purposes."
The Court also stated that had Congress intended for the Act to provide the FTC with only procedural rulemaking authority, Congress would have amended the Act to reflect this authority in its 1975 amendment, following the D.C. Circuit's holding in National Petroleum.
The Uncertain Road Ahead for Employers
These rulings further highlight the conflicting viewpoints regarding non-compete clauses and offer no resolution to the legality of the Federal Trade Commission's Non-Compete Rule moving forward. If allowed to take effect on September 4th, the Non-Compete Rule will create a national ban for non-compete clauses forcing many employers to adjust to a new reality. However, there are several events that are likely to take place prior to September 4th that could impact the enforceability of the Non-Compete Rule. First, in Ryan, the plaintiffs have filed a motion for summary judgment. Based on the Texas Court's analysis granting limited preliminary injunctive relief, it is anticipated the court will grant the plaintiff's motion for summary judgment staying the Non-Compete Rule and providing permanent injunctive relief to businesses nationwide. The ruling on this motion is scheduled to be issued no later than August 30, 2024. Of course, an appeal in either Ryan or ATS Tree Services could proceed prior to September 4th seeking emergency relief from the circuit courts. Lastly, yet another challenge of the Non-Compete Rule was filed in a Florida court, Properties of the Villages, Inc. v. FTC, in which the plaintiff has also sought a stay and preliminary injunction of the rule pending a final disposition. It is expected that the court will rule on the plaintiff's motion prior to September 4th as well.
At this point, however, because there is no nationwide injunction in place, the best practice for employers is to begin to prepare for the Non-Compete Rule to take effect on September 4th. Employers are highly encouraged to review all employment-related documents for the existence of non-compete clauses and secondly, to prepare to notify covered workers of the FTC's ban and rescission of said clauses should they exist. Under the Non-Compete Rule, for each worker that has entered into a non-compete clause, employers have an affirmative obligation to provide "clear and conspicuous" notice to the worker by the rule's effective date that the non-compete clause will not be, and cannot legally be, enforced. The FTC has provided model language for employers, which we encourage employers to review.
We will continue to monitor the Non-Compete Rule and all potential outcomes as they develop.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.