A federal court in Texas struck down the Federal Trade Commission's (FTC) rule banning noncompetes on Aug. 20, holding that the FTC exceeded its statutory authority and that the rule was arbitrary and capricious. Following this decision, employers relying on state-compliant noncompetes to protect key business interests can breathe a collective sigh of relief—the decision applies to all employers nationwide and eliminates the need to comply with the rule, pending any appeals.
The FTC's noncompete rule, first adopted on April 23, 2024, barred employers from entering into noncompetes with workers and required them to rescind existing noncompetes before Sept. 4, 2024. The FTC argued that noncompete clauses are "unfair methods of competition" under Section 5 of the FTC Act and that it had the power to issue the rule pursuant to Section 6(g) of the same act. In further support of its rule, the FTC pointed to studies which concluded that noncompetes stifle innovation and worker mobility.
The FTC rule faced immediate legal challenges after its adoption. Ryan LLC, a tax services and software firm in Dallas, along with the United States Chamber of Commerce and other business groups, filed emergency motions to preliminarily enjoin the FTC from enforcing the rule. These plaintiffs argued that the agency acted beyond the scope of its statutory authority and that the rule was arbitrary and capricious. On July 3, 2024, the court granted these motions and temporarily blocked the rule until it could hear more arguments on the matter. Thereafter, the plaintiffs filed motions to strike down the rule permanently. The FTC filed a counter motion to declare the rule as valid.
The court ultimately sided with the plaintiffs, confirming that the FTC overstepped its authority and that the rule was arbitrary and capricious. The court explained that Section 6(g) of the FTC Act did not expressly grant the agency the authority to promulgate substantive rules regarding unfair methods of competition. The court further noted that agencies must operate within the bounds of authority explicitly granted by Congress. It ruled that the FTC's expansive interpretation of its own rulemaking power was overly broad and unsupported by the statutory text.
The court also held that the FTC's rule lacked a reasonable explanation for its sweeping bans, was arbitrary and capricious, and unlawful under the Administrative Procedure Act (APA). The court determined the FTC relied on inconsistent and flawed empirical evidence to support the rule and failed to consider less onerous and targeted alternatives to the national ban without adequate justification. "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," the court stated in its ruling. The court also noted that the FTC had not considered the benefits of noncompetes, such as protecting trade secrets and encouraging investment into employee training.
Because the court invalidated the ban under the APA, the ruling applies nationally to all American companies. The ruling removes one roadblock for businesses' continued use of state-compliant noncompetes to safeguard valuable business interests. However, the enforceability of such restrictive covenants can vary based on the applicable law in each state.
FTC may appeal this ruling, seeking to defend its rulemaking authority and ability to regulate noncompetes. Employers should continue tracking this matter, as well as other looming threats to noncompetes. For example, last year, the National Labor Relations Board General Counsel took the position that noncompetes violate workers' rights to engage in concerted activities under Section 7 of the National Labor Relations Act. Several states have also passed laws curbing the use of noncompetes. Without question, noncompete law is rapidly evolving and requires vigilant monitoring by businesses to ensure they remain in compliance with all appliable laws.
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