In a massive setback for the FTC’s efforts to ban non-competition covenants nationwide, on August 20, 2024, the U.S. District Court for the Northern District of Texas held that the agency’s Non-Compete Rule (the “Rule”) is unlawful and must be “set aside.” Accordingly, businesses can take a breath after having prepared for the Rule to come into effect on September 4th, 2024.
Background
As BFKN has reported previously, on January 5, 2023, the FTC issued a Notice of Proposed Rulemaking seeking public comment on its proposed rule to ban nearly all non-competition covenants as “unfair method[s] of competition” under Section 5 of the FTC Act.
Over a year later, on April 23, 2024, the FTC issued the final version of the Rule which largely followed the proposed rule in banning nearly all non-competition covenants going forward, and voiding nearly all pre-existing non-competition covenants. The Rule was ultimately scheduled to come into effect on September 4, 2024.
Litigation followed immediately after the FTC published the Rule, including one suit filed the same day by Ryan, LLC (“Ryan”), a Texas-based tax advisory firm. The U.S. Chamber of Commerce (the “Chamber”) and a handful of other business groups ultimately intervened as Plaintiffs in that case and, on July 19, 2024, Ryan, the Chamber, and the other Plaintiff-Intervenors filed motions for summary judgment asking the court to hold the rule unlawful.
The Challengers’ Motion for Summary Judgment & the Court’s Decision
The challengers’ motions for summary judgment raised several substantive objections to the Rule. First, they argued that the FTC did not have statutory authority under the FTC Act to issue the Rule. Second, they argued that, even if the FTC Act did authorize the FTC to issue the Rule, then to that extent the FTC Act is unconstitutional under the doctrine of nondelegation, which, as commonly understood, limits Congress’s ability to give its vested legislative powers to other entities. Third, they argued that the FTC acted arbitrarily and capriciously in promulgating the Rule, and so violated the Administrative Procedure Act. Fourth, they argued that the FTC itself is unconstitutional (and so has no authority to issue any rules at all).
Ultimately, the court declined to rule on most of the challengers’ arguments, but held that the FTC did not have statutory authority under the FTC Act to issue the Rule, and held that the FTC had acted arbitrarily and capriciously in promulgating the Rule.
Importantly, the court frequently invoked the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024), in which the Court overruled its 1984 decision in Chevron v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984). Chevron had required courts to generally defer to agencies’ interpretations of their own operative statutes. The Northern District of Texas’ decision here may be one of the most significant early results of the Supreme Court’s Loper Bright decision to do-away with Chevron’s deferential approach to agency decisions.
The FTC’s (Lack of) Statutory Authority
Section 5 of the FTC Act provides that “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful.” 15 U.S.C. § 45.
The FTC argued that the Rule was authorized by virtue of the agency’s authority under Section 6(g) and/or Section 18 of the FTC Act (15 U.S.C. §§ 46(g), 57a). The court rejected both arguments, however, holding that neither section authorized the FTC to issue “substantive” rules regarding “unfair methods of competition” (as opposed to substantive rules regarding “unfair or deceptive acts or practices” which are authorized under Section 18(a)(1)(B)).
Accordingly, the court concluded that the FTC had no authority to issue the Rule classifying non-competition covenants an “unfair method of competition.”
The FTC Acted Arbitrarily & Capriciously
The court also held that the FTC had acted arbitrarily and capriciously when issuing the Rule because the Rule “is unreasonably overbroad without a reasonable explanation.” In particular, the court highlighted an absence of empirical evidence supporting the imposition of “such a sweeping prohibition” compared to “targeting specific, harmful non-competes.” The court also concluded that the FTC had failed “to consider the positive benefits of non-compete agreements” and had disregarded a “substantial body of evidence supporting these agreements.”
Similarly, the court held that the FTC had “failed to sufficiently address alternatives to issuing the Rule” such as issuing a narrower rule or conducting “case-by-case adjudication of the enforceability of non-competes.”
Having concluded that the Rule is unlawful, the Court held that it must be “set aside” under the Administrative Procedure Act, and prohibited the FTC from enforcing the Rule against any person or entity.
Takeaways
Businesses can take a breath—for now—and set down their preparations for the September 4 effective date of the Rule. However, the FTC is highly likely to appeal the ruling to the U.S. Court of Appeals for the Fifth Circuit and, however the Fifth Circuit comes down, the losing side is likely to appeal to the U.S. Supreme Court. It is likely, then, that the Northern District of Texas will not have the last word on the Rule.
In addition, the upcoming Presidential elections may have a significant impact on next steps. A Trump administration is likely to withdraw the Rule completely and moot any legal challenges. By contrast, a Harris administration may elect to withdraw the rule and issue a replacement rule in an attempt to avoid the challengers’ arguments.
Regardless, the story of the Rule is likely not over yet and businesses should stay alert.
