On July 3, 2024, the Federal District Court in the Northern District of Texas granted a preliminary injunction staying an FTC rule banning essentially all post-termination non-compete agreements (the “FTC rule” or the “rule”). (See here for Freshfields’ initial analysis of the rule).
The court imposed the injunction, which applies only to the plaintiffs in this case, following a challenge to the FTC rule filed with the court immediately after the rule was issued in April 2024. The challenge was filed by Ryan, LLC, a global tax services and software provider, and subsequently was joined by multiple intervenors, including the Chamber of Commerce. The plaintiffs challenged the FTC’s authority to issue the rule, the administrative process employed to craft the rule, and the constitutionality of the FTC’s structure itself.
The court based its ruling on a straightforward preliminary injunction analysis. In discussing the first prong of that analysis, the court concluded that the plaintiffs' challenge is likely to succeed on the merits because the FTC does not have authority to issue substantive rules regarding the "unfair methods of competition" provision of its statute, and in any event, the rule itself is arbitrary and capricious.
The FTC’s Authority to Issue Substantive Rules
First, the court considered whether the FTC exceeded its delegated power under the FTC Act when it issued the rule. Section 5 of the FTC Act affords the FTC with the authority to regulate “unfair methods of competition in or affecting commerce,” and Section 6(g) further provides the FTC may “[f]rom time to time classify corporations and . . . make rules and regulations for the purpose of carrying out the provisions” of the FTC Act, 15 U.S.C. § 46(g). Section 6(g), the FTC argues, allows it to issue rules to implement the prohibition on ”unfair methods of competition” contained in Section 5.
The court’s analysis focused on whether Section 6(g) permits the FTC to issue certain substantive (i.e., regarding enforcement), as opposed to procedural, rules. The court analyzed the proper interpretation of the rulemaking authority vested in the FTC by Section 6(g), including the “text, structure, and history of” the FTC Act. The court concluded that the text of Section 6(g) on its face does not provide the FTC with authority to issue substantive rules. Relying on precedent, the court reasoned that Section 6(g) is instead a “housekeeping statute” that authorizes merely “rules of agency organization procedure or practice.” The court noted that this reading is supported by the absence of statutory penalties for failure to conform to regulations issued pursuant to Section 6(g), which Congress historically has included in statutes that grant enforcement power. The court further reasoned that subsequent Congressional actions to vest the FTC with substantive rulemaking, including the Magnuson-Moss Act, 15 U.S.C. § 57a, which authorizes substantive rulemaking for other portions of Section 5, notably omitted authorization of substantive rulemaking related to the FTC’s regulation of unfair methods of competition. The court concluded that these omissions reflect both Congress’s initial intent to limit the FTC’s authority with Section 6(g) and the continued limitations placed on the FTC in its use of substantive rulemaking to regulate unfair methods of competition.
The court referenced the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, where the Supreme Court held that “courts need not and under the [Administrative Procedure Act (APA)] may not defer to an agency interpretation of the law simply because a statute is ambiguous.” No. 22-1219, 2024 WL 3208360, at *14, *35 (U.S. June 28, 2024). While the court here did not rely on Loper Bright, the decision significantly reduces the deference that must be paid by the court to the FTC’s interpretation of its statutory authority. While the court welcomed additional arguments regarding statutory interpretation, Loper Bright indicates the court’s reasoning likely will carry through to its final decision.
The FTC Rule Likely Violates the Requirements of the APA
The court also addressed whether the FTC’s rule complied with the requirements of the APA – i.e., whether the FTC’s rule is arbitrary and capricious. The APA imposes requirements on federal agencies when promulgating and adopting rules, including the FTC rule at issue. In relevant part, the APA permits courts to “hold unlawful and set aside agency action findings and conclusions found to be . . . arbitrary and capricious[.]” 5 U.S.C. § 706(2)(A). Though the APA provides some deference to agency decision making, this standard imposes a requirement that rules be “reasonable and reasonably explained.” To meet this standard an agency must show, among other considerations, it has not “failed to consider an important aspect of the problem [or] offered an explanation for its decision that runs counter to the evidence before the agency[.]”
The court’s analysis focuses on the “basis articulated by the agency itself.” Here, the court considered whether the FTC provided sufficient support for its rule and properly considered less expansive alternatives. The court found that the FTC relied only on “a handful” of studies examining the economic effects of less expansive state non-compete policies, which amounted to reliance on “inconsistent and flawed empirical evidence.” The court also found that the FTC did not consider either evidence showing the potential benefits of non-compete agreements or less expansive alternatives, such as rules more tailored to individual circumstances, and the FTC provided no evidence or reasoned basis for imposing a categorical ban. Finally, the court noted that the FTC failed to assess whether there were significant reliance interests implicated by the rule and did not weigh those interests against its policy. The court’s view of the FTC’s failed process and reasoning led the court to hold that the plaintiffs are likely to succeed on the merits in arguing the rule is arbitrary and capricious in violation of the APA.
Scope of Preliminary Injunction
The court declined to issue a nationwide injunction, instead granting the preliminary injunction as applied to the plaintiffs in the case only. Moreover, because the plaintiffs did not brief associational standing, not even the members of the plaintiff associations (e.g., members of the Chamber of Commerce) will receive the benefits of the preliminary injunction. These limitations carry little import, however, since the FTC’s rule will not take effect until September 4, 2024, after the court issues its final opinion on the merits.
Takeaways
The FTC’s final rule imposing a ban on essentially all non-competes is now subject to a preliminary injunction, applicable only to the plaintiffs in the case, pending the court’s ruling on the merits. That decision is expected to issue by August 30, 2024.
- The court’s analysis in this order likely foreshadows the opinion on the merits it will issue later this summer. That ruling will almost certainly be appealed to the Fifth Circuit.
- Even if the FTC’s final rule banning non-competes is invalidated, we anticipate a continued focus on non-compete agreements between employers and employees. Congress and various state legislatures are considering bills on the topic.
- Moreover, the FTC will retain its ability to challenge individual agreements as unlawful under Section 5. We expect the FTC to continue challenging non-competes on an ad-hoc basis, consistent with its recent challenges to several companies that had entered into non-compete clauses with their employees.
- Given this continued focus on non-competes at both the federal and state levels, it would be prudent for employers to review their non-compete agreements with employees and ensure that those agreements would be deemed reasonable under traditional standards.
Freshfields will continue to monitor developments related to the FTC’s final rule and is available to advise regarding both the implications of the rule and the broader landscape regarding non-competes. Please reach out to a member of the Freshfields Antitrust or People and Reward teams with any questions.
