Earlier this year, we wrote a couple of blog posts[1] on the Federal Trade Commission (“FTC”) issuing its Non-Compete Clause Rule (“Final Rule”) which is meant to prohibit non-competition agreements nationwide.[2] Non-competition agreements (“non-competes”) generally are provisions in contracts whereby an employee agrees not to enter into competition with an employer after their employment period with that employer is over. This “competition” could be taking a similar role with a competing company or starting their own company or venture that would compete with the work of their former employer. The FTC’s Final Rule was supposed to make any such non-competes unlawful, effective as of September 4, 2024, and require employers to notify existing employees of the ineffectiveness of any existing non-competes. However, since the Final Rule was issued, it has been challenged with various lawsuits in federal courts by plaintiffs seeking to invalidate the Final Rule. Importantly, one federal district court in Texas recently struck down the Final Rule on a nationwide basis. This blog post will briefly discuss this ruling and the effects.

Ryan LLC v. Federal Trade Commission

Shortly after the Final Rule was issued in April 2024, Ryan LLC, a tax service firm in Dallas, Texas (along with the U.S. Chamber of Commerce, and a handful of other business organizations) sued to challenge the Final Rule in the United States District Court for the Northern District of Texas, questioning whether the FTC had the authority to issue the Final Rule.[3] As part of its suit, the plaintiff filed a motion ahead of the final ruling to stay the effective date of the Final Rule by requesting a preliminary injunction against the FTC. On July 3, 2024, the U.S. district court judge granted the motion for preliminary injunction and postponed the effective date of the Final Rule, as it applied to the plaintiffs in the Ryan case, noting she would rule on the Final Rule as it applied nationwide before September. On Tuesday, August 20, 2024, the judge issued her final ruling, which invalidated the Final Rule on a nationwide basis.[4]

In its final ruling, the U.S. district court focused on two points when invalidating the Final Rule: (i) that the FTC lacked statutory authority to promulgate the Final Rule, and (ii) that the Final Rule should be set aside because it is arbitrary and capricious. First, the court concluded the FTC lacked substantive rulemaking authority under the FTC Act with respect to unfair methods of competition, and thus exceeded its statutory authority when decreeing the Final Rule.[5] The court reasoned the FTC Act only gives the FTC the power to issue procedural rules to address unfair methods of competition, not substantive rules, which would otherwise be the purview of Congress. Therefore, substantive rules like the Final Rule are for Congress to enact, not the FTC.

Second, to invalidate the Final Rule itself, the court had to determine whether the Final Rule is “arbitrary and capricious,”[6] a federal standard used for determining whether an administrative agency’s action is unlawful. When reasoning the Final Rule is arbitrary and capricious, the judge found that the Final Rule is unreasonably overbroad without a reasonable explanation, would impose a one-size-fits-all approach on non-competes with no end date, would have been broader than any individual state’s existing non-compete laws, and did not target specific, harmful non-competes.[7] The judge also noted that when promulgating  the Final Rule, the FTC failed to consider the positive benefits of non-competes and the potential alternatives to a nationwide ban.[8] Accordingly, the court found the FTC’s promulgation of the Final Rule unlawful because, as an act of the agency, it was arbitrary and capricious. The court and sided with the plaintiffs to invalidate the Final Rule on a nationwide basis.[9]

We discuss these decision points because they could be relevant as the Final Rule continues to be litigated in federal courts. While this U.S. District Court for the Northern District of Texas ruled on the Final Rule and effectively defeated it nationwide for the time being, the FTC will likely appeal this ruling and could potentially achieve a different outcome in the Fifth Circuit Court of Appeals (the appellate court that would hear an appeal from the Northern District of Texas) or with the U.S. Supreme Court, either of which could reverse this ruling. Further, and as noted in our previous blog posts, the Final Rule is still being litigated (can could be further litigated) in other federal courts around the country. If any other such federal cases result in a circuit split – different federal courts across the country ruling differently on the issues of the FTC’s rulemaking authority and whether the action is arbitrary and capricious – then the Final Rule’s effectiveness could be interpreted differently across the country. At that point, it would be very appropriate for the U.S. Supreme Court to rule on the Final Rule. However, the ruling from the U.S. District Court for the Northern District of Texas is the only federal ruling striking down the Final Rule on a nationwide basis, and therefore invalidates the Final Rule for the time being.

Practical Guidance

Even though there are still some unknowns, the current state of the Final Rule is that it is invalidated on a nationwide basis. Therefore, employers remain in the status quo that existed before the Final Rule was issued by the FTC in April; state-specific restrictions will govern whether a non-compete is valid. Employers should review the state-specific laws that apply to any non-competes they have with their employees and determine whether they are allowed or prohibited. Further, employers do not have to notify employees of the ineffectiveness of their non-competes as they otherwise would have been required to under the Final Rule. Until the Final Rule is validated, no notice is necessary.

 

 

[1]  Update: Federal Court Challenges to Federal Trade Commission Final Rule Banning Non-Competition Agreements  and Federal Trade Commission Issues Final Rule Banning Non-competition Agreements .

[2] FTC Announces Rule Banning Noncompetes, Federal Trade Commission, available at: https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes.

[3] Ryan LLC v. Federal Trade Commission, Civil Action No. 3:24-CV-00986-E.

[4] Id.

[5] Id. at 22.

[6] Id. (citing 5 U.S.C. § 706(2)(A)).

[7] See Id. at 23-25.

[8] See Id. at 24-26.

[9] See Id. at 26-27.