Strike One Against the FTC’s Non-Compete Ban

When the Federal Trade Commission (FTC) issued its final rule banning employment non-competes over two months ago, it was widely expected to be struck down in some fashion. The U.S. District Court for the Northern District of Texas has levied the first of those strikes, but it is far from a strikeout for the FTC.

What Issues Did the Court Consider, and How Did It Rule?

As a reminder, at a high level, the final rule bans new non-competes and requires employers to notify employees who don’t qualify as senior executives that their non-competes are no longer enforceable. (Find more detail in our prior article.) The Texas federal court considered the first legal challenge filed against the ban and was initially tasked with deciding whether to enjoin (think “pause enforcement of”) the ban on a preliminary basis. Because the case was in its early stages, the challengers had to meet a high bar to show that they were entitled to an injunction while the case was pending.

The court declared that the challengers cleared this hurdle but only paused enforcement of the ban against some of them. Specifically, the court held that:

• The FTC did not have authority to issue this kind of rule (i.e., that it “lacks substantive rulemaking authority with respect to unfair methods of competition under Section 6(g) [of the FTC Act]”).
• “There is a substantial likelihood the Rule is arbitrary and capricious because it is unreasonably overbroad without a reasonable explanation” that “imposes a one-size-fits-all approach with no end date.”

As one of the first decisions after the fall of Chevron deference (a legal doctrine that courts defer to certain legal interpretations of administrative agencies like the FTC) in Loper Bright Enterprises v. Raimondo, we also received a peek of how courts will use that decision going forward. The Texas federal court cited the Loper Bright opinion (issued by the U.S. Supreme Court only days before this court ruled) in outlining why the text of the FTC Act did not support the FTC having authority to issue a substantive rule regarding “unfair methods of competition” — rejecting the arguments and interpretations of the FTC itself.

The court considered extending this injunction nationwide but declined to do so, determining that it was not “an ‘appropriate circumstance’ that would merit nationwide relief” and was not necessary for the challengers to receive the relief they were entitled to at this preliminary stage. It also did not apply the injunction to the members of the U.S. Chamber of Commerce and other challengers who sought injunctive relief by association.

What Comes Next?

The clock continues to tick toward September 4 — the effective date by which employers must provide the required notice and after which they will be prohibited from entering into new non-competes. In the meantime, things could still change.

The Texas federal court is expected to issue a final order by August 30, and a Pennsylvania federal court is expected to issue a preliminary injunction ruling by the end of July after a hearing scheduled for July 10. Rulings in either or both of those cases may be appealed and lead to a ruling with broader, potentially even nationwide, impact.

How Should Employers React?

As of the time of this article, only the employers who received injunctive relief in this case are protected against enforcement of the FTC’s non-compete ban taking effect September 4. While that could change (as described above), such change is not guaranteed and employers should evaluate their risk tolerance and develop a structured game plan for compliance as September 4 approaches. Perhaps that game plan includes filing legal challenges of their own.

And there may be a difference in how employers evaluate compliance with the ban on new non-competes versus the notice requirement to employees bound by current non-competes. Because of the difficulty in retracting notices if something changes, it may make sense to wait as long as possible before notifying employees that current non-competes will no longer be enforceable.

But as for whether to continue entering new non-competes before September 4, employers should consider the possibility that they may eventually have to inform employees who enter such agreements but don’t qualify as senior executives that their non-competes are unenforceable. With the final rule being just part of a growing tide against non-competes, this looming ban presents another reason for employers to re-evaluate their strategy regarding restrictive covenants and reserve non-competes for the situations where they are most justified (i.e., senior executives).

If you have questions regarding this topic, please contact Fredrikson’s Employment, Labor & Benefits Group.