Challenges to the FTC’s Non-Compete Clause Rule Will Likely Prevent The Rule from Taking Effect

Many clients have been reaching out with questions about reviewing and updating their employment agreements and removing non-compete provisions after the Federal Trade Commission (FTC) issued the Non-Compete Clause Rule (the “Final Rule”) earlier this year. However, taking such action might be premature as a Texas Federal Court issued an order on July 3, 2024, preventing the FTC from implementing and enforcing the Final Rule as to the parties in that suit, signaling trouble for the FTC’s full implementation of the Final Rule.

On April 23, 2024, the FTC, by a 3-2 vote, issued the Final Rule which would make it a violation of Section 5 of the FTC Act for businesses to enter into non-compete clauses with their employees stating it is an unfair method of competition. Under the Final Rule, existing non-compete clauses—with exceptions for existing non-competes with senior executives—would be unenforceable. Going forward, the Final Rule would prohibit all non-compete agreements, even those with senior executives. Set to go into effect on September 04, 2024, the Final Rule has raised major concerns from various business interests.

Indeed, within hours of issuing the Final Rule, the FTC faced the first in a series of lawsuits challenging its authority to promulgate the Final Rule. The first lawsuit was filed by Ryan, LLC (Ryan) a global tax services firm owned and operated by principal-shareholders who are sought after tax experts.[1] Ryan alleged the FTC had no statutory authority under the Administrative Procedure Act, 5. U.S.C. §706(2)(c) to issue substantive rules and, in the alternative, if Congress did grant the FTC this authority, it was an unconstitutional delegation of legislative power in violation of Article I of the United States Constitution.[2] Further, Ryan directly challenged the constitutionality of the FTC Act claiming it violated Article II of the Constitution because the executive branch did not have removal power over FTC’s Commissioners.[3] Ryan sought declaratory judgment that: (i) the Final Rule violated the Administrative Procedure Act; (ii)Section 5 of the FTC Act violated the Constitution’s nondelegation doctrine; and (iii) the FTC is unconstitutionally structured.[4]

By April 25, 2024, two more lawsuits were filed against the FTC by ATS Tree Services (ATS)[5] and by the Chamber of Commerce of the United States of America, Business Roundtable, Texas Association of Business, and the Longview Chamber of Commerce (USCC).[6] ATS is a tree service company based in Pennsylvania that uses non-compete agreements with its employees. The ATS lawsuit raised substantially similar arguments to the Ryan lawsuit adding a claim that the FTC acted arbitrary and capricious in rendering existing non-compete agreement for non-senior executives unenforceable.

USCC also raised substantially similar claims but added counts that: (i) FTC’s promulgation of the Final Rule was unlawful because the FTC did not have authority to issue binding regulations related to unfair methods of competition;(ii) the FTC exceeded their authority under section 5 of the FTC Act; and (iii) the FTC lacked authority to issue retroactive regulations.[7] Further, USCC claimed the FTC acted arbitrary and capricious by failing to engage in reasoned decision-making by relying on a flawed cost-benefit analysis and failed to consider alternative proposals.[8] Because the Ryan litigation was filed first, the FTC filed a motion to apply the first-to-file doctrine and stayed the USCC litigation—and the court ultimately dismissed the USCC litigation—allowing USCC to intervene as a plaintiff in the Ryan litigation.

These lawsuits summarize the history of the FTC as it relates to promulgating rules against unfair methods of competition, the economic impact of the Final Rule, and the context that led to the issuance of the Final Rule. For example, the lawsuits note the longstanding state regulation of non-compete agreements, the history of the congressional debates surrounding non-compete clauses and previous failures of the FTC to regulate non-compete agreements. Further, the lawsuits claim the consequences of the Final Rule will be in the billions of dollars and affect millions of employers and employees. Finally, the lawsuits note the origins of the Final Rule in executive orders by President Biden and the record surrounding its issuance.

These lawsuits are currently pending with the most significant and imminent challenge to the September 04, 2024, implementation of the Final Rule occurring in the Ryan litigation. There, on May 01, 2024, Ryan filed a motion to stay the effective date of the Final Rule and a preliminary injunction to not enforce the Final Rule. On July 03, 2024—after over sixty amici interests weighed in on the issue— the Northern District of Texas granted the plaintiffs’ motion finding: (i) the plaintiffs were substantially likely to prevail on the merits of their challenge to the FTC; (ii) plaintiffs will suffer irreparable harm if no preliminary injunction is issued; (iii) the balance of harms favors the Plaintiffs; and (iv) the public interest favors issuance of a preliminary injunction.  Importantly, this decision only prevents the FTC from implementing or enforcing the Final Rule as to the plaintiffs in the Ryan litigation, until the Court’s decision on the merits. The Court expressed its intent to enter a decision on the merits by August 30, 2024- a ruling that could have broader implications on the FTC’s authority related to the Final Rule.

With relief granted to the plaintiffs, the FTC will need to appeal to the pro-business Fifth Circuit Court of Appeals, who will likely affirm the decision. Likewise, the court in the ATS litigation is expected to rule on a similar motion by July 23, 2024, with an appeal going to the Third Circuit. Further appeals would go to a United States Supreme Court—in its current form—that is looking to roll back agency power. In fact, on June 28, 2024, the U.S. Supreme Court issued a decision reversing its long-standing precedent in Chevron USA, Inc., v. Natural Resources Defense Council, which required courts revising federal agency actions to afford significant deference to them.[9] Among the rules likely to be impacted by this decision is the FTC’s Final Rule on non-competes. Thus, it is highly likely that the FTC will not be able to justify its power to implement the Final Rule on the merits and it may not go into effect.

For now, it is recommended that employers should take a wait-and-see approach before changing any current policy or procedures and stay attuned to any further updates.

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[1] Ryan, LLC, v. Fed. Trade Comm’n, No. 3:24-cv-986 (N.D. Tex. April 23, 2024).
[2] Id. at ¶¶ 51-63.
[3] Id. at ¶¶ 64-68.
[4] Id.at ¶¶ 72-74.
[5] ATS Tree Servs., LLC v. Fed. Trade Comm’n, et al., Case 2:24-cv-01743 (E.D. Pa. Apr. 25, 2024).
[6] Chamber of Commerce of the United States of America, Business Roundtable, Texas Association of Business, and Longview Chamber of Commerce v. Fed. Trade Comm’n, and Lina Khan, Case 6:24-cv-00148 (E.D. Tex. Apr. 24, 2024).
[7] Id. at ¶¶ 88-97, 102-106.
[8] Id. at ¶¶ 107-120.
[9] Loper Bright Enterprises, et al. v. Raimondo, et al. (No. 22-451) (decided June 28, 2024) (overturning Chevron,  467 U.S. 837 (1984)