A Texas federal court has struck down the FTC’s proposed nationwide ban on non-compete agreements, just weeks before it was set to take effect. This decision by the United States District Court for the Northern District of Texas halts the FTC’s Final Rule, which would have required employers across the country to notify their employees by September 4, 2024, that non-compete agreements would become unenforceable.

Legal Challenges Following the FTC’s Final Rule

When the FTC issued the Final Rule this past April 23rd barring most non-compete agreements, the legal challenges were immediate. One of the first was Ryan, LLC v. Federal Trade Commission, filed in the Texas District Court in which the U.S. Chamber of Commerce intervened. The Court preliminarily enjoined the implementation and enforcement of the Final Rule but only as to the parties in the lawsuit. The United States District Court for the Middle District of Florida has recently held similarly.

The focus of the legal challenge was whether the FTC’s rulemaking authority extended to non-compete agreements imposed on employees. Ryan, LLC asserted that the FTC did not have statutory authority, that the FTC’s exercise of power in implementing the Final Rule was unconstitutional, and the FTC’s acts, findings and conclusions supporting the Final Rule were arbitrary and capricious. In its ruling, the Court began with an analysis of the Administrative Procedure Act (APA) which was instituted by Congress in 1946 as a check upon agencies, to avoid excess uses of power not contemplated by the legislation they were directed to implement or enforce. Section 706 of the APA directs that when a court reviews an agency rule it “must hold unlawful and set aside agency action, findings, and conclusions found to be:

• Arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.
• Contrary to constitutional right, power, privilege, or immunity.
• In excess of statutory jurisdiction, authority, or limitations, or short of statutory right.

Ryan argued that the FTC violated all three prohibitions; the Court agreed as to the first and third and pretermitted the second.

The Court’s Ruling

The Court specifically found that the Federal Trade Commission Act granted the FTC the power to prevent unfair methods of competition and to make procedural rules and regulations as “housekeeping methods” to for the purpose of carrying out that power. It did not however authorize substantial rulemaking by the FTC, which is exactly what the FTC did in implementing a rule banning non-compete agreements. As one indicia of the limitation on substantive rulemaking, the Court pointed to the FTC Act’s failure to include any sanction for the violation of rules promulgated by the FTC. The Court found that the lack of any penalty in the Act was further support for the conclusion that the FTC was only granted the power to make housekeeping rules. Notably, the Final Rule contained no penalty for employers who violated the Final Rule. As stated by the Court, “[t]he role of an administrative agency is to do as told by Congress, not to do what the agency thinks it should do.”

The Court further concluded that the Final Rule is “unreasonably overbroad without a reasonable explanation” and “imposes a one-size-fits-all approach with no end date” and therefore “fails to establish a ‘rational connection between the facts found and the choice made.” The FTC’s failure to target specific, harmful non-compete agreements and instead impose a ban so broad, especially in light of what the Court found as the FTC’s flawed empirical evidence and its failure to consider the benefits of non-compete agreements violated the prohibition against arbitrary and capricious action.

Finally, in accordance with the APA which directs a reviewing court to “hold unlawful and set aside agency action” arbitrary and capricious actions and excess uses of statutory jurisdiction, the Court did just that, concluding that setting aside agency action under section 706 had nationwide effect and is not party restricted.

Implications for Employers

For now, the Final Rule has been rendered impotent and will not take effect on September 4, 2024. However, The U.S. District Court for the Eastern District of Pennsylvania issued a decision finding that the FTC does have the authority to impose a ban on non-compete agreements. The conflict among these courts virtually guarantees that the matter will be further scrutinized by Courts of Appeal, and eventually, by the United States Supreme Court.  We will continue to report to you about this matter.