The Federal Trade Commission’s (FTC) rulemaking crusade suffered a serious blow this week, when Judge Ada Brown of the Northern District of Texas set aside the agency’s Final Rule that made most employment-related non-compete agreements unenforceable. The court found that the rule exceeded the FTC’s authority and was arbitrary and capricious. Absent appellate intervention, the decision will prevent the rule from taking effect nationwide.

Although the rule arose from the FTC’s competition mission, the rationale of the decision has larger implications and highlights some of the challenges the FTC faces in its effort to regulate broad swaths of the economy, including as part of its consumer protection efforts.

The Rule

In January 2023, after studying the issue for several years, the FTC announced its first cases challenging non-competes. Days later, the FTC proposed the Non-Compete Rule, justifying the agency’s expertise in the area by citing the recent cases. In April 2024, the FTC adopted the Final Non-Compete Rule, which broadly banned non-compete provisions in employment relationships. The rule was scheduled to take effect on September 4, 2024.

In promulgating the rule, the FTC claimed that Sections 5 and 6(g) of the FTC Act authorized the agency to make rules prohibiting unfair methods of competition. Section 5 permits the FTC to prevent covered entities “from using unfair methods of competition in or affecting commerce and unfair or deceptive acts or practices in or affecting commerce.” Section 6 allows the FTC to promulgate rules and regulations to carry out its mission.

The Challenges

Litigation challenging the rule under the Administrative Procedure Act (APA) quickly ensued in the Northern District of Texas. The plaintiffs alleged that the FTC’s actions in issuing the rule exceeded the agency’s authority, were unconstitutional, and were arbitrary and capricious.

On July 3, 2024, the court granted the plaintiffs’ motion for a preliminary injunction enjoining the FTC from enforcing the rule as to the named plaintiffs. By contrast, in a case brought by different parties, a district court in the Eastern District of Pennsylvania subsequently denied a similar request for an injunction, creating a split.

The parties in the Texas action cross-moved for summary judgment, and this week the court granted the plaintiffs’ motion and denied the FTC’s motion.

The FTC Exceeded Its Authority

Judge Brown began her analysis by quoting the Supreme Court’s recent decision in Loper Bright, noting that the APA serves “as a check upon administrators whose zeal might otherwise have carried them to excesses not contemplated in legislation creating their offices.” She then concluded that Section 6(g) did not authorize the Non-Compete Rule for the following reasons:

• The plain language of Section 6(g) and its placement in the overall statutory scheme (separate from the substantive rulemaking provisions) demonstrated that it permitted the FTC to engage in procedural rulemaking, but not substantive rulemaking
• The lack of any provision creating a penalty or consequence for violating rules issued under Section 6(g) also supports the conclusion that Section 6(g) permits only procedural rulemaking
• Before the Non-Compete Rule, the FTC had not promulgated a substantive rule under Section 6(g) since 1978 and, even before that, had rarely invoked Section 6(g)
• Congress has never affirmatively granted the FTC substantive rulemaking power regarding unfair methods of competition. When Congress added Section 18 to the FTC Act, it provided the FTC with substantive rulemaking authority that was limited to unfair and deceptive acts or practices
• Although Section 18 states that it does not affect the FTC’s authority to prescribe rules or policy statements on unfair competition, that does not affirmatively grant the FTC the authority to issue substantive rules

Based on this analysis, the court concluded that the FTC had exceeded its statutory authority in issuing the Non-Compete Rule.

The Rule Is Arbitrary and Capricious

The court also found that the rule was overbroad without a reasonable basis for that breadth, rendering the rule arbitrary and capricious under the APA. In so finding, the court noted:

• The FTC relied on studies examining the effects of state non-compete policies, but no state had enacted a rule as broad as the FTC’s Non-Compete Rule, and the FTC had failed to provide an evidentiary basis for that breadth
• The FTC ignored the positive benefits of non-compete agreements and the empirical evidence regarding such benefits
• The FTC failed to sufficiently address alternatives to the broad rule

Remedy and Consequences

Pursuant to the APA, the court set aside the rule and ordered that it shall not be enforced or take effect, explicitly stating that the remedy was to apply nationwide.

The decision here is part of a long string of decisions in the Fifth Circuit pushing back against novel or expansive exercises of agency power. The Supreme Court has been sympathetic to some, but not all, of these efforts. This case is likely headed to the Fifth Circuit and then the Supreme Court, absent a change in administration and regulatory approach.

The case is also significant for the rest of the FTC’s rulemaking agenda. To the extent that the FTC was considering other regulations on unfair methods of competition, such regulations seem dead on arrival for now. The court’s criticisms of the FTC’s rulemaking as arbitrary and capricious will also be raised by plaintiffs challenging other FTC rules, including rules touching on consumer protection issues.