A federal court in Texas has determined the Federal Trade Commission’s (FTC) final rule prohibiting most noncompete agreements is unlawful, meaning that for now, employers in jurisdictions that permit such agreements can continue to enter into and enforce them with their employees.

In its Aug. 20, 2024 ruling, the court entered a final judgment invalidating the final rule, directing the FTC not to enforce it and otherwise prohibiting the rule from taking effect. The court’s order applies nationwide.

However, this issue is far from final resolution. It is likely that the FTC will appeal the Texas court’s decision to the 5th Circuit. Further, a similar Pennsylvania case, in which the district court reached the opposite conclusion at the preliminary injunction stage, could create a circuit split if upheld by the 3rd Circuit. Such a split would need to be resolved by the U.S. Supreme Court.

It also remains important to ensure compliance with state law, since many prohibit or limit the use of noncompete provisions.

Background

As we explained in a prior alert, in April 2024, the FTC issued a final rule banning virtually all preexisting and future noncompete agreements with limited exceptions. This final rule was immediately challenged by several employers and employer interest groups. One employer, Ryan, LLC, a global tax consulting firm, filed a case against the FTC in the U.S. District Court for the Northern District of Texas challenging the authority of the FTC to issue the final rule under the Administrative Procedures Act (APA) and seeking, among other things, a preliminary injunction.

On July 3, the Texas court granted Ryan’s request for a preliminary injunction, temporarily enjoining the FTC’s final rule until the court issued a final decision on the issue. The preliminary injunction, however, applied only to Ryan and various entities that had intervened in the case, such as the U.S. Chamber of Commerce.

While the Ryan case was pending, another employer, ATS Tree Services, LLC, filed a similar action in the U.S. District Court for the Eastern District of Pennsylvania. ATS also sought a preliminary injunction. However, on July 23, 2024, the Pennsylvania court denied ATS’s request holding that ATS was not entitled to injunctive relief because, among other things, it could not establish irreparable harm should the FTC final rule take effect.

The Texas Court’s August 20 Decision

The Texas court granted summary judgment to Ryan and invalidated the FTC final rule for two reasons. First, the court held that the final rule exceeded the FTC’s authority. The court held that “the text and the structure of the FTC Act reveal [that] the FTC lacks substantive rulemaking authority with respect to unfair methods of competition, under Section 6(g)” which was the basis of the final rule. According to the court, Congress never delegated to the FTC the authority to issue substantive rules (as opposed to procedural rules) concerning methods of unfair competition. As the FTC claimed that the final rule prohibiting noncompetes was necessary to prevent unfair competition, and such rule was substantive, the final rule was beyond the authority of the FTC and therefore invalid.

The court noted that the FTC’s lack of statutory authority was sufficient to invalidate the final rule. Yet, the court went further and held that even if the FTC had the authority to issue the final rule, it would still be invalid because it was arbitrary and capricious. The court noted that the FTC’s “lack of evidence as to why they chose to impose such a sweeping prohibition . . . instead of targeting specific, harmful non-competes, renders the Rule arbitrary and capricious.”

Having concluded that the FTC’s final rule was invalid on two different grounds, the court set the final rule aside nationwide. The court stated that “the APA does not contemplate party-specific relief . . . setting aside agency action under [the APA] has ‘nationwide effect.’”

Surprisingly, the court did not reference two similar actions: one in the U.S. District Court for the Eastern District of Pennsylvania and one in the Middle District of Florida. In the Pennsylvania case, the court denied a preliminary injunction finding that the FTC had legal authority to issue the final rule and that the plaintiff could not establish irreparable harm should the FTC final rule go into effect. In the Florida case, the court granted a preliminary injunction finding that the FTC’s final rule implicated the major questions doctrine.

The Texas court’s decision brings temporary relief to employers, which have been in a holding pattern seeing if the final rule would or would not go into effect.

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