The Federal Trade Commission (FTC) issued a final rule on April 23, 2024, that would ban most employer-employee non-compete agreements. That same day, a challenge to the rule was filed in the U.S. District Court for the Northern District of Texas. The U.S. Chamber of Commerce and other business groups filed a second challenge the following day, which was later consolidated with the initial challenge. Other challenges to the rule have been filed elsewhere.

The Texas district court provided an initial ruling in response to the named plaintiffs’ challenge to the rule on July 3, 2024. The court held that the FTC likely lacked “substantive rulemaking authority” to issue the rule banning most non-competes and that the rule likely was “arbitrary and capricious” under the Administrative Procedure Act (APA). The court enjoined the FTC from enforcing the rule against the specific named plaintiffs in that case, and only those entities, while the litigation proceeds. The court expressly held that the members of the U.S. Chamber of Commerce (and the other organizational plaintiffs that had joined the case) would not benefit from the court’s preliminary ruling at this point. A ruling on the ultimate merits question is expected by Aug. 30, 2024, before the rule’s Sept. 4, 2024, effective date.   

The Court’s Ruling

The parties challenging the rule asked the Texas district court to preliminarily enjoin the FTC from enforcing the rule and to permanently vacate the rule. The court’s July 3, 2024, decision only concerned the first of these requests — whether the court would preliminarily enjoin the FTC from enforcing the rule while the ultimate merits questions is being litigated. The court’s July 3, 2024, opinion did not explicitly address the ultimate merits question — i.e., whether the rule will ultimately be vacated — although its opinion strongly suggests the court’s views on the legality of the rule.

The challengers raised a series of arguments against the rule, asserting: (1) the FTC lacks statutory authority under the FTC Act to issue rules defining unfair methods of competition; (2) the FTC Act is unconstitutional if it is read to include authority to issue rules defining unfair methods of competition; (3) the rule is arbitrary and capricious and thus violates the APA; and (4) more generally, the FTC’s structure is unconstitutional. As McGuireWoods has previously noted, many of these arguments had been widely anticipated, including by former FTC Commissioners. 

The court did not reach all these arguments in its opinion. It concluded that the challengers were likely to succeed on the merits based on two conclusions: (1) the FTC lacked statutory authority to issue the rule under the FTC Act, and (2) the rule was “arbitrary and capricious” under the APA.

On the first point, the court examined “the text, structure, and history of the FTC Act” before concluding the relevant provisions do “not expressly grant the Commission authority to promulgate substantive rules regarding unfair methods of competition.” Accordingly, the court concluded that the FTC “exceeded its statutory authority in promulgating the Non-Compete Rule.”

The court also identified an alternative independent basis that demonstrated the challengers were likely to succeed on the merits. It concluded “there is a substantial likelihood the Rule is arbitrary and capricious because it is unreasonably overbroad without a reasonable explanation.” In particular, the court criticized “the evidence put forth by the Commission” as being insufficient to support the ban on almost all non-competes. The court also criticized the FTC for failing to adequately consider alternatives to the rule.

After holding that the challengers were likely to succeed on the merits, the court also held that the challengers satisfied the remaining requirements for entry of preliminary relief.

The Scope of the Ruling

Critically, the court limited the scope of its ruling in important ways. The court’s ruling is only preliminary. It could reverse course and ultimately uphold the rule as lawful in its final decision, although that seems unlikely based on the reasoning in its July 3, 2024, opinion. The court indicated that it expects to issue its final decision by Aug. 30, 2024 — shortly before the rule’s Sept. 4, 2024, effective date.

More importantly, the court emphasized that its opinion only prevented the FTC from enforcing the rule against the specific plaintiffs that brought this challenge. It also refused to apply its ruling to the members of the U.S. Chamber of Commerce and the other intervenor business groups. By its terms, the ruling only applies to the five named entities that brought (or intervened in) the challenge. The current Sept. 4, 2024, effective date remains in place for all other entities subject to the rule.

Where Does This Leave Other Companies?

There are several paths whereby the court’s ruling could nevertheless be applied to other companies that remain subject to the rule. 

First, the challengers in the case have sought vacatur of the rule. The Fifth Circuit has held that vacatur is the “default” remedy for agency actions that are held to be unlawful under the APA, and such a remedy would typically apply universally — i.e., to prevent the FTC from enforcing the rule against non-parties to the litigation. Although the Texas district court held that the challengers had not demonstrated a need for the preliminary injunction to be universal, it may well conclude that the final judgment should follow the Fifth Circuit’s universal vacatur default rule.

Second, there are other challenges to the rule pending in other courts throughout the country. It is possible that one of these courts could enter a preliminary injunction preventing the FTC from enforcing the rule more broadly.

Third, other companies could take proactive steps to gain the benefit of the court’s ruling. The court’s opinion held that the U.S. Chamber and other business groups had not demonstrated associational standing such that the rule would be applied to their members. These business groups may attempt to make that showing with additional briefing or evidence. If they succeed in establishing associational standing, companies that are not parties to the Texas district court litigation could potentially gain the benefit of the ruling by becoming members of one of those entities. Alternatively, companies could seek to directly intervene in the Texas district court litigation and ask the court to extend its ruling to them. Which of these or other approaches is appropriate for a specific company may vary based on the individual circumstances of that company.

Finally, even if such litigation does not extend this ruling nationally, companies facing future challenges to their non-compete covenants may still be able to utilize the court’s rationale to defend them. If the FTC seeks to enforce its rule or if a worker argues that their non-compete is barred by the rule, an employer defendant may be able to argue that a future court should adopt the Texas district court’s rationale and invalidate the rule. For companies determining how to prepare for the rule’s effective date, such as those in the healthcare industry, having this reactive tool pending final decisions on the merits is another helpful outcome of the court’s opinion.

In sum, the July 3, 2024, opinion is welcome news to challengers of the FTC’s non-compete rule and may be a harbinger of broader relief to come. But for the time being, its application is limited in scope. Companies desiring to avail themselves of the ruling should consult with counsel to assess their options. This is a developing area of law and McGuireWoods is ready to assist in assessing the effect the litigation and the rule may have on businesses.