Texas federal court rules FTC’s non-compete order exceeds authority

On July 3, 2024, a federal judge in Texas issued a preliminary injunction barring the FTC from enforcing its proposed near-absolute national ban on noncompete agreements. The rule was set to take effect on September 4, 2024, but the court postponed that effective date until a final ruling, which it expects to issue by the end of August. The case is Ryan, LLC, v. Federal Trade CommissionNo. 3:24-cv-986-E (S.D. Tx., July 3, 2024).

As reported in our alert, the FTC voted to adopt the proposed Non-Compete Rule on April 23, 2024. The ban would apply to all companies, regardless of size, with exceptions only for senior executives and transactions involving the sale of a company. The FTC’s justification for the Rule is that non-compete agreements constitute unfair competition because they restrict competition in labor markets.

However, Judge Ada Brown of the Northern District of Texas ruled that the FTC had exceeded its rulemaking authority, as granted by Congress in the FTC Act. She found that the FTC’s authority is limited and does not extend to substantive rules such as noncompete provisions.

Citing a Fifth Circuit case involving another agency, Judge Brown noted that “agencies do not have unlimited authority to implement their policy preferences unless Congress prohibits them from doing so; they have only the authority granted to them by Congress through a written authorization agreement.” Central Forwarding, Inc. v ICC, 698 F.2d 1266, 1272 (5^t Cir. 1983). Held that, based on the text and structure of the legislation establishing the FTC, Congress did not grant the agency substantive authority to make regulations regarding unfair methods of competition.

US Supreme Court supporters know, of course, that the US Supreme Court issued its ruling on June 28, 2024. (Loper Bright Enterprises v. Raimondo) invalidating his 1984 Chevron decision that ordered federal courts to defer to the interpretation of statutes by administrative agencies within their jurisdictions (known as the “Chevron appeal”). While Judge Brown briefly addressed Loper Bright Enterprises her opinion makes it clear that she would have made the same decision regardless of whether the Supreme Court eliminated the Chevron deference rule.

Judge Brown did not rule on several other grounds for invalidating the Rule raised by plaintiffs, which we discussed in our May 14 Alert. However, she agreed with plaintiffs that even if the FTC has the authority to issue a significant rule in this area, the Rule would likely be found to be “arbitrary and capricious” because there is no rational connection between the FTC’s reasons for adopting the Rule and the Rule’s “general” prohibition on virtually all noncompetes.

To obtain an injunction, plaintiffs had to show that they would suffer irreparable harm as a result of the Rule’s implementation. The court was convinced that the impact of the sudden repeal of many noncompete agreements, along with the immediate prohibition on entering into new ones, satisfied that requirement.

A significant issue raised in this case is the proper scope of the injunction. Judge Brown determined that the record did not support a national injunction. She therefore limited the injunction to the plaintiff (Ryan, LLC) and several business associations that intervened in the case on the plaintiff’s side.

In light of the Rule’s September 4 effective date, the FTC cannot take any enforcement action before that date. As noted, the Court has committed to issuing a final order (presumably against the FTC) by August 30. In that final order, the Court could expand the order nationwide or it could retain its limited scope. In the latter case, the FTC could theoretically ignore the Court’s order, except for these specific reasons, and begin enforcing the Rule in the rest of the country. In either case, the FTC will almost certainly appeal the final order. As such, employers will continue to face uncertainty for some time.

We note that there is another case that poses a similar challenge to the FTC’s authority to prohibit noncompetes. This case is ATS Tree Services, LLC v. Federal Trade Commission, pending in the Eastern District of Pennsylvania. The judge has scheduled a hearing on the plaintiffs’ motion for a temporary injunction for July 10, 2024, and is expected to rule later that month. At this point in the case, it’s unclear what the scope of the injunction might be (limited vs. nationwide). A decision to deny the injunction would create conflict between two federal courts, making it more likely that the Supreme Court will ultimately take up the issue.

In a future alert, we’ll take a closer look at the potential outcomes and how employers should plan for them. For now, though, employers are a bit less likely to have their noncompete agreements voided.