By G. Scott Fiddler and Michael Drab

The Ruling

On July 3, 2024, a federal court in the Northern District of Texas issued an injunction against enforcement of the Federal Trade Commission’s rule banning non-compete agreements (the “Rule”). The Rule was to become effective September 4, 2024. The Court has stated it intends to issue a ruling on the merits on August 30, 2024, less than a week before the Rule is scheduled to take effect.

Background

The Rule, issued on April 23, 2024, bans non-competes across the country, including any agreements that “function or prevent” a worker from seeking or accepting work or operating a business. If the Rule takes effect as scheduled, it would be unlawful to enter into, enforce, or attempt to enter into or enforce a non-compete agreement with employees, independent contractors, interns, volunteers, and sole proprietors. Companies would also have to give written notice to workers that their non-competes are no longer enforceable. By the FTC’s own estimate, the Rule retroactively voids as many as 30 million non-compete agreements throughout the country.

The Rule excepts pre-existing non-competes with senior executives, non-competes executed as part of the sale of a business, franchisee non-competes, and non-competes on which a cause of action arose prior to September 4, 2024. Given the Rule’s preemptive effect on conflicting state law, there is no denying the Rule was poised to seriously alter the way companies contract with their employees and contractors throughout the country.

The Lawsuits

Within hours of the Rule’s issuance, lawsuits challenging its enforceability were filed, two in federal courts in Texas and one in Pennsylvania. The Eastern District of Texas stayed its proceedings under the first-to-file doctrine and later dismissed the lawsuit without prejudice after the plaintiffs, including the U.S. Chamber of Commerce, were permitted to intervene in the Northern District of Texas lawsuit. The plaintiffs in all the cases sought a nationwide injunction against the Rule’s enforcement until the case could be decided on its merits.

What the Court Ruled

In the opinion issued on July 3, 2024, United States District Judge Ada Brown held that Ryan and intervening plaintiffs were likely to succeed on their challenge to the FTC’s rule. Although the FTC has authority to make adjudicative rulings on a case-by-case basis, Judge Brown found that the plaintiffs were likely to prevail on their claim that the FTC lacks authority to promulgate substantive rules regarding unfair methods of competition. In other words, Judge Brown found the FTC likely had no power to issue the Rule in the first place.

Additionally, Judge Brown found the plaintiffs were likely to prevail on their claim that the Rule is arbitrary and capricious, in violation of the Administrative Procedure Act (a statute that governs federal agencies). Specifically, Judge Brown found the Rule “unreasonably overbroad” and faulted the FTC for insufficiently addressing less restrictive alternatives to the harms allegedly targeted.

The most surprising part of Judge Brown’s opinion, however, was her denial of the plaintiffs’ request for a temporary nationwide injunction. Instead, the Court limited the injunctive relief for now to Ryan and those plaintiffs intervening in the lawsuit. Notably, although some of the intervening plaintiffs include associations (U.S. Chamber of Commerce, Business Roundtable, Texas Association of Business, and Longview Chamber of Commerce), the injunctive relief provided does not extend to the members of those organizations because, as Judge Brown explained, those organizations did not allege or brief the court on associational standing for purposes of bringing suit on behalf of the organization’s members.

Judge Brown did, however, state the Court intends to conduct an evidentiary hearing on the merits on August 30, 2024, less than a week before the Rule is scheduled to take effect. A ruling then that follows the rationale of the Court’s July 3, 2024 opinion would not only strike down the FTC’s non-compete rule but strike a serious blow to the FTC’s rulemaking authority.

The court in Pennsylvania was scheduled to rule on the motion to stay and to enjoin enforcement on July 23, 2024. At this point, that court could follow Judge Brown’s ruling or carve its own path. Undoubtedly, however, both decisions will wind up in Circuit Courts, where a split may occur that requires resolution by the Supreme Court of the United States.

Now What?

Given the narrow scope of the Court’s injunction, businesses will still have to take a wait-and-see approach until July 23, 2024, or August 30, 2024, and keep in mind that issuing written notices to workers that their non-competes will be unenforceable may constitute a waiver of the right to enforce them if the Rule does not become effective September 4, 2024. In the event of an adverse final determination, the FTC is likely to appeal the order to the Fifth Circuit, and the issue may appear before the Supreme Court as early as next year.

With the term of one of the Democrats on the FTC who voted for the Rule set to expire in 2026, the election of Donald Trump in November could lead to the appointment of another Republican to the FTC and a withdrawal of the rule banning non-competes.

With all the public attention that has been focused on non-compete agreements over the past two years, the public has learned what non-compete lawyers have known for years: while there are times when non-compete agreements are justified, non-competes are used far too often, most are far too restrictive, and defending enforcement is far too expensive for the average worker.

As a result, the public will may be strong enough to demand federal legislation to curb abuses. Another possibility is a move toward the adoption of a uniform non-compete act by state legislatures, as we saw with the Uniform Trade Secrets Act. One thing is clear: it is unlikely we end up where we were a few years ago.

The opinions expressed are those of the authors and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for informational purposes only and does not constitute legal advice. For more information on this proposed regulation or for assistance in drafting a comment for the FTC’s review, please contact Scott Fiddler and Michael A. Drab or a member of the Labor and Employment practice.

Meet Scott

G. Scott Fiddler is board certified in both Labor & Employment Law and Civil Trial Law by the Texas Board of Legal Specialization, placing him among only approximately 25 attorneys in Texas board certified in both specialties. Scott’s practice focus is on employment litigation, including non-compete and trade secret disputes. He has been recognized as a Texas Super Lawyer every year since 2007, has appeared on multiple Texas Super Lawyer Top 100 lists and The Best Lawyers in America list, and has been selected by the Texas Lawyer as its Lawyer of the Week.

Meet Michael

Michael A. Drab specializes in departing employee disputes, with an emphasis on the protection of trade secrets and confidential business information. Michael has litigated non-compete and trade secret cases in state and federal court and in arbitration proceedings. He has been recognized as a Texas Rising Star in the area of Employment Litigation.