Court Sets Aside FTC’s Rule Banning Non-Compete Agreements

Just over two weeks before the FTC’s rule banning post-employment non-competition covenants (“the Rule”) was slated to take effect on September 4, a court set aside the Rule and blocked the FTC from enforcing it against any employer anywhere in the country. In Ryan LLC v. FTC, a district court in the Northern District of Texas granted plaintiff’s motion for summary judgment, holding that the FTC exceeded its statutory authority in promulgating the Rule and that the Rule is arbitrary and capricious under the Administrative Procedure Act.

The Ryan decision is a major setback for the FTC and its efforts to ban the use of non-competes on a wholesale basis. The decision may not be the end of the road for the Rule, however, as FTC spokesperson Victoria Graham indicated that the agency is “seriously considering a potential appeal.”

Background

In April, the FTC issued the Rule, which bans virtually all non-compete agreements between employers and workers, deeming them to be an unfair method of competition in violation of Section 5 of the FTC Act. Within hours, Ryan LLC filed suit challenging the Rule and, thereafter, four other business associations (including the US Chamber of Commerce) joined the suit as plaintiff-intervenors.

On July 3, the Ryan court granted a preliminary injunction barring the implementation of the Rule, but its scope was limited to the plaintiffs in the case. The court held that the FTC had exceeded its statutory authority because the FTC Act “does not expressly grant the Commission” the authority to issue substantive rules to address unfair methods of competition. Alternatively, the court found a “substantial likelihood” that the Rule is arbitrary and capricious in violation of the APA because it is unreasonably overbroad without sufficient supporting evidence: “It imposes a one-size-fits-all approach with no end date, which fails to establish a ‘rational connection between the facts found and the choice made.’”

This case is one of several pending challenges to the Rule. Other district courts around the country have heard similar cases and also made preliminary rulings. On July 23, in ATS Tree Services v. FTC, the Eastern District of Pennsylvania denied plaintiff’s motion for a preliminary injunction, taking nearly the complete opposite view on the issue as the Ryan LLC court did in granting the preliminary injunction. In ATS Tree Services, the court found that the plain language of the Act granted the FTC broad rulemaking authority and that the plaintiff would not suffer irreparable harm if the court denied the preliminary injunction. The parties are currently briefing cross motions for summary judgment. On August 14, the Middle District of Florida in Properties of the Villages, Inc. v. FTC granted plaintiff’s motion for a preliminary injunction. Like the preliminary injunction ruling in Ryan LLC, the court’s ruling was limited to the plaintiff in that case only.

The Court Enjoins the Rule

The Ryan LLC court became the first court in the country to enter a final opinion on the merits (as opposed to a preliminary injunction) and the first to grant nationwide relief, rather than just to the plaintiff(s) bringing the challenge.

• FTC’s Statutory Authority: The court concluded that the FTC lacks statutory authority to promulgate substantive rules to address unfair methods of competition under Section 6(g) of the FTC Act, the FTC’s claimed authority for issuing the rule. According to the court, “the text, structure, and history of the [FTC] Act,” indicate that the provision “encompasses only housekeeping rules—not substantive rulemaking power.” For example, the lack of a statutory penalty for violating rules promulgated under Section 6(g) indicates that it does not encompass substantive rulemaking authority. In addition, for many years the FTC disclaimed substantive rulemaking authority to address unfair methods of competition, and it has not promulgated any such rules since 1978, other than the non-compete rule.
  
  
• APA Challenge: As an alternative ground for enjoining the rule, the court found that the FTC’s actions were arbitrary and capricious under the APA. The court found the rule to be “unreasonably overbroad without a reasonable explanation,” and explained that the rule’s “one-size-fits-all approach” fails to create a connection between the facts and the Rule itself. The court noted that the Rule is “based on inconsistent and flawed empirical evidence” as the rule “fails to consider the positive benefits of non-compete agreements.” The court further explained that the FTC “failed to sufficiently address alternatives to issuing the Rule.”

Looking Ahead

In what amounts to the biggest blow to the Rule to date, employers nationwide will not be required to comply with the Rule on its original effective date of September 4. Employers should continue to monitor the issue, as the FTC has indicated an interest in appealing the Ryan decision to the Fifth Circuit. As noted above, the Rule has been challenged in other district courts around the country, and those courts are still making final determinations.

While a wholesale ban will not go into effect, the FTC continues to have the ability to challenge non-compete agreements on a case-by-case basis. The agency has filed several such challenges in recent years. And, of course, state laws governing non-compete agreements continue to apply.

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O’Melveny’s Antitrust & Competition and Labor & Employment teams continue to track developments as the law on non-competes evolves. For any questions related to the Rule or non-compete issues, please contact the O’Melveny lawyer whom you work with or one of our Key Contacts.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Julia Schiller, an O’Melveny partner licensed to practice law in the District of Columbia, New Jersey, and New York; Anna T. Pletcher, an O’Melveny partner licensed to practice law in California; Eric Amdursky, an O’Melveny partner licensed to practice law in California; Kim Williams, an O’Melveny partner licensed to practice law in Texas; and Mike Rosenblatt, an O’Melveny associate licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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