Employer Victory in Texas – Court Strikes Down FTC Ban on Non-Compete Agreements

In a victory for employers nationwide, the United States District Court for the Northern District of Texas set aside the FTC’s Rule banning essentially all post-employment non-compete agreements. The ruling, which applies nationwide, means the Rule cannot be enforced or otherwise take effect on September 4. The FTC “is seriously considering” appealing the decision.

The Opinion

The Court ruled solely on the briefings provided by the parties, which were just completed on August 16. Consistent with the reasoning underlying its decision granting the preliminary injunction, the Court held that “the FTC exceeded its statutory authority in implementing the Rule, and the Rule is arbitrary and capricious” in violation of the Administrative Procedures Act and Declaratory Judgment Act. Characterizing Section 6(g) as a “housekeeping statute,” the Court agreed with the Plaintiffs that Section 6(g) of the FTC Act does not give the FTC the authority to make substantive rules on unfair methods of competition. This is because, the Court reasoned, “Section 6(g) of the Act does not expressly grant the Commission authority to promulgate substantive rules regarding unfair methods of competition.” Section 6(g) also does not have a statutory penalty for violating rules promulgating under it – a clue that Congress did not intend for this section to grant substantive rulemaking power. The Court further disagreed with the FTC that the Magnuson-Moss Act and the Federal Trade Commission Improvements Act of 1980 gave the FTC any additional power with regard to substantive rulemaking for unfair methods of competition.

The Court concluded that the Rule was arbitrary and capricious because “it is unreasonably overbroad without a reasonable explanation.” The Court criticized the Rule’s “one-size-fits-all” approach that, in its opinion, was not supported by evidence. Notably, the Court stated the FTC’s “lack of evidence as to why they chose to impose such a sweeping prohibition—that prohibits entering or enforcing virtually all non-competes—instead of targeting specific, harmful non-competes, renders the Rule arbitrary and capricious.” The Court also condemned the FTC for failing to consider less disruptive alternatives, finding the FTC simply dismissed any possible alternatives. A combination of a statutory reading of the FTC Act and the FTC’s overreach in the Rule itself led the Court to conclude that the Rule “shall not be enforced or otherwise take effect on September 4, 2024, or thereafter.”

Implications

Of course, this ruling means that, unless overturned on appeal, the FTC’s Rule will not go into effect. Unless the Rule is reinstated, companies can forgo sending notices to employees and former employees that their non-compete agreements are no longer enforceable. In addition, companies can continue to consider non-compete agreements as a viable option for protecting their valuable business interests.

The fact that the Court held broadly that Section 6(g) did not give the FTC the power to issue substantive rules regarding unfair methods of competition deals a significant blow to the FTC’s rulemaking authority. Prior to this ruling, such rulemaking authority was murky, with some case law supporting the FTC’s position. In fact, the Eastern District of Pennsylvania relied on the case law supporting the FTC’s power to issue substantive rules on unfair methods of competition. Now, opponents to the FTC’s aggressiveness have another arrow in their quiver to challenge its ability to issue broad rules.

There are still two cases that have not yet ruled on the merits of the Rule. As mentioned, the Eastern District of Pennsylvania signaled its support for the FTC in denying the preliminary injunction, while the Middle District of Florida followed Texas in granting a preliminary injunction. Whether this ruling will sway either court remains to be seen.

Take Aways

As we have said previously, the FTC can still challenge overbroad non-compete agreements as it has done in the past. In addition, even in states that permit non-compete agreements in some form, aggressive Attorneys General can challenge overbroad non-compete agreements using the state’s antitrust and consumer protection statutes. However, now, the FTC, states and private plaintiffs will need to do so on a case-by-case basis, likely picking the most egregious uses of non-compete agreements.

While companies do not need to rescind or remove post-employment non-compete agreements (as long as the Rule is not reinstated), businesses should analyze their use of non-compete agreements to ensure they are narrowly tailored to protect legitimate business interests and adhere to the state laws that apply to them. But, non-compete agreements are just one piece of the puzzle. A comprehensive program involving protection of trade secrets, confidential information and intellectual property involves not only proper agreements and policies, but also training, reminders and systems for such protections.

In parallel, companies should carefully audit their trade secret policies to assess the integrity of these programs – both with and without the availability of non-competes. One key ingredient of a robust trade secret policy is a properly tailored confidentiality agreement. Likewise, documented exit interviews not only provide a useful reminder to departing employees about ongoing obligations with respect to a company’s valuable confidential information, they can provide powerful evidence in a subsequent trade secret lawsuit that the company engaged in reasonable protective measures.