Recent federal court decisions may spell the end for the rule.
On Aug. 20, 2024, a federal court judge struck down a final rule from the Federal Trade Commission (FTC) that would have been a near total ban on noncompete clauses (“noncompete”) in employment contracts. The ruling was issued just two weeks before the ban was scheduled to take effect, Sept. 4, 2024. The FTC argues that a ban is necessary because noncompete clauses are anti-competitive. But proponents of noncompete clauses say that the agreements promote competition by restricting bad-faith actors and anti-competitive behavior in a business setting. This article will examine the final rule and the ongoing litigation.
Noncompetes are common in many industries, including multifamily housing. Businesses use noncompete agreements to protect proprietary information and trade secrets by preventing former employees from joining a competitor within the same industry. They help to ensure that a company’s “secret sauce” remains in-house. The FTC claims that the noncompete ban will promote economic competition by “protecting the fundamental freedom of workers to change jobs, increasing innovation, and fostering new business formation.” But the FTC has never engaged in substantive rulemaking around noncompetes until it enacted the total ban this year.
Background
The FTC issued a Notice of Proposed Rule Making on Jan. 5, 2023. The agency approved the final rule by a narrow margin after a required comment period. The rule bans almost all noncompete clauses in employment agreements. “Noncompete clause” is defined broadly to include any term or condition of employment that “prohibits,” “penalizes” or “functions to prevent” a worker from seeking or accepting work or operating a business in the same field after the conclusion of employment.
The final rule covers most types of workers, including employees and independent contractors. There is one major exception: Senior executives. Existing noncompetes for “senior executives,” defined as employees earning more than $151,164 who are in policy-making positions, could remain in force under the new rule. But the ban stops companies from entering new noncompete arrangements with those senior executives. Noncompetes that are part of a business sale are permitted under the rule, and certain entities, including true nonprofits, banks and common carriers, are also exempt.
The benefits of noncompete agreements have historically been accepted from a legal standpoint. Courts have often upheld their validity based on reasonableness, geography and scope. Local policymakers have addressed concerns that noncompetes are inappropriately restrictive, especially with respect to low wage workers, through legislation. But until the FTC promulgated this rule, noncompete agreements have never been officially regulated at the federal level.
Response to the FTC’s Rule
After the rule was promulgated, business leaders immediately questioned the agency’s authority to enact the sweeping ban. U.S. Chamber of Commerce CEO Suzanne P. Clark criticized the Notice of Proposed Rule Making right away. She called it a “blatant power grab” by the FTC and an “unnecessary and unlawful” overreach by the agency.
Several members of the Congressional Committee on the Judiciary also sent a letter to the FTC commissioners criticizing the noncompete ban. In the letter, the committee members argued that the proposed ban “exceeds [the FTC’s] delegated authority and imposes a top-down, one-size-fits-all approach that violates basic American principles of federalism and free markets.”
The ban has also faced criticism from the FTC’s own commissioners. In April, before the ban went into effect, FTC Commissioner Christine S. Wilson issued a dissenting statement that accompanied the Notice of Proposed Rulemaking. Commissioner Wilson noted that the proposed rule “represents a radical departure from hundreds of years of legal precedent.” Commissioner Wilson also predicted that if the FTC promulgated a final rule, it would be “vulnerable to meritorious challenges.” Subsequent lawsuits bore this assertion out.
Two other FTC commissioners issued a dissenting statement in June after voting against the final rule. The dissenting statement, authored by Commissioner Andrew Ferguson and joined by Commissioner Melissa Hoyoa, argued that the ban was “by far the most extraordinary assertion of authority in the Commission’s history.” Commissioner Ferguson stated that the ban was clearly unlawful because the FTC lacked the authority to enact such a rule. Similar arguments were used by plaintiffs’ counsel in the lawsuits that followed.
FTC Rule Making Authority
The FTC and Department of Justice have always had the authority to bring individual actions against companies that use anti-competitive employment agreements under federal antitrust statutes. But prior to this action, there had never been a total ban of noncompete agreements under federal law.
The FTC argues that their statutory authority to promulgate the noncompete ban is found in Section 5(a)-(b) and Section 6(g) of the FTC Act. Section 5 of the FTC Act prohibits “unfair methods of competition” affecting commerce and Section 6 grants the agency “additional powers…to make rules and regulation for the purpose of carrying out the provisions of that [FTC] act.” However, the agency’s reading of Section 6(g), is a unique interpretation of administrative law.
Section 6 of the FTC Act has rarely been invoked as the basis for a substantive “legislative” rule. In fact, it has traditionally been interpreted as an administrative housekeeping rule. This is one reason that the agency’s noncompete ban has failed to withstand judicial review and, as the basis for their statutory authority, it is a major reason that it faces an uphill battle in court.
Legal Challenges
Ryan, LLC was the first to challenge the FTC’s noncomplete ban in federal court. The company filed their lawsuit in the Northern District of Texas three days after the final rule was announced. The company claimed that the FTC did not have the authority to promulgate a noncompete ban and that they violated federal law in doing so. The Chamber of Commerce, which filed a lawsuit contemporaneously, eventually joined the Ryan case in Texas. Both parties asked the court to issue an injunction to prevent the rule from going into effect nationwide.
On July 3, 2024, Judge Ada Brown granted Ryan, LLC a limited preliminary injunction. The order was only effective for Ryan and the other plaintiff interveners. Judge Brown declined to issue a nationwide injunction until all the issues had been briefed. However, she found that the plaintiffs were likely to succeed on the merits of their arguments. Judge Brown issued her final ruling in Ryan just before the noncompete ban was scheduled to take effect on Sept. 4.
In her opinion, Judge Brown emphasized that the noncompete ban was overly broad and that the FTC “[failed] to consider the benefits of noncompete agreements, [or] the substantial body of evidence supporting those agreements.” Judge Brown also noted that the agency based their rule-making authority on provision 6(g) of the FTC Act, which is essentially a “housekeeping” statute. (According to Judge Brown, the statute authorized the agency to create rules of organization but not substantive rules.) Ultimately, after reviewing the “text, structure, and history” of the FTC Act, Judge Brown held that the agency exceeded their authority when it created the rule banning noncompetes in employment contracts.
In Properties of the Villages vs. FTC and ATS Tree Services vs. FTC, the FTC faces challenges to its noncompete ban on similar legal grounds. The judges in those cases have entered preliminary rulings that bind the involved parties, but the holding in Ryan is final and affects all businesses, nationwide.
Properties of the Villages (POV) is a real estate company suing the FTC in the U.S. District Court for the Middle District of Florida. In their pleading, they argue that the FTC does not have the authority to ban noncompetes and that the agency is acting outside of their purview under federal law. POV sells properties exclusively in a Florida retirement community and uses noncompetes to prevent their salespeople from giving confidential information to competitors. Their agreements were upheld in state court as being reasonable. The federal court issued a preliminary injunction against the FTC in the case, finding that POV was likely to succeed on the merits. The injunction only binds the FTC to POV for now, but this may change in the final ruling.
In ATS Tree Services, a federal judge in the Eastern District of Pennsylvania elected not to stop the ban from going into effect against a landscaping company that challenged the rule on similar grounds. ATS argued that the agency did not have the authority to issue a total ban on noncompete clauses in employment agreements. They also argued that their noncompetes are only used to “[minimize] the risk that employees will leave and immediately use [the] specialized training [from ATS] and ATS’s confidential information to benefit a competitor.” But the court was not persuaded. It found that ATS did not demonstrate that it would suffer irreparable harm absent a ruling in their favor and that they were, otherwise, unlikely to succeed on the merits of their argument. The court’s final ruling is expected in November.
Recent decisions from the United States Supreme Court (SCOTUS) may prove that business leaders are right to push back against the FTC’s substantive rule-making authority. In a relatively fresh opinion, SCOTUS ruled that it would no longer defer to a federal agency’s interpretation of ambiguous administrative law. (Loper Bright Enterprises v. Raimondo and Relentless Inc. v. Department of Commerce) In both Looper Bright and Relentless, the court found that a federal agency overstepped its statutory authority when it promulgated a final rule based on its erroneous interpretation of an administrative statute. SCOTUS held that a federal rule is unlawful if an agency addresses a “major question” that Congress has not assigned to it for oversight. Therefore, agencies like the FTC will now be hard-pressed to argue that their reading of an act is correct if an appellate judge has a differing opinion.
On Sept. 24, 2024, the FTC gave notice that it plans to appeal the preliminary injunction in Properties of the Villages. The ATS and Ryan decisions are also likely to be appealed. If the appellate court rulings differ, SCOTUS may elect to examine this issue.
Impact
If the FTC’s ban on noncompete agreements is upheld, it will pose several challenges for the rental housing industry. Many companies rely on noncompete agreements to protect themselves from anti-competitive behavior. If this ban is upheld, employees, including executives, would be able to move from a company to a competitor without having to promise that they will not give the competitor an unfair advantage. These employees could also take with them proprietary information and unique methodology without having to worry about reprisals. Therefore, a noncompete ban might foster anti-competitive activity where the FTC’s goal is to prevent it.
In addition, the constant departure of key employees is sure to disrupt business operations, especially if those employees leave for a competitor. Some companies might be forced to invest capital into areas of the business that they normally might not. Recruitment and retention costs will likely rise if they want to attract top talent in the employment market, and companies are sure to face increased legal costs as they work through the compliance requirements as well.
As companies continue to grapple with the pending outcomes of these cases, they might consider alternatives to noncompete clauses. Non-disclosure agreements (NDAs), non-solicitation agreements and confidentiality agreements serve similar purposes. Also, businesses might reevaluate their existing noncompetes to stay ahead of the proverbial litigation curve. For instance, it’s likely a good idea to consider which employees should sign noncompetes in the first place. (The FTC’s ban carves out existing noncompetes for senior executives.) And businesses can always review the scope and substance of their agreements with local counsel to ensure compliance with state law.
NAA’s Legal Affairs team will continue to track the case law as it develops. We will also update our membership as new information becomes available. However, if you have any questions about how the FTC’s ban might affect your operations, please don’t hesitate to reach out to your local counsel to discuss strategies for complying with the final rule.
Mark Russell Jr. is a Staff Attorney at NAA.