FTC Faces Setback in U.S. District Court Over Noncompete Rule

On July 3, 2024, Judge Ada Brown of the United States District Court for the Northern District of Texas preliminarily enjoined the Federal Trade Commission ("FTC") from enforcing the Final Noncompete Rule ("Rule") against the parties to the pending lawsuit.

At this time, the prohibition on enforcement of the Rule is limited to the parties to the lawsuit. After additional briefing, the court deferred broader relief to later proceedings and intends to rule on the merits of the claim for injunctive relief on or before August 30, 2024.

As indicated in our previous alert, on January 19, 2023, the FTC proposed the Noncompete Rule, which would prohibit employers from entering into noncompete agreements with workers. The definition of "worker" includes employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a person. This Rule is subject to limited exceptions, namely, senior executives or bona fide business sales. On April 23, 2024, the FTC adopted the Final Noncompete Rule.

The Texas district court case addressed the FTC’s rulemaking authority and whether the FTC exceeded its statutory authority in implementing the Final Noncompete Rule. The Court granted the plaintiffs a preliminary injunction, finding that:

• the plaintiffs were likely to succeed on the merits;
• irreparable harm would result without the issuance of injunctive relief; and
• the balance of harms and public interest weighs in favor of granting injunctive relief.

Likelihood of Success

A. Statutory Authority

The plaintiffs challenged whether the FTC’s rulemaking authority under Section 6(g)^[1] encompassed substantive rulemaking, in addition to procedural rulemaking. The FTC claimed that Section 6(g) permits the FTC to issue rules for carrying its requirement under Section 5^[2].

Accordingly, the issue before the Court was whether the FTC’s ability to promulgate rules concerning unfair methods of competition included the authority to create substantive rules regarding unfair methods of competition.

The Court held that while the FTC had some authority to promulgate rules to preclude unfair methods of competition, the "FTC lacks the authority to create substantive rules through this method." The Court noted that the "lack of a penalty included within Section 6(g) supports that such provision encompasses only housekeeping rules, not substantive rulemaking power."

Also, the Court explained that after reviewing the FTC Act's text and structure, it determined that the "FTC lack[ed] substantive rule-making authority with respect to unfair methods of competition." Therefore, the Court concluded that the FTC exceeded its statutory authority in promulgating the Noncompete Rule.

B. Arbitrary and Capricious

The Court also found that the Noncompete Rule is arbitrary and capricious because it is "unreasonably overbroad without a reasonable explanation. It imposes a one-size-fits-all approach with no end date."

The Court said that no state has ever enacted a noncompete rule as broad as the FTC’s Final Rule. The Court determined that the Final Rule was inconsistent, based on flawed empirical evidence, failed to consider the positive benefits of noncompete agreements, and disregarded a substantial body of evidence supporting these types of agreements. Additionally, the Court noted that the FTC insufficiently addressed alternatives to issuing the Rule.

Irreparable Harm

The plaintiffs alleged that if the Noncompete Rule took effect, their noncompete agreements with present and former principals would be invalidated, they would be barred from entering into new noncompetes, and would have to inform their workers that their noncompete agreements are invalid.

This process would require the plaintiffs to expend significant costs in complying with the Rule, and time to update all employment agreements. The Court agreed with the plaintiffs and held that compliance with this Rule would result in financial injury, and the plaintiffs would be unable to recover costs for complying with the Rule. Moreover, the FTC failed to "make a developed responsive argument."

Balance of Equities and Public Interest

The Court also held that granting injunctive relief serves the public interest and tips the balance of harms in favor of the plaintiffs. Granting the injunction would serve the public interest by maintaining the status quo and preventing the substantial economic impact of the Rule while simultaneously inflicting no harm on the FTC.

[1] “From time to time classify corporations and to make rules and regulations for the purpose of carrying out the provisions of this subchapter.”

[2] “The Commission is hereby empowered and directed to prevent persons, partnerships, or corporations…from using unfair or deceptive acts or practices in or affecting commerce.”