Overview
Last week a court temporarily enjoined the Federal Trade Commission’s rule prohibiting non-compete terms in employee contracts, though the preliminary injunction does not have nationwide effect. While the future prospects of the FTC’s rule look grim, there remain risks to using non-compete provisions even if the non-compete rule never goes into effect nationwide, both under some state laws and from potential individual FTC investigations. And for companies with ongoing concern about risk arising from the non-compete rule, our original recommendations still stand: take appropriate precautions now so that you are ready if compliance becomes necessary on short notice.
In April, the FTC issued its broad ban on non-compete terms – provisions in employer-employee agreements prohibiting the employee from working for a competing employer. Almost immediately, Ryan LLC (a tax preparation firm) and the US Chamber of Commerce filed a declaratory judgment action in the business-friendly Northern District of Texas, seeking to enjoin enforcement of the rule. On July 3, Judge Ada Brown provisionally agreed with the plaintiffs, entering a preliminary injunction because “the text, structure, and history of the FTC Act reveal that the FTC lacks substantive rulemaking authority with respect to unfair methods of competition.” Specifically, the court held that while the FTC has the authority to issue substantive rules regarding unfair or deceptive acts or practices, it does not have express statutory authority to issue rules regarding unfair methods of competition. The court also found that the ban on non-competes is arbitrary and capricious, because 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,’” and FTC failed to cite evidence to support the need for a total ban or consider non-compete provisions’ potential procompetitive effects.
But Judge Brown did not enter the preliminary injunction nationwide, and instead limited its application to the plaintiffs themselves. While the US Chamber of Commerce purported to represent all of its members, the court found the issue insufficiently briefed and refused to enter a nationwide injunction. For the moment, therefore, the rule still stands as to all other persons.
Even though the preliminary injunction does not apply nationwide, it seems unlikely that the non-compete rule will bounce back to life, at least in its current form. Judge Brown’s thorough decision strongly suggests that she will enter a permanent injunction in the case by her self-imposed August 30 deadline. And while Judge Brown rejected a nationwide preliminary injunction, she noted that there was insufficient briefing on the issue, so she could issue a broader injunction in August. And neither the Fifth Circuit nor the US Supreme Court—where this case may well end up—are likely to share the FTC’s expansive understanding of its own authority, even before the Supreme Court jettisoned Chevron deference in Loper Bright Enterprises v. Raimondo. Moreover, if former President Donald Trump wins the election in November, it is likely that the Department of Justice (which is defending the FTC’s rule) will reverse its position and stop defending the rule, allowing the injunction to stand.
As the preliminary injunction does not yet prevent application of the non-compete rule to any company not a plaintiff to the action, companies with continued concern about the non-compete rule can take these two practical and low-cost steps to be prepared:
- Businesses should identify the non-compete provisions and policies that they currently use in existing contracts, so that they will be prepared to ensure that non-compete provisions are not included in new or renewed contracts; and
- Businesses should prepare (but not issue) a draft notice to employees, compliant with the rule, stating that existing non-compete provisions are not enforceable. The FTC has released suggested language for the notice but we advise consultation with counsel to address context-specific issues. Depending on the size of the workforce and the scope of a company’s existing use of non-competes, a blanket notice may be more effective and efficient than identifying specifically affected workers.
Despite this preliminary ruling, companies should understand the ongoing risks in using non-compete provisions. First, this preliminary ruling does not purport to companies besides plaintiffs, so there remains risk the rule will go into full effect for everyone else.
Second, the court’s injunction does not affect the many state laws already limiting or prohibiting non-compete provisions, including near-total bans in California, Colorado, Minnesota, North Dakota, and Oklahoma, with New York likely joining soon. Further, expect that with the likely failure of the federal non-compete rule, more states’ legislatures will look to enact non-compete bans or strengthen their existing limitations.
Third, the injunction does not stop the FTC from bringing enforcement actions against companies using non-compete terms. The FTC has already entered consent decrees with four companies for using non-compete clauses in employee contracts. The FTC could continue this targeted approach without a rule, using its authority to prevent companies from “using unfair methods of competition.” FTC targets will likely include non-compete provisions binding lower-wage workers, and those effectively preventing entry or locking up entire employment markets.
