Judge Ada Brown of the U.S. District Court for the Northern District of Texas issued an Aug. 20 order effectively striking down the Federal Trade Commission’s (FTC) April 2024 rule barring noncompete clauses (“noncompetes”) in employment contracts. Ryan LLC, a global tax-services and software provider, had challenged the rule, which had been scheduled to take effect in September.
Judge Brown’s decision held that, in promulgating the rule, the FTC acted “arbitrarily and capriciously” and outside its statutory authority. This violated the Administrative Procedure Act (APA), a federal statute that regulates how federal agencies create and issue rules.
The court’s decision is not limited to plaintiff Ryan—rather, it benefits all companies that have noncompetes. The court emphasized that its ruling has “a nationwide effect,” is “not party-restricted,” and “affects persons in all judicial districts equally.”
Judge Brown’s sweeping ruling came five days after Judge Timothy J. Corrigan of the U.S. District Court for the Middle District of Florida issued a preliminary decision temporarily enjoining the noncompete rule in Properties of the Villages Inc. v. FTC. Corrigan held that the plaintiff “showed a “substantial likelihood of success on the merits.”
The Texas and Florida decisions, are, however, at odds with a July 23 decision by Judge Kelley Brisbon Hodge of the U.S. District Court for the Eastern District of Pennsylvania that declined to issue an injunction halting the rule. According to Judge Hodge, ATS Tree Services, the company that had sought to block the rule, “failed to establish ‘a reasonable chance, or probability, of winning’” its lawsuit.
Unlike the Texas holding, which is effective nationwide, the Florida and Pennsylvania holdings only apply to the parties before the two courts.
This story is far from over. It is nearly certain that the Texas, Florida, and Pennsylvania decisions will be appealed to three separate federal circuit appeals courts. If the appeals courts differ on the legality of the noncompete rule, the U.S. Supreme Court may well agree to decide the matter (the Supreme Court is far more likely to accept an appeal if there is a “circuit split”).
The appeals process will take time. Once the litigation dust settles, the noncompete rule will, in all likelihood, be set aside. What’s more, the FTC’s authority to promulgate “competition rules” will probably fall by the wayside, as well.
The Texas District Court Decision
Section 5(a) of the FTC Act prohibits “unfair methods of competition” in or affecting commerce. Section 5(b) empowers the FTC to bring administrative actions to order parties to “cease and desist” from engaging in such conduct.
Section 6 of the FTC Act grants the FTC “[a]dditional powers,” most of which deal with the conduct of investigations and “administrative housekeeping.” One short phrase in Section 6(g) enables the FTC “to make rules and regulations for the purpose of carrying out the provisions of the [FTC] Act.”
Section 18 of the FTC Act contains long and detailed provisions authorizing the FTC to promulgate consumer-protection rules (that define and prohibit specific “unfair acts or practices”) and provides for civil penalties if those rules are violated. Various FTC rules have been enacted under this section.
The FTC based the noncompete rule on Section 6(g), which had virtually never been invoked in the past as the basis for a substantive “legislative” rule. The rule classifies noncompetes as “unfair methods of competition.”
The FTC Lacks the Statutory Authority to Promulgate the Rule
“[A]fter reviewing the text, structure, and history of the [FTC] Act,” Judge Brown concluded that “the FTC lacks the authority to create substantive rules” through Section 6(g). She said that Section 6(g) is indeed a housekeeping statute, authorizing what the APA terms “rules of organization or practice,” as opposed to “substantive rules.” She noted in particular that “Section 6(g) contains no penalty provisions – which indicates a lack of substantive force.” Accordingly, Judge Brown “conclude[d] the Commission has exceeded its statutory authority in promulgating the [n]on[c]ompete rule.”
The Rule Is ‘Arbitrary and Capricious’ Under the APA
Furthermore, Judge Brown held that the noncompete rule is “arbitrary and capricious” within the meaning of the APA, and thus must be held unlawful. She stressed that the rule is “unreasonably overbroad” and “fails to establish a ‘rational connection between the facts found and the choice made.’”
The court pointed to two key factors that demonstrated the rule’s arbitrary and capricious nature.
First, “the [r]ule is based on inconsistent and flawed empirical evidence, fails to consider the benefits of noncompete agreements, and disregards the substantial body of evidence supporting those agreements.”
“Second, the record shows the FTC failed to sufficiently address alternatives to [u]sing the [r]ule.”
The APA Requires that the Rule Be Set Aside Nationwide
Finally, Judge Brown stressed that the APA directs the reviewing court to “set aside” rules that are “in excess of statutory authority” and “arbitrary and capricious.” Judge Brown also pointed to case law in support of her conclusion that setting aside the noncompete under the APA “has nationwide effect.”
Multiple Factors Demonstrate That The FTC Eventually Will Lose
Appeals courts will no doubt consider multiple factors that all point in the same direction: the noncompete rule, and FTC competition rules in general, lack a legal basis.
Judge Brown’s opinion is in line with the bulk of recent scholarship, which is highly skeptical about the FTC’s claim of competition-rule authority.
The fact that two of the five FTC commissioners (Commissioners Andrew N. Ferguson and Melissa Holyoak) wrote separate highly scholarly dissents opining that the FTC lacks authority to enact competition rules should be especially compelling for reviewing judges.
The noncompete rule plainly addresses a “major question” of fundamental economic importance that Congress has not assigned to the FTC for statutory oversight. As such, recent Supreme Court decisions prevent the FTC from regulating it.
In addition, two recent essentially unanimous Supreme Court decisions express skepticism about FTC overreach.
In AMC Capital Management v. FTC (2021), the Supreme Court unanimously held that the FTC lacks the implied authority to obtain monetary relief from defendants under the statutory provision (Section 13(b) of the FTC Act) that allows it to seek injunctions. Significantly, the Court determined that such an authority would not “fit well” within the overall structure of the FTC Act, which contains other clauses providing specifically for monetary awards. Judge Brown’s analysis embodies a similar structural approach in finding a lack of support for competition rulemaking, “viewing the [FTC Act] statute as a whole.”
In Axon Enterprise v. FTC (2023), all nine Supreme Court Justices agreed (in three separate opinions) that parties subject to an internal FTC administrative-enforcement proceeding could challenge the constitutionality of the proceeding in federal district court without having to wait for a final FTC decision. While not directly applicable to competition rulemaking, this holding’s “atmospherics” suggest concern about the degree of deference due to FTC administrative actions.
Finally, the Supreme Court’s very recent decision in Loper Bright Enterprises v. Raimondo and Relentless Inc. v. Department of Commerce (2024) merits note. In Loper Bright, the Court overturned the 40-year-old “Chevron Doctrine,” under which the courts deferred to a federal agency’s interpretation of ambiguous language in the law it administered. Federal judges now will rely on their own interpretations of ambiguous provisions. This undermines any FTC argument that courts should defer to its reading of Section 6(g) rulemaking as substantive.
The Best Path Forward for the FTC
The University of Michigan’s Daniel Crane conducted an April 2024 poll of legal scholars on the likely fate of the noncompete rule. In a Yale Journal on Regulation commentary, Crane reported that “almost everyone thought the rule will be struck down, either by SCOTUS [the Supreme Court] or a lower court.”
A realistic analysis of the situation indicates that the death knell is sounding for the noncompete rule and for FTC competition rulemaking in general. The commission should carefully reevaluate its policy priorities in that light.
The resources employed in what is likely to be a fruitless effort to defend such rulemaking would be far better deployed prosecuting clearly anticompetitive conduct or hardcore consumer deception. (There are, for example, a lot of scams over the internet that merit attention.) Such a resource redeployment would benefit American consumers and enhance competition.
