Legal Challenges Presented by the FTC Non-Compete Clause Rule

Legal Challenges Presented by the FTC Non-Compete Clause Rule

By Camille Alley*

Approximately one in five workers in the United States are bound by a non-compete agreement.^[1] In response, the Federal Trade Commission (FTC) announced its Final Non-Compete Clause Rule (“Rule”) banning post-employment non-compete clauses between employers and employees.[2] The Rule was published in the Federal Register on May 7, 2024, and the effective date was set for September 4, 2024.[3] However, as of August 20, 2024, a federal court in the Northern District of Texas set aside the Rule in Ryan LLC v. Federal Trade Commission and ordered that the FTC cannot enforce it.^[4]

What is the FTC’s “Final Rule?”

The FTC promulgated a broad rule to ban most non-competes for U.S. workers, arguing that non-compete agreements unfairly block workers from switching jobs and undermine labor competition.^[5] The Rule operates retroactively and requires employers to give notice that existing non-competes are no longer enforceable.[6] The FTC asserts that because non-compete clauses are “unfair methods of competition” under Section 4 of the FTC Act, and pursuant to the authority granted to them in Section 6(g) of the Act, the Commission has the authority to issue the Rule.[7]

Non-compete clauses are defined by the FTC as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”^[8] A term or condition of employment “includes but is not limited to, a contractual term or workplace policy, whether written or oral.”^[9]

The Rule bans almost all non-competes between employers and workers with limited carve-outs, but it does not explicitly ban non-disclosure agreements, customer non-solicitation agreements, or employee non-solicitation agreements.[10] Nevertheless, the Rule does ban these other forms of restrictive covenants when they operate in the same manner as non-compete clauses.[11] According to the Rule, a non-disclosure clause operates as a non-compete “where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job.”[12] Such non-disclosure agreements operate as non-compete clauses for practical purposes when “they function to prevent a worker from working for another employer in the same field and are therefore non-competes under [the Rule].”^[13] Likewise, the definition of a non-compete clause may also be satisfied by non-solicitation agreements “where they function to prevent workers from seeking or accepting other work or starting a business after their employment ends.”^[14] With the exception of non-profit enterprises,[15] most employers will be subject to the Rule if it is reinstated. However, certain entities are exempt from the FTC’s jurisdiction under the FTC Act.[16] Outside of those certain entities, the major exceptions include (1) existing agreements for “senior executives,” (2) non-competes entered in connection with the bona fide sale of a business, and (3) non-competes enforced where the cause of action accrued prior to the Rule’s effective date.[17] Regarding the senior executive exception, the Rule allows employers to maintain existing non-compete agreements with “senior executives.”[18] A “senior executive” is one with over $151,164 annual compensation and in a policy making position.[19] A “policy-making position” includes but is not limited to the firm’s president and most of the C-suite.[20] Senior-executives of another sub-part are not covered by the exception, and thus, their existing non-competes would be void.

Legal Challenges

After the Ryan LLC plaintiffs were granted a preliminary injunction against the Rule on July 3, 2024,^[21] the court held that the Rule cannot be enforced because the FTC exceeded its statutory authority in implementing the Rule.^[22] Specifically, the court determined that Congress did not grant the FTC authority to make substantive rules regarding “unfair methods of competition.”^[23] Most importantly, the court rejected the FTC’s argument that relief should be limited to the Ryan LLC plaintiffs.^[24] Therefore, the ruling applied nationwide.

The FTC appealed to the U.S. Court of Appeals for the Fifth Circuit.^[25] While it is likely that the district court’s decision will be upheld, the appeals process may take 12-18 months before the case reaches the Supreme Court. Nevertheless, the Supreme Court’s recent Loper Bright decision may dispose of the appeal on the merits.^[26]

First, the major questions doctrine is a threshold hurdle to the application of Chevron deference.[27] The major questions doctrine has been applied in other cases where agencies have claimed the power of regulation over economic areas.^[28]The FTC’s Rule unequivocally involves a claim of substantial new regulatory power and thus raises a “major question.” Pursuant to the court’s opinion, Congress has not granted the FTC clear authority to make rules over “unfair methods of competition[,]” and thus, the FTC does not have the authority to make this decision of vast economic significance.[29] Accordingly, the Rule fails a major questions challenge.

Second, the “Chevron deference” doctrine can no longer save the Rule. Chevron deference requires that federal courts defer to an agency’s reasonable interpretation of statutes by federal agencies charged with administering those statutes.[30] Under this doctrine, if a law is unclear, courts must uphold an agency’s interpretation so long as it is “reasonable.”[31] In January 2024, the Supreme Court heard oral arguments in two companion cases, Loper Bright Enterprises v. Raimondo and Relentless, Inc. v. Department of Commerce, which sought to overrule Chevron. The Supreme Court’s decision in Loper Bright dismantled the requirement for courts to defer to federal agencies as they have under Chevron.^[32] Thus, the overturning of Chevron eliminated the requirement that courts defer to the FTC’s interpretation that non-compete agreements constitute “unfair methods of competition” under the FTC Act. As a result, the decision makes it more likely that the Rule will never be enforced.

Conclusion

Due to constitutional challenges, the FTC’s authority to enact and enforce the Rule is in a poor position. Today, non-competes remain legal and enforceable. However, other plaintiffs are following the FTC’s lead and are now attempting to use antitrust law to challenge non-competes.^[33] The future of non-compete agreements remains uncertain due to ongoing litigation. In the meantime, counsel should carefully follow the legal challenges and monitor the deadline for compliance should the Rule become effective.

* J.D. Candidate, University of Tennessee College of Law, Class of 2025; Tennessee Law Review Articles Editor.

^[1] Non-Compete Clause Rulemaking, Fed. Trade Comm’n (Jan. 5, 2023), https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.

[2] Non-Compete Clause Rule, 89 Fed. Reg. 38342 (May 7, 2024) (to be codified at 16 C.F.R. § 910.1-6) [hereinafter Federal Trade Commission].

[3] Id.; 16 C.F.R. § 910.6 (proposed).

^[4] 746 F.Supp.3d 369, 388 (N.D. Tex. 2024) (enjoining the FTC from enforcing the Rule).

^[5] See Federal Trade Commission, supra note 2, at 38348.

[6] See Federal Trade Commission, supra note 2, at 38348.

[7] See Federal Trade Commission, supra note 2, at 382348–59; see 15 U.S.C. §§ 45(a)(2), 46(g); see Ryan LLC, 746 F.Supp.3d at 373.

^[8] Federal Trade Commission, supra note 2, at 38363 (quoting 16 C.F.R. § 910.1 (proposed)).

^[9] Federal Trade Commission, supra note 2, at 38361 (quoting 16 C.F.R. § 910.1 (proposed)).

[10] See Federal Trade Commission, supra note 2, at 38365 (quoting 16 C.F.R. § 910.1-6 (proposed)).

[11] See Federal Trade Commission, supra note 2, at 38365.

[12] Federal Trade Commission, supra note 2, at 38361.

^[13] Federal Trade Commission, supra note 2, at 38365.

^[14] Federal Trade Commission, supra note 2, at 38362.

[15] Federal Trade Commission, supra note 2, at 38357.

[16] 15 U.S.C. § 46(a). Specifically, the Rule does not apply to “banks” and “persons, partnerships, or corporations insofar as they are subject to the Packers and Stockyards Act . . . .” Federal Trade Commission, supra note 2, at 383447.

[17] Federal Trade Commission, supra note2,at 38432, 38437–52 (quoting 16 C.F.R. §§ 910.2(a)(2), 910.3(a) (proposed)). The Rule also does not apply to fixed-term employment. Federal Trade Commission, supra note 2, at 38424–32.

[18] Federal Trade Commission, supra note 2, at 38432 (quoting 16 C.F.R. § 910.2(a)(2) (proposed)).

[19] The $151,164 figure does not include board, lodging, medical or life insurance payments, retirement plans, and other fringe benefits. Federal Trade Commission, supra note 2, at 38416.

[20] “Policy-making authority” entails the “final authority to make policy decisions that control significant aspects of a business entity or common enterprise” but does not include “authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.” Federal Trade Commission, supra note 2, at 38418 (quoting 16 C.F.R. § 910.1 (proposed)).

^[21] Ryan LLC v. Federal Trade Comm’n, 739 F.Supp.3d 496, 521 (N.D. Tex. 2024).

^[22] Ryan LLC v. Federal Trade Comm’n, 746 F.Supp.3d 369, 385 (N.D. Tex. 2024).

^[23] Id. at 382.

^[24] Id. at 387.

^[25] Notice of Appeal, Ryan LLC v. Federal Trade Comm’n, 746 F.Supp.3d 369 (5th Cir.) (No. 3:24-CV-00986-E).

^[26] See generally Loper Bright Enter. v. Raimondo, 603 U.S. 369 (2024).

[27] The major questions doctrine is a principle in U.S. administrative law that requires Congress to provide clear authorization for federal agencies to make decisions of vast economic and political significance, and courts will not defer to agency interpretations of its own enabling statutes. See West Virginia v. Env’t Prot. Agency, 597 U.S. 697, 744 (2022).

^[28] Id. at 716–17.

[29] Ryan LLC, 739 F.Supp.3d at 382.

[30] Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 863 (1984).

[31] Id. at 850.

^[32] Loper Bright Enter. v. Raimondo, 603 U.S. 369, 403 (2024).

^[33] See generally Goforth v. Transform Holdco LLC, No.6:23-cv-03167-MDH, 2024 WL 3461077 (W.D. Mo. July 18, 2024).