Federal Court Strikes Down FTC Noncompete Ban and Noncompete Issues Generally

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Federal Court Strikes Down FTC Noncompete Ban

 
and Noncompete Issues Generally

 

August 23, 2024

 

 

The Federal Trade Commission on May 7, 2024 published a ban on all noncompete clauses as an unfair method of competition, effective September 4, 2024 (with the exception of grandfathered agreements in effect on Sept. 4, 2024, which can continue to be enforced for senior executives, i.e., earning over $151,164 and in a policy-making position). However, the U.S. District Court for the Northern District of Texas, in Ryan LLC v. Federal Trade Commission, ruled on August 20, 2024, that the FTC noncompete ban exceeds the FTC authority and the noncompete ban is set aside and may not be enforced against anyone and cannot take effect on Sept. 4, 2024 or thereafter. Note that there are other challenges in other district courts that may fail; but regardless of those outcomes, this Northern District of Texas district court decision is enough to keep the FTC noncompete ban from being enforced, unless Ryan LLC v FTC is overturned on appeal.

 

State laws in 14 states have recently banned some or all types of noncompete provisions, and the state laws are not subject to the Federal court challenges. Also, noncompete provisions, even prior to FTC and state legislation, were subject to restrictions by state court case-law. Ryant LLC v. FTC notes that

 

 

I.    FTC Noncompete Clause Ban and Court Challenges

 

A.     FTC Rules Banning Practically All Noncompete Provisions – Effective Sept. 4, 2024 – On May 7, 2024, the Federal Trade Commission (FTC) published final rules that would ban all noncompete clauses as an unfair method of competition, and therefore violating Section 5 of the FTC Act. Federal Trade Commission (FTC) New Final Noncompete Clause Rule in 26 CFR § 910, announced by the FTC on April 23, 2024, and published in 89 Fed. Reg. 38342 (May 7, 2024). The effective date is Sept. 4, 2024. The effective date of the FTC noncompete ban would be 120 days after publication, i.e., September 4, 2024.  This rule: (i) would prohibit employers from entering into noncompete agreements and other clauses with all employees or service providers (“workers”); and (ii) would prohibit enforcement of existing noncompete clauses against all workers (with the exception of grandfathered agreements in effect on Sept. 4, 2024, which can continue to be enforced for senior executives).  These FTC rules were designed to protect the fundamental freedom of workers to change jobs, increase innovation, and foster new business formation.

 

B.      Key Points in FTC Rule – The following are the key provisions in the FTC noncompete ban:

 

1.           Ban on Noncompete Clauses – Under the FTC rule, it would be an unfair method of competition for a person (including an employee or independent contractor): (i) to enter into or attempt to enter into a noncompete clause; (ii) to enforce or attempt to enforce a noncompete clause; or (iii) to represent that the worker is subject to a noncompete clause. 16 CFR § 910.2(a)(1).  The FTC’s final rule aims to enhance worker mobility, encourage entrepreneurship, and spur innovation by banning noncompete provisions and promoting a more dynamic economy.

 

2.           Senior Executives Exception for Grandfathered Contracts – For senior executives, there would be an exception if the noncompete was entered into prior to the effective date of the FTC regulations (Sept. 4, 2024). “Senior executives” mean workers who (i) are in a policy-making position, and (ii) received annual compensation of at least $151,164 in the preceding year (or annualized if was employed for only part of the year; and “policy-making position” means the president, chief executive officer or equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. 16 CFR § 910.1 Thus, with respect to senior executives, any noncompete clauses entered into prior to Sept. 4, 2024 would continue to be enforced. 16 CFR § 910.2(a)(2).  After the effective date, no new noncompete provisions can be entered into.

 

3.           Notice Requirement – The new FTC rule provides that employers would need to provide notice to workers (other than senior executives) who are bound by an existing noncompete that they will not be enforcing any noncompete provisions against them.  16 CFR § 910.2(b)(1).  The notice may be on paper delivered by hand to the worker, or by mail at the worker’s last known personal street address, or by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address, or cell phone text message. 16 CFR § 910.2(b)(2)(b). The FTC rule would provide a model notice that employers can use for workers, which states how prior noncompetes may not be binding. 16 CFR § 910.2(b)(4) (figure 1).

 

4.           Sale Exception – The Final Rule would not prohibit enforcement of noncompete clauses that are entered into with respect to the bona fide sale of a business, including a bona fide sale of (i) a business entity, (ii) an individual’s interest in a business entity or (iii) all or substantially all of a business entity’s operating assets. See 16 CFR § 910.3.

 

5.           Only for Post-Employment Bans; Non-Solicitation Clauses – The FTC noncompete ban would specifically apply to post-employment noncompetes, so it does not affect restrictions on moonlighting in the same field.  Non-solicitation clauses that do not prohibit or function to prevent a worker from switching jobs or starting a new business are generally not restricted by the FTC rule, as noted in the preamble to the 2024 final rule.[1]

 

 

C.      Federal Court Stikes Down FTC Noncompete Ban

 

1.     Potential Stay by Federal Northern District in Texas – Within a day or two of when the FTC announced the final rule banning noncompete clauses, two lawsuits were filed in Texas to challenge the rule, (i) Ryan LLC v. FTC  on Apr. 23, 2024 in the Northern District in Texas, No. 3:24-cv-009; (ii) Chamber of Commerce of the U.S. v. FTC, No. 6:24-cv-00148 (E.D. Tex., Apr. 24, 2024) filed the day after the rules.  The Eastern District Court of Texas dismissed the Chamber of Commerce case because, under the first to file rule, the Ryan LLC case was filed first, and joined the Chamber of Commerce as a party in the Ryan LLC case.  Chamber of Commerce of the U.S. v. Federal Trade Commission, — F.Supp.3d –, 2024 WL 1954139 (E.D. Tex., May 3, 2024). The Texas Northern District judge (Asa Brown), in Ryan LLC v. Federal Trade Commission, 2024 WL 3297524, — F.Supp.3d — (N.D. Tex. July 3, 2024), imposed a parital stay on the FTC noncompete ban only with respect to the parties to the case, i.e., Ryan LLP and the U.S. Chamber of Commerce, but it did give indication that it is likely to strike down the FTC noncompete ban once it rules.

 

2.     Pending District Courts in Northern District of Pennsylvania and Middle District of FLorida – In ATS Tree Services, LLC v. FTC, No. 2:2024cv01743 (E.D. Pa. Apr. 25, 2024), a similar suit was filed on Apr. 25, 2024 in the Eastern District in Pennsylvania. ATS Tree Services filed a motion for preliminary Injunction on May 14 seeking a stay of the effective date. The Eastern District in Pennsylvania, in ATS Tree Services, LLC v. Federal Trade Commission, 2024 WL 3511630 (E.D. Pa., July 23, 2024), denied ATS Tree Services motion to stay and preliminary enjoin enforcement of the FTC noncompete ban because it did not find any irreparable harm.

 

        In general, the Fifth Circuit in Texas (where the Ryan LLC case was filed) is less employee friendly than the Third Circuit in Pennsylvania (where the ATS Tree Services case was filed), and therefore, even though the Fifth Circuit ruled against the FTC, this may not be the view of the Fifth Circuit, and this could lead to an appeal to the Supreme Court to resolve the differences.

 

3.     Florida Case – In Properties of the Villages v. Federal Trade Commission, No. 5:24-cv-316-TJC-PRL, filed on July 2, 2024, a motion for a preliminary injunction on the FTC noncompete ban was filed in the Federal district court for the Middle District of Florida.

 

4.     Arguments for Challenges – Arguments made by the lawsuits include that: (i) the rules implicates the major questions doctrine, which would necessitate additional legal authority from Congress; (ii) the FTC rule is arbitrary and capricious under the Administrative Procedure Act because the evidence the FTC relies on cannot justify a nationwide ban of noncompetes in all situations; (iii) the FTC rule incorrectly expands what is a prohibited an unfair method of competition; and (iv) the rule unlawfully infringes on state contract laws.

 

5.     FTC Noncompete Ban Struck Down by District Court in Texas in Ryan LLC v. FTC – In Ryan LLC v. Federal Trade Commission, __ F.Supp.3d __, 2024 WL 3879954 (N. Dist. Tex. Aug. 20, 2024), Judge Ada Brown held that the FTC exceeded its authority in promulgating the noncompete ban, Congress did not give the FTC authority to impose new substantive restrictions, the authority of the FTC to issue regulations was only for housekeeping rules and not for new substantive restrictions and the FTC acted in an arbitrary and capricious in issuing the regulations; therefore the district court granted the plaintiffs’ motion for summary and held that the FTC noncompete rules are invalid and may not be enforced at all on September 4, 2024 or any time thereafter.

 

II.      States that Have Banned Noncompete Provisions (all Since 2021)

 

A.     Four States Ban All Noncompete Agreements – In the past three years, California, Minnesota, North Dakota and Oklahoma have passed broad legislation banning post-employment noncompete agreements, regardless of salary. (California has had long-standing legislation banning most noncompete agreements, but this was expanded by 2023 legislation even to out-of-state contracts.)

 

B.      Ten States and D.C. Ban Noncompete Agreements for Non-Highly Paid Employees – Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, Washington and the District of Columbia have all passed laws in the past three years prohibiting post-employment noncompete agreements unless the employee earned above a certain threshold. There are also non-compete rules from a few states prior to 2020, like Massachusetts in 2018 (and California, as noted above).  (Also, in July 2024, Pennsylvania banned noncompete covenants for health care providers if it is for more than one year or the health care provider was dismissed by the employer.)

 

C.      New York – In New York a bill that would ban almost all noncompete agreements was passed but was vetoed by Governor Hochul because it was too broad.  

 

III.     Existing State Law Regarding Noncompete Agreements.

 

A.     Existing States’ Case-law Would be Applicable if Statutory Ban is Stayed – If the FTC noncompete ban on noncompete clauses is stayed or struck down in court, or reversed or limited in future legislation or FTC guidance, preexisting state law and state cases would become operative. In states that have not enacted recent bans on noncompete provisions (or where such state bans have been struck down), the existing case law in those states will again be operative.   

 

B.      Enforceability of noncompete agreements – State laws vary regarding enforceability of noncompete provisions. Generally, noncompete provisions will be enforced in most states if the restrictions are reasonable in geographical scope and reasonable in time period, and they are necessary to protect legitimate business interests.

 

For example, in New York, which is fairly liberal in allowing noncompete restrictions, the noncompete restrictions will be enforceable if: (i) the time period of restriction is reasonable, (ii) the geographical scope is reasonable, (iii) the burden on the employee is not unreasonable, (iv) public policy is not harmed, and (v) the restrictions are necessary for the employer’s protection (see, e.g., Service Systems Corp. v. Harris, 341 N.Y.S.2d 702 (4th Dep’t 1973); Mallory Factor Inc. v. Schwartz, 146 A.D.2d 465, 536 N.Y.S.2d 752 (1st Dep’t 1989); International Paper Co. v. Suwyn, 951 F. Supp. 445 (S.D. N.Y. 1997)).  In New Jersey noncompete restrictions will be enforced only if reasonable under the circumstances (e.g., Community Hosp. Group, Inc. v. More, 183 N.J. 36, 869 A.2d 884 (2005)).  Texas and Florida statutes restrict noncompete requirements unless they are reasonable restrictions necessary to protect legitimate business interests (Texas Business & Commerce Code §15.50; Florida Statutes Annotated §542.335).

 

California by statute, even prior to the 2023 ban, would generally void noncompete provisions, providing that “except as provided in this Chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” (California Business & Professional Code §16600) The Ninth Circuit allowed “narrow restraint” enforcement of noncompete provisions that are very limited, but the California Supreme Court rejected this exception.[2] The 2023 California legislative ban would, presumably, supersede these prior rules.

           

D.     Blue-penciling Noncompete Agreements – Where noncompete provisions are overbroad and therefore unenforceable on their terms, many states will “blue pencil” the restrictive covenants to a limited scope for which they would be enforceable. For example, in New York restrictive covenants will be blue penciled.[3] Often, employment agreements will add language to specifically provide for blue penciling.

 

CHARLES C. SHULMAN, ESQ.
212-380-3834 / 201-357-0577
cshulman@ebeclaw.com
www.ebeclaw.com