Federal court declares FTC final rule banning non-competes unlawful

A U.S. federal court in Texas has invalidated the Federal Trade Commission’s rule banning most non-compete clauses with workers and service providers, which was set to take effect on September 4¹. The Court declared the ban unlawful and issued a nationwide injunction, indefinitely postponing its implementation and enforcement. The FTC is likely to appeal the ruling, but a final resolution is expected to take time.

What you need to know

As a practical matter, the Court’s decision means that employers:

• do not need to deliver a notice to current and former workers and service providers stating that their non-competes would be unenforceable, or otherwise comply with the ban at this time;
• should remain attentive regarding further developments pending the FTC’s anticipated appeal; and
• may want to consider addressing the matter through drafting in ongoing transactions (described further below) in the event that the rule is ultimately upheld on appeal.

The Ryan decision

As discussed in previous bulletins, the FTC’s final rule (the Non-Compete Rule) would have (i) invalidated virtually all new and existing non-compete clauses (non-competes) that prohibit a worker or service provider from working or operating a business in the U.S. during any post-employment period, and (ii) required employers to provide written notice to all current and former workers and service providers subject to a banned non-compete that such clause would be illegal and unenforceable. Several lawsuits were filed across the country to overturn the Non-Compete Rule, but the Court in the Ryan case is the first to do so on the merits and with nationwide application.

The Court’s August 20, 2024 decision found that the FTC exceeded its statutory authority. Further, the Court held that the FTC did not adequately consider (i) the positive pro-business effects of non-compete clauses or (ii) alternative, less sweeping means of accomplishing its stated goal of limiting non-competes in order to maintain fair methods of competition. As a result, the Court found that the Non-Compete Rule as currently drafted does not fall “within a zone of reasonableness” and is not “reasonably explained”, and is therefore arbitrary and capricious. In reaching its conclusion, the Court favorably cited the U.S. Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, which eliminated long-established deference to regulatory agencies such as the FTC.

What comes next for employers?

As the FTC is likely to appeal the Court’s decision, further developments regarding the Non-Compete Rule are expected. Although the FTC could seek an emergency order from the appeals court that would cause the rule to take effect as scheduled, such a scenario is doubtful. Instead, pending a final resolution that could be years in the making, employers should take appropriate measures when drafting transaction documents and employment-related agreements to protect their interests.

For example, acquirers of businesses and employers should determine whether confidentiality, trade secret, intellectual property and non-solicitation covenants to which their workers and service providers are subject are sufficiently robust and, if necessary, enhance those protections. Additionally, the Non-Compete Rule does not prohibit enforcing non-competes during employment, and employees on garden leave or during a notice period may be subject to a non-compete so long as they receive the same compensation as when they were active employees. Consequently, employers may consider increasing their use of reasonable garden leave or notice periods in lieu of post-termination non-competes should the Non-Compete Rule ultimately be upheld. Lastly, private equity sponsors and other acquirers of businesses will want to be thoughtful in specifying whether a non-compete covenant represents consideration for sale of a business, an obligation concomitant to share ownership, or arises out of an employment relationship. This approach will account for the possibility that the Non-Compete Rule may ultimately be upheld and takes into consideration preexisting state laws that generally provide greater enforceability to non-employment-based non-competes.