Federal Court Enjoins FTC Noncompete Rule: Impact On Small Business Limited For Now

On July 3, 2024, the U.S. District Court for the Northern District of Texas entered an order enjoining enforcement of an April 23, 2024 Federal Trade Commission (FTC) rule eliminating most noncompete agreements in the United States. The Federal Court order is preliminary and so for now applies only to the individual plaintiffs in that case. Nonetheless, the order commits the Court to issue a final order on or before August 30, 2024. The rule banning noncompete agreements was to go into effect on September 4, 2024.

Last April 23, the FTC voted 3-2 to ban most noncompete provisions in employment agreements. The two dissenting commissioners expressed concern that the FTC lacked authority to promulgate the rule. Legal challenges were filed almost immediately.

The essential features of the FTC rule are:

First, it prohibit employers from imposing noncompetes on workers (including independent contractors and unpaid workers), and the ban extends to all terms or conditions of employment that either "prohibit" a worker from, "penalize" a worker for, or "function to prevent" a worker from either seeking or accepting work in the U.S. with a different person, or operating a business in the U.S., after their employment ends.

Second, it requires employers to give notice that existing noncompete agreements are no longer enforceable. In addition to preventing employers from entering into new noncompete agreements, the rule also requires employers to notify non-excepted employees that existing noncompetes will not be, and cannot be, enforced.

Third, only two categories of noncompete agreements are excluded by the rule. One, it allows existing noncompetes with “policy-making” senior executives to remain in force, but it bans new noncompetes with senior executives. Two, it allows noncompetes in certain sales of business agreements.

Finally, the rule supersedes all contrary state laws.

As a substantive matter of law, the rule provides that the use of noncompete agreements constitutes unfair competition and subjects violating employers to fines, penalties, and other injunctive relief.

The rule specifically excludes some employers including banks, credit unions, charitable organizations, and air carriers.

Many small and medium-sized businesses (SMBs) are franchises. The rule does not categorically ban franchise noncompete agreements. The definition of a "worker" subject to the noncompete prohibition "includes a natural person who works for a franchisee or franchisor," but explicitly excludes "a franchisee in the context of a franchisee-franchisor relationship." The rule provides that franchise agreement noncompetes may in some cases present concerns similar to those between employers and workers. So, the rule creates a confusing landscape for SMB franchisees.

With this background, the first challenge to the rule was filed by tax service firm Ryan LLC (a large company with 5,000 employees) in the Northern District of Texas on the same day the FTC voted, April 23, 2024. The federal case in Texas was followed by similar challenges in Florida and Pennsylvania.?

Following the preliminary injunction, it appears the Ryan court will likely enter a final injunction in August applicable to noncompete agreements nationwide, meaning that it would bar the FTC from enforcing the rule against any employer in the U.S.

The court’s reasoning would be based on its preliminary finding that the rule exceeds the FTC’s authority. While the FTC has rulemaking powers akin to “housekeeping” precluding unfair methods of competition, the court found the FTC cannot create genuinely substantive rules. ?In any event, there is time before a final order for evidence and arguments to be offered by both sides. But no surprises are expected. And even after the court renders its opinion, there will likely be appeals up through the U.S. Supreme Court. But no surprises should be expected there either…

In light of last week’s Supreme Court decision ending the Chevron Doctrine –giving deference to agency rules? -- on one would expect plaintiffs in Ryan to argue that that decision further supports the conclusion the FTC overreached its authority by adopting the noncompete rule.

What should SMBs be doing now? While it appears the FTC’s rule is only stayed as to a single employer -- the named plaintiff in the Ryan case – there appears little urgency for small business owners to eliminate noncompetes as it is unlikely the rule will be enforceable by – no irony intended here – Labor Day.?

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Robert Unterberger

VP - Solutions

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