In a win for countless businesses throughout the United States, a federal court in Texas has just issued an order setting aside the Federal Trade Commission’s newly promulgated nationwide ban on the use of noncompete agreements.
Businesses of all shapes and sizes and across nearly all industries in the United States use noncompete and nonsolicitation agreements to serve legitimate business needs. Particularly, the needs to protect their confidential information from being used against them by competitors and to protect long-term investments in client relationships, strategic business plans and strategies, and research and development. As we have repeated since the FTC first hinted at its would-be rule, banning noncompete agreements would be bad for business.
The current FTC, which has become increasingly more aggressive towards businesses and specific industries in recent years, announced its final Noncompete Rule April 23, with the rule set to go into effect Sept. 4. Despite widespread doubts regarding the FTC’s authority to make such a rule (doubts which we shared), and despite thousands of commentators speaking out against the proposed rule, the FTC moved forward on a 3-2 vote to ban nearly all noncompete agreements across the country. The final rule and discussion ended up being more than 500 pages long, and it was extremely broad, failing to account for location, business size, competition, specialization or any of the factors upon which individual businesses make their operating decisions on a daily basis. Rather than leave the decision regarding noncompetes to Congress or the individual states, the FTC — a body made up of unelected officials — decided that it knew what was best for nearly every business and worker in the country.
But the FTC did not just flex an outsized power over national business interests; it did so in a haphazard manner positioned to generate extremely harsh results. For example, the rule not only prohibited enforcing noncompete agreements or entering into new noncompete agreements after the effective date, it also required employers to issue notices to workers by the effective date informing them that their noncompete agreements will not be and cannot legally be enforced. Seeing as the FTC could seek a maximum civil penalty of $51,744 per knowing violation, the rule’s requirements served as a proverbial gun to the head of many businesses.
The speed with which businesses were expected to obey the FTC’s rule put many in a precarious situation. As an example, we were recently approached by a national company to counsel about complying with the FTC’s rule. This company contracts with thousands of full-time independent contractors, all of whom have noncompete agreements. At the time, the FTC’s rule was being litigated across the country, with multiple courts suggesting that the rule would be set aside. We had been closely monitoring the cases and were optimistic that the rule would be invalidated before the effective date. Our client had hoped that a “good faith” exception would permit it to wait and see whether the rule was even legal before changing its agreements and notifying workers that current agreements were invalid. But as we quickly found out, the FTC expressly forbade this, instead forcing businesses to take drastic measures before courts could sort out the legality of the rule. “The rule is simply unreasonable” is not a satisfying answer for a client. But a $51,744 penalty for each unnotified worker is worse. Our advice was somewhere in between: Prepare to comply, but not until you absolutely must.
Luckily for our client and for businesses across the U.S., Judge Ada Brown for the United States District Court for the Northern District of Texas set aside the rule Aug. 20, preventing it from being enforced or taking effect across the country. In a 27-page opinion, Judge Brown held that the FTC does not have the authority to ban practices it deems unfair methods of competition by adopting broad rules such as a nationwide ban on noncompete agreements. Judge Brown went on to hold that even if the FTC had the power to adopt its rule, the agency did not have a justifiable or evidence-based reason “to impose such a sweeping prohibition — that prohibits entering or enforcing virtually all non-competes — instead of targeting specific, harmful non-competes.” Thus, the rule was “arbitrary and capricious” and therefore invalid.
Judge Brown’s opinion is both well-reasoned and well-written, but it is not surprising. For one thing, the FTC’s Noncompete Rule was perhaps one of the most intrusive and broad-reaching rules that the Commission has ever promulgated. As many commentators pointed out, the nature of the near-total ban on noncompete agreements is a measure that should only come from an elected legislature — not an administration. For another, a near-total ban on noncompetition agreements with only minor exceptions is simply not justifiable. While the FTC says that noncompete agreements are an unfair restraint on competition and workers’ mobility, it could not demonstrate that such extreme measures were necessary to protect those interests, particularly where those same measures would threaten employers’ abilities to safeguard trade secrets and other confidential information.
In light of the invalidation of the FTC’s rule, employers can breathe easy knowing that they can continue to utilize noncompete agreements to protect themselves. Of course, the FTC can, and likely will, appeal the decision. But given Judge Brown’s reasoning, as well as the ideology of the Fifth Circuit Court of Appeals and the U.S. Supreme Court, we expect the rule to remain invalid.
John C.C. Sanders a partner in the Dallas office of Winston & Strawn, LLP, represents companies in cases involving trade-secret theft, employee raiding, breach of employment agreements with post-employment restrictive covenants, and injunctive relief. Jackson Smith is a complex commercial litigation associate at Winston & Strawn.