Last-Minute Ruling Saves Non-Competes

 

Confused about what is going on in the land of non-competes? You’re not alone.

In short:

• April 23, 2024: the Federal Trade Commission (FTC) adopts a rule banning non-compete clauses (the “FTC Rule”), originally set to go into effect September 4, 2024.
• Also on April 23, 2024: Ryan, LLC, a tax firm in Texas, filed a lawsuit in federal court in the Northern District of Texas, challenging the FTC Rule.
• April 25, 2024: ATS Tree Services, LLC filed a challenge to the FTC Rule in federal court in the Eastern District of Pennsylvania.
• July 23, 2024: the Pennsylvania federal court denied ATS Tree Services’ request to temporarily halt implementation and enforcement of the FTC Rule.
• August 20, 2024, in the Ryan case, the Texas federal court issued an injunction blocking the FTC Rule from taking effect or being enforced, and holding that this block applies nationwide.

So, we are back to the status quo, which essentially leaves the question of whether non-compete provisions are valid largely a matter of state law.

In Wisconsin, a non-compete clause, as well as other restrictive covenants in the context of employment, can generally be valid if narrowly tailored as defined by the Wisconsin statutes and interpreted by the courts.

Back to the drama…

 

What happened?

The FTC Rule, a brand-new federal rule (having, for all intents and purposes, the same force and effect as statutes and other laws) was set to take effect September 4, 2024. The FTC Rule would have prohibited any new workplace non-compete clauses (also called non-competition clauses) and invalidated virtually all existing workplace non-compete clauses. However, on August 20, 2024, a federal court in Texas issued an injunction which halted the rule nationwide. Though the FTC Rule is now on hold and will not go into effect on September 4, the FTC is likely to appeal the Texas decision.

 

Why was the FTC Rule challenged?

Three major challenges to the FTC Rule were filed across the country, with mixed results. Only one final decision has been reached in any of those courts, but temporary orders have been granted pending final decisions in the remaining cases.

1. Texas

In Texas, Ryan, LLC initially challenged the FTC Rule on the basis that the FTC exceeded its statutory rule-making authority by defining “unfair methods of competition.” After the challenge was filed, the United States Supreme Court issued its decision in Loper Bright Enterprises v. Raimondo, which overturned prior precedent of deferring to federal agencies on many rule-making questions. After temporarily staying enforcement of the FTC Rule, the Texas court issued a final decision on August 20, 2024, agreeing with Ryan, holding that the FTC did exceed its rule-making authority under the Administrative Procedure Act (the “APA”). This halted the FTC Rule entirely, and under prior precedent regarding judicial review of federal agency actions, the Texas court’s decision applies nationwide.

In support of finding that its decision applies nationwide, the Texas court relied on a 2024 Fifth Circuit case, “‘As [the Fifth Circuit] put it in a couple of recent cases, setting aside agency action under § 706 has ‘nationwide effect,’ is not ‘party-restricted,’ and ‘affects persons in all judicial districts equally.’” citing Braidwood Management., Inc. v. Becerra.

The nationwide applicability of a decision like this has been questioned by various authorities, including some sitting justices of the United States Supreme Court. In a 2023 concurring opinion, Justices Gorsuch, Thomas, and Barrett expressed skepticism that the Administrative Procedure Act empowers courts to entirely vacate actions by federal agencies.[ii] Rather, the justices indicated that the law directs courts to disregard unlawful agency actions only as applied to the case at hand.[iii] In other words, a court could halt a rule’s application to an individual plaintiff in the case before it, but that halt would not apply nationwide. Some scholars have agreed with this interpretation, noting that Congress did not likely envision courts broadly vacating agency actions at the time the Administrative Procedure Act was enacted.[iv]

2. Florida

In Florida, real estate company Properties of the Villages, Inc. filed a substantially similar challenge to the challenge filed in Texas. There, the court temporarily stayed enforcement of the FTC Rule, but only as applied to Properties of the Villages, Inc. Unlike the Texas case, the Florida court has indicated that Properties of the Villages, Inc. is not likely to succeed on the merits of their argument that the Federal Trade Commission has exceeded its statutory rule-making authority. Instead, the court stated that the Federal Trade Commission has likely violated the Supreme Court’s major questions doctrine—in essence, that the FTC Rule is so significant that it should only be enacted directly by Congress.

3. Pennsylvania

In Pennsylvania, ATS Tree Services, LLC also filed a similar challenge to the FTC Rule. Unlike the Texas and Florida cases, the Pennsylvania court declined to temporarily stay enforcement of the FTC Rule. Though the case will still proceed to a final decision, the court has indicated that ATS Tree Services, LLC’s challenge is unlikely to succeed.

 

Where does that leave us?

For now, the Texas decision halted the FTC Rule nationwide, and nothing will change on September 4, 2024. However, the FTC is likely to appeal that decision. As such, while enforceability of non-compete clauses is largely back to the states, the status may change again.

 

What should we expect?

With an appeal likely and the Pennsylvania and Florida decisions pending, the final outcome remains uncertain. Employers should remain alert for new developments and consider the effect on their businesses if the FTC Rule is ultimately reinstated.

 

*** The following is a summary of the (as of this moment, invalid) FTC Rule***

 

What would the FTC Rule do, if it were to take effect?

As of the date the FTC Rule was set to go into effect, Employers would no longer be able to create or enforce non-compete clauses, nor represent that any worker is subject to a non-compete clause. They would also have been required to provide notice to employees of the invalidity of any current non-compete clauses, or risk penalties.[v]  If employers violated the FTC Rule, they could have been ordered to cease the activity and be subjected to penalties for continued violations.

 

What is a non-compete clause, exactly?

In the FTC Rule, the FTC had defined a non-compete clause as any term or condition of employment that prohibits, penalizes, or functions to prevent a worker from seeking or accepting work, or operating a business, after the conclusion of their employment.[vi]

Note, Wisconsin has its own definition of a non-compete clause (STILL VALID!), the details of which are ripe for a separate KEW Tip.

 

Who would the FTC Rule affect?

The FTC Rule would broadly apply to all workers, nationwide. The FTC indicated that “workers” would include past and current workers regardless of title or pay status, including employees, independent contractors, interns, volunteers, apprentices, or sole proprietors providing services to a person.[vii] “Person” would mean any natural person, partnership, corporation, association, or other legal entity within the FTC’s jurisdiction. For clarity, our discussion of the FTC Rule here (in good company with many other discussions of the FTC Rule) uses the term “employer” as that is how this definition of “person” would be applied in practice under the FTC Rule.

 

What would be required of employers?

Any employer with any non-compete clause in effect would be required to provide clear and conspicuous notice to all workers (other than senior executives, as explained below) on or before the FTC Rule’s effective date, that states that any non-compete clause cannot and will not be enforced.[viii] The notice would require the identification of the person or entity who entered into the agreement with the worker, and must be delivered directly to the worker by hand, mail, email, or text message.[ix]

The FTC provided a model notice in the rule, and stated that it would satisfy the notice requirement if completed and provided to the worker:[x]

 

Would there be any exceptions to the FTC Rule?

Yes. First, senior executives may still be bound by existing non-compete clauses entered before the effective date of the FTC Rule.[xi] “Senior executive” would be defined as workers with policy-making authority who received at least $151,164 in total compensation during the preceding year (or, if only employed during part of the preceding year, whose salary would total at least $151,164 when annualized).[xii] While they may still be bound by existing agreements, the prohibition on creating new non-compete clauses after the rule takes effect would apply to all workers, including senior executives.[xiii]

Second, the FTC Rule would include an exception for non-compete clauses entered in connection with the sale of a business. When selling a business entity, an ownership interest in a business entity, or substantially all of a business entity’s operating assets, a seller would be able to enter into a valid non-compete clause.[xiv]

Finally, the FTC Rule would not apply where a cause of action under an existing non-compete clause had accrued before the effective date of the FTC Rule.[xv] This means that if a worker had violated a non-compete clause before the effective date of the FTC Rule, the employer would still be able to pursue that violation after the FTC Rule goes into effect. This also means that any ongoing litigation surrounding a non-compete clause would not be affected by the FTC Rule taking effect.

 

How far-reaching would the FTC Rule be?

The FTC Rule would not explicitly ban any clause other than a non-compete clause. However, any clause which functions to prevent a worker from seeking or accepting work or operating a business would be prohibited by the FTC Rule.[xvi] Depending on specific drafting language and circumstances, other clauses would potentially be prohibited, such as a non-solicitation of employees/no-hire clause, a non-solicitation of customers clause, a training-repayment clause, or a non-disclosure/confidentiality clause.

One certainty among these unknowns is that, if it takes effect, the FTC Rule will spur additional litigation, which should provide some clarity. Until then, the FTC throws employers a bone with a “good faith” exception. The exception provides that it is not an unfair method of competition to enforce or attempt to enforce a non-compete clause or to make representations about a non-compete clause where a person has a good-faith basis to believe that the FTC Rule is inapplicable.[xvii] It seems likely that this good faith exception would be heavily relied on by employers, at least while clarity on the reach of the FTC Rule is being determined.

 

What now?

If you have a business and have any employees or independent contractors, discussing how the FTC Rule and restrictive covenants in general may affect your business is a smart next step. Contact one of the Kramer, Elkins & Watt, LLC attorneys by calling 608-709-7115 or emailing info@kewlaw.com.

 

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[i] 16 C.F.R. § 910.6

[ii]  United States v. Texas, 599 U.S. 670, 695-96, 143 S. Ct. 1964, 216 L. Ed. 2d 624 (2023)

[iii] Id. at 697

[iv] See John Harrison, Vacatur of Rules under the Administrative Procedure Act, 40 Yale J. on Reg. 119 (2023)

[v] 16 C.F.R. § 910.2(a)

[vi] 16 C.F.R. § 910.1

[vii] 16 C.F.R. § 910.1

[viii] 16 C.F.R. § 910.2(b)(1)

[ix] 16 C.F.R. § 910.2(b)(2)

[x] 16 C.F.R. §§ 910.2(b)(4) and (5)

[xi] 16 C.F.R. § 910.2(a)(2)

[xii] 16 C.F.R. § 910.1

[xiii] 16 C.F.R. § 910.2(a)(2)

[xiv] 16 C.F.R. § 910.3(a)

[xv] 16 C.F.R. § 910.3(b)

[xvi] 16 C.F.R. §§ 910.1 and 910.2(a)

[xvii] 16 C.F.R. § 910.3(c)