FTC's Rule Banning Non-Competes Survives Pennsylvania Challenge

On July 23, 2024, the U.S. District Court for the Eastern District of Pennsylvania issued a decision greenlighting the Federal Trade Commission's (FTC) final rule banning most non-compete agreements in the United States and giving employers a bit of whiplash when it comes to determining whether or not that rule will actually come into effect on September 4, 2024, the date it is slated to apply to millions of private agreements in the United States. In ATS Tree Services, LLC v. Federal Trade Commission, Judge Kelley B. Hodge denied a small tree company's request for a preliminary injunction that would have stopped the FTC rule from taking effect September 4. While the judge could have limited her ruling to a narrow conclusion that the small business could not show it would suffer irreparable harm in the absence of emergency relief, she opted for a more expansive holding that the FTC does in fact have legal authority to impose the ban.

Judge Hodge's ruling is the first court decision after the ban was adopted earlier this year to say that the FTC has, and did not exceed, statutory authority to issue the ban and that Congress did not unconstitutionally delegate legislative power to the FTC. The court's reasoning, which is likely to be appealed to the U.S. Court of Appeals for the Third Circuit, adopted the FTC's position that Section 6(g) of the FTC Act gives the FTC broad rulemaking authority to prevent unfair competition, which it has utilized in the past (albeit in different contexts and more narrow ways).

The Pennsylvania court's holding is a 180-degree turn from the decision by a federal judge in the Northern District of Texas earlier this month in the case of Ryan, LLC v. Federal Trade Commission, which we discussed in a previous alert. In Ryan, a Dallas federal judge said that the FTC likely lacks authority under Section 6(g) of the FTC Act to issue binding regulations governing unfair methods of competition and therefore cannot move forward with its proposed nationwide rule banning non-compete agreements. While that ruling spelled a victory for the challengers, it was a preliminary decision that was limited solely to those parties — not to every employer in the United States. The Texas federal court says it will enter a final order on the merits by August 30, 2024. It may very well issue nationwide injunctive relief by that date, which would stop the FTC rule from going into effect on September 4, 2024.

Though we believe there is a strong likelihood that the Texas federal court will issue such relief (or another court may, too), it is possible that the September 4 date will arrive without any court stopping the ban from going into effect. But we believe that is unlikely.

In the event the FTC rule becomes effective, there are several things that businesses might consider now to be prepared and to protect competition-sensitive relationships and interests:

• First, the FTC rule requires notice by September 4, 2024, to workers, both current and former, that their existing non-competes are no longer enforceable. Though such notices need not be sent yet (sending them prematurely could result in a waiver of contractual rights that is not advisable), it may be wise to start inventorying and listing all agreements that could implicate the FTC's rule. Non-competition, non-solicitation, non-disclosure, no-hire, repayment, and other clauses may be found in offer letters, employment agreements, independent contractor agreements, severance agreements, operating agreements, signing bonus agreements, equity incentive award agreements, partnership agreements, stock option and profits interest unit agreements, and benefits plan agreements, among other documents. Creating a list of those agreements, plans, and other materials that could be impacted by this rule could help businesses prepare for providing any notice that might be needed if there is no nationwide injunction by September 4.
• Second, businesses could consider an action plan for between August 30 and September 4 if the FTC's ban is not enjoined by the Texas federal court as anticipated. In that event, preparing the form of notice required by the FTC rule will ready businesses for distributing it by September 4. Though there is a good faith exception under the rule, and there are practical limitations to the FTC's ability to regulate the millions of private contracts subject to the notice requirement, businesses still should consider being prepared, around Labor Day next month, if required notices will need to be sent under the rule.
• Third, consider developing a game plan for how to begin updating and rolling out revisions to agreements impacted by the rule, with an eye towards more narrow and targeted crafting of confidentiality, non-solicitation, and other restrictive covenants that might still pass muster if the FTC ban were to take effect.
• Fourth, businesses should not give up on monitoring and enforcing existing rights under current restrictive covenant agreements. The FTC's ban has exceptions for causes of action that accrue before the effective date of the rule and for certain "senior executives" as defined in the rule, for conduct before or after the effective date. This means that employees who violate non-competes prior to September 4, or covered senior executives who violate existing agreements before or after September 4, would still be liable for violating those agreements.
• Fifth, these developments make it essential to consider measures to protect company data now through multiple channels. This includes beefing up both the exit and entrance procedures for employee onboarding and offboarding, robust processes for recovering all company-owned property prior to departure (particularly from remote workers), giving regular reminders to employees of their ongoing duty to preserve, and not to disclose, company proprietary information and/or trade secrets, and implementing technical measures to protect competition-sensitive data through access controls, regular compliance monitoring, encryption and data transfer limitations.

The dueling Pennsylvania and Texas decisions are really just a harbinger of things to come. Both the Third Circuit and the Fifth Circuit will likely be asked to weigh in once the district courts issue their final orders in these cases. Given the stakes, we believe it is likely the U.S. Supreme Court will ultimately review the FTC's statutory authority to regulate unfair methods of competition under Section 6(g). In the meantime, employers should be prepared for all potential outcomes, although the FTC may lose this battle.