On August 20, 2024, a Texas federal judge issued a nationwide injunction barring the implementation of a controversial Federal Trade Commission (FTC) regulation that would have invalidated tens of millions of existing non-compete agreements and precluded the adoption of new covenants. The decision comes as a tremendous relief to employers that feared the FTC’s regulation would have made it nearly impossible to prevent unfair competition and protect employers’ investment in its employees and against the misappropriation of confidential and proprietary information.

As we first reported in April, the FTC issued a regulation (the “Non-Compete Rule” or “Final Rule”) that, on its September 4, 2024 effective date, would have barred the enforcement of existing non-compete covenants in all but a handful of cases involving highly compensated senior executives, finding that such agreements are inherently anti-competitive due to their impact on employee mobility. The Final Rule also prohibited employers from entering into nearly all new non-compete agreements after the Effective Date, regardless of the job duties performed, and incomes earned, by employees.

Since the publication of the Final Rule, it has been subject to various legal challenges, with mixed results. (See here and here.) For example, in July 2024, a Texas federal court issued a preliminary injunction postponing the implementation of the Final Rule, but only as to the parties before the Court, leaving open the possibility of the Rule going into effect on its September 4, 2024 effective date as to all other persons in the judicial district and outside the judicial district. Several weeks later, a Pennsylvania federal court issued a directly contrary decision, finding that the Final Rule was within the FTC’s authority and that it was consistent with the FTC’s Congressional mandate to prevent unfair competition practices. Late last week, a Florida federal court followed the example of its Texas counterpart, issuing a preliminary injunction but only as to the parties before the court.

This mixed bag of jurisprudential decisions left employers on the horn of a dilemma: with the September 4, 2024 effective date rapidly approaching, should they notify their employees of the purported invalidity of their restrictive covenants even though a final judgment had not been entered or risk agency action for failing to timely notify employees of the Final Rule? Thankfully, employers can breathe a sigh of relief as the Texas federal court that first took on this issue ruled on August 20, 2024 that the Final Rule is enjoined nationwide as to all parties, adding unequivocally: “The Court sets aside the Non-Compete Rule.” Specifically, the court concluded that the FTC exceeded its statutory authority when it adopted the Final Rule, and that the Final Rule itself was arbitrary and capricious.

Although the FTC has some authority to promulgate rules to preclude unfair methods of competition, the court found that the FTC lacks the authority to create substantive rules, as opposed to “housekeeping” rules, and found further that the FTC Act does not include a statutory penalty for violating rules promulgated by the FTC, underscoring the agency’s lack of substantive rulemaking power. Indeed, the court reminded, for 48 years, the FTC “explicitly disclaimed substantive rulemaking authority,” and even when the agency suggested it had such authority, it did not promulgate a single substantive rule under the specific subsection of the FTC Act on which it relied for the authority to issue the Final Rule. Based on all of this, the court “concludes the text and structure of the FTC Act reveal the FTC lacks substantive rulemaking with respect to unfair methods of competition” and that “the [FTC] has exceeded its statutory authority in promulgating the Non-Compete Rule.”

Although the lack of statutory authority to issue the Final Rule was sufficient to end further discussion, the court added that the FTC’s agency action also was arbitrary and capricious, a standard that considers whether an agency has failed to consider an important aspect of a problem in undertaking agency action or offers an implausible justification for its action. The court found that the FTC’s Final Rule was arbitrary and capricious under this analysis “because it is unreasonably overbroad without a reasonable explanation,” imposing “a one-size-fits-all approach with no end date” to try to resolve the issue of reduced employee mobility resulting from covenants not to compete. The court was unpersuaded that the studies on which the FTC relied in drafting its sweeping Final Rule clearly demonstrated adverse economic effects from state policies toward non-competes warranting such overbreadth. The Final Rule was broader than any state’s prohibition on non-competes—even California—suggesting that the “categorical ban” was disproportionate to the issue the FTC sought to address and failed “to consider the positive benefits of non-compete agreements” on entrepreneurship and protection of proprietary information. The Final Rule also “failed to sufficiently address alternatives” to a sweeping ban as reflected by the FTC’s failure to provide a reasoned explanation for its ban over other less disruptive alternatives. The FTC’s only explanation for why it adopted a blanket rule rather than conducting a case-by-case adjudication of specific non-competes was inconvenience, which the court found fell far short of the compelling justification necessary to dismiss possible alternatives.

For both reasons—lack of statutory authority and arbitrariness—the court concluded that the Final Rule was “an unlawful agency action” and found that the proper remedy under the Administrative Procedures Act (APA) was to set aside the agency action in its entirety, as to all persons. The decision thus has nationwide effect, is not party-restricted, and affects persons in all judicial districts equally. In other words, the Final Rule is DOA. Though the FTC has suggested it will appeal the decision and plans to continue to examine non-compete agreements on an as-applied basis, for now, employers can rest easy that the draconian Final Rule is set aside and that their non-compete agreements with employees will survive provided they comply with applicable state and local law. Given the heightened scrutiny around such agreements, employers are encouraged to review their template agreements with employment counsel.