The fate of the FTC’s ‘noncompete’ rule appears muddled after early court decisions (updated)

Aug. 20 update: This article has been updated with news that a court has halted the FTC’s rule from taking effect. See the update below.

A highly scrutinized rule prohibiting employers from using noncompete agreements has received a mixed reaction in the courts during the leadup to its implementation.

Set to take effect Sept. 4, the regulations quickly became the subject of litigation after the Federal Trade Commission (FTC) published them as a final rule in May. The rule institutes new requirements across industries, banning noncompete clauses for all future hires by covered entities. Non-competes also will cease to be enforceable for all current workers, with an exception for employees who meet the rule’s definition of senior executive.

Not-for-profit (NFP) organizations generally fall outside the FTC’s enforcement authority, meaning they are not subject to the rule. Yet NFP hospitals will be affected by the provisions, including because the rule applies to physicians and any other staff who work at an NFP hospital but are employed by a for-profit staffing company. American Medical Association data puts the share of physicians who are covered by noncompete agreements at between 37% and 45%.

If the rule takes effect, however, the process of penalizing a noncompliant employer appears as though it will be prolonged and, potentially, cumbersome for the FTC.

As explained in legal analyses after the rule’s publication, the FTC first would file a complaint against the employer. If the employer challenged the complaint, the FTC would take the matter to an administrative hearing and, if it prevailed, issue a cease-and-desist order. If the order held up after an appeals process and the employer remained noncompliant, the commission could file a lawsuit seeking penalties.

A loss for the FTC

In a pair of cases that were filed soon after the rule’s publication, including one led by the U.S. Chamber of Commerce, a judge with the Northern District of Texas court issued a preliminary injunction July 3 that applies to the two sets of plaintiffs.

Among the reasons cited was that the Federal Trade Commission Act “does not expressly grant the Commission authority to promulgate substantive rules regarding unfair methods of competition.” Only procedural rules addressing that issue are permissible (as are substantive rules about unfair or deceptive acts or practices).

“Thus, when considering the text … the Court concludes the Commission has exceeded its statutory authority in promulgating the Non-Compete Rule, and thus Plaintiffs are likely to succeed on the merits,” states the opinion by Judge Ada Brown (a Trump nominee).

The court also deemed the proposed rule to be an “arbitrary and capricious” action by the FTC “because it is unreasonably overbroad without a reasonable explanation.” Specifically, the “categorical ban” on noncompete agreements was implemented without the presentation of evidence that establishes such a need, the court said.

One precedent cited in the decision was the Supreme Court’s recent ruling reversing the 40-year-old Chevron doctrine, which had given federal agencies a presumption of authority in litigation. The June 28 ruling by the high court ended that deference and obligated courts to rely more directly on their interpretation of the relevant statute.

A win for the FTC

The FTC received a more favorable decision later in the month. A judge with the Eastern District of Pennsylvania court declined a tree-care company’s request for an injunction on the regulations.

In the July 24 opinion, Judge Kelley Hodge (a Biden nominee) ruled that the plaintiffs had not met the standard of showing they would be irreparably harmed if the rule is allowed to take effect in September. Furthermore, she said they had not demonstrated they were likely to prevail at trial.

The judge interpreted the language of the FTC Act differently from her counterpart in Texas: “When taken in the context of the goal of the [FTC] Act and the FTC’s purpose, the Court finds it clear that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition,” the opinion states.

The word prevent in the statutory language is key, according to the court: “The [plaintiffs’ interpretation] would limit the FTC’s power to only responsive or remedial methods of addressing unfair methods of competition through adjudication, which is inherently at odds with the ordinary interpretation of the word ‘prevent.’”

And the court was not persuaded by a separate argument that even if the FTC has statutory authority to issue such regulations, it exceeded reasonable bounds by banning all future and most current noncompete clauses. Extensive stakeholder feedback provided prior to the final rule’s publication established that noncompete agreements often place workers at a disadvantage, Hodge wrote.

Countering another of the plaintiffs’ arguments, she also said such regulation does not have to be left to the states, and the federal rule rightfully will take precedence in the event of a conflict.

Concerns for hospitals

Hospital advocates, including those representing NFP organizations that won’t have to abide by the regulations, are stating their opposition to the rule.

The American Hospital Association (AHA) and the Federation of American Hospitals (FAH), the latter of which represents for-profit hospitals, filed a joint amicus brief with the Texas court in support of the plaintiffs.

Quoting comments submitted by the AHA to the FTC, the brief states that the proposed rule “would profoundly transform the healthcare labor market — particularly for physicians and senior hospital executives.” Specifically, it would “instantly invalidate millions of dollars of existing contracts, while exacerbating problems of healthcare labor scarcity, especially for medically underserved areas like rural communities.”

The labor market would be irreparably skewed in a scenario where only for-profit hospitals are subject to the regulations, the groups wrote. Even NFP hospitals in some markets would experience a reduction in the availability of highly trained, highly skilled labor.

In NFP hospital guidance about the rule, Fitch Ratings wrote, “One potential benefit is the improvement in labor supply and enhancement of the labor and physician recruiting pool. On the other hand, the rule could place further upward pressure on wages and potentially introduce operating volatility if there were increased healthcare staff turnover. This may be especially true for smaller or rural NFP hospitals, which may struggle to keep staffing at adequate service levels without ramping up costs.”

The AHA and FAH called on the FTC to exempt the healthcare industry, or at least certain tiers of physicians and hospital executives, from the regulations.

Looking ahead

A similar case on the rule is pending at a Florida district court.

Although the injunction issued in Texas extends only to the plaintiffs, the court said it expects to announce a decision on the case’s merits by Aug. 30. A formal determination that the FTC’s rule lacks a statutory basis could trigger nullification, although such rulings can be stayed until the appeals process plays out.

If the split decisions then continue at the appellate level, where some circuit courts have more of a business-friendly reputation than others, the Supreme Court likely would settle the issue.

The rule’s fate also may hinge on the outcome of the November presidential election — which, in turn, will determine the makeup of leadership at the FTC and the possibility that the new regulations would be retracted or modified.

Aug. 20 updates

As anticipated after granting plaintiffs a preliminary injunction (see the original story above), a Texas federal judge has blocked the Federal Trade Commission’s noncompete final rule from taking effect Sept. 4 as scheduled.

In ruling for plaintiffs that included the U.S. Chamber of Commerce, Judge Ada Brown of the Northern District of Texas court found several points of concern with the rule, including issues relating to the commission’s legal authority to draft and implement the regulations. She also deemed the rule arbitrary and capricious, restating some of the points (described in the original story) that she made when issuing the injunction.

Whereas the injunction applied only to the plaintiffs, the Aug. 20 summary judgment negated the rule. Brown cited Administrative Procedure Act guidance that describes when regulations should be set aside, including when an agency is found to have exceeded its statutory authority or has issued regulations that are assessed to be arbitrary and capricious.

Noting the FTC’s counterargument that such relief should be limited to the named plaintiffs, Brown said that approach was not sufficient because the regulations have a nationwide scope and affect parties in all judicial districts equally.

In a statement, the FTC said it would “strongly” consider appealing the decision and retains authority to address the issue of noncompete agreements “through case-by-case enforcement actions.”

Notably, however, the appeal would be made to the U.S. Court of Appeals for the Fifth Circuit, widely considered one of the most conservative-leaning and business-friendly judicial circuits. If any such appeal falls short, the Supreme Court would be the government’s last option.

In the meantime, employers should be aware of state laws that prohibit or restrict non-compete agreements. This map shows the diverging approaches among the states.