FTC’s Non-Compete Ban Hit with Multiple Legal Challenges
On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule banning many noncompete clauses in employee contracts and several parties quickly filed lawsuits challenging those rules. Only one day after the FTC issued the rule, on April 24, 2024, the Chamber of Commerce of the United States of America, the Business Roundtable, the Texas Association of Business, and the Longview Chamber of Commerce filed suit against the FTC in the United States District Court for the Eastern District of Texas. On April 23, Ryan, a tax services firm, also filed suit against the FTC in the United States District Court for the Northern District of Texas based on the issuance of the noncompete rule. On April 25, ATS Tree Services filed suit against the FTC in the United States District Court for the Eastern District of Pennsylvania.
We expect additional lawsuits will follow these initial challenges, but this post focuses on three of the first challenges filed. This post first describes the new non-compete rules and then details the claims made in these three cases as they challenge the new rules using a wide range of legal theories.
The FTC’s final rule bans most, but not all, noncompete employment clauses
Noncompete clauses are terms in contracts between employees and employers that prevent workers, once their employment is over, from competing with that employer (typically by working for a competing employer, or starting a competing business). Non-compete provisions are often limited to a specific period of time and/or a particular distance from the original employer. These clauses limit the ability of workers to easily change jobs, as their options for future employment are restricted.
The FTC's rule defines “noncompete clauses” to include “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”
The FTC’s new rule will make existing noncompete clauses unenforceable for most workers, but there is an exception for existing noncompete clauses for “senior executives” (defined as workers earning more than $151,164 annually and who are in policy-making positions; this definition encompasses less than 0.75% of workers). The rule would ban employers from creating or enforcing any new noncompete clauses, including those for senior executives.
The FTC’s rationale for the ban is their determination that the clauses are an "unfair method of competition," and therefore a violation of Section 5 of the FTC Act. Since section 5 of the FTC Act does not apply to non-profits, the ban may not apply to employment contracts with non-profit healthcare systems. However, the FTC indicated that it will not simply accept non-profit tax status as proof that an entity is a non-profit. Instead, the FTC will determine what businesses will be subject to the rule by examining if they are profit-making enterprises, or are organized for the profit of members, based on their actual operations and goals. At an open hearing on the rule, Commissioner Rebecca Slaughter noted that there are many healthcare workers with noncompetes “that our rule will struggle to reach” because they work for non-profit health systems.
The FTC rule exempts noncompetes created as part of a bona fide sale of a business. The FTC rule will also permit “Garden Leave” provisions, where a worker leaves a job, but remains on the payroll and is not allow to work elsewhere, because the FTC does not consider them to be post-employment restrictions.
The FTC stated that employers still have alternatives to noncompetes that allow business to protect investments, including trade secret laws, training repayment agreements, nonsolicitation agreements, and non-disclosure agreements. The FTC says these alternatives would be impermissible only if they are “so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.”
The FTC authority to enforce requirements of Section 5 of the FTC Act includes initiating court actions. According to the FTC, more than 26,000 comments were received in response to the 2023 proposed version of the noncompete rule, with over 25,000 in support of the ban. The FTC also claims the adoption of the rule will lead to the creation of more than 8,500 new businesses each year, will raise earnings for the average worker by $524 per year, and reduce health costs by $194 billion over a decade. The Final Rule was published in the Federal Register on May 7, and will take effect on September 4, barring any judicial action.
The Final FTC Rule Only Pre-empts State Laws That Are Inconsistent With The Final Rule
Non-compete clauses have long been the domain of state governments, and state governments have taken a wide variety of approaches to address them. A handful of states, including California, North Dakota, and Oklahoma, have statutes that make almost all non-compete clauses void. Other states have passed laws that treat non-competes with physician separately than other professions, and many states have common law standards for the reasonableness of noncompetes. Some states use factors, including the worker’s earnings, to determine what noncompetes to allow.
The FTC final rule states that the rule preempts all state laws inconsistent with the final rule, meaning that the FTC rule would preempt state laws that allow non-competes, but state laws that offer greater protection would remain in effect. For example, customer non-solicits would continue to be void in California. This aspect of the final rule means that employers will need to be familiar with both the terms of the FTC’s rule as well as state laws to determine proper conduct.
Details of current cases filed against the FTC
US Chamber of Commerce Case: The case brought by the US Chamber of Commerce, joined with other business groups, rests primarily on a claim that the FTC does not have the authority to issue a rule defining unlawful methods of competition without a clear legislative mandate from Congress. In a related press release, the Chamber of Commerce stated “The Federal Trade Commission’s decision to ban employer noncompete agreements across the economy is not only unlawful but also a blatant power grab that will undermine American businesses’ ability to remain competitive. Since its inception over 100 years ago, the FTC has never been granted the constitutional and statutory authority to write its own competition rules.”
Specifically, the complaint argues that Congress never empowered the FTC with general rulemaking authority, and that even if it did have that authority, the noncompete rule would be invalid under the claim that noncompete agreements are not categorically unlawful under Section 5 of the FTC Act. The suit also claims that the rule is “impermissibly retroactive” and that it “reflects an arbitrary and capricious exercise of the Commission’s powers.”
The Chamber is asking the court to either issue a stay to stop the rule from going into effect, or grant a preliminary injunction to prevent the FTC from enforcing the rule, or both. The suit ultimately is asking the court to find the noncompete rule unlawful and set it aside.
Ryan Case: Ryan, the tax services firm, makes similar arguments about the rule exceeding the FTC’s authority to act, alleging that Congress did not give the FTC the “authority to decide the major question of whether non-compete agreements are categorically unfair and anticompetitive”. The case makes the claim that the “Constitution vests all legislative powers in Congress, which may delegate rulemaking responsibility to an agency only when it provides an intelligible principle to guide the agency’s discretion, such that the agency’s role is to fill in details and find facts.” The suit asks the court to: 1) vacate and set aside the noncompete rule, 2) declare that the FTC does not have the authority to issue rules defining acts to be unfair methods of competition, 3) declare that Section 5 of the FTC Act violates the Constitution’s nondelegation doctrine, and 4) declare that the FTC is unconstitutionally structured because its Commissioners are improperly insulated from presidential removal. Ryan is represented by Eugene Scalia, Secretary of Labor during the Trump administration, and son of former Supreme Court Justice Antonin Scalia.
ATS Tree Service Case: The case brought by ATS Tree Services focuses on the idea that the FTC’s rule on non-compete agreements “must be set aside as unconstitutional and contrary to law to avoid the significant harm it will impose on ATS and other small businesses.” The case argues that “[b]ecause of the significant personal investment ATS makes in its employees and the proprietary business information it shares with them, ATS requires its employees to sign a reasonable non-compete agreement” and that the noncompete agreements are “a critical component of its internal operations and overall success in the tree-care industry”. While this case focuses heavily on a perceived need for small businesses to have the ability to use noncompete clauses, it makes legal arguments similar to the previous cases that “the FTC does not have statutory authority to promulgate substantive rules to prevent purported unfair methods of competition” and that “the FTC act unconstitutionally delegates legislative power to the FTC”. ATC asks for both preliminary and permanent injunctions of the Final Rule to avoid these harms.
Implications for the Noncompete Rule in Healthcare
While employers in many industries use noncompete clauses, the prevalence of noncompete clauses in healthcare employment contracts means that the FTC rule, and the outcomes of the cases against it, may significantly affect the healthcare worker marketplace. Experts estimate 20% of workers overall are subject to noncompete clauses, but the estimate for healthcare workers is that 45% are subject to noncompete clauses. A recent poll of 4,853 physicians showed that 87% supported the FTC proposal to ban noncompetes. The growth of consolidated hospital chains, and the decline in private practices of noncompetes on healthcare wages and mobility, as more healthcare workers are actually employed and physicians have limited options to practice outside of the large health systems. Policymakers and antitrust enforcers should continually reassess the role of noncompete agreements in promoting competitive healthcare markets. As health systems continue to expand, including many that have grown to span multiple geographic markets, and many physicians are now employed by large “payviders” like Optum, oversight of restrictive agreements like noncompetes is particularly important.