A federal judge on Wednesday upheld the first legal challenge to the Federal Trade Commission’s ban on noncompete agreements, which is scheduled to take effect in September.
Judge Ada Brown granted an injunction sought by several plaintiffs, saying the ban cannot be enforced against them pending a final ruling.
But while the ruling was preliminary, it said the FTC had no “substantive authority to issue regulations” regarding unfair competition practices and that the plaintiffs “would likely succeed on the merits” of their challenge.
Judge Brown of the U.S. District Court for the Northern District of Texas said he expects to issue a final decision by the end of August.
The commission “supports our clear authority, supported by statute and precedent, to issue this rule,” said Douglas Farrar, a spokesman for the FTC. He added that the agency would “continue to fight” noncompetes in an effort to promote worker mobility and economic growth.
In April, tax firm Ryan LLC filed a lawsuit to block the near-total ban on noncompetes, just hours after the FTC voted 3-2 to adopt the rule. The U.S. Chamber of Commerce later joined the case as a plaintiff, as did the Business Roundtable and two Texas business groups.
Banning noncompete agreements, which prohibit workers from changing jobs within an industry, would increase workers’ earnings by at least $400 billion over the next decade, the FTC estimates. The agreements affect about one in five American workers, or about 30 million people, according to the agency, whose jurisdiction includes antitrust and consumer protection issues.
“If you’re not working in the most productive place you could be because of a noncompete clause, that’s a loss to the economy,” Aviv Nevo, director of the FTC’s Bureau of Economics, said at a conference in April.
Business groups argue that the ban would limit their ability to protect trade secrets and confidential information. The Chamber of Commerce and other groups say the FTC lacks constitutional and statutory authority to adopt the proposed rule, with Ryan LLC calling it “arbitrary, capricious and otherwise unlawful.” Another lawsuit seeking to block the rule is pending in federal court in Pennsylvania.
But the three Democrats on the five-member commission argue that it can legally issue rules defining unfair competition practices under the FTC Act of 1914, the law that created the agency. Their position has also garnered some bipartisan support: Rep. Matt Gaetz, Republican of Florida, argued in a brief filed in the Texas case that the noncompete provision falls “fully within” the commission’s rulemaking authority granted by Congress.
The Supreme Court’s decision last week to limit the broad regulatory power of federal agencies could increase the agency’s legal hurdles.
Mark Goldstein, an employment lawyer at the New York law firm Reed Smith, said that while it only applies to the plaintiffs at this stage, Judge Brown's injunction was a strong signal that he would deem the FTC rule invalid, preventing it from taking effect nationwide.
“The writing is on the wall,” Mr. Goldstein said. “I have never seen a court issue a preliminary injunction and then, absent extremely unusual circumstances, issue a final order that was inconsistent with the preliminary injunction.”
As litigation over the noncompete rule drags on, some lawyers are already advising employers to start relying more on separate agreements to protect trade secrets and corporate interests.
In a blog post published after the FTC adopted the noncompete, the law firm Winston & Strawn suggested that employers adopt alternative measures, such as targeted confidentiality agreements and requirements that employees reimburse the company for training costs if they leave before a set time, known as training reimbursement agreement, or TRAP, provisions.
“The focus on these additional protections has gotten bigger,” said Kevin Goldstein, antitrust partner at Winston & Strawn.
But those agreements are also coming under increasing scrutiny. The commission’s final rule includes “de facto noncompetes,” provisions that effectively bar a worker from changing jobs within an industry, even if they aren’t labeled as noncompetes. And employers are keeping a close eye on the changing landscape of state and federal restrictions on such agreements, including nondisclosure agreements, beyond the FTC rule.
While the commission’s vote to ban noncompete clauses has drawn the most attention, other federal agencies and state legislatures are also increasingly challenging agreements that limit worker mobility.
“There has been a general increase in hostility across the country toward these deals,” said Christine Bestor Townsend, co-chair of the unfair competition and trade secrets practice group at Ogletree Deakins.
Last month, a National Labor Relations Board judge ruled for the first time that a noncompete clause is an unfair labor practice, as part of his decision in a wrongful termination case. The judge also broke new ground by banning a nonsolicitation clause, which limits solicitation of customers or employees of a former employer; he argued that both types of agreements could limit protected activity, including union organizing.
The ruling follows a memo last year from the labor agency’s general counsel, Jennifer Abruzzo, clarifying her view that noncompete clauses in employment contracts violate the National Labor Relations Act, except in limited circumstances.
“It’s one thing to get a guidance memo from the general counsel, which is meaningful and important,” said Jonathan F. Harris, an associate professor at Loyola Law School in Los Angeles who studies contracts and employment law. “And it’s another thing to see the adjudicatory side of the NLRB agree with her.”
Such restrictive covenants tend to scare workers away from organizing, Mr. Harris said, “because the consequences of getting fired for organizing become much more severe if you can't find another job later.”
Other federal agencies have also jumped in, eyeing a series of employment provisions they say unfairly restrict workers. It’s part of the Biden administration’s government-wide approach to what it sees as anticompetitive restrictions on labor mobility.
For example, last summer the Consumer Financial Protection Bureau released a report on the dangers of provisions that require workers to repay training costs if they leave their jobs before a certain amount of time has passed.
It’s not just a federal push: State governments are also stepping in to promote worker mobility, a trend that was underway before the FTC voted to ban noncompete clauses in April but has since gained momentum.
Last month, the Rhode Island Legislature passed a law to ban non-compete clauses, joining Minnesota, California, Oklahoma and North Dakota. Dozens of other states have enacted partial restrictions.
“Minnesota hasn’t turned into a gaping crater,” said Pat Garofalo, director of state and local policy at the American Economic Liberties Project, a progressive think tank, referring to the state’s far-reaching noncompete ban that went into effect last year. “Once one domino falls, a bunch of other dominoes fall afterward.”
State laws may also prove more resistant to challenge than federal rules.
“State legislatures obviously have a great interest in getting these rules into effect right now,” Mr. Garofalo said.