Sometimes, life seems like an episode of Seinfeld. And with the U.S. District Court’s recent decision invalidating the Federal Trade Commission’s (“FTC’s”) “ban on non-competes,” I can see the script already:
George: [Anxiously enters Jerry’s apartment]
Jerry: What’s that? What’s wrong?
George: “It’s a cease and desist, Jerry! From the New York Yankees! They say I broke my non-compete!”
Jerry: “WHAT!”
Kramer: “pfft. Tell them to pound sand, George. Non-competes, they are completely unenforceable! Unenforceable!”
Jerry: “Who said that?”
Kramer: “The FTC, Jerry. The FTC.”
Instead of taking it from Kramer, let’s dive into what is happening with this ban on non-competes.
The enforceability of non-competes has been left to the states–whether through statute or common law (e.g., court decisions). States vary widely on the circumstances in which they will enforce non-competes (e.g., California prohibits v. Florida favors enforcement). Traditionally, non-competes weren’t a big thing–until they were:
“[A]t some point in the late 1980s, these provisions, used only sparingly in industries like TV, became widespread. Over the next twenty years, states confronted the challenge of enforceability, and many, like Texas and Florida, passed laws clarifying that non-compete agreements are enforceable in court by employers. In the era of Bill Clinton and George W. Bush, the ideological goal was to encourage capital, and according to this logic, constraining employees, like offshoring to China or facilitating big tech mergers, seemed only logical.”
In 2016, the Treasury Department reported that 20% of Americans had a non-compete, and 40% had signed one during their career. In 2018, the FTC began studies on non-competes and requested public comments in 2020. In January 2023, the FTC proposed banning non-competes, and on April 23rd, the FTC adopted the rule (the “Non-Compete Ban”).
As the name suggests, the Non-Compete Ban banned non-competes between employers and “workers” (e.g., employees, contractors, partners). The FTC broadened the meaning of what would traditionally be a non-compete provision by looping in things like non-disclosure, non-solicitation, and potentially clawback or forfeiture provision.
The Non-Compete Ban would also be retroactive, essentially invalidating non-competes that existed before the effective date (except the carveouts), which was set to go into effect on September 4, 2024. Importantly, the Non-Compete Ban required employers to notify all applicable current and former workers of the ban and that their non-compete provisions would be unenforceable.
There were a few notable exceptions to the ban:
Highly Compensated Senior Executives. Agreements with senior executives (employees with “final” policymaking authority over more than just a segment of a business and making over $1,541,164 in annualized compensation) that exist before the effective date would remain in place (but they could still be unenforceable for other reasons).
M&A. Non-compete agreements may be imposed and enforced when entered into in relation to a bona fide sale of a business.
Within hours of the FTC’s adoption of the rule, Ryan, LLC, filed suit against the FTC in the U.S. District Court for the Northern District of Texas, claiming (i) the FTC acted without statutory authority; (ii) the Non-Compete Ban is the result of an unconstitutional exercise of power by the executive branch; and (iii) the FTC’s acts, findings, and conclusions leading to the adoption of the Non-Compete Ban were arbitrary and capricious.
In May, Ryan filed a motion seeking to stay the effective date of the Non-Compete Ban and a preliminary injunction. In July, the court issued an opinion and order granting Ryan’s motion to stay the effective date of the Non-Compete Ban and enjoining the FTC’s enforcement–however, the scope was limited to the plaintiffs and not the public at large.
A few weeks later, both parties filed motions for summary judgments (basically, motions telling the court that the facts are undisputed and they should be granted relief as a matter of law) and respective oppositions.
On August 20, the court delivered its long-awaited opinion–in which it found (i) the FTC exceeded its statutory authority in implementing the rule and (ii) the rule is arbitrary and capricious. Thus, the court held the Non-Compete Ban to be unlawful, set aside the Non-Compete Ban, and determined that it shall not be enforced or take effect on September 4th or thereafter.
Exceeded Statutory Authority
The crux of whether the FTC had statutory authority came down to whether the FTC’s ability to create rules concerning unfair methods of competition includes the ability to create substantive rules as opposed to procedural or administrative rules (an important distinction).
The court focused on the fact that Section 18 of the FTC Act empowers the FTC to prescribe “interpretive rules and general statements of policy with respect to unfair or deceptive acts or practices affecting in or affecting commerce[,]” but did not mention anything about unfair methods of competition.
Although the court acknowledged that Section 18 has some rulemaking power “with respect to unfair methods of competition in or affecting commerce[,]” the court found that such rulemaking power does not include substantive rules but only procedural rules–in part due to the context of the statute, the FTC’s prior statements related to its lack of substantive rulemaking authority, and the lack of statutory penalties for violating the rules (which, to this court, demonstrated a lack of substantive rulemaking power).
Arbitrary and Capricious
As I write this, I can hear Jackie Chiles say, “This law is outrageous, egregious, preposterous, arbitrary, and capricious!” It is more difficult, however, to understand the court’s justification for finding the Non-Compete Ban arbitrary and capricious.
The court claimed that the Non-Compete Ban was “unreasonably overboard and without a reasonable explanation” and “is based on inconsistent and flawed empirical evidence, but fails to consider the positive benefits of non-compete agreements, and disregards the substantial body of evidence supporting these agreements[,]” but doesn’t provide much detail as to those items (e.g., what evidence was inconsistent).
The Other Lawsuit.
Ryan wasn’t the only case challenging the Non-Compete Ban. Over in the Eastern District of Pennsylvania, the Non-Compete Ban survived its first challenge with the court in ATS Tree Service v. FTC, denying the plaintiff’s motion for a nationwide preliminary injunction on the Non-Compete Ban. The court found that the plaintiff failed to demonstrate it was likely to prevail in its claim that the rule was unlawful.
So, where does that leave us? More importantly, where does that leave George? Is Kramer right? Can George continue to work at Play Now, or can the Yankees prevent him from doing so?
The short answer is that things go back to the status quo. The enforceability of non-competes will be determined by state laws and courts, which will consider the facts and circumstances and apply them to various tests that generally measure some measure of “reasonableness.”
Although the FTC will likely appeal the decision in Ryan, the Fifth Circuit will likely uphold it. The Supreme Court will also likely hear and determine the life or death of the Non-Compete Ban.
BUT WHERE DOES THAT LEAVE GEORGE?
George might be in trouble. It depends on New York’s non-compete laws and the provisions of his contract. New York will govern the enforceability of his non-compete based on a reasonableness standard (e.g., is it reasonable in geography, scope, duration) and whether enforcement is necessary to protect a legitimate business interest of the Yankees (e.g., trade secrets).
How broadly did the Yankees describe the scope of their business to determine competition–could working for a professional baseball team also extend to working for a sporting goods company? Should it? What if George was the head of equipment purchasing instead of the assistant to the traveling secretary?
A blanket ban on non-competes with limited exceptions hardly seems like a great answer. People are starting and divvying up equity in businesses every day. Investors are putting large amounts of capital into companies to help them grow. Employees are taking equity in companies as an important part of their compensation. They are contributing unique talents for a stake in a future outcome with the implicit agreement that they won’t turn around and compete–presumably using all the information gained from the others.
In many circumstances, non-competes are valuable and incentivize beneficial conduct for all parties. But they should be narrowly tailored and suitable to the situation. An assistant to the traveling secretary for the New York Yankees shouldn’t be signing a non-compete that would prohibit him from selling playground equipment to a city park.
Hey, I am Shayn. I am the Founder of Junto Law, and a partner at Capacity Capital. If you like this post, follow me on X or set a time to chat.
Disclaimer: While I am a lawyer who enjoys operating outside the traditional lawyer “box,” I am not your lawyer. Nothing in this post should be construed as legal advice, nor does it create an attorney-client relationship (I mean, I just wrote about Seinfeld). The material published above is only intended for informational, educational, and entertainment purposes. Please seek the advice of counsel, and do not apply any of the generalized material above to your facts or circumstances (or any episode of Seinfeld) without speaking to an attorney.
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