Judge says FTC lacks authority to issue rule banning noncompete agreements

FTC Chair Lina Khan sitting at a Congressional hearing
Enlarge / FTC Chair Lina Khan testifies before the House Appropriations Subcommittee on May 15, 2024, in Washington, DC.

Getty Images | Kevin Dietsch

A US judge ruled against the Federal Trade Commission in a challenge to its rule banning noncompete agreements, saying the FTC lacks “substantive” rulemaking authority.

The preliminary ruling only blocks enforcement of the noncompete ban against the plaintiff and other groups that intervened in the case, but it signals that the judge believes the FTC cannot enforce the rule. The case is in US District Court for the Northern District of Texas, so appeals would be heard in the US Court of Appeals for the 5th Circuit—which is generally regarded as one of the most conservative appeals courts in the country.

In April, the FTC issued a rule that would render the vast majority of current noncompete clauses unenforceable and ban future ones. The agency said that noncompete clauses are “an unfair method of competition and therefore a violation of Section 5 of the FTC Act,” calling them “a widespread and often exploitative practice imposing contractual conditions that prevent workers from taking a new job or starting a new business.”

A tax services firm called Ryan, LLC sued the FTC in an attempt to block the rule. The lawsuit was joined by the US Chamber of Commerce, two Texas business groups, and a lobbyist association that represents chief executive officers at US businesses.

In a ruling on Wednesday, US District Judge Ada Brown granted a preliminary injunction and postponed the effective date of the rule as it applies to the plaintiffs. The rule is scheduled to take effect on September 4, 2024. As of now, the FTC’s ban on noncompetes is slated to apply to everyone except the entities involved in the lawsuit.

“FTC lacks substantive rulemaking authority”

“The issue presented is whether the FTC’s ability to promulgate rules concerning unfair methods of competition include the authority to create substantive rules regarding unfair methods of competition,” Brown, a Trump appointee, wrote.

Brown acknowledged that “the FTC has some authority to promulgate rules to preclude unfair methods of competition.” But “the text, structure, and history of the FTC Act reveal that the FTC lacks substantive rulemaking authority with respect to unfair methods of competition under Section 6(g),” she wrote.

The FTC has argued it can impose the rule using authority under sections 5 and 6(g) of the FTC Act. “Alongside section 5, Congress adopted section 6(g) of the Act, in which it authorized the Commission to ‘make rules and regulations for the purpose of carrying out the provisions of’ the FTC Act, which include the Act’s prohibition of unfair methods of competition,” the FTC said when it issued the rule.

“The FTC stands by our clear authority, supported by statute and precedent, to issue this rule,” an FTC spokesperson told Ars today. “We will keep fighting to free hardworking Americans from unlawful noncompetes, which reduce innovation, inhibit economic growth, trap workers, and undermine Americans’ economic liberty.”

Consumer advocacy group Public Knowledge called Brown’s ruling “the latest in a series of attacks on the administrative state, which only further embolden judges without subject matter expertise to seize power from federal agencies and prevent them from effectively serving the American people.”

The Supreme Court last week overturned the 40-year-old Chevron precedent, which gave agencies leeway to interpret ambiguous laws as long as the agency’s conclusion was reasonable. The SCOTUS ruling effectively gives courts more power to block federal rules.

FTC’s cited authority just a “housekeeping statute”

Brown concluded that section 6(g) is merely a “housekeeping statute,” authorizing “rules of agency organization procedure or practice” but not “substantive rules.”

“Plaintiffs next contend the lack of a statutory penalty for violating rules promulgated under Section 6(g) demonstrates its lack of substantive rulemaking power. The Court agrees,” Brown wrote. “When authorizing legislative rulemaking, Congress also historically prescribes sanctions for violations of the agency’s rules—confirming that those rules create substantive obligations for regulated parties.”

The judge said the plaintiffs are likely to succeed on the merits and would be harmed if the rule takes effect. Brown intends to issue a ruling on the merits by August 30.

The preliminary injunction does not apply nationwide, as Brown chose to limit “the scope of the injunctive relief herein to named Plaintiff Ryan, LLC and Plaintiff-Intervenors Chamber of Commerce of the United States of America; Business Roundtable; Texas Association of Business; and Longview Chamber of Commerce.”

The business trade groups wanted the injunction to apply to all of their member entities but could not convince Brown to extend the injunction that far. “Plaintiff-Intervenors have directed the Court to neither sufficient evidence of their respective associational member(s) for which they seek standing, nor any of the three elements that must be met regarding associational standing. Without such developed briefing, the Court declines to extend injunctive relief to members of Plaintiff-Intervenors,” Brown wrote.

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