Diverging from Texas Federal Court’s Preliminary Ruling, Pennsylvania Federal Court Declines to Enjoin FTC’s Rule Banning Non-Compete Agreements

The Federal Trade Commission (“FTC”) is now batting .500 in its effort to defend its rule banning most employee non-compete agreements.  On July 23, 2024, Judge Kelley Hodge of the U.S. District Court for the Eastern District of Pennsylvania denied the request for a preliminary injunction to block that rule from going into effect pending a full trial.  This decision is at odds with the decision issued earlier this month by Judge Ada Brown of the U.S. District Court for the Northern District of Texas, which found that the FTC had exceeded its statutory authority and issued a limited preliminary injunction that prevented the rule from becoming effective as to the plaintiffs in that case. 

The Pennsylvania court rejected plaintiff ATS Tree Services’s (“ATS”) request for injunctive relief after finding that ATS—a 12-person company—had not (i) alleged the requisite irreparable harm and (ii) established that the FTC lacks statutory authority to issue substantive competition rules.  The FTC’s non-compete rule is expected to become effective on September 4, 2024, unless the Texas court’s final decision expands the injunction to apply nationwide.  For more information on the Texas court’s decision, please see Crowell’s earlier alert on that decision: “Texas Federal Court Preliminarily Enjoins FTC’s Non-Compete Ban, But Declines to Issue Nationwide Preliminary Injunction.”

In the likely event that the Texas court issues a final decision against the FTC, there will be conflicting decisions on the lawfulness of the FTC’s non-compete ban.  If both decisions are affirmed on appeal, there will be a federal circuit split, which will increase the likelihood that this issue ultimately will be decided by the U.S. Supreme Court.

The ATS Decision

ATS Tree Services, LLC v. Federal Trade Commission was one of several complaints filed in the wake of the FTC’s April 23, 2024 announcement of a new rule that would ban substantially all non-compete agreements. 

As with all cases seeking a preliminary injunction, ATS had the burden of proving to the court that (1) it would suffer irreparable harm if not granted injunctive relief, and (2) it was likely to succeed on the merits.  Unlike the Texas court, the Pennsylvania court found that neither of these requirements was satisfied.  Most importantly, in contrast to the Texas court, the Pennsylvania court ruled that the plaintiff had not met its burden of showing that “there is a reasonable probability that the FTC lacked authority under the FTC Act to issue the Final Rule, or that Congress’s delegation of such authority under the FTC Act was unconstitutional.”

Irreparable Harm Ruling

The Pennsylvania court rejected ATS’s argument that it would be immediately harmed by the FTC’s ban in two ways: (1) by incurring “non-recoverable efforts to comply” with the rule; and (2) by losing the “contractual benefits from its existing non-compete agreements.”  In rejecting this argument, the court noted that the Third Circuit does not recognize “nonrecoverable compliance costs” as a basis for finding the existence of irreparable harm. This is, in fact, the opposite of the Fifth Circuit law (which includes the Northern District of Texas), and is one of many reasons the Texas plaintiffs successfully challenged the FTC rule.

To reach its conclusions, the court found that the costs the 12-employee-company would incur were too small, and that ATS’s argument that it would suffer “unquantifiable” costs in investment losses from losing employees should non-competes be invalidated was far too speculative.  The court also rejected ATS’s argument that it would be irreparably harmed by the contractual rights it would lose should the ban go into effect, as ATS can still use other contractual avenues, such as non-disclosure agreements, to protect its proprietary information.

Likelihood of Success on the Merits Ruling

Like the Texas court, the Pennsylvania court began its analysis of whether the FTC had the authority to issue its non-compete rule by examining the history of the FTC Act and meaning of the statutory text.^[1] Unlike the Texas court, she concluded that Section 5 (authorizing action by the FTC to “prevent” “unfair methods of competition”) and Section 6(g) (creating additional powers for the FTC to carry out its directive from Congress) of the FTC Act are complementary. In other words, “the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition.” The court further reasoned that because Section 6(g) authorizes action to “prevent” unfair competition, the FTC has the authority to act proactively, and not just react to ongoing harms.

The court also considered the numerous amendments to the FTC Act since it was enacted in 1914, including several substantive amendments. In doing so, the court concluded that in none of these amendments did Congress, despite having the opportunity, act to limit the authority of the FTC.

ATS also argued that, even if the FTC had authority to promulgate some sort of rulemaking related to non-compete agreements, it exceeded that authority with such a sweeping ban.  The court rejected each of ATS’s arguments, including that the validity of non-compete agreements should be judged under the traditional reasonableness standard; the FTC is venturing into an area regulated by state law; because of the significance of this rulemaking, clear intent from Congress is required; and Congress unconstitutionally delegated legislative authority to the FTC.  Judge Hodge’s determinations regarding the FTC’s authority are in direct contrast to the Texas court, and likely will be the basis of appeals going forward.

What’s next?

Judge Hodge’s opinion in ATS was a decision on ATS’s motion for interim relief, to stay the effective date of the rule, and for a preliminary injunction.  ATS’s complaint has not been dismissed—and ATS still may seek to overturn the FTC’s ban as unconstitutional through a full litigation record. Moreover, in the Texas case—where the plaintiffs were successful in their bid for a preliminary injunction, albeit limited in scope to the plaintiffs in the case—the judge has indicated she intends to rule on the merits by August 30, 2024, and, based on her initial ruling, we strongly expect she will permanently enjoin the rule.  A key question will be whether the Texas judge decides to revisit her initial decision declining to issue a nationwide injunction.  Another key question will be what, if any, influence does the Pennsylvania court’s decision have on the Texas court’s final ruling.

Given the uncertainty created by these conflicting decisions regarding the enforceability of the FTC’s rule, companies that rely on non-compete agreements should assess their legal risks and whether different tools, such as non-disclosure agreements, could provide sufficient protection while the legal issues surrounding the FTC’s rule work their way through the appellate process.

Companies that want to re-examine their existing non-compete agreements and audit their protections and controls over confidential and trade secret information can reach out to members of Crowell’s antitrust, labor, or trade secrets teams, including the contacts for this alert.