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Editorial 9 MIN READ

The FTC noncompete rule, frozen in place before it started

A Texas district court set aside 16 CFR Part 910 three weeks before the September 4 effective date, and the Fifth Circuit now decides whether it ever takes effect

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. What the rule would have done
  2. The Texas injunction
  3. The parallel cases and the split
  4. The Fifth Circuit appeal
  5. State law is the binding constraint
  6. What to do before the Fifth Circuit rules
  7. Sources

he FTC noncompete rule is not in force anywhere in the United States today. On August 20, 2024, Judge Ada Brown of the Northern District of Texas set the rule aside nationwide under the Administrative Procedure Act, fifteen days before it was scheduled to take effect on September 4. The agency has appealed to the Fifth Circuit.

What founders, in-house counsel, and HR leaders actually need to know is narrow: the rule published in the Federal Register on May 7, 2024 is currently without legal effect, existing noncompetes remain enforceable under state law, and the outcome turns on a statutory authority question the Fifth Circuit will likely reach in the first half of 2025.

What the rule would have done

On April 23, 2024, the Federal Trade Commission voted 3-2 to issue a final rule codified at 16 C.F.R. Part 910, published at 89 Fed. Reg. 38342 (May 7, 2024). The rule declares it an unfair method of competition under Section 5 of the FTC Act for any person to enter into, enforce, or attempt to enforce a post-employment noncompete clause with a worker. It sweeps in employees, independent contractors, externs, interns, volunteers, and sole proprietors who provide services to a client or customer.

Existing noncompetes with workers other than senior executives become unenforceable on the effective date. Noncompetes with senior executives already signed as of the effective date may continue, but no new ones may be entered. "Senior executive" is defined narrowly as a worker in a policy-making position earning more than $151,164 in the preceding year, a definition the Commission estimated covered less than one half of one percent of workers.

The rule preserves noncompetes entered as part of a bona fide sale of a business, the sale of a person's ownership interest, or the sale of all or substantially all of a business's operating assets. It does not preempt state law that is more protective of workers. It requires employers to provide individualized notice to current and former workers that their noncompetes will not be enforced, with model language supplied in the rule.

The Commission estimated the rule would free roughly 30 million workers from noncompete clauses and produce earnings gains in the hundreds of billions over a decade. Dissenters Christine Wilson (before her resignation) and Andrew Ferguson argued the Commission lacked substantive rulemaking authority to issue any rule of this kind under Section 6(g) of the FTC Act.

The Texas injunction

On the same day the final rule was published, Ryan LLC, a Dallas tax services firm, sued in the Northern District of Texas. The U.S. Chamber of Commerce and several trade associations intervened. The case landed with Judge Ada Brown.

On July 3, 2024, Judge Brown issued a preliminary injunction limited to the named plaintiffs, holding that the plaintiffs were likely to succeed on their claim that the FTC lacks statutory authority to promulgate substantive rules defining unfair methods of competition. She declined to enter relief broader than the parties before her, reserving the merits for a Rule 56 ruling.

On August 20, 2024, she granted summary judgment and set the rule aside. Ryan LLC v. FTC, 2024 WL 3879954 (N.D. Tex. Aug. 20, 2024). The holding rests on two grounds.

First, statutory authority. Section 6(g) of the FTC Act, 15 U.S.C. § 46(g), authorizes the Commission to "make rules and regulations for the purpose of carrying out the provisions of this subchapter." The court read that language, its placement among a list of otherwise ministerial housekeeping powers, and the absence of any penalty provision for Section 6(g) rules to mean the Commission has only procedural rulemaking authority, not the authority to issue substantive rules defining what conduct is unlawful under Section 5. The 1973 D.C. Circuit decision in National Petroleum Refiners Ass'n v. FTC, 482 F.2d 672, which had long been cited for substantive rulemaking authority, was read narrowly and treated as non-binding on a Texas district court writing in the era of West Virginia v. EPA and Loper Bright.

Second, the APA. The court held that even if the Commission had authority, the rule was arbitrary and capricious. The opinion criticized the Commission's reliance on a handful of state-level studies of narrow noncompete bans to justify a categorical nationwide rule, the thin treatment of alternatives short of a ban, and the lack of a reasoned explanation for the senior-executive carve-out.

The remedy is the piece that matters for planning. Judge Brown ruled that 5 U.S.C. § 706 requires a reviewing court to "hold unlawful and set aside" agency action, and that the "set aside" remedy operates on the rule itself rather than only on the parties. The rule is therefore vacated as to everyone, and the FTC is enjoined from enforcing it against anyone. Commentary at the time disputed whether Section 706 compels universal vacatur, but the order as written does.

The parallel cases and the split

The FTC drew three suits. The other two came out the other way on preliminary injunctions, producing a genuine split on the merits question.

In ATS Tree Services, LLC v. FTC, No. 2:24-cv-01743 (E.D. Pa. July 23, 2024), Judge Kelley Hodge denied a preliminary injunction, holding that the Commission does have substantive rulemaking authority over unfair methods of competition under Section 6(g) read alongside Sections 5 and 18, and that the plaintiff was unlikely to succeed on the merits. The opinion engages directly with Judge Brown's reasoning in the earlier Texas preliminary-injunction order and rejects it.

In Properties of the Villages, Inc. v. FTC, No. 5:24-cv-00316 (M.D. Fla.), Judge Timothy Corrigan granted a preliminary injunction in August 2024, but on major-questions grounds rather than a flat denial of Section 6(g) authority, and limited to the plaintiff. The Florida court's reasoning is narrower than Judge Brown's and closer to a remand than a vacatur.

The practical result: a Pennsylvania district court says the rule is lawful, a Florida district court says it probably fails under the major-questions doctrine, and a Texas district court has set it aside nationwide. Because the Texas vacatur runs against the rule itself, the ATS and Properties cases will not revive the rule if they eventually come out in the FTC's favor. The Fifth Circuit is the tribunal that matters.

The Fifth Circuit appeal

The FTC filed its notice of appeal from the Ryan judgment on October 18, 2024, docketed as No. 24-10951 in the Fifth Circuit. The Chamber of Commerce is also on appeal from the Properties of the Villages order in the Eleventh Circuit, No. 24-13102. A split between those two circuits would point toward Supreme Court review.

The Fifth Circuit has been hostile to broad agency rulemaking over the last several years, and the panel draw will matter. If the court affirms on Section 6(g) authority, the rule is dead unless the Supreme Court reverses, and the FTC's regulatory path on noncompetes collapses back to case-by-case enforcement actions under Section 5 plus whatever Congress is willing to do. If the Fifth Circuit reverses on authority but remands on APA grounds, the Commission can try again with a better record.

A merits decision within twelve to eighteen months is realistic. In the interim, employers should plan as if the rule will not take effect.

State law is the binding constraint

While the federal rule is tied up, noncompete enforceability is what it has been for decades: a state-by-state question, and the states have been moving.

California has banned noncompetes for employees since 1872, currently codified at Cal. Bus. & Prof. Code § 16600. Section 16600 voids every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind, subject to narrow exceptions for the sale of a business (§ 16601), dissolution of a partnership (§ 16602), and dissolution of an LLC (§ 16602.5). SB 699, signed in 2023 and effective January 1, 2024, makes any noncompete void in California regardless of where or when signed, authorizes employees to sue employers that attempt to enforce one, and obligates employers to notify current and former employees with out-of-state noncompetes that those agreements are void. The sale-of-business exception under § 16601 survives but is read narrowly by California courts.

Minnesota joined California in 2023. Minn. Stat. § 181.988, effective July 1, 2023, voids any covenant not to compete entered into on or after that date, with exceptions only for agreements made in connection with the sale of a business or in anticipation of the dissolution of a business. Existing noncompetes signed before July 1, 2023 remain enforceable under prior law.

Oklahoma and North Dakota have long had statutory bans. 15 Okla. Stat. § 219A voids noncompete agreements generally, permitting only narrow nonsolicitation restrictions. N.D. Cent. Code § 9-08-06 voids noncompetes subject to sale-of-business and partnership-dissolution exceptions. Montana restricts noncompetes through Mont. Code Ann. § 28-2-703 and a body of common law that treats noncompetes as presumed unreasonable.

Every other state permits noncompetes under a reasonableness test that varies substantially. Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia, and Washington have all narrowed their statutes in the last several years with income-threshold rules, notice requirements, or outright bans below specified wage levels. Employers with workers in multiple states cannot rely on a single template.

The FTC rule, had it taken effect, would have preempted the less protective of these state laws but left California and Minnesota in place, a point the final rule made explicit. With the rule vacated, state law is the only layer that matters.

What to do before the Fifth Circuit rules

For founders forming an entity this quarter, the practical posture is straightforward. Do not rely on the FTC rule. Draft noncompetes, if at all, to the most protective state your workforce touches, with a choice-of-law provision that a court in that state will respect. California and Minnesota residents should not be asked to sign a noncompete except in a sale-of-business context. For senior hires, assume a Fifth Circuit reversal is possible and that the rule's senior-executive carve-out may return; document the policy-making nature of the role and the compensation level.

For employers with existing noncompetes in force, do nothing precipitous. The notice obligation under 16 C.F.R. § 910.2(b) has not taken effect and will not take effect unless the Fifth Circuit reverses. Sending the model notice now, voluntarily, tells workers their noncompetes are void, a representation the employer may not want to be bound by if the rule is overturned.

For acquirers, the sale-of-business exception under the vacated rule tracked the common state-law exception and would have permitted noncompetes signed by persons with at least a 25 percent ownership interest. The state-law version is what governs now, and the relevant question is whether the seller has enough equity to fall within the particular state's exception. California's 16601 sets no percentage floor but requires substantial ownership; Minnesota's exception is broader on its face; most states permit reasonable sale-of-business noncompetes without a percentage threshold.

The quiet development is that the FTC, whatever the Fifth Circuit decides, has put noncompetes on the enforcement agenda. Case-by-case challenges under Section 5, coordinated with state attorneys general, do not require Section 6(g) rulemaking authority. A defeat on appeal would narrow the agency's tools but not remove them.

Sources

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