Federal District Court Declines to Stay Enforcement of FTC’s Non-Compete Rule

July 26, 2024

By: Stephen B. Stern

     In addition to the lawsuit that was filed in Texas challenging the new rule promulgated by the Federal Trade Commission (“FTC” or “Commission”) that bans most non-compete agreements (see summary of the rule here), the FTC’s rule banning non-compete agreements has been challenged in the United States District Court for the Eastern District of Pennsylvania by ATS Tree Services, Inc. (“ATS”).  Unlike the United States District Court for the Northern District of Texas, however, the Eastern District of Pennsylvania declined to stay the enforcement of the new rule in ATS Tree Services, Inc. v. Federal Trade Commission, Civil Action No. 24-1743, 2024 U.S. Dist. LEXIS 129398 (E.D. Pa. July 23, 2024).  The contrasting outcomes leaves much uncertainty for businesses on how they should proceed with the rule’s September 4, 2024 effective date fast approaching.

     ATS’s complaint includes four causes of action:  Count I contends the FTC lacks authority to promulgate substantive rules that prevent unfair methods of competition; Count II contends that, if the FTC has substantive rulemaking authority, the ban on all non-compete agreements exceeds its statutory authority; Count III contends that rendering existing non-compete agreements for non-senior level executives unenforceable is arbitrary and capricious; and Count IV contends the Federal Trade Commission Act (the “Act” or “FTC Act”) unconstitutionally delegates legislative power to the FTC.  ATS’s motion for preliminary injunction, which asked the court to stay the implementation of the FTC’s rule, only addressed arguments involving Counts I, II, and IV (not Count III).

     The court started its analysis by engaging in a lengthy recitation of provisions of the FTC Act, including amendments to the statute.  Among other things, the court noted that “[a]ll the committee reports and statements of those in charge of the [Act] reveal an abiding purpose to vest both the Commission and the courts with adequate powers to hit at every trade practice . . . which restrained competition or might lead to such restraint if not stopped in its incipient stages.”  The court also quoted from Section 5 of the Act, noting that “[t]he Commission is hereby empowered and directed to prevent persons, partnerships, or corporations, except banks, savings and loan institutions, . . . credit unions . . . [and other entities and individuals not regulated by the FTC] from using unfair methods of competition in or affecting commerce and unfair or deceptive acts or practices in or affecting commerce.”  The court then pivoted to addressing the factors to issue a preliminary injunction: (1) whether movant has shown “a reasonable probability of success on the merits;” (2) whether the movant will be irreparably harmed by denying the injunctive relief; (3) whether granting the injunction will result in greater harm to the nonmoving party; and (4) whether granting injunctive relief will be in the public interest.

     The court started by finding that ATS did not establish it would suffer irreparable harm.  ATS argued that it would incur nonrecoverable costs by complying with the FTC rule in the form of (1) costs associated with notifying its employees about the invalidity of their non-compete agreements, (2) costs and efforts to “review and modify [its] business strategy,” and (3) unquantifiable costs and efforts associated with altering its specialized training program for employees. The court rejected ATS’s arguments in this regard, explaining that ATS relied on precedent from the United States Court of Appeals for the Fifth Circuit that holds incurring nonrecoverable costs, including purely economic costs, to comply with a rule constitutes irreparable harm, but the United States Court of Appeals for the Third Circuit (which is the circuit that governs Pennsylvania) has reached the opposite conclusion.  The court further found that the one-time notice costs (estimated at less than $30.00) was de minimis and the cost of revising contractual practices (estimated at less than $1,250) did not rise to the level of “peculiar” costs that warrant preliminary injunctive relief.  Additionally, the alleged cost of scaling back training was unpersuasive because it was too attenuated in the court’s view to constitute irreparable harm and, furthermore, the court noted that providing the specialized training could give ATS a competitive advantage that encourages employees to stay with ATS.  The court further found that ATS’s additional argument that its employees would leave to work for competitors without the non-compete agreements in place was unsubstantiated, explaining that ATS did not submit “any indication that its employees are planning to leave, or examples of employees previously attempting to leave to join competitors.”

     Next, the court rejected ATS’s other argument regarding irreparable harm – that it would be deprived of its contractual benefits if the non-compete agreements were not enforced.  In rejecting this argument, the court noted that ATS again was relying on non-binding precedent from outside the Third Circuit (this time relying on a case from the United States District Court for the Eastern District of Michigan), just as it did when arguing about nonrecoverable costs, and the court declined to follow the non-binding precedent here as well.

     The court then found, even if ATS could establish irreparable harm, it did not establish that it was likely to prevail on the merits.  To this end, the court found that nothing in Sections 5 or 6 of the FTC Act “expressly limits the FTC’s rulemaking power to issuing exclusively procedural rules [and] nowhere in the text does Congress expressly limit the FTC’s enforcement mechanisms to adjudications; in fact, Congress does just the opposite by empowering the FTC to issue rules.”  After conducting other textual reviews of the statute, the court ultimately found that “it [is] clear that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition” and, therefore, the court rejected ATS’s argument that the FTC is limited to making procedural rules and not substantive rules.  Additionally, the court found that the FTC Act’s directive to “prevent” unfair methods of competition necessarily includes the power to make substantive rules, otherwise the FTC would be limited to preventing unfair competition only through adjudicative acts, which is in direct conflict with the text of the statute.

     The court then analyzed some additional textual and constitutional arguments that need not be reviewed here and it did not undertake an analysis of the balancing of the equities or the public interest factors (the other two factors to be considered when evaluating whether to issue a preliminary injunction).

     The court’s decision in ATS is significant for multiple reasons.  First, it leaves the FTC’s rule banning non-compete agreements in place and on track to take effect on September 4, 2024.  Second, it creates more uncertainty for businesses (and individuals) because the outcome contrasts with the decision of the United States District Court of the Northern District of Texas (see summary of that decision here) from earlier this month.  Thus, businesses that utilize and want to continue utilizing non-compete agreements should confer with their counsel on how to approach these conflicting decisions and the upcoming September 4 effective date for the final rule.  In the meantime, businesses (and individuals) also should continue to monitor the courts for additional outcomes that might give guidance on the status of the new FTC rule.