noncompetes Archives - The National Law Forum

Non-Compete Associated with Partial Sale of Business Must Be “Reasonable” To Be Enforced

Samuelian v. Life Generations Healthcare, LLC, 104 Cal. App. 5^th 331 (2024)

Robert and Stephen Samuelian co-founded Life Generations Healthcare, LLC. When they sold a portion of the business, the company adopted a new operating agreement that restrained its members (including the Samuelians) from competing with the company. The Samuelians later filed a dispute in arbitration challenging the enforceability of the non-compete, contending that it was per se unenforceable pursuant to Cal. Bus. & Prof. Code § 16600; in response, the company contended that the “reasonableness standard” (as set forth in Ixchel Pharma, LLC v. Biogen, Inc., 9 Cal. 5^th 1130 (2020)) should be applied to determine the enforceability of the non-compete.

The arbitrator and the trial court agreed with the Samuelians and held that the agreement was per se unenforceable pursuant to Section 16600. In this opinion, the Court of Appeal reversed, holding that Section 16600 only applies if the restrained party sells its entire business interest and that the statute does not apply “to partial sales after which an individual retains a significant interest in the business.” In the case of a partial sale, the Ixchel reasonableness standard applies to determine the enforceability of the noncompete. The court also held that the “sale of the business” exception to Section 16600 (Sections 16601, et seq.) only applies if there has been: (1) a sale of the entire business interest; and (2) a transfer of “some goodwill” as part of the transaction. The opinion also contains a detailed discussion of members’ fiduciary duties in a manager-managed company under the Revised Uniform Limited Liability Company Act (RULLCA) and holds that an operating agreement can impose reasonable non-compete restrictions on members of a manager-managed company.

US District Court Sets Aside the FTC’s Noncompete Ban on a Nationwide Basis

On August 20, the US District Court for the Northern District of Texas held that the Federal Trade Commission’s (FTC) final rule banning noncompetes is unlawful and “set aside” the rule. “The Rule shall not be enforced or otherwise take effect on its effective date of September 4, 2024, or thereafter.”

The district court’s decision has a nationwide effect. The FTC is very likely to appeal to the Fifth Circuit. Meanwhile, employers need not concern themselves for now with the rule’s notice obligations, and the FTC’s purported nationwide bar on noncompetes is ineffective. Employers do, however, need to remain mindful of the broader trend of increasing hostility to employee noncompetes.

The Court’s Decision

On April 23, the FTC voted 3-2 to publish a final rule with sweeping effects, purporting to bar prospectively and invalidate retroactively most employee noncompete agreements. The court’s decision addressed cross-motions for summary judgment on the propriety of the FTC’s rule. The court denied the FTC’s motion and granted the plaintiffs’ motion for two reasons.

First, the court held that the FTC lacks substantive rulemaking authority with respect to unfair methods of competition under Section 6(g) of the FTC Act. In reaching its holding, the court considered the statute’s plain language, Section 6(g)’s structure and location within the FTC Act, the absence of any penalty provisions for violations of rules promulgated under Section 6(g), and the history of the FTC Act and subsequent amendments. Because the FTC lacked substantive rulemaking authority with respect to unfair methods of competition, and hence authority to issue the final noncompete rule, the court did not consider additional arguments regarding the scope of the FTC’s statutory rulemaking authority. Notably, the court did not consider whether the final rule could overcome the major questions doctrine.

Second, the court held that the FTC’s final noncompete rule was arbitrary and capricious under the Administrative Procedure Act (APA) because it was “unreasonably overbroad without a reasonable explanation” and failed to establish “‘a rational connection between the facts found and the choice made.’” The court heavily discounted studies that the FTC had relied upon that purported to measure the impact of statewide noncompete bans because no state had ever enacted a ban as broad as the FTC’s ban: “[t]he FTC’s evidence compares different states’ approaches to enforcing non-competes based on specific factual situations — completely inapposite to the Rule’s imposition of a categorical ban.” “In sum, the Rule is based on inconsistent and flawed empirical evidence, fails to consider the positive benefits of non-compete agreements, and disregards the substantial body of evidence supporting these agreements.” The court further held that the FTC failed to sufficiently address alternatives to issuing the rule.

In terms of a remedy, the court “set aside” the FTC’s final noncompete rule. The “set aside” language is drawn verbatim from the APA. The court noted that the FTC’s argument that any relief should be limited to the named plaintiffs in the case was unsupported by the APA. Instead, the court noted that its decision has a nationwide effect, is not limited to the parties in the case, and affects all persons in all judicial districts equally.

Further Litigation

In addition to a likely FTC appeal to the Fifth Circuit, two other cases are pending that likewise challenge the FTC’s final noncompete rule. First, in ATS Tree Services v. FTC, pending in the Eastern District of Pennsylvania, the district court previously denied the plaintiff’s motion for a preliminary injunction. Second, in Properties of the Villages, Inc. v. FTC, pending in the Middle District of Florida, the court enjoined the FTC from enforcing the rule against the named plaintiffs. A final judgment in one of these cases that differs from the result in the Northern District of Texas could eventually reach the courts of appeals and potentially lead to a circuit split to be resolved by the US Supreme Court.

Takeaways for Employers

For now, the FTC’s noncompete rule has been set aside on a nationwide basis, and employers need not comply with the rule’s notice obligations. Noncompetes remain enforceable to the same extent they were before the FTC promulgated its final rule. Depending on how further litigation evolves, the rule could be revived, a temporary split in authority could arise leading to confusion where the rule is enforceable in certain jurisdictions but not in others, or the rule will remain set aside.

An important part of the court’s decision is its rejection of the FTC’s factual findings, which were made in support of the rule, as poorly reasoned and poorly supported. As we discussed in our prior client alerts, we anticipate that employees may cite the FTC’s findings to support challenges to enforceability under state law. The court’s analysis of the FTC’s factual findings may substantially undermine the persuasive authority of the FTC’s findings.

Employers should anticipate that noncompete enforcements in the coming years will remain uncertain as courts, legislatures, and government agencies continue to erode the legal and policy justifications for employee noncompetes. This counsels in favor of a “belt and suspenders” approach for employers to protect their legitimate business interests rather than relying solely on noncompetes.

Opposing Decisions – Does the FTC Have the Authority to Ban Non-Compete Clauses?

In April, the Federal Trade Commission (FTC) promulgated a new rule banning non-competes (the Rule); the FTC adopted the Rule to prohibit employers from entering into or enforcing non-compete clauses with workers and senior executives. Several lawsuits were quickly filed challenging the rules. Separate parties filed in Texas (in which cases were consolidated), and ATS Tree Services, LLC, filed an action in Pennsylvania.

On July 23, 2024, the U.S. District Court for the Eastern District of Pennsylvania issued a ruling denying ATS Tree Services’ motion for a stay and a preliminary injunction against the Rule. ATS Tree Services, LLC v FTC, No: 2:24-cv-01743-KBH, at p.18 (E.D. Pa. July 23, 2024). The Court held that ATS had not demonstrated the irreparable harm necessary to justify the issuance of a preliminary injunction and also held that ATS failed to establish a reasonable likelihood of success on the merits of its action.

The ruling is diametrically opposed to the July 3, 2024, ruling from the U.S. District Court for the Northern District of Texas, which preliminarily enjoined the Rule and postponed its effective date in Ryan, LLC v. U.S., No. 3:24-CV-00986-E, 2024 (N.D. Tex. July 3, 2024). However, the district court declined to issue a universal injunction, making its ruling applicable only to the Ryan plaintiffs.

The Decisions

In ATS Tree Services, the court first held that nonrecoverable costs of compliance do not rise to the level of irreparable harm, in that “monetary loss and business expenses alone are insufficient bases for injunctive relief.” ATS Tree Services at p.18. Additionally, the court held that the claimed loss of contractual benefits was too speculative. Id. 20-21.

Even though the court found that ATS failed to establish irreparable harm, it added an analysis of ATS’s likelihood of success on the merits, spending the majority of its decision assessing (just as the Ryan Court had) whether “[s]ection 6(g) empowers the FTC with the authority to make substantive rules related to unfair methods of competition in or affecting commerce, or whether the rulemaking authority therein is limited to procedural rules relating to adjudications of unfair methods of competition in or affecting commerce.” ATS Tree Services, at p.8. Notably, the Court relied upon the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244, 2263 (2024) to “independently interpret the statute and effectuate the will of Congress subject to constitutional limits.” Id. at 25. In doing so, the Court harmonized sections 5 and 6 of the FTC Act, concluding:

When taken in the context of the goal of the Act and the FTC’s purpose, the Court finds it clear that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition. Thus, the Court rejects ATS’s argument that it should read the word “procedural” but not the word “substantive” into the statutory text defining the FTC’s rulemaking authority. This argument is inherently inconsistent and therefore untenable. Id. at 26.

This was directly contrary to the Ryan decision where the court found under section 6(g) that the FTC lacks the authority to create substantive rules because the Act is only a “housekeeping statute” that allows the FTC to promulgate general “rules of agency organization procedure or practice,” not “substantive rules.” Ryan at *15 (citing Chrysler Corp. v. Brown, 441 U.S. 281, 310 (1979)).

The court in ATS Tree Services went on to address the FTC’s mandate to “prevent prohibited ‘unfair methods of competition’” under section 5, thereby acknowledging Congress’s terms were “intended to act prophylactically to stop ‘incipient’ threats of unfair methods of competition, not solely responsively through adjudications, as courts interpreting the statute have confirmed.” ATS Tree Services, at p. 28. In addition, the court found that the FTC’s rulemaking authority had been confirmed by other circuit courts. Finally, in the rest of the decision, the Court disposed of the other alternative challenges made by ATS. This was contrary to the Ryan decision, where the Texas court had held that the FTC acted arbitrarily and capriciously, because the Rule was “unreasonably broad without a reasonable explanation” and did not sufficiently address alternatives to issuing the Rule.

Key Takeaways

The two courts have issued opinions with conflicting analyses. While Texas has issued a preliminary injunction specific to the Ryan plaintiffs, the court did indicate it intends to make a final determination on the merits by August 30, 2024, prior to the Rule’s effective date. The Ryan Court will have the opportunity to vacate the Rule in its entirety as unlawful and issue a permanent injunction, with the scope of the relief ordered yet to be decided. This new ruling sets up the potential for an appeal to the U.S. Court of Appeals for the Fifth Circuit and possibly seek direct relief from the U.S. Supreme Court.

*This post was co-authored by Lily Denslow, legal intern at Robinson+Cole. Lily is not admitted to practice law.

Pennsylvania Federal Court Declines to Preliminarily Enjoin FTC Rule Banning Non-Competes

Earlier today (July 23, 2024), Judge Hodge in the U.S. District Court for the Eastern District of Pennsylvania denied a tree care company’s motion to stay the effective date and preliminarily enjoin the Federal Trade Commission’s (“FTC”) proposed final rule (“Final Rule”) banning nearly all non-competes. ATS Tree Services, LLC v. Federal Trade Commission, No. 2:24-cv-01743-KBH (E.D. Pa.). The decision comes in the wake of the U.S. District Court for the Northern District of Texas’ July 3, 2024 ruling to the contrary in Ryan LLC v. Federal Trade Commission, No. 3:24-cv-00986-E, which stayed the Final Rule’s effective date as to the plaintiffs in that case, but had no nationwide effect.

The Pennsylvania Court’s Decision

The Pennsylvania court denied Plaintiff ATS Tree Services, LLC’s (“ATS”) request for a preliminary injunction based on its conclusion that the company failed to establish that it (i) would suffer irreparable harm if injunctive relief was not issued; and had a reasonable likelihood of succeeding on the merits of its claims.

ATS argued it would be harmed by incurring “nonrecoverable efforts to comply” with the Rule, and by losing “the contractual benefits from its existing non-compete agreements.” ATS described its nonrecoverable compliance costs as: costs associated with notifying its twelve employees of the change in accordance with the Rule’s notice provision; the costs and efforts to “review and modify [its] business strategy”; and the unquantifiable costs and efforts of altering its specialized training program. But court found these either insufficient or too speculative to support injunctive relief. ATS further argued it would face the risk that its employees would leave and transfer confidential information to direct competitors. The court found these risks too speculative.

ATS also unsuccessfully argued that it would succeed on the merits because, it asserted, the FTC lacks substantive rulemaking authority under its enabling statute, the FTC exceeded its authority, and Congress unconstitutionally delegated legislative power to the FTC. The court rejected each argument. The court further found that the “major questions doctrine” did not apply, because the Final Rule falls within the FTC’s core mandate, and the FTC has previously used its Section 6(g) rulemaking power in similar ways to the Final Rule.

Looking Forward

The Pennsylvania court’s decision did not analyze the Ryan decision, which reached contrary conclusions. It is likely that the dispute will ascend to the Third and Fifth Circuits, respectively. Notably, the Ryan court has indicated that it intends to issue a final judgment on the merits by August 30, 2024, which is likely to be appealed, and the Final Rule is scheduled to become effective by September 4, 2024.

FTC Approves Non-Compete Ban

On Tuesday afternoon, April 23, the Federal Trade Commission (FTC) voted 3-2 along party lines to approve its new rule on non-competes. The new rule, which will take effect in 120 days, essentially bans non-competes for all workers, finding them “an unfair method of competition – and therefore a violation of Section 5 of the FTC Act.”

Notably, a non-complete clause is broadly defined as a “contractual term or workplace policy that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment or operating a business in the United States after the conclusion of the employment.”

The new rule applies retroactively to prior agreements, other than those for senior executives earning more than $151,164 a year in a “policy-making position.” Employers must provide notice to other workers subject to non-compete agreements that they are no longer enforceable.

Not limited to employees, the non-compete ban extends to independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a person. It does not include non-competes entered into pursuant to a bona fide sale of a business entity or in a franchisor-franchisee relationship.

While the rule is final, expect legal challenges to follow. For example, the U.S. Chamber of Commerce, the nation’s largest business lobby, told reporters it plans to sue over the rule, claiming the FTC is not authorized to make this rule, that non-competes are not categorically unfair, and the rule is arbitrary. The Chamber’s thoughts were echoed by the opposing Republican FTC voters, who cited concerns about the FTC’s authority (as compared to the merits of such a rule).

While employers’ protectable interests are often a concern, it is important to note that this rule does not ban non-disclosure and confidentiality agreements.

“…it is an unfair method of competition – and therefore a violation of Section 5 of the FTC Act – for employers to enter into noncompetes with workers after the effective date.”

Tag: noncompetes

Non-Compete Associated with Partial Sale of Business Must Be “Reasonable” To Be Enforced

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