Preemption Questions Continue as FTC and NLRB Fight Restrictive Covenants

As federal administrative agencies wade further into rulemaking and adjudicative efforts to outlaw noncompetes and restrictive covenants, defendants are beginning to raise preemption arguments in response to state court breach of contract claims on the topic.

A recent case shows defendants are taking things into their own hands and not waiting for the Federal Trade Commission (“FTC”) to conclude its announced rulemaking on the subject or for the National Labor Relations Board (“NLRB”) to rule on the NLRB General Counsel’s stated position that nearly all noncompetes violate the National Labor Relations Act (“NLRA”). Instead, they are preemptively raising federal preemption arguments to try to stop enforcement actions in their tracks. This recent case shows that making these arguments, and seeking to remove a state court action to federal court, faces many legal hurdles. In UGI Energy Services, LLC v. Manning, No. 5:23-cv-3169 (E.D. Pa., Oct. 26, 2023), the Court held that raising FTC and NLRA claims did not “completely preempt” a plaintiff’s state law breach of contract claim, and, therefore, the defendant could not remove the case to federal court.

UGI Energy initially sued defendant Manning in Berks County, Pennsylvania for breach of contract related to an alleged “blatant violation of the terms of a Confidentiality, Non-Competition and Non-Solicitation Agreement” (“Agreement”) between Manning and UGI. The Agreement prohibited Manning from (1) competing with UGI for a period of one year after the parties’ separation in the states in which UGI conducts business, (2) soliciting customers of UGI for a period of two years after the parties’ separation, and (3) disclosing or using any confidential information of UGI.

Per UGI’s Complaint, Manning was terminated for siphoning natural gas to his secondary business while he was employed by UGI. The Complaint further alleges that after Manning’s termination, he started a new business that competed with UGI for customers, encouraged customers to breach their contracts with UGI, and relied on confidential information gathered during Manning’s employment with UGI.

Following the filing of the state court Complaint, Manning removed the action to federal court, citing multiple federal questions implicated by the charge, including the federal Unfair and Deceptive Trade Practices statute and the Americans with Disabilities Act, but also asserting that the underlying Agreement violates “Fair Trade” laws and the NLRA on the grounds that both agencies’ public statements indicate a future intent to restrict such agreements. The Notice of Removal also stated that Manning intended to file an NLRB claim alleging his termination was in retaliation for his protected activity and asserting that the enforcement of the Agreement violates the NLRA, which it appears he has done.

UGI moved to remand the action to state court, arguing that there were no federal questions raised in UGI’s state breach of contract claim and that the defendant cannot create federal court jurisdiction by pleading defenses or counterclaims that raise issues of federal law.

Siding with UGI, the Court remanded the matter to State court, holding that removal to federal court requires that the federal question be cognizable on the plaintiff’s well-pled complaint, and that anticipated defenses cannot form the basis for removal. The Court also addressed the defense’s argument that federal jurisdiction was proper because federal law was allegedly violated in the formation of the agreements, holding:

The legality of a contract is not an element of a breach of contract claim, but rather, illegality is an affirmative defense to the enforcement of a contract…. Defendants[’] various arguments for why the contract was invalid under federal law are proposed counterclaims or defenses, not elements of any of the well-pleaded claims. (Citations omitted).

Finally, the Court held that ordinary preemption arguments do not provide an independent basis for federal jurisdiction, and only “complete preemption” serves as grounds for removal to federal court. The Supreme Court established the concept holding that “Congress may so completely preempt a particular area, that any civil complaint raising this select group of claims is necessarily federal in character.” Metropolitan Life Ins. Co. v. Taylor, 481 U.S. 58, 107 S.Ct. 1542, 1546, 95 L.Ed.2d 55 (1987). As the District Court noted, complete preemption only arises under ERISA, the Labor Management Relations Act, and the National Bank Act.

While rejecting federal jurisdiction, the District Court hinted that the defendant may make forum preemption arguments, upon the action’s return to state court, but rejected that as a rationale for federal jurisdiction, because the fact that a defendant might ultimately prove that a plaintiff's claims are preempted under the NLRA does not establish that they are removable to federal court, citing Caterpillar, Inc. v. Williams, 482 U.S. 386, 398 (1987)).

This action, therefore, is back in state court. However, if the NLRB takes the position that the underlying Agreement is unlawful, the NLRB itself is likely to take the position that prosecution of the state court enforcement action is unlawful because it is preempted by the NLRA. UGI may have won this round, but the battle will likely continue.