The capacity of energy companies and other businesses in highly regulated industries to succeed has become increasingly dependent on the actions of administrative agencies, whose power over certain sectors of the economy is pervasive. The high degree of judicial deference shown to administrative agencies reportedly has caused companies to reluctantly accept even clearly erroneous or arbitrary permitting, enforcement, or regulatory decisions – even when those decisions result in notably adverse consequences for individual companies or whole industries.

The situation has been exacerbated over the past several years by escalating regulatory actions. However, after many years of judicial deference to the regulatory state (sometime referred to as the “fourth branch” of government), a recent decision by the US Supreme Court suggests the pendulum is swinging toward closer judicial scrutiny of all regulatory actions – including not only promulgation of regulations but also permitting and enforcement decisions.

On June 20, 2016, the Supreme Court issued a 6 to 2 decision in Encino Motorcars, LLC v. Navarro, which confirmed that federal courts will not give deference to regulatory actions if an agency fails to provide an adequate explanation for a change of policy or rules. While technically the Court’s holding in Encino Motorcars was narrow – the decision did not even resolve the merits of the underlying dispute regarding the Department of Labor’s interpretation of the Fair Labor Standards Act (FLSA) – the decision may have broader implications. In the wake of Encino Motorcars, courts may be less inclined to defer to agency decision-making, especially when regulators deviate without adequate explanation from a longstanding prior policy that the business community had come to rely upon.

The discrete issue in Encino Motorcars was whether “service advisors” – i.e., the car dealership employees who listen to customers’ concerns about their cars and then suggest/sell repair or maintenance services – are entitled to overtime pay under the FLSA. Since 1974, the FLSA has exempted from overtime requirements “any salesman, partsman, or mechanic primarily engaged in selling or servicing automobiles, trucks, or farm implements.” In 1978 and again in 1987, DOL published guidance that interpreted this statutory language as exempting service advisors from overtime requirements. Then in 2008 (during the waning months of the Bush Administration) DOL proposed regulations to codify this long-standing interpretation of the FLSA. However, when DOL issued the final rule in 2011 (during the Obama Administration), it abruptly changed course by abandoning its decades-old policy of treating service advisors as exempt – with almost no explanation for the change.

Following the predictable suit by automobile dealerships, the Ninth Circuit evaluated DOL’s regulations under the standard established by the Supreme Court’s 1984 decision in Chevron U.S.A. Inc. v. NRDC. Under Chevron, if an agency promulgates a regulation interpreting an ambiguous statute, courts will defer to the agency so long as its interpretation is reasonable. Ostensibly applying Chevron, the Ninth Circuit deferred to DOL’s interpretation of the FLSA that service advisors are not covered by the overtime exemption.

The Supreme Court began its analysis in Encino Motorcars by noting that “one of the basic procedural requirements of administrative rulemaking is that an agency must give adequate reasons for its decisions.” Agencies “are free to change their existing policies as long as they provide a reasoned explanation for the change.” In such a scenario, however, the agency must at least “display awareness that it is changing position” and “show that there are good reasons for the new policy.” According to the Court, “it follows that an ‘unexplained inconsistency’” in an agency’s position is inherently “arbitrary and capricious” and “unlawful” and thus “receives no Chevron deference.”

Applying these principles, the Court ruled that DOL’s “2011 regulation was issued without the reasoned explanation that was required in light of [DOL’s] change in position and the significant reliance interests involved.” The Court noted that the automobile dealership industry “had relied since 1978 on [DOL’s] position that service advisors are exempt from the FLSA’s overtime pay requirements,” and that adaptation to DOL’s new position could necessitate systemic, significant changes to the dealerships’ negotiated and structured compensation arrangements. The Court concluded that DOL’s lack of any “reasoned explanation for a regulation that is inconsistent with [DOL’s] longstanding earlier position results in a rule that cannot carry the force of law.” The Court remanded the case back to the Ninth Circuit with instructions to interpret the statute without deferring to DOL’s position.

Beyond the narrow question of whether service advisors are entitled to overtime pay under the FLSA, Encino Motorcars has the potential to increase the leverage companies have in dealing with regulators. If an agency takes a legally erroneous or inexplicable action in a permitting or enforcement context, companies may now have a greater ability to challenge that decision without a court reflexively deferring to the agency. Although Encino Motorcars specifically applied to Chevron deference, the decision will arguably limit other forms of administrative deference as well – such as courts deferring to agencies’ interpretation of their own regulations (i.e., Auer deference).

According to a report in Greenwire, just two days after the Supreme Court’s opinion in Encino Motorcars was issued, former solicitor general Paul Clement, representing Arch Coal Inc., relied on the decision in a case before the DC Circuit challenging EPA’s move to block a mountaintop-removal mining project in West Virginia. In that case, an Arch Coal subsidiary argued that EPA “failed to engage in reasoned decision-making” because it gave no weight to the company’s reliance on a US Army Corps of Engineers dredge-and-fill permit. After EPA vetoed that permit years after it was issued, the agency argued that its decision was entitled to judicial deference. In response to Arch’s reliance on Encino Motorcars, EPA countered that the decision actually supported the agency’s position because EPA’s veto of the permit was not a reversal of a previous position and EPA provided a reasoned explanation for its decision that took into account the company’s reliance on the permit.

On the other side of the ledger, Greenwire also reported that Earthjustice and the Sierra Club were quick to rely on Encino Motorcars in their pending challenges to the EPA’s air pollution standards for boilers. The environmentalist groups claimed that Encino Motorcars was relevant because “EPA failed to acknowledge or explain a departure from its interpretation” of the Clean Air Act when it promulgated rules limiting emissions from industrial boilers.

These early examples demonstrate the potential usefulness of Encino Motorcars to companies operating in highly regulated industries. While agencies have traditionally been loath to acknowledge any modification in established policies, courts may now be more likely to overturn administrative actions (including permitting and enforcement decisions) that result from a change in an agency position that is either unacknowledged or unexplained. And although agencies have always been required to provide a reasoned explanation for a change in position, Encino Motorcars also suggests that courts should weigh the adequacy of the explanation against the potential detrimental effects that could result from changing a policy upon which regulated entities have come to rely. If an agency fails to include consideration of these impacts in its explanation of the modified position, courts may rule the agency’s action unlawful and/or ineligible for deference. Such enhanced judicial scrutiny could in turn increase rationality, transparency, and accountability in the administrative process, which would redound to everyone’s benefit.