The FTC Ban on Non-Competes – Impact of Final Rule on M&A Transactions
The Federal Trade Commission last year proposed a sweeping rule outlawing most non-competition agreements nationwide. The rule applied both to non-competes in the employer-employee context and to a seller of a business in an M&A transaction. The rule as modified goes into effect September 4, 2024; however, a federal court has struck down the rule as exceeding the FTC’s rulemaking authority. It remains to be seen whether the rule will survive this and several other judicial attacks.
Nonetheless, it is important to analyze the final rule for whenever and in what form it goes into effect. Non-competes are under attack across the country, and practitioners would be well advised to at least attempt to meet some of the more objectionable aspects of non-competes, particularly in the M&A context.
The proposed rule applied the non-compete ban to a seller of a business except if the seller owned 25% or more of the business being sold. The final rule drops the 25% ownership requirement. The prohibition on non-competes now does not apply “to a non-compete clause that is entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.”
The key term is “bona fide sale”. According to the Commission, “a bona fide sale is one made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule.” [Italics added.] The Commission further elaborated that it considers a bona fide sale to be “one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.”
The Commission rejected a number of comments proposing additional guardrails to assure that the exception is not abused through the use of “sham transactions with wholly owned subsidiaries, ‘springing’ non-competes, repurchase rights, mandatory stock redemption programs, or similar evasion schemes.” The FTC declined to specifically delineate each kind of sales transaction that is not a bona fide sale subject to the exception “to avoid the appearance that any arrangement not listed is allowed under the exception.”
It remains to be seen whether inventive minds will nonetheless interpret the term “bona fide sale” to justify non-competes in questionable circumstances, but the elimination of ownership or other requirements to be entitled to the exception in the sale context is a welcome change.
Another aspect of the final rule that could impact M&A transactions is the exception for existing non-compete agreements for “senior executives”, if the agreement was entered into prior to September 4, 2024, the current effective date of the rule. (This date will almost certainly be pushed later if and when the rule survives judicial challenges.) The proposed rule banned all non-competes, retroactively and prospectively, for all workers regardless of level or role within an organization or other criteria such as compensation. The final rule, however, now excepts previously agreed non-competes with senior executives because, as the Commission notes, “this subset of workers is less likely to be subject to the kind of acute, ongoing harms currently being suffered by other workers subject to existing non-competes and because commenters raised credible concerns about the practical impacts of extinguishing existing non-competes for senior executives.”
“Senior executive” is defined as a worker who both (a) was in a “policy-making position” and (b) received “total annual compensation” of at least $151,164 in the preceding year (or partial year annualized). “Total annual compensation” includes salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned during the preceding 52-week period. Total annual compensation does not include board, lodging and other facilities, and does not include payments for medical insurance, payments for life insurance, contributions to retirement plans or the cost of other similar fringe benefits. Significantly, compensation does not include discretionary bonuses or the value of stock or other equity grants, which can be a significant percentage of total compensation for these executives.
“Policy-making position” means “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.” The Commission stated that an officer of a subsidiary or affiliate of a business entity that is part of a “common enterprise” who has policy-making authority for the common enterprise may be deemed to have a policy-making position for purposes of this exception. However, a person who does not have policy-making authority over a common enterprise may not be deemed to have a policy-making position even if the person has policy-making authority over a subsidiary or affiliate that is part of the common enterprise.
Although this exception will grandfather many non-compete agreements entered into with senior executives of a seller that do not necessarily have an ownership stake in the business being sold (and therefore would not be excepted under the “bona fide sale” exception), the exception leaves many workers who buyers typically consider important (such as operating subsidiary chiefs) free retroactively from non-compete agreements entered into as part of the sale.
Moreover, if these “senior executives” indeed are “less likely to be subject to the kind of acute, ongoing harms currently being suffered by other workers,” then it is hard to understand why the exception only applies to pre-existing non-competes and not to those entered into going forward. Certainly, these key workers are usually able to fend for themselves in an M&A transaction.
There are many other aspects of the final rule that could impact M&A transactions. For example, there is no exception for non-competes for highly trained or technical workers such as high-level software engineers that buyers often wish to tie up in connection with an acquisition. So although the final rule provides some welcome relief from the total non-compete ban, it remains to be seen how buyers adapt to the new landscape in negotiating M&A transactions that typically involve interlocking “bundled” consideration, including non-competes and other restrictive covenants.
*This was republished with permission from Association of Corporate Counsel. Click to access the publication.
