M&A Deals Escape FTC Ban on Noncompete Agreements by Fabio De Filippo, CPA
On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule banning businesses nationwide from entering into noncompete agreements with most new employees beginning on Sept. 24, 2024, and nullifying the enforcement of existing noncompetition clauses in most employer/employee contracts. This rule, which is facing a mountain of lawsuits, will require buyers and private equity firms across all industries to reconsider many of their M&A acquisition plans as it will have a material impact on these transactions in the future. While these cases make their way through the legal system, the final rule’s effective date is expected to be delayed, leaving businesses in limbo.
Background
An estimated 30 million U.S. workers are subject to noncompete clauses whose terms and conditions of employment prohibit, prevent or penalize workers from/for accepting employment or starting a new business after the conclusion of their current employment ends. According to the FTC, these arrangements are deemed “unfair methods of competition” that violate Section 5 of the FTC Act and exploit workers’ lack of bargaining power by coercing them into staying in jobs they would rather leave or forcing them to leave a profession or even relocate for employment.
Under the final FTC rule, employers may neither enforce existing noncompete clauses with U.S. employees nor may they enter into new noncompete agreements with workers unless they meet an exception. For example, employers have until Sept. 24, 2024, to enforce existing noncompete agreements with senior-level executives who are in policy-making positions and earned more than $151,164 in the preceding year.
However, should the law withstand all the legal challenges it currently faces and go into effect on or after Sept. 24, 2024, enforcement of all existing arrangements is banned, and businesses may not execute any new noncompete provisions with any of their employees. Compliance simply requires businesses to notify workers bound by an existing noncompete that they will not enforce the agreements in the future. Yet, it should be noted that FTC the rule does not apply to other types of restrictive employment agreements, such as non-disclosure agreements (NDAs) and non-solicitation agreements.
Exception for M&A Activities
A second exception to the final rule applies to employees and equity partners under 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 FTC defines a bona fide sale as one “between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale.” In other words, employers may execute and enforce noncompete provisions with any employees or partners who are essential to the business’s value and ultimate sales price.
If the enforcement of those noncompetes with key employees is revoked, “the bargained-for value” of a business sale may decrease,” and the buyer would lose the value of what it paid for the business and have no way to recoup those costs. This is an especially important point for M&A and private equity transactions.
Conflicts to State Laws
Another issue businesses should consider when trying to enforce noncompete provisions is how state law treats these arrangements. For example, only four states currently ban noncompetes (California, Minnesota, North Dakota and Oklahoma) with limited exceptions for the sale of a business or dissolution of a partnership. On the other end of the spectrum, 13 states allow noncompetes as a “reasonable necessity” to protect legitimate business interests, but the enforceability of those arrangements is left to the courts. For most U.S. states, however, noncompete clauses are banned for specific industries (i.e., healthcare, financial services) or restricted to specific time periods and/or employees whose salaries exceed certain thresholds.
The FTC makes clear in the final rule that it does not limit or affect state laws that restrict noncompete agreements, but it does preempt state laws that conflict with the final rule. Therefore, if a state law has a narrower exception to the noncompete ban than the FTC’s final rule, the state law will prevail. By contrast, the FTC provisions would prevail when a state law has a broader exception to the ban.
In the current environment, businesses looking to keep trade secrets and other proprietary information confidential should assess their current noncompete policies against the provisions of the FTC’s final rule and, in some cases, consider alternative measures, such as NDAs, nonsolicitation agreements and other remedies under intellectual property laws. Even with a delay to the final rule’s effective date, it is possible the FTC will investigate and pursue legal challenges to individual businesses’ non-compete provisions.
About the Author: Fabio De Filippo, CPA, is a director of Transaction Advisory Services with Berkowitz Pollack Brant, where he works closely with clients, private equity and strategic acquirers on buy and sell-side deals in a wide range of industries. He can be reached at the CPA firm’s New York City office at (646) 213-7600 or info@bpbcpa.com.
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