FTC’s new noncompete ban allows exceptions for mergers

The Federal Trade Commission last month announced a sweeping ban on most noncompete agreements, but some exceptions were granted for certain mergers and acquisitions.

Those exceptions come through a sale-of-a-business provision in the agency’s new rules, which permit entering into a noncompete with a person who is selling a business or disposing of all of the person’s ownership interest in a business in a “bona fide sale.”

In its 570-page final rule, the FTC noted that its overall purpose for the wider ban on noncompetes is to address conduct that harms fair competition.

An estimated 18% of the workforce—or 30 million Americans— are subject to noncompetes, which are agreements that prohibit employees from competing against their employer or revealing proprietary information after they have left the company.

“Concern about non-competes dates back centuries, and the evidence of harms has increased substantially in recent years,” the FTC said in a statement.”However, the existing case-by-case and State-by-State approaches to non-competes have proven insufficient to address the tendency of non-competes to harm competitive conditions in labor, product, and service markets.”

What are the impacts?

It’s unclear if the new rules will survive legal challenges. Still, there are certain exceptions to explore under the sale–of-business provision, said Kevin Roberts, an associate labor and employment law attorney with Barnes & Thornburg’s Indianapolis office.

In order to qualify for the exception, Roberts said, parties need to make sure sales are made between two independent parties at arm’s length, in which the seller has a reasonable opportunity to negotiate the terms of the sale.

He said he would be advising clients that sellers and buyers in mergers and acquisitions should be represented by counsel in any transactions.

Roberts said the FTC has also included out a good-faith provision which requires a bona fide sale to be made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule.

The attorney said potential buyers, in their due diligence, should figure out what the selling company is doing to protect their confidential information, like what kind of password protection is in place, and also take inventory and determine things like how many employees there are and whether they have non-compete agreements in place.

Roberts said there are a lot of questions buyers should be asking as they consider a merger or acquisition.

“If this business gets sold to me, are these employees going to stay?” Roberts said.

Roberts said the FTC approached the final non-compete rule from the vantage point of a lack of negotiating power for employees and trying to eliminate unfair bargaining positions.

Harmony Mappes, a partner at Faegre Drinker Biddle & Reath LLP and co-leader of the firm’s non-compete and trade secret practice, said that based on what is known about the FTC rule, its impacts on mergers and acquisitions would be limited.

Mappes said the upshot is that non-compete agreements would be allowed in that buying and selling context.

Greg Ellis, the Indiana Chamber of Commerce’s vice president of energy, environmental affairs and federal relations, said it’s unclear to him how the new noncompete rules would impact mergers. However, he believes a section allowing noncompetes for existing senior executives relates to mergers and makes them feasible.

For senior executives, existing non-competes can remain in force. Fewer than 1% of workers are estimated to be senior executives under the final rule, with those executives defined as workers earning more than $151,164 who are in a “policy-making position.”

Ellis said those provisions make sense, though he otherwise believes the FTC overstepped its authority by interfering in contracts between businesses and individuals.

Ellis said he wouldn’t buy a company if all of the senior executives had the potential of leaving right away and forming their own, competing business.

“And those would be the people that have the skills to do that,” Ellis said.

Legal challenges

The FTC’s rules are expected to take effect Sept. 4, but legal challenges already have been filed against them..

Reuters reported May 3 that a Texas federal judge stayed a lawsuit by the U.S. Chamber of Commerce and other business groups challenging the FTC’s near-total ban on employee noncompete agreements.

The district judge cited an informal court doctrine known as the “first to file rule,” in ordering that a nearly identical lawsuit that tax service firm Ryan filed against the FTC a day earlier should proceed first.

Ellis said how long it takes for a definitive legal resolution depends on how far the FTC wants to go in court.

He said it could take six to nine months or drag on for a couple of years.

The outcome of this year’s presidential election could also be a factor, Ellis said.

Mappes said she also believes it could take months or even years for the courts to reach a final determination on the rule’s viability.

If the rule as it’s written survives legal challenges, Mappes said there is some potential for differing interpretations on what constitutes a bona fide sale or the definition of two independent parties in a sale.

“I’m sure down the road there will be disputes about what that means,” Mappes said.

In general, Mappes said business clients are interested in the FTC rule and it has become a hot topic.

“I think it has the potential to touch every industry. So many folks use non-competes or a restrictive covenant,” Mappes said.•