FTC Non-Compete Ban and Its Impact on M&A Transactions

UPDATE: On August 20, 2024, a federal judge in Texas granted an injunction barring implementation, halting the ban so non-competes stand. For now, employers can continue to enter into contracts with non-compete provisions that comply with state-specific restrictions instead of the nationwide sweeping ban.*

When you’re buying a business, whether it’s an asset deal or equity deal, you want to make sure the seller or key people don’t start over or set up shop soon after as competitors. The value of most companies goes beyond the inventory and brand name, so you don’t want anyone with the relationships and connections the business is built upon to undermine continued success by siphoning off customers, vendors, or workers. Here, we’ll explore the sale-of-business exception to the ban on non-competes.

Most purchase agreements contain a non-compete clause (also called a non-competition provision) to protect against a seller or key people engaging in potentially competitive businesses that provide the same goods or services, and/or non-solicit (non-solicitation) to prevent a seller from poaching personnel, customers, or vendors. Another common restrictive covenant (no-no post-close) is non-disclosure/confidentiality. Over the past several years, individual states have begun to shift towards banning or refusing to enforce most non-competes, but a “bona fide sale of business” is one scenario in which many  non-competes  stand.

The Federal Trade Commission (FTC) announced a sweeping ban on non-compete clauses effective September 4, 2024, 120 days after it was published in the Federal Register on April 23, 2024. The rule defines “non-compete clause” as a term or condition of employment that either “prohibits” a worker from, “penalizes” a worker for, or “functions to prevent” a worker from “(i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.” One of the few exceptions to this ban is that non-competes are allowed in the context of a bona fide sale of a business. 16 C.F.R. § 910.3(a). 

(a) Bona fide sales of business. The requirements of this part 910 shall 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.

This exception requires a bona fide sale to be a sale “made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule,” and generally considers a bona fide sale to be a sale between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate terms. “Sale of a business entity” could mean a sale of 100% of the interests in the business entity or a smaller stake, and there isn’t yet a clear minimum for what percentage of the business has to be sold for the exception to apply instead of the ban. The FTC mainly seeks to limit employers from engaging in non-competes or using a “sham transaction” to skirt the rules. 

Buyers of businesses will need to do due diligence around the enforceability of non-compete clauses that are supposed to bind key employees of the target company; some of those non-compete clauses may have been rendered unenforceable and even constitute violations of the new rule exposing the company to risks not only of competition, but the FTC can impose fines or a civil penalty up to $51,744 for each violation, and each day of continuance of such failure or neglect is deemed a separate offense.

Notably, the FTC initially proposed and later backed off a requirement that the restricted person bound by a sale-of-business non-compete had to be a substantial owner, substantial member, and substantial partner and hold at least a 25% percent of the ownership interest in the business entity being sold. It also rejected a requirement that a seller must sell their entire interest in the business. While the proposed rule only provided an exception for non-competes tied to the sale of a business for owners who held a 25% ownership interest or more, the final rule removed that ownership percentage threshold, so any workers and even those without an equity stake could be subject to non-competes as part of a bigger deal

The FTC wanted to ensure buyers do not use “sham transactions” or other ways to skirt the rule. To qualify for the sale-of-business exemption, the underlying transaction must be a “bona fide sale.” Generally, 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.” This definition should not prevent the overwhelming majority of sale transactions whereby buyers require non-competes from the selling parties.

Under the FTC’s new rule, existing non-competes for the vast majority of workers will no longer be enforceable after the rule’s effective date. Existing non-competes for senior executives - who represent less than 1% of workers - can remain in force under the FTC’s final rule, but employers are banned from entering into or attempting to enforce any new noncompetes, even if they involve senior executives. Employers will be required to provide notice to workers (besides senior executives) who are bound by an existing non-compete that they will not be enforcing any non-competes against them.

Employers have several alternatives to non-competes that still enable them to protect their companies  without having to enforce a non-compete. Trade secret laws and non-disclosure/confidentiality agreements (NDAs) both provide employers with well-established means to protect proprietary or sensitive information, and non-solicitation provisions can help guard against directly poaching clients, vendors, or other personnel if a worker does decide to do their own thing. Also, if an employee leaves before a certain time, they could be required to repay training costs under training repayment agreement provisions (TRAPs). 

Under the final rule, existing non-competes for senior executives can remain in force. Employers, however, are prohibited from entering into or enforcing new non-competes with senior executives. The final rule defines senior executives as workers earning more than $151,164 annually and who are in policy-making positions.

There are currently appeals and injunctions threatening implementation of the non-compete ban, but time will tell whether it goes into effect. If it’s important to you as a buyer to make sure the talent that’s part of a target company sticks with you or doesn’t start a competing business, the sale-of-business exception will work in your favor as one of the only allowable forms of non-compete clauses. 

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