By Michael Sweeney & Sophie Bellacosa | On April 23, 2024, the Federal Trade Commission (FTC) issued its final Non-Compete Clause Rule (the Final Rule), which effectively prohibits the use of almost all noncompete clauses in the normal employment context.
The Final Rule will take effect September 4, 2024 (the Effective Date); however, legal challenges are expected to delay or void the Final Rule before the Effective Date. The FTC’s stated intention behind the Final Rule is to promote competition by banning non-competes nationwide, protecting the fundamental freedom of workers to change jobs, increasing innovation, and fostering the formation of new businesses.
The Final Rule prohibits employers from entering certain non-compete arrangements with employees following the Effective Date and will invalidate any existing non-compete clauses in place prior to the Effective Date. Existing non-competes for workers earning more than $151,164.00 annually and who are in a “policy-making position” — the Final Rule defines “policy-making position” as any officer of a business entity or natural person within the business entity who has policy making authority — (Senior Executives) will remain valid under the Final Rule, but employers will be prohibited from entering into or attempting to enforce any new non-competes with Senior Executives following the Effective Date.
This summary addresses the high-level impact of the Final Rule in the M&A context.
How Does the Final Rule Impact M&A Transactions?
The Final Rule does NOT apply to non-compete arrangements entered into by a person pursuant to [1] a bona fide sale of a business entity, [2] of a person’s ownership interest in a business entity or [3] of all or substantially all of a business entity’s operating assets.
Although we believe a sale of a majority interest will certainly fall under the exception, it is not clear based on the language whether the “sale of a business” exception will be triggered by the sale of a non-controlling or minority interest. Notwithstanding the ambiguity of the Final Rule, we expect that non-compete clauses will continue to be enforceable against sellers in M&A transactions as they are supported by separate consideration (i.e. purchase price) not wages, which creates a protected interest in an asset (including goodwill) of the purchased business.
Retention Considerations for Targets Going Forward
It is important to note, however, that while the “sale of a business” exception will allow “seller non-competes” to remain enforceable, the Final Rule will have an impact on standard buyer protection strategies when it comes to key employees (i.e., non-owner employees, including Senior Executives) of a target entity (Key Employees).
Specifically, M&A transactions where the continued employment of Key Employees is a component of the purchaser’s valuation of the target entity will be negatively affected by the Final Rule as new non-competes will be prohibited. Buyers and their M&A advisors will need to revise or create new tools and incentives to offset this risk. Accordingly, following the Effective Date, buyers and their M&A advisors are well advised to propose more creatively tailored post-closing Key Employee retention incentives, such as employment agreements with beefed up deferred compensation arrangements, conditional equity or synthetic equity rights, and related vesting and forfeiture provisions that protect goodwill but do not prevent employee choice or block competition.
Planning Ahead
Regardless of the Final Rule, owners/sellers, acquirers and their M&A advisors need to consider new ways to secure goodwill value and reduce risk by proposing and implementing mutually beneficial incentive arrangements before the M&A process is underway.
Duffy & Sweeney regularly advises sellers, buyers, and Key Employees in all aspects of M&A transactions, including planning and implementing incentive and retention policies, plan options and agreements, and will continue to monitor developments relating to the Final Rule.
For more information, contact Mike Sweeney or Sophie Bellacosa here.