We have previously talked about the value of non-compete agreements when selling a business, so you, as a business seller or buyer, may be spooked by recent headlines regarding the proposal by the Federal Trade Commission (FTC) to ban non-competes nationwide. Don’t panic—while splashy, the headlines don’t tell the full story, particularly in the context of selling a business.
What would the proposal prohibit?
As a reminder, a non-compete is an agreement between a company and an employee that prohibits or restricts the employee’s ability to work for another business after their termination of employment. The typical non-compete blocks the employee from working for a competitor or starting a competing business within a certain geographic area for a certain number of years after their employment ends. If the employee violates the non-compete, then their former employer can sue them for breach of contract.
While business owners and potential buyers view non-competes as necessary to protect the value of a business, the FTC believes that non-competes harm employees by preventing them from moving to higher paying jobs or starting their own business.
As a result, it has proposed a rule that, if it becomes law, would prohibit any company from entering into a non-compete agreement with any employee, contractor, or other worker. It would also require employers to terminate any existing non-compete agreements.
Currently there is no federal law regarding non-competes, which means each state can come up with its own rules. While some states, such as California, have already banned non-competes for workers in their state, most states still permit reasonable non-competes for some or all employees. So, this proposal would certainly change the game for companies across the U.S.
However, the proposal contains an important exception to the ban that applies to employee-shareholders when a business is sold.
What is the “sale exception?"
The “sale exception” would allow companies to enter into non-compete agreements with certain employee-shareholders in connection with the sale of a business. For the exception to apply, you must meet two criteria: (1) the employee must be at least a 25% shareholder and (2) the non-compete clause must be entered into upon the sale of the business entity, (or the employee-shareholder’s sale of their entire ownership in the business entity) or a sale of substantially all of the assets of the business. (Note that a non-compete entered in connection with a sale would still be subject to state law, which may include time limits, geographic constraints, or other conditions).
Why shouldn’t I panic?
- First and foremost, this is just a proposal and is not yet law. It may never become law, or it may be watered down before the final rule is adopted. The proposal is open to public comment for a period of 60 days, after which the FTC will draft the final rule (or it could withdraw the proposal). The FTC has specifically asked for comments on whether executive-level employees should be treated differently than rank and file employees, so it is possible that the final rule would still permit non-competes for executive-level employees. Even if the FTC passes a final rule, it is expected to face legal challenges.
- Second, as explained above, the proposal still permits a business to enter into a non-compete with some employee-shareholders at the time the business is sold, and the proposal provides no additional rules for these agreements other than those already in effect under state law. These large employee-shareholders are likely the same group of individuals from whom a buyer would want to secure a non-compete, so it may be “business as usual” for many deals.
- Third, the proposal does not prohibit non-solicitation agreements and nondisclosure/confidentiality agreements which, when used together, could still provide business owners and buyers with some protection. Non-solicitation agreements prohibit former employees from attempting to poach a business’s clients or prospects. They can also include language prohibiting former employees from trying to steal a business’s employees. Nondisclosure or confidentiality agreements prevent employees from disclosing or using trade secrets or other special knowledge acquired from the employer. So, even if you can’t prevent an employee from moving to a competitor or starting their own business in the same industry, you could still use a combination of other agreements to prevent the former employee from contacting your current and former customers and prospects, your employees, and using or disclosing your confidential information.