By Fabio De Filippo, CPA

On August 21, 2024, a federal judge in Texas threw out the Federal Trade Commission’s (FTC) nationwide ban on noncompete agreements that was scheduled to go into effect on September 4, 2024. However, the FTC cautions, the decision does not prevent the agency from addressing noncompetes on a case-by-case basis or filing an appeal. Moreover, buyers and private equity firms involved in M&A acquisition plans would be well served to recognize how these actions may have a material impact on their transactions in the future.

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 exit a profession or even relocate for employment.

On April 23, 2024, the FTC issued a final rule that would have prohibited U.S. businesses from enforcing existing noncompete agreements or entering into any new noncompete arrangements with most of their employees. However, the FTC made it clear that the ban would 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 would have applied 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 defined 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 could execute and enforce noncompete provisions with any employees or partners who were essential to the business’s value and ultimate sales price.

If enforcing 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 with State Laws

Another issue businesses must 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 periods and/or employees whose salaries exceed certain thresholds.

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 the recent court action, it is possible the FTC will investigate and pursue legal challenges to individual businesses’ non-compete provisions.