The FTC’s M&A Exception in its proposed Non-Compete Clause Rule
In January 2023, the Federal Trade Commission (the “FTC”) proposed the Non-Compete Clause Rule (the “Proposed Rule”).* The Proposed Rule would, among other things, provide the following:
“it is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.”
For mergers and acquisitions transactions, Section 910.3 of the Proposed Rule (the “M&A Exception”) would exempt certain non-compete clauses between the seller and buyer of a business from coverage under the Proposed Rule. As drafted, Section 910.3 states that the requirements of the Proposed Rule shall not apply to a non-compete clause that is entered into by:
- a person who is selling a business entity or otherwise disposing of all of the person's ownership interest in the business entity, or
- a person who is selling all or substantially all of a business entity's operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity (defined as an owner, member, or partner holding at least a 25% ownership interest in the business entity) at the time the person enters into the non-compete clause.
Section 910.3 also clarifies that “[n]on-compete clauses covered by this exception would remain subject to Federal antitrust law as well as all other applicable law.”
The FTC explains in its Notice of Proposed Rulemaking that the M&A Exception would apply only in a narrow set of circumstances. The Proposed Rule, as a whole, would apply only to non-compete clauses between employers and workers. This means that the M&A Exception would apply only where the party restricted by the non-compete clause is a worker; for example, where the seller of a business is going to work for the acquiring business. When the person restricted by the non-compete clause is not an employee or other worker, the Proposed Rule would not apply as an initial matter.
Notwithstanding the limited scope of the M&A Exception, there appears to be a (presumably unintended) drafting glitch, in that it might not cover substantial owners of a company selling its assets—something that is quite standard for non-compete provisions in asset sale transactions. That is because as drafted, the M&A Exception references only “a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause” (emphasis added).
While the Proposed Rule relates only to non-competes with workers (and thus buyers could freely subject many owners of businesses to non-competes), a substantial owner of the business could also be a “worker” at the business. Thus, a substantial owner who is also an executive might not be subject to the M&A Exception (and would be exempted from a non-compete) due to the simple fact that it is the company, and not the owner/executive personally, that is selling the business via the asset transaction. This wording “glitch” of the Proposed Rule would not make a lot of sense, and could cause unintended problems for buyers of businesses in asset transactions.
After reviewing some of the comments on the Proposed Rule, none of which appear to address this concern explicitly, we reached out to the FTC contact listed in the Notice of Proposed Rulemaking to raise this issue and find out whether it might be addressed before finalization. After some limited discussion, the FTC contact acknowledged the potential issue, but did not want to engage in a dialogue, noting that the comment period was over. The period had been extended from the allotted 60 days allowing 104 days, or until April 19th, for comments.**
It will be interesting to see whether the FTC takes note of the hole that we perceive in the M&A Exception as currently drafted, and does anything to fix it. Of course, the FTC may not acknowledge that there is any issue, or may take the position that while the M&A Exception does not exactly say so, it is not intended to prevent a substantial owner/executive of a company selling its assets qua owner from being subject to a non-compete.
As new rules and amendments are created and enforced by the FTC, it becomes increasingly important to be proactive on rule proposals. If you have any questions or concerns on the non-compete clause rule, please contact me at email@example.com
*To view the full Proposed Rule, click here.
**By the comment period closing date on April 19th, 2023, the FTC had received a spectrum of comments on the Proposed Rule ranging from support, to concerns, to proposed amendments. Among those comments was a letter from the Small Business Majority, an organization composed of over 85,000 small businesses, in support of the Proposed Rule; and a letter from the U.S. Chamber of Commerce, in opposition to the Proposed Rule.