On May 7, 2024, the Federal Trade Commission published a final rule (the “Rule”) that results in a federal ban on non-compete clauses nationwide, with limited exceptions. The Rule, effective September 4, 2024 (the “Effective Date”), provides that it is an unfair method of competition- and therefore a violation of section 5 of the Federal Trade Commission Act (“FTC Act”) – for employers to take certain actions that limit workers’ rights, such as for an employer to require new non-compete clauses with “workers,” on or after the final rule’s effective date. The final rule defines “worker” as “a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.”
With regard to existing non-compete clauses (already in effect as of the Effective Date), the Rule defines two sub-categories of “workers” and makes an exception in that it allows existing non-compete clauses with senior executives to remain in place, but not existing non-compete clauses with workers other than senior executives. The Rule requires employers to provide notice to such workers that their non-compete clause is no longer enforceable.
The final rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.”
Many SBA lenders are already experiencing pushback from Sellers in SBA-financed transactions. Importantly, the final rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity.
See 910.3 Exceptions:
- Bona fide sales of business.
The requirements of this part 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.
. . .
Therefore, sellers and departing owners in any business acquisition financed by an SBA loan may still be required by the lender to enter into a non-compete clause. However, non-competes between the seller and the buyer of a business remain subject to state limitations on scope, duration, and reasonableness.
The Rule defines a bona fide sale to be one that is made between two independent parties at arm’s length, and in which the seller has a reasonable opportunity to negotiate the terms of the sale. It should be noted that many states, such as California, already prohibit or severely restrict non-compete clauses, with certain exceptions. However, every state statute banning non-competes includes an exception which allows some or all non-competes between the seller and the buyer of a business. The federal Rule is designed to preempt any state rules that are less restrictive with regard to non-compete clauses, exclusive of this limited exception.
Conclusion:
With regard to non-compete provisions that are not covered by the exception identified herein, the Rule imposes a comprehensive ban on new non-competes with all workers. While this excludes the sellers of “all or substantially all” of the assets or ownership of business, it leaves unaddressed how this will play out in light of the recent SOP changes involving partial owner buyouts.
There are already legal challenges being present to the rule, but a full analysis of the impact of the Rule may be required depending on the specific transactional facts of any proposed loan structure. Contact Corrie Thrasher at cthrasher@starfieldsmith.com or 404.389.9041 with additional questions.
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