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Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 8 offices, was ranked number 1 in the category “Most innovative North American law firms: New working models” by The Financial Times and was 1 of 7 firms shortlisted for The American Lawyer’s inaugural Legal Services Innovation Award. The firm has been recognized by the National Law Journal as a Legal Technology Trailblazer and featured by Bloomberg for its innovative service delivery models, which drive accuracy and predictability. The firm’s commitment to innovation is embodied in Thompson Hine SmartPaTHTM – a smarter way to work – predictable, efficient and aligned with client goals. For more information, please visit ThompsonHine.com and ThompsonHine.com/SmartPaTH.

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You may have heard murmurs about significant new prohibitions on non-compete covenants (“non-competes”) and might be concerned about how these developments could threaten your current, past and future deals. In the M&amp;A context, buyers often rely on non-competes as part of a broader strategy to retain the value of the businesses they are purchasing. If any of the target company’s executives, salespeople, owners, developers of IP or others who hold important client relationships or trade secrets can easily leave and compete against the target company, the buyer immediately loses some of the assets and value they just purchased. On the other side, sellers might worry about not receiving the anticipated or desired price for their businesses if they feel they cannot adequately assure buyers that they will receive the full benefit of the transaction.

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While these are legitimate concerns, particularly in jurisdictions that have enacted near-total bans on non-competes, here we summarize current and proposed restrictions (and applicable exceptions) and, most importantly, introduce potential workarounds that may preserve value and deter unethical or bad-faith competition.

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California, North Dakota, Oklahoma and Minnesota have all banned non-competes, with narrow exceptions for the sale of a business. New York will soon follow. Similar to the National Labor Relations Board (NLRB) and Federal Trade Commission (FTC) actions described below, even with exceptions for seller non-competes, there are potential key employees who may not legally enter into non-competes due to these prohibitions. Most states limit employers to some degree so that non-competes will not be used in anti-competitive ways or to restrict the free movement of low-paid employees. Employers are already familiar with these restrictions, which don’t typically interfere with M&amp;A activity.

National Labor Relations Act (the “Act”):

This year, the general counsel of the NLRB published a memo stating that non-competes violate the Act. This finding may impact a business being purchased if that company has relied on non-competes to preserve the value of its IP or customer relationships, but the Act excludes managers and supervisors (as defined in the Act or NLRB case law) from this prohibition and would therefore not directly interfere with non-competes a buyer might want to enter into with executives of a seller company. The restrictions could, however, be a potential roadblock if a company’s value resides in a few key people who are not managers or supervisors (e.g., small biotech companies that rely on a few scientists or companies that have a few major customers kept happy by deep relationships with key salespeople).

Congressional Activity and FTC Enforcement and Rule Proposal:

At the federal level, lawmakers and rulemakers have been busy proposing increased restrictions on non-competes including a number of proposed bills to enact near-total bans. More pressingly, the FTC has stepped up enforcement actions and proposed a ban on most non-competes. Some experts speculate that the ban will be more narrowly tailored than the initial iteration and that it will likely be challenged, but this all remains uncertain. The FTC’s proposed rule is essentially a complete ban but includes a narrow carve-out for acquisitions where buyers may enter into a noncompete with a seller who holds at least 25% of the equity of the target company. As currently written, this carve-out would prohibit non-competes with minority owners who hold less than 25% of the target, non-owner salespeople, executives, IP developers, and others who might be considered key employees to potential buyers.

The comment period on the FTC’s proposed rule has ended and the publication of a revised rule or other response to public comment is expected by spring of 2024.

Ultimately, in situations where non-competes are illegal but the potential consequences of seller- or key employee-competition would damage the business to be purchased, buyers have to preserve value by building relationships and structuring the deal to encourage loyalty and commitment. As a buyer, you can work with your legal counsel to consider either structural deal changes or specific types of agreements or tools to protect your investment. Some of these may be considered positive incentives (i.e., carrots) while others introduce negative consequences for competition (i.e., sticks), such as the following:

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Though M&amp;A practitioners have come to rely on non-competes as a first line of defense to protect acquired businesses from unethical competition from sellers or sellers’ key employees, as new policies make these restrictive covenants less available, buyers can work with their legal teams to tailor creative solutions to best protect their investments.

Betsy Thacker (Case Western Reserve University School of Law, ’24) contributed significantly to this article as a Thompson Hine summer associate; she is not admitted to the practice of law.

https://admin.thompsonhine.com/wp-content/uploads/2023/10/Thompson-Hine-Business-Law-Update-October-2023.pdf

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This article may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. It is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.

Creative Solutions for Buyers as Non-Compete Bans Increasingly Affect M&A Deals

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