“The Federal Trade Commission regulations (“Rule”) on non-competition agreements are the subject of considerable discussion among employment and corporate attorneys. Still, similar attention has yet to be given to this development among estate planners. The Rule has a far-reaching impact on estate planning; the ramifications on how small businesses that have used non-compete provisions will meet new competition, especially by its current employees, and the valuation of companies may be significantly affected. For some family and closely held businesses, the impact of succession planning could be dramatic.”

 

Martin M. Shenkman, Jonathan G. Blattmachr and David Ritter provide members with some thoughts on how the new FTC non-compete regulations impact estate and business planning.

Martin M. Shenkman, Esq. is an attorney in private practice in New York who concentrates on estate planning. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), served on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network, Weill Cornell Medicine Professional Advisory Council, and is active in other charitable organizations.

Jonathan G. Blattmachr is the author or co-author of nine books and over 600 articles.  He is a director at Pioneer Wealth Partners LLC, director of estate planning for the Peak Trust Company, and co-developer with Michael L. Graham, Esq., of Dallas, Texas, of Wealth Transfer Planning, a software system for lawyers, published by Interactive Legal LLC (www.interactivelegal.com).

David J. Ritter, Jr. is a Member of Brach Eichler L.L.C. and works in the Trusts and Estates and Corporate Transactions departments. 

Now, here is Marty, Jonathan and David’s commentary:

EXECUTIVE SUMMARY:

At the end of April, the Federal Trade Commission (FTC) issued final regulations relating to non-competition agreements that prohibit or have the effect of inhibiting certain independent contractors, current and former employees, and others from competing with a former employer or contracting party.  These new regulations are very far-reaching, and except for certain “senior executives” (a very narrow group, such as the company’s president) and certain other limited exceptions, prohibit entering into or enforcing a non-competition provision even if entered before the effective date of the new regulations, September 4, 2024. (There is no exception for senior executives for new agreements.) The fact that a noncompete was specifically negotiated and paid for is irrelevant.  Employers must advise those who otherwise could be covered by non-competition provisions that they are no longer bound by them.  These new regulations will affect how some businesses operate and may affect the value of some companies. In some instances, these new prohibitions will significantly impact succession planning for families and closely held businesses. The new Rule prohibits employers from even representing that workers are subject to non-compete clauses because the FTC was concerned that even that itself could inhibit competition. 

COMMENT:

Introduction

The Federal Trade Commission (FTC) estimates that about 18%, or 30 million, “workers” in the United States are subject to non-competition provisions that inhibit their taking new employment or starting their own businesses.  There have been attempts to have these restrictions apply to high-ranking “employees”, independent contractors, and professionals such as physicians and lawyers, including business owners. It appears that such restrictions among non-highly compensated workers were widespread. Many organizations incorporated non-compete and other restrictions as standard clauses in employment and other agreements with even mid-level employees who likely had no legal representation in negotiating those agreements and may have merely signed them agreeing to restrictions without any meaningful understanding as to the potential impact on them.   

Note that many people in the medical field are employed by non-profit organizations and the new rules, it was thought, would not apply to such companies (although it have nonetheless applied to their subsidiaries). However, it appears that the FTC has expressly made the ban applicable to non-profit organizations and some commentators have indicated that they believe that application will stand up unless the entire Rule is overturned. Also, note that ABA Model Rule 5.6 essentially prohibits non-competes for attorneys except in connection with retirement. However, the FTC ban seems to prohibit non-competes in a broader context. Unless the retiree was a senior executive subject to a grandfathered agreement (in place before the effective date) or part of the bona fide sale of equity, a non-compete in retirement may no longer be valid even if permitted under the ABA rules.

The FTC has now issued regulations that will make most non-competition restrictions and similar restrictions illegal. They are to become effective 120 days after publication in the Federal Register, making the effective date September 4 of this year. See part 910 of chapter I in title 16 of the Code of Federal Regulations.

Dozens of issues relate to these new rules. The regulation itself and the commentary provided by the FTC comprise 560 pages. See https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf. 

Two areas where immediate attention must be given are (1) complying with the requirement that all workers who are no longer subject to the restrictions previously imposed on them must be advised by the employer that the restrictions are no longer applicable and (2) determining what companies can do to protect themselves from current or former workers working for the company’s competitors. Concerning the latter point, it appears that for employees who qualify as “senior executives,” it may still be possible to implement restrictive agreements before the new rule's effective date.   It may not be obvious, but the new regulations may be especially troublesome for certain closely held businesses and how they may affect owners' estate planning.

What Constitutes a Noncompete Agreement

A non-compete agreement restricts future employment or imposes economic penalties for accepting other employment. It may, for example, be incorporated into an employment agreement that an employee signs to accept employment by an employer. The restrictions in these agreements limit or prohibit the employee from accepting new employment other than with the current employer or starting a competing business. These types of contracts can be limited or very broad. For example, an employee may be restricted from accepting employment with a competitor in the same industry within 50 miles of the business location of the current employer for one year after leaving the current employer for any reason. 

Others, by their terms, are unlimited in time and distance. For example, an employee could be broadly restricted from competing in the industry throughout the continental U.S. for ten years or longer after employment terminates for any reason.   The mere threat of a lawsuit and termination of payments otherwise due to the worker inhibits former employees from even challenging the provision.  For example, a doctor in a medical practice is discharged because of age or contention of not meeting the standards (say, for collections on medical procedures) the practice says must be met.  The medical practice documents provide that the matter must be resolved by arbitration in the event of a dispute. The discharged physician knows that, in the past, the arbitrators have tended to side with the organization.  Moreover, continuing financial payments to the physician are lost if the practice determines the doctor competed.  Unless the doctor can establish that the restrictions are unlawful, he or she will not dare to make a challenge. There is also the cost that the doctor will incur to hire counsel and perhaps other experts and the time the doctor will have to invest in a litigation process that could drag on for years. In contrast, the employer organization may have counsel on retainer that has handled many similar cases over decades. The playing field is far from level, which is part of the motivation for the FTC’s actions.  As a practical matter, the physician’s practice days are over.   

The scope of “noncompete” arrangements covered by the new rule could be broad, and one of the challenges employers and businesses now face is ascertaining what protections may still be viable after the effective date and which may not be. The Rule defines noncompete as follows:

Non-compete clause means:

(1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

(i) 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

(ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.

(2) For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.

The definition broadly refers to any term or condition. Thus, other types of arrangements that may not explicitly restrict employment may still be covered.  

Noncompete agreements can take many forms, not just an obvious restriction in an employment agreement under the caption “Noncompete.” For example, restrictions on an employee’s ability to disclose or use confidential information relating to their employment might be so broad and restrictive that they could make it difficult for such an employee to secure employment elsewhere. Similarly, non-solicitation agreements may inhibit competing with the former employer.  Thus, banning non-compete agreements may be even broader than just non-compete provisions. The FTC pronouncement clarifies that other contractual arrangements that rise to the level of being a functional noncompete are also prohibited. Consider the practical implications of this broad definition on employers evaluating large numbers of past employment and independent contractor agreements to identify which have restrictions that will require compliance with the notification provisions. 

The Rule also prohibits “…an agreement that extinguishes a person’s obligation to provide promised compensation or to pay benefits due to a worker seeking or accepting other work or starting a business after they leave their job. One example of such an agreement is a forfeiture-for-competition clause…imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, expressly conditioned on the employee seeking or accepting other work or starting a business…”

The New FTC Restrictions on Noncompete Agreements on Most Employees

The FTC rule creates an all-encompassing ban on new noncompete agreements for all workers. Existing noncompete agreements with employees (not senior executives) will no longer be enforceable after the effective date. All non-compete agreements, regardless of whether signed decades ago, will no longer be valid for employees who are not senior executives. Note that employers must affirmatively advise workers (other than senior executives) that they will no longer be subject to the non-compete agreement that had been applicable to them. 

Consider the impact of this. What if the compensation package negotiated with the affected employee was increased in a bargained-for exchange to include the restrictions on competition? The employer may have intentionally paid more compensation or perquisites to protect itself from the employee learning key skills and then jumping to a competitor. The employee may have been represented by independent counsel, so the arrangement was a truly negotiated arm’s length transaction. None of these factors is relevant under the new Rule.  What happens to those arrangements? Merely because the noncompete provision in an employment agreement is invalidated may not give the employer any right to adjust or renegotiate compensation for that change. Will employees with vital skills to a business’s survival jump ship to a new employer absent such restrictions to earn higher compensation?  The FTC anticipates that they will, and the government believes this will be better for the economy and the country.  This is, perhaps, somewhat similar to when the government imposed anti-trust laws (which in some ways are similar in their effect to non-compete agreements).  Some of us are old enough to remember when the telephone industry was once run by a monopoly.  A short long-distance call could cost over $100 at today's price standard.  However, the courts struck down the monopoly, eventually resulting in free calling anywhere in the country. According to the FTC, competition is an economy’s best friend, even if some individual businesses are harmed in the process or left with a costly financial arrangement that pays for restrictions that cannot be enforced. Identifying which client businesses may experience material harm and what, if anything, might be done to mitigate that harm will be important for advisers to focus on.

Exception for Existing Noncompete Agreements with Senior Executives

The FTC defines “senior executive” as employees earning more than $151,164 in a “policy-making position.” A “Policy-making position means a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority. An officer of a subsidiary or affiliate of a business entity that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position for purposes of this paragraph. A natural person who does not have policy-making authority over a common enterprise may not be deemed to have a policy-making position even if the person has policy-making authority over a subsidiary or affiliate of a business entity that is part of the common enterprise.” What is the policy-making authority? “Policy-making authority means final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.” These definitions are vague which may make determining the status of an employee as being a senior executive difficult. But also, the nature of the definition could exclude key persons that the business may have tried to restrict to protect itself. 

The FTC estimates fewer than 1% of employees are in this category. For noncompete agreements that existed before the effective date of the new rules, different restrictions will apply to senior executives rather than to other workers. Existing agreements covering senior executives can remain in force. That may provide family businesses with existing restrictions for senior executives the ability to maintain their succession plans. However, new agreements will not be permitted. It is unclear if the restrictions, under a pre-existing agreement, on senior executives will apply if there is a change in their relationship with the company and a new “employment” agreement is entered. Will a modification or renegotiation of certain aspects of a pre-effective date agreement with a senior executive taint the “grandfathering” of that arrangement?  In any case, restrictions will not be permitted if there is a turnover in senior executives or new key employees are hired as part of an intended succession plan.

It is also unclear whether grandfathered restrictions for a person who is a senior executive would continue to be grandfathered if such person ceased to be a senior executive.  Suppose a person is a partner at a company and is also on the company’s management committee.  If that person remains a partner at the company and continues to work exactly as he/she had been, but he/she either steps down from the management committee or is not re-elected, are the restrictions still enforceable or have they now become unlawful?

Impact on Family Business Succession Planning  

Example: A family manufacturing business begins planning its succession and estate planning in mid-2025. Anticipating the reduction in the estate tax exemption, the founder of the business wants to make gifts of business interests into an irrevocable trust to avoid future estate taxes that could undermine his or her ability to bequeath the business to his or her children and grandchildren. As part of that estate tax planning process, the estate planning attorney recommends that the client formulate a business succession plan. That is vital, as merely avoiding estate taxes is unlikely to facilitate the business's survival if there is no management succession plan. Two of the founder’s four children and one grandchild work in the business. The founder does not feel that the children are ready to run the business and believes that two key employees can help transition the business to the children and serve the long-term needs of the business when the current owner, as the founder, retires, dies or is incapacitated. He or she suggests that the key employees be offered more generous employment agreements, bonus arrangements, and profit sharing if they commit to remain with the business following the death, disability, or retirement of the founder.  Specifically, the owner would like to entice and bind the key employees to remain with the company for at least five years after the owner has to cease involvement to help the two children in the business mature and gain business acumen. The Founder is more than willing to offer what he or she believes is an above-market compensation package for the security of knowing he or she can secure the business transition. But if the key employees assume this role, the owner needs to provide them with extra training and access to critical confidential information. So, the owner requests that the attorney include a non-disclosure agreement (NDA) and non-compete provisions so that once that extra training and confidential information is provided, neither of the two key employees can use that information to set up a competing business, thereby undermining the company and hopes to transition it to the next generation. In the past, the key employees would have hired their own attorney to review and negotiate bargained-for employment agreements. That would have been a good deal for everyone. However, the attorney informs that noncompete agreements, and possibly even the nondisclosure provisions, may not be enforceable because of the new FTC rule. So now the dilemma is how can the founder and employees, all of whom want to enter into a deal to benefit everyone, secure the arrangement for the founder and the business? It may not be possible.  Although it might be that highly compensated executives with independent legal representation should be able to negotiate to receive generous pay packages in exchange for agreeing not to compete, it appears that the freedom to contract, even in such circumstances, is no longer allowed. Business succession planning, perhaps the key component of an estate plan for many family businesses, will be more difficult to achieve. While providing some equity to the key employees and leveraging the restrictions based on their equity sale may be feasible, it is unclear whether that exception (discussed below) will suffice. In any event, allowing the key employees to threaten to leave the business may make the company stronger and more valuable.

Can Non-disclosure, Non-Solicitation, and Deferred Compensation Substitute For the Now Prohibited Noncompete?

The FTC’s new rules restricting or prohibiting noncompete agreements do not expressly prohibit employee non-solicitation arrangements, confidentiality or non-disclosure arrangements, or customer non-solicitation arrangements. But, the new rules state that other forms of restrictive covenants, such as the above, are prohibited if the functional effect is the same as a non-compete provision.  A non-disclosure arrangement or non-solicitation agreement can function similarly to a non-compete if these ancillary arrangements encompass such a broad amount of data that they serve to restrict employees from other employment or starting a business after terminating their employment with the current employer.  If they serve to prevent a worker from working for another employer in the same industry, they are analogous to a prohibited non-compete agreement and are, therefore, also restricted. So, recasting a non-compete agreement as other types of restrictions will not permit avoiding the new rules.  

However, many businesses and professional practices will likely begin to place more reliance on non-disclosure and non-solicitation agreements, given the ban on non-compete arrangements. It would be advisable to draft those provisions considering the FTCs Rule, as clearly and narrowly as possible. There may well be future litigation over NDAs and non-solicitation agreements to establish clearer boundaries of what is within the FTC Rule and what is fair and enforceable, even apart from that rule. NDAs and non-solicitation agreements may become longer and more detailed as businesses seek to make those agreements precise and easier to enforce. However, a non-solicitation arrangement can be challenging to enforce. For example, a former employee’s direct email to a firm customer would seem to be an obvious violation. But is that a solicitation if the former employee generally makes announcements of their new position? Would banning that be more akin to a now-prohibited noncompete? Did the departed employee solicit a client or customer of their former firm? What if the employer instead tried to rely on a provision prohibiting a departing employee from accepting a client of the firm to avoid uncertainty over whether solicitation occurred?  That arrangement may be more akin to a noncompete and face a greater likelihood of violating the FTC ban on noncompete arrangements.

The new Rule could be problematic for closely held and family businesses. Non-competes will be eliminated, which may have been the most important restriction. The business may be able to use non-solicitation and confidentiality restrictions to some extent, but those will have less teeth than in the past. There may be deferred compensation structures that may be tied to the company's performance to give an employee incentive for the current company to succeed. 

The Rule “…does not categorically prohibit other types of restrictive employment agreements, for example, NDAs, TRAPs, and non-solicitation agreements. These types of agreements do not by their terms prohibit a worker from or penalize a worker for seeking or accepting other work or starting a business after they leave their job, and in many instances may not have that functional effect, either. However, the term “functions to prevent” clarifies that, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.”

Thus, restrictions are still permissible, but to be permissible a non-disclosure or non-solicitation restriction would have to pass muster under the above standard. It could not penalize a worker for seeking or accepting other work or starting a business after they leave their job. This will be a facts and circumstances test that will have to be evaluated carefully. These restrictions to be permissible could not “function similarly to non-competes.” To be valid these restrictions could not “constitute an unfair method of competition.” Restrictions could not “prevent a worker from seeking or accepting other work or starting a business after they leave their job.”

“NDAs may be non-competes under the “functions to prevent” prong of the definition where they span such a large scope of information that they function to prevent workers from seeking or accepting other work or starting a business after they leave their job. Examples of such an agreement may include an NDA that bars a worker from disclosing, in a future job, any information that is “usable in” or “relates to” the industry in which they work. Such an agreement would effectively prevent the worker from working for another employer in that industry. A second example would be an NDA that bars a worker from disclosing any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information. These agreements are so broadly written that, for practical purposes, they function to prevent a worker from working for another employer in the same field and are therefore non-competes…”

Non-Disclosure May Still be Viable

So, it appears that employers can still use non-disclosure and non-solicitation provisions. But if they arise to the level of a noncompete they will be restricted. These are facts and circumstances tests. The language of how the restriction is set up will be a factor, but the geographic area covered and how the industry functions may also be relevant to the analysis. A non-solicitation that prohibits the former employee from specifically soliciting other employees and customers and which is clearly and reasonably defined may not arise to the level of a non-compete. The company’s attorney may exempt general non-targeted solicitations such as general advertisements. That might provide a defense that the former employee can compete but that they just cannot call specific people. But might that arise to the level of a non-compete? The final Rule provides that an employer can use less restrictive measures such as non-solicitation. So, the argument is that limiting the restriction on the employee to being prohibited from calling named customers may be safer than prohibiting the calling of any client of the former employer. There should also be a time frame, e.g. five years or whatever is appropriate to the particular situation. Likely, the more tailored the non-disclosure and non-solicitation restriction the more likely it will pass muster under the new Rule.  

An NDA would not be a non-complete if it merely prohibits disclosure. 

Proprietary information from the company, copyrighted materials, etc., should still be restricted. The FTC is concerned that it is not a level playing field. But if it is sufficiently narrow, these other types of restrictions are allowed. 

The final rule will not prevent adopting garden-variety NDAs, but it will prevent overbroad NDAs that seek to prevent an employee from accepting business. That may mean you cannot disclose proprietary information but can go to customers of former employers. Is soliciting a former customer disclosing confidential information? All of this is a fact-specific inquiry. 

Perhaps the inquiry now changes the focus to the employee's ability to find other employment under a facts and circumstances test, whether with a new employer or by starting their own business. The new lens is the impact on the employee to obtain gainful employment following the departure. If under the specific facts and circumstances the restrictions prevent the former employee from obtaining new employment, then the restrictions may be invalid.

The FTC may consider the particular industry and the actual geographic area. For example, if the prior employer were in a rural area and most potential customers used that prior employer, the restriction could be tantamount to a non-compete as it might prevent the restricted employee from finding any later employment.

Note that the FTC was concerned about the burdens the employer is putting on the employee, and that must be considered. The FTC may well enforce the Rule against employers who utilize overbroad NDA and non-solicitation provisions to send a message to employers not to try to circumvent the Rule by using redesigned non-disclosures and non-solicitations to accomplish a similar result to a noncompete.

Any restrictions will require more thought and effort to ensure that they do not arise to the level of a functional noncompete. A critical issue is where the FTC will draw the line. But what if the line is crossed and the other restriction is improper? Some argue that that will not give rise to a private cause of action. The FTC can pursue an injunction or fines.

Practitioners might consider crafting savings language, that if a new restriction is overly broad such that it violates the Rule it will be constrained so that it does not. However, savings language may not avoid a violation the FTC may still penalize.

Family Dynamics

The prevalence of sibling rivalries and other negative family dynamics is well known. What will the impact of the new ban on noncompete agreements and other restrictions be on the dysfunctional family business client? Suppose nondisclosure and non-solicitation restrictions cannot be enforced. Might some family businesses have to evaluate differently whether a particular family member or in-law should even be permitted to join the business? Might the family dispute with parties unbound by restrictions motivate a disgruntled family member to leave and set up a competing business, whereas in the past, they could not have? 

Sale of Business Exception

If an employee (or non-employee) sells their business interests in a real bona fide sale, the restrictions on noncompete agreements will not apply. Perhaps the concept is that if you are receiving a fair or bona fide price for your business interests, restricting you from competing is part of the price you pay to get that buyout. This exception can also apply if there is a sale of all or substantially all of a business entity’s operating assets. It seems that the purpose for this exception is to protect a buyer so that the buyer can pay fair price for the goodwill of a purchased business and protect it. But what types of arrangements will fit under this exception?

Initially, the proposed FTC exception for certain non-competes between a business's seller and buyer applied only to a substantial owner with at least 25% ownership interest in the business entity being sold. Based on comments, the Commission adopted an exception for the bona fide sale of a business without requiring that the seller have at least a 25% ownership interest. Section 910.3(a): “Exception for Persons Selling a Business Entity.” 

A bona fide sale is one made in good faith as opposed to, for example, a transaction whose sole purpose is to evade the final rule. This concept may make it difficult to structure an employee to have equity used to justify imposing a non-compete. With the elimination of the 25% equity requirement, is there any de minimus amount that is too small to support a non-compete? Would non-voting equity interests suffice?  Would a mere profits interest suffice to constitute equity? Will a contract partner arrangement suffice? Will that depend on the terms of the arrangement? Employees may evaluate offers of modest equity or contract partner positions differently. The new calculus might be is it worth becoming a nominal “equity” holder if that becomes the foundation upon which a restrictive non-compete will be based? Will this change how large professional practices are structured and operated? 

In general, the Commission considers a bona fide sale to be 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. So-called “springing” non-competes and non-competes arising out of repurchase rights or mandatory stock redemption programs are not entered into pursuant to a bona fide sale because, in each case, the worker has no goodwill that they are exchanging for the non-compete or knowledge of or ability to negotiate the terms or conditions of the sale at the time of contracting. 

The above seems rather vague, and it may be difficult for a family business to use the above exception to bind a key employee as part of a succession plan. If the employee is given or allowed to purchase equity in the company, something many closely held family businesses will balk at, how can that equity be controlled and also bring in a non-compete without violating the FTCs new restrictions? Also, a business will have to consider the potential for negative publicity or a negative impact on the business's reputation and goodwill if it is held to have fabricated an “equity” arrangement to impose a noncompete or similar restriction in violation of the FTC’s Rule.

It is unclear why the FTC views a business sale differently than a bonus compensation arrangement negotiated in good faith with independent counsel. Conceptually, in both instances, the employee would be receiving a substantial economic benefit.

Requirement to Notify Employees

The FTC was not content with largely banning noncompete agreements. It also enacted comprehensive informational requirements to ensure that their employers notify affected employees of the new rules and that non-competes are no longer enforceable. This requirement could create a substantial administrative burden that must be complied with by the effective date of the legislation. The Rule does not, however, require that employers enter into new agreements removing the no-longer valid restrictions.

The employee who entered into a non-compete arrangement must be given “clear and conspicuous notice” that the non-compete arrangement will not be, and cannot be, enforced. The notice the employer must give must: (1) identify the employee who entered into the non-compete arrangement; (2) be written and hand-delivered to the employee, or by mail at the employee’s last known personal street address, or by email to the employee’s current work email address or last known personal email address, or by text message at the employee’s cellular telephone number. Might the first requirement of identifying the employee require customized notification to each employee? The sample notice the FTC provided did not appear to indicate that so the implications are unclear.

The FTC provides an exception from the notice requirement if the employer has no information about the employee's physical address, email address, or cellular phone number. The FTC has provided sample language employers should probably track in their notice to assure compliance. 

What is a company to do if it does not have the names and addresses of its former employees who must now receive notice?  First, begin by making a list of all persons who might be covered by non-compete provisions, including certain independent contractors.  Second, err on the side of caution by advising virtually every former employee (which may include an independent contractor) that any non-competition that applies or might apply to him or her cannot and will not be enforced.

Consider the practical implications of the notice requirement. There does not appear to be any time restriction. So if a business had boilerplate noncompete provisions that lasted for a long duration, that business may have to go through decades of historical records to identify potentially affected employees and independent contractors. Given the breadth of the types of restrictions that could apply, it will not be sufficient only to identify noncompete arrangements, but also non-disclosure, non-solicitation, and other restrictions will need to be identified. Consider that noncompete agreements may not be labeled prominently as such in a contract. Once agreements that contain provisions that may be prohibited are identified, the employee’s status as a senior executive, or not, will have to be ascertained.  Might this then require a review of every agreement by counsel? Or, as an alternative, should a broad brush approach of notifying any former employer or consultant/contractor be taken? Another aspect of the notice requirement will include the process the employer must go through. Are all historic personnel records digitized? If digitized, have they been formatted for optical character recognition, iso that they can be searched, or must that be undertaken first to facilitate keyword searches of older historical documents? What if the employer has not digitized all historic employment records? Will old paper files have to be manually reviewed? It would seem so. How will the employer’s document retention policy affect this process? If old contracts past some date have been destroyed, there may be no means to identify agreements before that date. It would seem that whatever is done, employers should consider documenting the process they go through to demonstrate reasonableness in their efforts to comply with the new rule.

Consequences of Not Complying with FTC Regulations

Undoubtedly, some companies will not advise their former employees that they are no longer bound by the restrictive non-compete provisions that have applied to them.  Moreover, some companies may threaten to enforce them, causing former and current employees not to take action for the company’s failure to comply with the new regulations.  A company may do so if it acts in good faith.  However, failure to comply with FTC requirements can be costly. The FTC has the authority to impose fines on companies that do not comply with its rules. In addition, the FTC can seek an injunction forcing a company to comply.  The company may suffer civil penalties and have reputation losses as well.  But, certainly, some will not voluntarily comply.  Some have already sought to prevent the regulations from taking effect.  Note that a federal district court judge in Texas issued an injunction to suspend the use of mifepristone despite the FDA’s approval of the drug.  (That case is now before the United States Supreme Court.)

Valuation Considerations

At the end of 2025, the estate, gift, and GST exemptions will be reduced by half. Many owners of closely held family businesses will have their business interests appraised as a prerequisite to planning those transfers. Consideration should be given to the potential impact of the loss of the ability to protect the business using non-compete, non-disclosure, and non-solicitation agreements. In some instances, the loss of these safeguards may reduce the value of the business, and that may at least have some positive impact on estate planning values but not the value of the business transitioned. For some businesses, costs may be increased when hiring workers, given the increased flexibility the rule will create in the marketplace.  In some instances, it might also increase the value of a business because it can hire current or former employees of its competitors.  Consider what happened to Pan American Airlines. It was a very lucrative business in a regulated industry that essentially foreclosed competition.  But when the industry was deregulated, Pan American Airlines went out of business. Still, the industry grew tremendously by competitors, resulting in lower prices and greater coverage of areas with flights.

Consideration for Professional Practices 

The American Bar Association in Model Rule 5.6 prohibits lawyers from enforcing a non-compete except in connection with retirement. 

Rule 5.6: Restrictions on Right to Practice

Share: Law Firms And Associations

 A lawyer shall not participate in offering or making:

(a) a partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement; or

(b) an agreement in which a restriction on the lawyer's right to practice is part of the settlement of a client controversy.

 

Lawyers cannot generally be bound by a non-compete even before the new Rule. The non-compete restrictions are new for other professional practices and will have a broad impact. CPA and brokerage firms that have limited competition, such as trying to prevent practitioners that leave from contacting prior clients of the firm they left, may no longer be able to be restricted. Professional practices will have to consider the impact of the FTC rule. In many CPA firms, if a partner retires and has to sell equity back in the firm, will that permit the attachment of a non-compete? But is that equivalent of equity and the sale of a business? Will those non-competes be upheld? What about the position of a non-equity partner in a professional practice? No non-compete should apply to that position as there is no equity to sell to support the exception to the non-compete. Will some of those characterized as a “partner” really be treated as mere employees for the purposes of the rule, thereby prohibiting the application of the sale of equity exception? For owners who are functionally like employees, even if they have some control and equity, the term “worker” may encompass them, and the restrictions on non-competes will apply.

Conclusion

While the FTC’s restrictions or prohibition on the use of non-compete, non-disclosure, and non-solicitation agreements certainly will help many employees, the impact on many closely held and family businesses could be negative and dramatic. In particular, business owners must evaluate how these new rules may adversely affect succession planning. Consideration should be given to how these new rules will affect the valuation of companies for tax and non-tax purposes.

 

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

 

Marty Shenkman 

Jonathan Blattmachr

David Ritter, Jr.

 

CITE AS:

LISI Estate Planning Newsletter #3122 (June 3, 2024) at http://www.leimbergservices.com. Copyright 2024 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. Our agreement with you does not allow you to use or upload content from LISI into any hardware, software, bot, or external application, including any use(s) for artificial intelligence technologies such as large language models, generative AI, machine learning or AI system. This newsletter is designed to provide accurate and authoritative information regarding the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI