Understanding the Bona Fide Sale Exception to the FTC’s Noncompete Ban

The Federal Trade Commission (FTC) issued a final rule to ban noncompetes on April 23. The FTC determined noncompetes are an unfair method of competition. The final rule prohibits employers from entering into new noncompetes and enforcing existing noncompetes.

The FTC provided limited exceptions to the prohibition. One exception, however, is the bona fide sale of a business. The rule provides an exception that allows noncompetes between the seller and buyer of a business.

The exception states the prohibition on noncompetes does not apply to a noncompete clause entered into by a person pursuant to a bona fide sale of:

• A business entity
• The person’s ownership interest in a business entity
• All or substantially all of a business entity’s operating assets

The noncompetes allowed by the bona fide sale exception will be governed by state law.

A “bona fide sale” is required to prevent the use of sham transactions, stock-transfer schemes, or other mechanisms that may be used to evade the rule. The FTC determined a bona fide sale is an arm’s length transaction made between independent parties, in which the seller had a reasonable opportunity to negotiate the terms of the sale.

The FTC provided two examples of transactions that do not qualify as bona fide sales. A transaction between wholly owned subsidiaries is not a bona fide sale because they are not independent parties. Noncompetes arising out of repurchase rights or mandatory stock redemption programs do not meet the requirements of a bona fide sale because the employees do not have goodwill they are exchanging for the noncompete and do not have the ability to negotiate the terms of the sale at the time of contracting.

Except with respect to bona fide sales of a business, parties will not be able to enter into valid, new noncompetes after the effective date of the FTC rule. Instead of relying on noncompetes, businesses will need to pivot to find alternative avenues and strategies to maintain and enhance their value and intellectual property. Some of these alternative strategies include specifically designed provisions in employment agreements related to confidentiality and trade secrets.

The FTC rule will become effective 120 days after publication in the Federal Register. However, there might be some roadblocks to the finalization of the FTC rule. At least three lawsuits, including a filing by the U.S. Chamber of Commerce, have been filed in federal court attempting to block the implementation of the ban. Phelps will keep clients informed of any updates to the FTC’s noncompete ban.

Contact any member of Phelps’ Business team if you have questions or need advice and guidance.