Unpacking the "Bona Fide Sale" Exception to the FTC's Non-Compete Clause

This article was written for the New Orleans Bar Association.

Last month, the Labor & Employment Law Committee discussed a final rule issued by the Federal Trade Commission (FTC) banning most noncompete agreements nationwide. As the article explained, the FTC’s Non-Compete Clause Rule (“the final rule”) signals a marked shift from traditional practices across many industries. However, the final rule includes an exception of particular interest to the Business Transactions Committee: namely, an exception that permits noncompetes in connection with the “bona fide sale” of a business.

The final rule explains that the ban shall not apply to noncompetes entered into pursuant to the bona fide sale of:

1. 1. a business entity,
   2. the person’s ownership interest in a business entity, or
   3. all or substantially all of a business entity’s operating assets. 

The FTC defines “bona fide sale” as a sale “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.”

The FTC’s insertion of the “bona fide” qualifier into the final rule – it was not included in the original Notice of Proposed Rulemaking (NPRM) – responds to concerns that businesses might exploit the exception in one of two ways: (1) by using “springing” noncompetes, which require workers to agree at the time of hiring to a noncompete in the event of a future sale, and other stock-transfer schemes requiring a worker to sell their shares upon the occurrence of a certain event, or (2) by entering into sham transactions with wholly owned subsidiaries to impose noncompetes that would otherwise be banned.

In the FTC’s view, the bona fide sale requirement addresses both sets of concerns. “Springing” noncompetes and other stock-transfer schemes do not occur as part of a bona fide sale (and are therefore not exempted from the general ban) because the worker has neither goodwill to exchange for the noncompete nor a reasonable opportunity to negotiate the terms or conditions of the sale at the time of contracting. Additionally, because the definition requires that bona fide sales be made at arm’s length between two independent parties, companies cannot employ sham transactions between affiliates to evade the ban.

While the FTC’s final rule added the concept of bona fide sales, it dropped the proposed limitation on the exception to sellers with a “substantial interest” in the company. In the NPRM, the exception for business sales applied only to an owner, member or partner with a substantial interest, i.e., at least a 25% ownership interest in the business entity being sold. The FTC originally asserted that the threshold was necessary to allow for noncompetes essential to the effective transfer of goodwill while prohibiting those likely to be exploitative and coercive.

However, the FTC abandoned this position in adopting the final rule, pointing out that noncompetes under the exception will be governed by state laws, which generally require them to be necessary to protect the value of the business. Ultimately, the FTC’s about-face on the substantial interest requirement means that a wider range of interested parties may be bound by noncompetes resulting from the sale of a business.

The final rule is set to become effective as of September 4, 2024, but as the Labor & Employment Law Committee noted, pending litigation leaves its potential impact less than certain. Regardless, the bona fide sale exception means that noncompetes will likely remain negotiated provisions in the context of business sales.