Subscribe
Share
Share
Embed
The Garden State Law Podcast discusses all things legal in the state of New Jersey. Presented by lawyers from Saiber LLC, the Garden State Law Podcast highlights trending topics in litigation, transactional law, real estate, and more.
00:00:03:20 - 00:00:10:16
Speaker 1
Welcome back to the Garden State Law Podcast. I'm your host, Tim Lough. Joining me today is corporate law and M&A attorney Pooja Patel. Pooja, thank you for joining us.
00:00:10:19 - 00:00:12:09
Speaker 2
Thank you, Tim, for having me today.
00:00:12:16 - 00:00:24:26
Speaker 1
Pooja and I will be discussing the FTC's recent ban on non-compete clauses and more specifically, how they impact the corporate world, particularly M&A transactions and venture capital. But before we get into this, Pooja, can you tell us a little bit about yourself and your practice?
00:00:24:27 - 00:00:53:00
Speaker 2
Absolutely. Thank you. I am a corporate transactional attorney. I have about eight years of experience, both in-house and at a law firm. The core of my practice is corporate counseling, corporate governance, equity and debt financing, and mergers and acquisitions. My clients are both on the company side. The investor side, they're private. They're public. They are, small, large.
00:00:53:03 - 00:00:53:25
Speaker 2
They're ...
00:00:53:25 - 00:00:54:25
Speaker 1
Full spectrum of business.
00:00:54:27 - 00:00:55:28
Speaker 2
The full spectrum.
00:00:55:29 - 00:01:05:07
Speaker 1
Great. So let's start from the beginning. We've talked about this on the podcast a little bit before, but we're going to kind of redefine it. What is the FTC's rule on non-compete agreements?
00:01:05:12 - 00:01:38:19
Speaker 2
The FTC rule on non-compete agreements is that, it is an unfair method of competition to enter into non-compete agreements with workers other than certain senior executives. It is an unfair method of competition to enforce non-compete agreements against workers other than certain senior executives, which we'll get to. And it's an unfair method of competition to represent that a worker is subject to a non-compete competition, again, other than certain senior executives, which we'll talk about.
00:01:38:20 - 00:01:42:18
Speaker 1
Sure. So maybe it'd be helpful to define what actually is the non-compete clause.
00:01:42:18 - 00:02:01:07
Speaker 2
Absolutely. A non-compete clause is any term provision agreement that prohibits or penalizes a worker from seeking employment, post their employment with an employer, or it prohibits or penalizes a worker from operating their own business.
00:02:01:12 - 00:02:07:00
Speaker 1
Okay, so you mentioned worker. Who are some of these workers and how are they defined specifically?
00:02:07:02 - 00:02:22:13
Speaker 2
Yeah, the FTC has a broad definition of worker. It's not only an employee. They include independent contractors. They include interns, externals. They include volunteers paid or unpaid. It's a pretty broad definition.
00:02:22:15 - 00:02:25:25
Speaker 1
And these exemptions include who specifically?
00:02:26:03 - 00:03:10:25
Speaker 2
There are a few notable exemptions here. The first one is existing non-compete with senior executives, existing non-compete with senior executives. The rule really looks into who is a senior executive right there. They have to have two qualifications. One, their compensation has to be over $151,164. And they need to be in a policy making position. When we look at what is a policy making position, right, there's guidance from the FTC that says if you are a head of a division in a company and have a, policy making position over a division of the company, that doesn't count.
00:03:10:27 - 00:03:47:12
Speaker 2
What they're trying to target is the CEOs, the presidents, that have the ability to make policy for the entire company. The second exemption is a sale of a bonafide business. When we're looking at the sale of a bonafide business... again, the FTC really tried to tighten this definition. When they talk about bonafide sale, they talk about a sale between two independent parties at arm's length, and in which the seller has a reasonable opportunity to negotiate for the terms of the sale.
00:03:47:14 - 00:04:02:11
Speaker 1
When can we expect, and I understand that this is a moving target, and we even received news yesterday that could impact the timing of this, but as of today, late July 2024, when can we expect this ban to be enforced?
00:04:02:13 - 00:04:06:00
Speaker 2
The effective date for the ban is September 4th, 2024.
00:04:06:00 - 00:04:07:25
Speaker 1
That's a big asterisks next to it probably.
00:04:07:28 - 00:04:26:21
Speaker 2
There is ongoing litigation. You know, recently we saw two courts, differ in their opinion on on how to handle this new rule. And we're going to see a lot of changes, or a lot of commentary from courts coming up because there are a number of challenges still present.
00:04:26:25 - 00:04:47:19
Speaker 1
Okay. So let's take a look at this kind of conceptually, I think sometimes the easiest way to kind of wrap your mind around things is to throw out a scenario. So I'm going to throw out a scenario, the sale of a business and certain employees and how this may or may impact different employees. So let's suppose for a second, I own a growing business, about 30 employees.
00:04:47:19 - 00:05:06:29
Speaker 1
We manufacture widgets. The last couple of years, we've had extreme growth, and we're at the point where we actually get to sell the business. And that's great news for us. So here are four different scenarios I want to walk through. Okay. Number one, there's me, the majority shareholder of the business. I am a part founder.
00:05:07:01 - 00:05:18:27
Speaker 1
I can make any decision I want with autonomy. And I make significant salary above $200,000. Scenario two I have a right hand man. She's been with me from the beginning.
00:05:19:02 - 00:05:19:15
Speaker 2
Woman.
00:05:19:20 - 00:05:39:13
Speaker 1
Right hand woman. She's with you from the beginning. She has a salary of about $200,000. She can make whatever decision she needs to. I have full confidence and trust in her. And she's truly, truly kind of a senior person of business. Number three is someone who also founded the company. I should say person two also has equity.
00:05:39:16 - 00:06:03:09
Speaker 1
33%. Person three also founded the company with us, although it's not as active as he used to be, and it's involved in some other business ventures. He does have equity in the company, but doesn't take much of a salary because he isn't doing a lot of day to day operations any longer. He has a senior level title because of his importance to the business, but doesn't really make the decisions any longer.
00:06:03:11 - 00:06:23:24
Speaker 1
Scenario four, fourth and final is everybody else. These are generally people who are entirely people making under $100,000, people who are more junior or even more senior people of the business, who don't have, decision making authority outside of their, department. So let's start with person number one, who's going to get rich, that's me.
00:06:23:27 - 00:06:27:03
Speaker 1
I'm selling the business. How is this going to impact me?
00:06:27:04 - 00:06:52:05
Speaker 2
Right. First, congratulations in this hypothetical. So we need to look at the buyer being an independent party. Right. We're going to make that assumption here. And we're also going to assume that you do not have an existing non-compete with your company. Sure. And so the exemption we'll look at here is the sale of a bonafide business right here.
00:06:52:07 - 00:07:23:20
Speaker 2
The investor is an independent party. You have the ability to negotiate your shares. The investor can come to you and say, hey, Tim, you know, you're selling this company. We don't want you to compete against us. Sign this non-compete agreement. That's okay. Under the rule, if the investor comes to you after the rule’s in effect, and say...
00:07:23:22 - 00:07:43:09
Speaker 2
Hey, Tim. You know, we want you to sign this agreement and work for us for a while. You know, and it has a non-compete clause because you had decision making power. You made a lot of money in compensation... that is not enforceable.
00:07:43:14 - 00:07:47:23
Speaker 1
Okay, so scenario two this is my right hand woman.
00:07:47:23 - 00:07:48:22
Speaker 1
Right.
00:07:48:25 - 00:07:55:20
Speaker 1
Been with me from the beginning. Seems like an executive senior executive. But how does this impact her?
00:07:55:23 - 00:08:24:17
Speaker 2
So we go through the same analysis when we're talking about the sale of a bonafide business, we're going to assume, buyer is an independent party transaction. Is arm's length, and she has the ability to negotiate the terms of her agreement. She falls under that exemption. Right. In the sale context, in the employment context, we're going to assume that she has an existing non-compete agreement with you.
00:08:24:19 - 00:09:04:21
Speaker 2
The original company and that, that she is a senior executive because her compensation is over the threshold of $151,000 dollars. And that, she has a policymaking position, right? She she's senior enough. She can make decisions for the entire company. So her existing non-compete with you, after the rule is in effect, is still enforceable.
00:09:04:23 - 00:09:39:10
Speaker 2
When we get to the buyer, right, the buyer comes in and says, hey, non-compete looks good, but, you know, we want to enter into a new employment agreement with your right hand woman. And, you know, we're going to make sure that the employment terms align with our policies and practices. But, you know, we're going to just cancel that agreement and enter into a new one, even though the terms of the non-compete agreement or the non-compete provision are the same, that would be ineffective and unenforceable.
00:09:39:12 - 00:09:42:18
Speaker 1
Scenario three is a little bit more nuanced, I think.
00:09:42:23 - 00:09:43:21
Speaker 2
Right.
00:09:43:24 - 00:10:04:27
Speaker 1
This individual is someone who is a, a founder of the company, still has a lot of equity. Was significant in its founding. Used to have the autonomy to make decisions, but now is involved in other business ventures. So not making those decisions and takes a smaller salary because he's really not working full time job there any longer.
00:10:05:00 - 00:10:07:22
Speaker 1
How is someone like this impacted?
00:10:07:24 - 00:10:33:15
Speaker 2
Again, we look at sale of Bonafide Business. We need to make sure here that when this employee is selling his share, that the company is not forcing him to sell his shares back to the company, or, you know, that there's no agreement that requires him to take any actions in which he is not negotiating.
00:10:33:16 - 00:11:03:07
Speaker 2
If he's negotiating with the buyer, and he has a reasonable opportunity to negotiate the terms, then he again is okay in the in the sale context, in the employment context, he doesn't meet the compensation threshold, right? He isn't in a policymaking position. So, after the effective date of the rule, his non-compete provision is unenforceable.
00:11:03:14 - 00:11:29:12
Speaker 1
Okay. So the fourth and final scenario, probably the most obvious, this is everybody else. The remaining 25 employees of the business, this is junior people. And, you know, mid, mid mid-level senior management but not senior can impact, you know, decision making in terms of a department but not company wide. All people who are making under $100,000, how about these people?
00:11:29:14 - 00:12:07:15
Speaker 2
Well, these people don't have equity. Don't fall under the exemption for a sale of bonafide business. They also don't meet the exemption for existing senior executives because they don't have policy making power and they don't meet the compensation threshold. So non-compete with these individuals, when the rule goes into effect, are not enforceable. And it's also important to note that you, as an employer, need to provide notice to these individuals prior to the effective date that their non-compete provisions are no longer enforceable.
00:12:07:20 - 00:12:53:01
Speaker 1
Okay, so that is one component of this. The other component is something that I find interesting, specifically as it relates to venture capital and how this can possibly impact them or not. If you're a venture capital company and you're looking at developing, growing tech businesses, and deciding where you want to invest your money, I'd have to think that this must come into play, because if you're making the decision to, make a significant monetary investment into a company with the unknown of whether or not these individuals are bound to an existing employment contract, does that impact their decision making?
00:12:53:01 - 00:13:07:24
Speaker 1
Or how does it impact just, a general, venture capital firm who says, like I have, you know, a small business with really a few, a few key people who... they are the business. How does it impact that decision making process?
00:13:07:24 - 00:13:38:04
Speaker 2
Well, it's a it's a great question. And, you know, people disagree on, on what the impact will be. And so there is this notion that in early stages of venture capital, what investors are really investing in is the key management personnel. Right? These are the individuals with charisma, skill, that are really pushing everything into the company.
00:13:38:06 - 00:14:05:18
Speaker 2
They have equity. These are the people that you're investing in. And, investors, they don't want those individuals to leave. Right. So that, you know, that's one side of it. The second side of it, when you're looking at venture capital, is you're looking at state laws like California. Right. California has banned non-compete for a very long time.
00:14:05:18 - 00:14:08:05
Speaker 2
And, Silicon Valley is...
00:14:08:05 - 00:14:08:19
Speaker 1
00:14:09:16 - 00:14:15:06
Speaker 2
in California. And there is a lot of innovation coming out of Silicon Valley.
00:14:15:06 - 00:14:19:03
Speaker 1
And as are VC firms. They’re heavily populated in the West Coast.
00:14:19:04 - 00:14:52:03
Speaker 2
Exactly, exactly. And so when you're making the argument that, the inability to enforce non-compete will significantly impact venture capital, you know, if you look at California, it hasn't stopped investors from investing in California companies. So that's one side of it. But the other side is that there are other tools that investors can use and maybe tighten up a little bit moving forward if they are concerned about retaining key management.
00:14:52:06 - 00:15:12:15
Speaker 2
And that includes reinvesting of their equity. You know, upon funding that includes, you know, if you want, instead of having at will employment, you want to have term employment for a certain amounts. There are other tools such as that. And also, you know, keeping your employees happy. Right?
00:15:12:17 - 00:15:12:28
Speaker 1
Yeah.
00:15:13:00 - 00:15:41:27
Speaker 2
Yeah. I think it's also important to note that when you're working with early stage companies, founders also often have this pressure that, if their prior employer had non-compete agreements that, when they're starting a company, they might be violating certain non-compete agreements or it's, you know, it's not clear whether this violates that or not... and this sort of alleviates that pressure for founders, allowing them to focus on building a company.
00:15:41:27 - 00:16:03:29
Speaker 2
And also it allows them to focus less on non-compets of talent that they're retaining, that may be violated because, you know, the non-compete definition of who's a competitor is very broad and they might come into it. And so now there's freedom, a little more freedom to hire talent and move around. Sure.
00:16:04:01 - 00:16:21:21
Speaker 1
So the key takeaway is whether you have an employment contract or a non-compete, whether you enforce them, whether you are wondering what you should be doing in preparation, what are some of the key takeaways for both employers and employees?
00:16:21:24 - 00:17:03:09
Speaker 2
I think the big one is, employers need to review their restricted covenant agreements, right? They need to consider whether they should enter into non-compete agreements with senior executives that meet the definition prior to the effective date of the FTC's final rule, and they need to review their current restrictive covenants to make sure that even, certain non-solicit provisions or, non disclosure provisions don't inadvertently act as non-compete and therefore render them invalid.
00:17:03:11 - 00:17:17:04
Speaker 2
The other thing is they need to look at these non-compete, non-solicit, non-disparagement, non-interference clauses in their agreement and make sure they're tight enough to cover and protect what they're looking to cover and protect
00:17:17:06 - 00:17:23:02
Speaker 1
So this is the time essentially. If there's ever a time to look at your employment contracts. That's today.
00:17:23:08 - 00:17:24:03
Speaker 2
Right.
00:17:24:05 - 00:17:39:28
Speaker 1
Okay. Thank you very much for joining us Pooja. If you have any questions for Pooja, you can contact her at (973) 845-7724 or ppatel@saber.com. Thank you all for listening. Make sure to subscribe to our YouTube and podcast channel and we'll talk to you next time.