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Dire Straits? The FTC’s Expanding Non-Compete Enforcement Seeks to Narrow Sale-of-Business Agreements

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Back in July 2021, President Biden signed Executive Order 14036 directing the Federal Trade Commission (“FTC”) to “address agreements that may unduly limit workers’ ability to change jobs.” As a result, gallons of ink were spilled by practitioners across the country predicting the downfall of non-compete provisions nationwide, replacing the current patchwork of state laws with something more akin to California.

While these predictions have not yet come to fruition, the FTC recently expanded its non-compete enforcement into an area that caught many by surprise – non-compete provisions executed in conjunction with a business sale. Most who follow this area of the law can be forgiven for not seeing this issue on the horizon, as the fanfare regarding President Biden’s EO mainly focused on non-competes in the employer-employee context. In fact, employer-employee provisions have been an enforcement strategy of state legislatures and attorneys general for the past several years. Few, if any, discussed these agreements as part of business deals.

This is because non-compete provisions in connection with a business sale have traditionally been viewed as a business necessity and not a mechanism that impedes on worker mobility. This concept is so commonly accepted that even California, the state that literally outlawed non-compete agreements, carved out a limited exemption for the “sale of goodwill of business or ownership interest.”  See Cal. Bus. & Prof. Code §16601.

The rational for this exemption is clear – as part of any business transaction, a business owner is selling their goodwill built up through years of operating their business. They have a customer and client base that provide the business with a revenue stream, without which the business would be valueless. The owner sells that goodwill, and then agrees not to compete with the buyer so that they can realize the benefit of purchasing that goodwill. This is all factored into the purchase price of the transaction. This makes business sense for both buyers and sellers.

THE ARKO TRANSACTION

Not so fast, says the FTC. This past June, the FTC published an administrative complaint taking action concerning a $94 million dollar transaction wherein a purchaser acquired 60 retail gasoline stations from the Corrigan Oil Company (“Corrigan”). Specifically, the FTC took issue with the non-compete provision included in the purchase agreement that restricted Corrigan from opening competing locations not only around the 60 locations being purchased, but also another 190 locations already owned by the purchaser. The FTC alleged that, by agreeing to this provision, there was a reduction in market participants in several local markets in Michigan. The FTC also alleged that, but-for the non-compete provision, “Corrigan … could have otherwise competed with retail fuel stations owned, leased, or operated by [purchasers] and other competitors in each of those areas.”

Ultimately, the parties and the FTC entered into a consent decree whereby the purchaser agreed to a number of remedies, most significant of which were:

  1. Returning five of the acquired retail locations to Corrigan;
  2. Limiting the non-compete provision for Corrigan to be no more than three years from the acquisition date, and no more than a three-mile radius from the actual acquired retail locations (not the 190 locations originally agreed upon);
  3. For a period of 10 years, the purchaser must seek prior approval of the FTC before acquiring any retail fuel outlet within three miles of the locations returned to Corrigan; and
  4. The purchaser will not enter into, or enforce, any non-compete agreement related to acquisitions that would serve to restrict competition solely around a fuel business already owned or operated by the purchasers.

The purchaser also has to notify third parties subject to similar agreements of the obligations under the consent decree.

In a press release issued by FTC Chair Lina Khan, the FTC acknowledged that non-compete provisions are necessary in protecting legitimate business interests, including “goodwill acquired in a transaction.” However, Chair Khan took the position that “a noncompete that limits prospects for reentry may in certain instances reflect that goodwill, if appropriately limited in geographic scope and duration.”

Against this backdrop, Chair Khan explained that the non-compete provisions in the ARKO transaction were “overbroad and facially unrelated to protecting any goodwill” the purchaser would hope to acquire. Rather, Chair Khan took the position that these non-compete provisions were drafted to ensure the purchaser “would not face direct or indirect competition from Corrigan … even in geographic areas far from the acquired stations.”

In doing so, Chair Khan drew a firm line in the sand – non-compete provisions that appear to go beyond the protectable goodwill in a transaction will be deemed overbroad and in violation of relevant FTC law.

TAKEAWAYS

Buyers, sellers, and the counsel and advisors who work with them, must take notice of this new FTC enforcement focus. This is not solely a legal concern that must be negotiated on the back-end of a purchase agreement – this is a decision that can affect the very purchase price of a transaction. If a purchaser is limited in how they protect their goodwill, this will necessarily be reflected in the purchase price.

That being said, practitioners will be well-served to draft non-compete provisions in sales agreements using one of the overarching themes that are seen with employer-employee agreements – ensuring the provision is only so broad as to incorporate a protectable interest, here, the goodwill being purchased.

This means the non-compete provision should be reasonable in scope and duration, and should only apply to assets that are actually being acquired in the transaction. The parties should also document to the greatest extent possible the goodwill being exchanged, so that there is no question about the value. While it’s unclear how the FTC will continue to alter the non-compete landscape, drafting provisions in accordance with this decision will certainly go far in avoiding scrutiny.

Employers and business owners should also be on the look-out for new rules coming from the FTC in this area, with the possibility of new restrictions as early as September.

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