The New FTC Noncompete Rule and Future Equity Awards to Senior Executives—Will These Awards Be Grandfathered?

This marks the fourth time we have written about the FTC’s new rule generally banning the use of noncompetition clauses in the employment context (see New FTC Rule Would Generally Ban All Non-Compete Agreements Except for Agreements with “Senior Executives” Entered Into Before the Effective Date; Texas Court Imposes Injunction Against FTC in Case Challenging FTC’s Non-Compete Ban; and Courts Are Now Split on Legality of FTC’s Non-Compete Ban—Pennsylvania District Court Determines that FTC Ban is Legal), reflecting the far-reaching nature of the noncompete rule and uncertainties about whether it will go into effect on September 4 and be ultimately upheld.  As previously recounted, as of today (1) one court has indicated its belief that the rule is legal and declined to issue a preliminary injunction blocking the rule and (2) one court has indicated its belief that the rule is illegal and blocked enforcement of the rule (but only as to the plaintiffs in the case) pending the court’s final ruling, which is expected by August 30, 2024.

Assuming an employer is concerned that the FTC rule will ultimately be upheld, this raises a grandfathering compliance issue with respect to that employer’s “senior executives,” since the rule provides an exception for noncompete arrangements with senior executives that are entered into on or before the September 4 effective date.  As previously discussed, the FTC definition of “senior executive” contains a number of ambiguities, which we will not discuss here. We will assume that an employer has executives that meet the FTC definition and wants to maintain its existing noncompete arrangements with them to the extent possible.  Assume also that the noncompete provisions do not violate any state laws, so the only question is whether it is barred by the FTC rule.

This blog concerns noncompete arrangements embedded in equity awards.  For example, we often see equity arrangements where certain types of terminations, for example, a qualifying retirement, result in favorable vesting, but the equity payout is delayed until the normal payout date.  For example, the employer may issue performance share units with a three-year performance period.  If the executive has a qualifying retirement during the performance period, he or she will be entitled to payout at the end of three years, based on the degree to which the performance metrics have been satisfied over the three-year period.  In these situations, it is not uncommon for the employer to require the executive to refrain from competition during the performance period and/or the remainder of the normal vesting period in order to receive the payout.

Here’s the issue.  Will a forfeiture-for-competition provision be valid if the award agreement is issued after September 4?  This may depend on which document contains the noncompete provision.  In particular, an arrangement we have often encountered is where the noncompete provision for each year’s award is embodied in that year’s award agreement.  So, the 2023 award agreement contains a noncompete provision with post-employment vesting for that year’s award (and a corresponding forfeiture provision for competition), the 2024 award has similar provisions pertaining to the shares subject to that award, etc.

If the noncompete provision is found in each award agreement, this appears to raise a problem for award agreements issued after September 4 since, as a technical matter, there is no restrictive covenant in place before September 5 providing for forfeiture as to the award granted after September 4.  What prompted this blog is a concern that some employers may not have focused on this nuance.

Assuming an employer faces this particular issue, there may be ways to solve the problem, so long as the appropriate arrangements are in place before September 5.  For example, subject to state contract law requirements pertaining to sufficiency of consideration, one approach would be for the employer and the executive to agree today that, in consideration for the potential issuance of future equity awards, the executive agrees that such awards will be subject to a provision that any shares that would otherwise be delivered post-employment will not be delivered if the executive competes during the post-employment period. 

This is a complex legal issue that requires the input of appropriate legal counsel, and the right solution may differ depending on the specifics of a company’s situation.  Notwithstanding these complexities, however, we think this potentially important topic may require immediate consideration in the case of companies that issue equity awards where post-employment payout of the equity award is subject to a noncompete restriction.

David Gordon
Managing Director

Dave Gordon’s practice as an executive compensation consultant covers a variety of industries, including extensive experience with financial institutions and utilities. Based on his years of experience as an executive compensation lawyer, he acts as the senior resource on numerous technical issues for the Firm. He frequently acts as an expert witness.

Bindu M. Culas
Managing Director

Bindu Culas has over 20 years of executive compensation experience. She works across industries with domestic and foreign public companies, pre-IPO companies and privately-held companies. She has deep expertise in designing annual and long-term incentive programs, structuring equity plans and award vehicles, navigating talent attraction, motivation and retention challenges through business cycles, and advising on governance and investor considerations. Previously, Bindu was a partner at Linklaters LLP and she is well versed in the complex regulatory, compliance and tax aspects of executive compensation.

Michael Abromowitz
Consultant

Michael Abromowitz consults on all aspects of executive and board compensation including executive compensation benchmarking, annual and long-term incentive program design, peer group development, and executive severance and change-in-control plans.