Erich Merrill, Miller Nash LLP
The author acknowledges the research assistance of Vivian Hernández for this article.
In the December 2024 edition of this newsletter, Justin Monahan and I cowrote an article discussing considerations of buying and selling a business from the perspectives of the buyer and the seller. Among the considerations explored was the post-closing transition process, which Justin expanded upon in a subsequent article. Another consideration included in our first article was the importance of non-competition agreements in such merger and acquisition (M&A) transactions. This article delves into the details of crafting non-competition agreements in preparation for, or as part of, M&A transactions.
Terminology: non-competes vs. other restrictive covenants
Creating non-competition agreements (or “non-competes”) is one contractual option for preventing employees from using their employer-company’s intangible business assets (e.g., customer lists, manufacturing techniques, or knowledge about suppliers) to set up a competing business or to work for a competitor after leaving the company. Non-competes are agreements in which an employee commits not to provide services to, or own an interest in, a business that competes with the company. To be enforceable, non-competes must be limited in both market area (traditionally geographic) and duration.
Other contractual methods for protecting against competitive use of a company’s business assets are non-solicitation agreements and nondisclosure agreements. For the purposes of this article, non-solicitation agreements are those under which an employee agrees not to hire or offer to hire the company’s employees, not to offer products or services to the company’s customers, or both. Nondisclosure agreements are agreements under which an employee agrees to refrain from disclosing or using information that the company considers proprietary.
Other protective agreements that companies often find desirable are work product assignment agreements and non-disparagement agreements. These agreements, while important tools for companies, are not the topic of this article.
Employee non-competes before the M&A transaction – state law restrictions
A number of business reasons can lead companies to decide that they will require non-competes from their employees. Companies that expect to engage in an exit transaction (i.e., an M&A transaction resulting in the sale of the company’s entire business to a buyer) have an additional incentive to require employee non-competes: obtaining non-competes from key employees can enhance the value of a business in the eyes of a buyer.
Counsel to such a company (or to its owners) must consider state law restrictions on non-competes before the company requires employees to agree to them. Oregon, Washington, and California, for example, each highly regulate non-competes, and in different ways.
As established in ORS 653.295, businesses with Oregon employees can require non-competes from employees but are subject to significant procedural and substantive limitations. Non-competes can be required only from salaried Oregon employees who are involved in administrative, executive, or professional roles and who make more than the threshold amount of $116,427, as of January 1, 2025. (This threshold is imposed under ORS 653.295 (1)(e).) With some exceptions, the employee must not be a licensed medical provider. The employer must have a protectible interest. Of particular significance for M&A purposes is Oregon’s requirement that non-competes be entered into at the time of initial employment or in connection with bona fide advancement. A new employee must be told of the non-compete in the job offer for the position, at least two weeks before starting work. Oregon allows employee non-competes to last for no more than twelve months. The case of Oregon Psychiatric Partners, LLP v. Henry, 316 Or. App. 726 (2022) provides a recent example in which failure to comply with the non-compete statute voided the non-compete.
Companies with employees in Oregon have other alternatives that can be effective to provide protection in lieu of a non-compete. Oregon permits both nondisclosure agreements and non-solicitation agreements. Oregon also permits bonus-restriction agreements, as defined in ORS 653.295(5). Under these agreements, a former employee can be required to refrain from competing with the company as a condition to receiving a bonus that will be paid after employment has ended.
Washington State also allows employee non-competes in limited circumstances and of limited scope. Under RCW 49.62.020, employee non-competes are unenforceable unless the company provides advance written notice to the new employee at the time of the initial employment offer or the non-compete agreement is supported by adequate consideration if it is being required after an employee has already begun work for the company. Washington does not permit companies to require a non-compete from any employee making less than a threshold amount ($126,858.83 as of January 1, 2026). Washington law also includes a presumption that any employee non-compete longer than eighteen months is unreasonable and therefore unenforceable.
Washington law strongly discourages the use of unlawful non-competes by imposing clear statutory penalties: any person harmed by an unlawful non-competition covenant can bring an action to recover the greater of actual damages or $5,000, plus attorney fees and costs. Employees or a subsequent employer are among the parties who might be harmed and are therefore permitted to bring an action to recover these amounts.
The Washington penalties for imposing a non-compete in the wrong circumstances can affect the value of a business in an M&A transaction. Companies preparing for an exit transaction may therefore prefer to rely on other means of protecting against former employee competition, such as a nondisclosure agreement.
Companies with employees in California, in some ways, have the easiest decision to make as to whether employee non-competes are appropriate. They are not. California prohibits and will not enforce employee non-competes. Under Cal Bus. & Prof. Code § 16600, any contract that restrains an individual from engaging in a lawful profession, trade, or business is void, regardless of its scope, duration, or other factors. Businesses with employees in California must rely on other means, typically nondisclosure agreements, in order to protect the business against use of intangible proprietary business assets by former employees. Traditional intellectual property protections such as patents, copyrights, and trademarks/service mark registrations are tools that businesses with employees in Oregon, Washington, or California can use for this purpose.
Non-competes in M&A transactions
The restrictions on employee non-competes in Oregon, Washington, and California are specific to the employment arena. The restrictions do not apply to non-competes that owners (limited to owners of more than a 1 percent interest in Washington) may enter in connection with the sale of their business. (See ORS 653.295(4); RCW 49.62.010(4)(d); Cal Bus & Prof Code §§ 16601, 16602, and 16602.5.) Owner non-competes are subject only to the common law requirement that such restrictions be of reasonable scope and duration. (See e.g., Eldridge v. Johnston, 195 Or. 379, (1952); Perry v. Moran, 109 Wash. 2d 691, (1987); Samuelian v. Life Generations Healthcare, LLC, 324 Cal. Rptr. 3d 596 (2024).) In virtually all M&A transactions, the buyer will require that the seller refrain from competing with the buyer (or with the business being sold) for a specified period of time.
Key negotiating points as to M&A non-compete provisions include who will be subject to the non-compete, how competition is defined, what exclusions will be specified, and scope in terms of duration and geographical area.
In an exit transaction structured as a sale of assets, the non-compete is usually directed at the selling entity. The owners of the selling entity may also be required to enter into a non-compete. In an exit transaction structured as a stock or equity sale, at least the controlling owner will be required to agree to a non-compete. Often other substantial owners will also be required to agree to a non-compete. In both types of transactions, the buyer will sometimes also require that key employees also agree to a non-compete, especially if those employees are also owners.
Numerous approaches can be taken as to the definition of competition or what constitutes a competing business. In some agreements, there is no definition of this concept, relying on the common understanding of competition to define the scope of the provision. More often, M&A agreements define a competing business as one that sells products or services that are substitutes for those sold by the acquired business, either as of the time of the transaction or at the time of the competing act after the transaction. For early stage or rapidly developing businesses, competing businesses can be defined as including those that are contemplated by the company’s research and development activities. While such a clause is desirable from the buyer’s standpoint, sellers should be cautious about agreeing to this flexible definition since it may be difficult after the transaction to understand exactly what business activities are prohibited.
Exclusions from the definition of competing business can be critical if a seller is selling one business but retaining another business. The retained business should be excluded from the noncompetition clause. The seller should also consider whether the retained business is likely to expand into additional sectors, in which case those should also be excluded from the definition.
The geographic (or market) scope and duration of the non-compete are also items that are commonly negotiated. The appropriate market scope of the non-compete will depend on what business is being sold, where its customers and operations are, and whether it is a bricks-and-mortar or virtual business, among other things. Attorneys for a buyer need to keep in mind that courts can strike down overly broad geographic or market scopes that the courts find unreasonable.
The duration of an M&A non-compete is typically three to five years after the closing date of the transaction, as to owners. If employee non-competes are part of the acquisition agreement, the duration will usually be substantially shorter, must be tailored to comply with applicable state statutes, and runs from termination of employment rather than from the closing date of the transaction.
Common non-compete mistakes by buyers
Buyers often stumble when formulating the non-compete provisions of an M&A transaction. A common mistake that buyers make is requiring existing employees to sign non-competes at the time of the business acquisition, without any significant consideration other than continued employment. In Oregon, amending an employee’s existing agreement to include a non-compete results in an unenforceable agreement if no bona fide advancement accompanies the amendment. In other states without statutory restrictions on non-competes, such an amendment can be subject to a challenge that there was no consideration, or inadequate consideration, for the amendment.
A less frequent (in my experience) but still surprising mistake is for buyers to require non-competes from employees in California or other jurisdictions where such provisions are clearly prohibited or unenforceable. This mistake usually occurs when the buyer and their attorney are located in states where non-competes are not restricted.
In both cases, attorneys representing buyers need to familiarize themselves with the laws of the states where the acquired business and its employees are located, to make sure that non-compete requirements comply with applicable state laws.
Diligence considerations
Both buyers and sellers should include the topic of non-competes in their diligence review and preparations for a potential M&A transaction. For the seller, the diligence review should include confirming that all existing non-compete agreements with employees have been appropriately documented, and that any agreements complied with applicable state law at the time they were entered into.
For the buyer, the diligence review for non-competes should focus on which non-compete obligations have been imposed on employees, whether obligations that do exist comply with applicable law and will be enforceable by the buyer, and whether any non-compete agreements that the seller has put in place may violate applicable law and subject the buyer to claims or penalties. For example, a buyer of a business with employees in Washington could be held liable to the employee or a former employee’s new employer for non-competition agreements entered into by the seller if those agreements did not comply with Washington’s requirements for such agreements.
Federal Trade Commission
On April 23, 2024, the Federal Trade Commission (FTC) issued a final rule that would have significantly restricted the ability of employers to require employees to agree to non-competes. The final rule has been stayed by the U.S. District Court for the Northern District of Texas (Civil Action No. 3:24-CV-00986-E) and remains the subject of litigation as well as uncertainty as to future action by the FTC. Unless and until the rule takes effect, restrictions under state law rather than federal law determine the limits on non-competes.
Practice tips
Attorneys representing sellers in M&A transactions, or representing companies preparing for an exit transaction, should consider the following factors when advising a client on non-compete agreements:
- When advising a company on non-competes prior to an M&A transaction, confirm whether applicable state law permits the non-compete for the employees of interest. If a non-compete is permitted, explore with the client whether a non-compete may be unacceptable as a business matter and whether other restrictive covenants or traditional intellectual property protection may provide adequate protection against competition by former employees. As to any non-competes that are permitted and desired, provide the client with appropriate documentation of the non-compete and assist the client in obtaining the non-compete from employees in accordance with procedures required by applicable state laws.
- When advising a seller in an M&A transaction, counsel the seller or owner who will be subject to the non-compete as to what parameters of the non-compete can be negotiated. The extent to which a non-compete requested by the buyer may be acceptable will likely depend to a large extent on the seller’s or owner’s future business plans. For example, an owner planning to retire may be unconcerned about a broad non-complete with a long duration and wide geographic scope.
Attorneys representing buyers in M&A transactions should consider the following matters when advising a client on non-compete agreements:
- Confirm that any non-compete requested by the buyer has a scope that will likely be considered reasonable and will therefore be enforceable.
- Confirm that any non-compete requested of the seller’s employees (or an owner in their role as an employee) complies with applicable state law. In particular, if a non-compete will be required of an existing seller employee who is not currently subject to a non-compete, confirm that the new non-compete is structured in such a way as to meet any requirements of applicable state law (if permitted at all).
- Counsel the buyer that employee non-competes cannot always be relied on. For example, if an employee moves to California, courts will no longer enforce a non-compete that may have been enforceable in the state in which it was originally entered (when the employee lived in or worked from another state).
Conclusion
Non-competition agreements from sellers, owners, and key employees are an important part of most M&A transactions. Business owners preparing for an exit transaction should consider the extent to which obtaining non-competes from new and existing employees may be desirable. Attorneys advising sellers or buyers in connection with an M&A transaction need to be familiar with the statutory limitations on non-competition agreements and ensure that any such agreements are structured to be enforceable to the extent permitted by applicable law. ♦
