FTC Challenges Scope and Duration of Noncompete Provisions of M&A Agreement

Last month, in a proposed consent order settling a challenge to a previously consummated transaction, the Federal Trade Commission not only succeeded in partially unwinding the transfer of certain assets but also secured a victory in substantially narrowing the scope of the noncompete provisions of the parties’ asset sale agreement.

The challenge thus underscores the commitment of FTC leadership to aggressively pursue consummated transactions it believes to be anticompetitive, but it is most noteworthy for its focus on the parties’ noncompete provisions, which historically have received little attention from the antitrust agencies. Moreover, existing federal court precedent arguably supports the legality of the specific provisions challenged by the FTC. As such, this action is entirely consistent with FTC Chair Lina Khan’s stated intention to aggressively expand the reach of existing antitrust law, even when doing so potentially entails litigation risks. Going forward it also serves as a warning that, as noted in a joint statement by Khan and the FTC’s two other Democratic commissioners, the agency will scrutinize mergers and acquisitions agreement noncompete provisions “with a critical eye.”

ARKO’s Acquisition of Corrigan’s Retail Assets

The FTC’s action arose from a 2021 transaction pursuant to which ARKO Corp. and its subsidiaries acquired from Corrigan Oil Company 60 retail gasoline and diesel fuel outlets in Michigan and Ohio. In its complaint, the FTC alleged that the acquisition reduced the number of independent market participants from two-to-one in one local market, and from three-to-two in four local markets, endowing ARKO with the ability to unilaterally raise prices in each of these highly concentrated areas. The FTC addressed these concerns by requiring ARKO to divest back to Corrigan the purchased fuel outlets in five local markets in Michigan.

In addition, pursuant to the noncompete provisions of the parties’ agreement, Corrigan was restricted from competing in the sale, marketing, and supply of gasoline and diesel fuel not only around the acquired locations but also at approximately 190 of ARKO’s other pre-existing locations. The FTC alleged that these provisions were unlawful because their scope and duration were unreasonably broad and long. According to the FTC, the noncompete agreement was designed by the parties solely to eliminate potential competition rather than to protect a legitimate business interest arising from the underlying transaction.

The FTC consent order thus requires the parties to amend the noncompete agreement to apply only to the retail fuel businesses acquired by ARKO. Further, the companies are required to limit the terms of the noncompete provisions in the relevant markets to no longer than three years in duration and no more expansive than three miles from each acquired Corrigan location. The consent order also prohibits ARKO from entering or enforcing any agreement not to compete in future acquisitions of retail fuel businesses where the noncompete relates solely to existing ARKO locations and not the locations being acquired.

The FTC’s actions are arguably in tension with relevant federal court precedent. The courts historically have recognized that noncompete agreements generally are lawful when they are ancillary to and reasonably necessary for achieving an otherwise legitimate business interest (e.g., facilitating an acquisition transaction by assuring the buyer that the seller would not undermine the value of the purchased assets by competing against the buyer for some limited time). For example, in Lektro-Vend Corp. v. Vendo Co. (1981), an asset acquisition agreement contained a noncompete prohibiting any affiliation by the seller with any business engaged in the manufacture and sale of the relevant product (i.e., vending machines) under any name similar to its present name, and prohibiting for a period of 10 years the seller’s entry into or engaging in the manufacture or sale of vending machines in the United States or any foreign country in which the buyer is also so engaged.

The Seventh Circuit emphasized that covenants not to compete are valid if (1) ancillary to the main business purposes of a lawful contract; and (2) necessary to protect the covenantee’s legitimate property interests, which require that the covenants be as limited as is reasonable to protect their interests. In this instance, the court found the noncompete was completely ancillary to the asset purchase, which was legitimate, and that the covenants were being enforced reasonably with respect to time, geographic scope and product (e.g., the seller was secretly developing a candy vending machine in the place where the buyer’s prior operations were based, not in some foreign country). Therefore, the court found the noncompete did not run afoul of the antitrust laws. The FTC’s action in the ARKO/Corrigan matter appears to raise the bar—at least incrementally—on what justifications will satisfy such analyses. This in turn may invite future litigated challenges in which parties argue they were relying on settled law when agreeing to their noncompete provisions.

Noncompete Agreements Will Continue To Be an Antitrust Focal Point

Following President Biden’s Executive Order last summer that directed the FTC to consider using its rulemaking authority to “curtail the unfair use of noncompete clauses or agreements that may unfairly limit worker mobility,” the FTC has increased its scrutiny of noncompete agreements and other post-employment restrictive covenants between employers and employees. At a joint FTC/DOJ workshop on competition in labor markets in December, FTC Chair Lina Khan included in her list of agency goals the scrutiny of noncompete provisions in employment agreements through rulemaking and enforcement actions. Following the confirmation of Commissioner Alvaro Bedoya in May, after months of partisan deadlock, the Democrats now have a majority at the FTC. With this majority, a potentially significant funding increase from Congress, and a full year of experience for Khan, the FTC is expected to use its rulemaking authority to address, among other things, noncompetes in employment agreements and possibly also in the M&A context.

Irrespective of potential rulemaking, the FTC’s approach to the ARKO/Corrigan matter indicates that the Commission also now will be scrutinizing noncompete agreements ancillary to the sale of a business and may challenge agreements with terms traditionally perceived to be reasonable and enforceable under the antitrust laws.

Key Takeaways:

When parties notify the antitrust agencies under the Hart-Scott-Rodino (HSR) Act of a proposed acquisition, the HSR rules require the parties to submit copies of any agreements not to compete as a part of their filing. The FTC’s recent order is a clear signal that the Commission is critically reviewing those agreements and also provides an outline for how the agreement may survive such scrutiny:

• Noncompete agreements need to reflect relevant market conditions. For example, gasoline and diesel fuel retail outlets exist in highly localized geographic markets (ranging in size from a few blocks to a few miles). A key component of the FTC’s allegations is that the noncompete agreement did not reflect these market conditions, and rather covered a much broader geographic range. Additionally, where an acquisition may eliminate one of only a relatively small number of independent competitors, further restrictions on competition in that market will be viewed with heightened scrutiny.
• If a noncompete is entered into as a part of the acquisition, then it should identifiably relate to the acquisition. The FTC seized on the fact that approximately 190 of the stations subject to the noncompete provisions were not directly implicated by any aspect of the transaction, apparently rejecting any justifications offered by the parties when concluding that the inclusion of those stations amounted to little more than a market allocation scheme (even if temporary). Thus, parties to future transactions should take steps to more purposefully calibrate the scope of a noncompete to the business being acquired or more visibly document and reinforce positive justifications early on in the process.
• Time matters. While the FTC did not specify the length of the original noncompete agreement, in its order the agency requires that the duration be no more than three years. There are no bright line rules on what duration is going to appear reasonable to the FTC in a given circumstance, but parties would be well-served to proceed cautiously and be ready to support the duration chosen.

The ARKO/Corrigan settlement is also an important reminder that the FTC’s reach goes beyond the parties’ core M&A agreements and includes noncompete agreements and any similar provisions in other agreements. It is also the case that the ARKO/Corrigan deal was not reportable under the HSR rules, demonstrating that not having an HSR filing requirement does not necessarily mean your transaction will escape scrutiny. Thus, while antitrust counsel are often consulted in drafting merger agreements, it is also important that they be specifically consulted for any noncompete agreements or clauses.