Saturday, January 7, 2023

Non-competes, and also SPACs

Couple of things this week.

First, the FTC proposed a new rule that would bar employers from requiring employees to sign noncompetes that extend post-employment.  It’s a very broad proposal; it applies to “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer,” and includes “a contractual term that is a de facto non-compete clause because it has the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”

The sole exception is for “a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.”  A substantial owner must have at least a 25% interest in the entity. 

There’s lots to recommend a proposal like this – I’m not an expert in this area, but others have written about, for example, how Silicon Valley’s innovation may have been a result of California’s prohibition on non-competes.  

Right now, different states have different rules about the permissibility of non-competes, which is why – as I explore in my new paper, Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine (forthcoming in the Wake Forest Law Review) – companies are increasingly trying to avoid them by writing non-competes and other employment-like terms into business entity documents (like LLC operating agreements and LP agreements), and then making employees members/partners/managers, on the theory that the non-compete is now no longer a “labor” contract, but an equity/investment contract, subject to the law of the state of organization.  That means courts – and, usually, Delaware courts – are left trying to sort out what counts as really an equity agreement versus what counts as an employment agreement.

So I wonder whether the FTC’s proposed rule could run into the same problem that Delaware is experiencing right now.  A plain reading of the proposal suggests that the rule applies to any contractual term between a worker and employer, regardless of whether the term appears in a contract of employment or some other kind of contract – but, another part of the rule (the model language for employers giving notice to workers) refers specifically to “employment contracts.”   If the rule becomes law, I can imagine employers might try to introduce some ambiguity by distinguishing “worker” contracts from entity documents.  To discourage that kind of gamesmanship, the FTC may want to add some language to clarify.

Second, previously, I blogged about Delman v. GigAcquisitions3 LLC, concerning the GigCapital3 de-SPAC transaction.   Well, VC Will has just sustained fiduciary duty claims against the Sponsor and directors of GigCapital3.  Among other things, she accepted plaintiffs’ allegations that the proxy was misleading because it represented that the SPAC’s shares were worth $10 each, when in fact they’d be worth less due to warrants and transaction fees.  Notably, VC Laster reached a similar conclusion in another SPAC case a few months ago.

But that’s not all. 

VC Will also held that Corwin cleansing simply is not available for SPACs, even if the vote is fully informed, because shareholders can both vote in favor of the deal and exercise their redemption rights (in fact, many are incentivized to vote in favor and exercise the redemption, rather than force liquidation, because they also hold warrants).  This means, according to Will, “the structure of the Gig3 stockholder vote is inconsistent with the principles animating Corwin.”  She also held that the MFW framework would be a poor fit because “The MFW process was designed to protect minority stockholders from the retribution of a controlling stockholder engaged in a self-dealing transaction—specifically, a squeeze-out. Those fears are not realized in a SPAC merger; public stockholders can simply redeem their shares.”

At this point, I’m feeling rather chuffed because these are exactly the arguments I made in one of my blog posts about the case, and later in my essay, The Three Faces of Control, at note 88 and accompanying text.

That said, even with the inapplicability of the MFW framework, she held that, at least for pleading purposes, the Sponsor’s control over the SPAC’s business – and ties to the directors – made it a controlling shareholder, even with less than 25% of the voting power (which meant the Sponsor had fiduciary duties to the SPAC).

Anyway, I’d say this is all a really big deal for SPACs – they'd have to do some pretty radical restructuring to avoid board-level/sponsor conflicts that would permit business judgment review in the absence of shareholder ratification under Corwin (and that doesn’t even get into the thing where they openly advertise for shareholders to vote even if they’ve already sold their shares) – except for how I think SPACs may pretty much be done anyway so we’ll all wake up one day and wonder what that was all about.

Ann Lipton | Permalink


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