January 24, 2023
Non-Competes: Executive Comp Implications of FTC’s Proposed Ban
The implications of the FTC’s proposed ban on the use of non-competes could have a very significant effect on executive compensation programs. This Morgan Lewis memo considers how the ban might affect equity compensation, tax considerations and other comp-related matters. This excerpt discusses the potential impact of a non-compete ban on golden parachute payments under Section 280G of the Code:
Under Section 280G of the Internal Revenue Code (Code), a corporation will be denied an income tax deduction on any “excess parachute payments” made to certain executives in connection with a change of control, and the executives receiving such excess parachute payments will be subject to a nondeductible 20% excise tax penalty, in addition to regular federal and state income tax. One of the primary exemptions that companies use to exempt compensatory payments from treatment as a parachute payment is by establishing by clear and convincing evidence that such payment is reasonable compensation for services to be provided after the change in control (which includes refraining from providing services due to an enforceable noncompete covenant).
To the extent that covenants based on noncompete clauses are unenforceable under the proposal, a significant tool used to reduce parachute tax penalties will cease to be available, potentially increasing the cost of impacted transactions. This is particularly an issue for public companies that are unable to use private company shareholder votes to cleanse 280G issues with respect to compensation that would otherwise be a parachute payment.
To further complicate matters, the memo highlights the fact that the current proposal doesn’t exempt completed transactions that have relied on noncompete covenants in 280G calculations. So, if the proposal is adopted in its current form, companies that recently closed deals might need to rerun 280G calculations to remove reliance on noncompete covenants to reduce the value of parachute payments and reevaluate their 280G tax position.
– John Jenkins