How non-competition clauses and other restrictive covenants can materially affect an M&A transaction.
How Restrictive Covenants Can Impact Manufacturing M&A Transactions
Restrictive covenants, including non-competition clauses, can have a material impact on M&A transactions.
Though often under-considered and under-utilized in the day-to-day operation and management of a business and its human capital, the frequently linked triad of restrictive covenants—(1) non-competition; (2) non-solicitation/anti-raiding; and (3) confidentiality—come into sharp focus and consideration in connection with the prospective sale or purchase of a business.
Understanding the Three Key Restrictive Covenants
From the perspective of an acquirer, non-competition clauses protect against competing businesses, non-solicitation/anti-raiding clauses protect the clients and employees of a business, and confidentiality clauses protect company property and information.
Though restrictive covenants should be carefully crafted and seriously considered at all times and stages in the life of a business, there are heightened concerns and strategies that must be addressed when restrictive covenants are involved in the purchase or sale of a business. Careful consideration helps ensure that both the buyer and seller receive the benefit of their respective bargains.
Protecting the Value of the Business After Closing
The purpose of these covenants is to ensure that the assets and value purchased—both tangible and intangible—are not diminished due to the post-closing actions of a seller.
In a simple example, the value of a metal fabrication business would be significantly diminished if, the day after closing, the seller of the business set up shop across the street and called upon the very Rolodex of clients and customers that made up the revenue and goodwill purchased by the buyer.
Thus, to allow the buyer to conduct the acquired business in the same manner following the transaction, the parties to the sale should consider covenants that are carefully defined and appropriately limited in the operative sale documents.
Scope, Duration, and Enforceability Matter
Though this article does not address the interpretation of these issues on a state-by-state basis—as doing so would turn this article into a treatise—generally, covenants associated with the sale of a business are enforceable provided that they are reasonable in scope and duration and serve a legitimate business purpose.
Covenants that are too broad in scope, time, or geography may not be enforced or may be narrowed in their application by courts through a process sometimes referred to as “blue-penciling.”
Confidentiality Provisions Require Equal Attention
Parties should be equally concerned with the proper drafting of confidentiality provisions.
Because all parties want to ensure the protection of the proprietary assets and trade secrets of a business, this type of covenant often has no time limit associated with it. A seller should carefully review confidentiality provisions to ensure that they cannot be used as a back-door non-compete clause to indefinitely squelch competition.
There Are No Bright-Line Rules
It is crucial to recognize that there are no bright-line rules with respect to restrictive covenants, whether analyzed in connection with the sale of a business or in human capital management to protect employees, which are often among the largest assets of a business.
Further, regardless of jurisdiction, the laws regarding the enforceability of restrictive covenants frequently change.
For that reason, it is crucial to speak with an attorney experienced in drafting and interpreting these covenants and handling business transactions. Proper communication regarding business terms and expectations between a seller and its lawyer will help ensure that the transaction documents are thoughtfully drafted to capture the expectations of the parties following a sale.
About the Guest Author
Christian Jensen, Esq., guest author, is an experienced business attorney and litigator whose practice includes complex commercial litigation, intellectual property matters, shareholder, member and partnership disputes, restrictive covenants, employment matters, business transactions, and other legal issues affecting business owners.