Restrictive Covenants, Like 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.
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 to ensure that the buyer and sellers get the benefit of their respective bargains.
The purpose of these covenants is to ensure that the assets and value purchased (both tangible and intangible) are not diminished due to 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, the parties to the sale should consider covenants that are carefully defined and limited in the operative sale documents.
Though this article does not address the interpretation of these issues on a state-by-state basis as this article would become a treatise, generally, covenants associated with the sale of a business are enforceable provided that they are reasonable in scope, 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 by way of “blue-penciling.”
Parties should be equally as concerned with the proper drafting of confidentiality provisions. As all parties want to ensure the protection of the proprietary assets and trade secrets of a business, this covenant often has no time limit associated with it. A seller should carefully review the confidentiality provisions to ensure that they cannot be used as a back-door non-compete clause to indefinitely squelch competition.
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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 the largest asset of a business. Further, regardless of jurisdiction, the laws regarding their enforceability frequently change. Thus, it is crucial to speak with an attorney experienced with drafting and interpreting these covenants and handling business transactions. Proper communication regarding business terms and expectations between a seller and its lawyer will assist in making sure that the transaction documents are thoughtfully drafted to capture the expectations of the parties going forward after a sale.
Christian Jensen, Esq., guest author, is a partner of the firm OlenderFeldman and focuses his practice in the areas of complex commercial litigation and intellectual property litigation, including shareholder, member, and partnership disputes; disputes concerning restrictive covenants (including non-competition, non-solicitation, and confidentiality/trade secret provisions); insurance disputes; response and resolution of data/security breaches and privacy issues; business and consumer fraud; employment disputes; and construction claims. Christian has experience representing clients of all sizes, including start-ups, and he represents clients in state and federal courts at the trial and appellate levels, as well as in various alternative dispute resolution forums (including as insurance panel and local counsel).
Accelerated Manufacturing Brokers, Inc., is excited to have Christian Jensen as a guest author and you will see more of his articles in the future. If you have legal questions related to the purchase, sale or operation of a business (including M&A/corporate, employment, litigation, real property or intellectual property issues), please contact Christian Jensen, Esq. of OlenderFeldman LLP, firstname.lastname@example.org; (908)964-2446. The firm handles transactions and legal issues for businesses and owners throughout the nation.