Non-Compete Agreements Related to a Sale of Business

Originally published by Leiza Dolghih.

In Texas, a 5 to 10 year non-compete agreement related to a sale of business is the norm.  Business owners often gloss over the terms of the non-competes when selling because the idea of starting another business similar to the one they just sold for millions of dollars seems very far-fetched at the time the sale closes.  But that is a mistake.

In addition to the non-compete restrictions in the sale documents, those sellers who stay employed by the buyer after the sale often sign a second non-compete agreement as part of their employment package, which does not kick in until after their employment with the buyer terminates. Again, quite frequently, not enough attention is paid to the specific restrictions in those agreements as the sellers are typically distracted by a hefty sale price.

However, the excitement of a sale often fades away within a few months or years, as the former owners are let go by the new owners of the company or they become disillusioned with the new ownership and quit. And if they did not accept employment with the new owner, former owners may begin to miss the industry in which they had become successful in the years (and maybe decades) leading up to the sale, and the itch to open a similar business, capitalize on old relationships, and re-create the success of the business they recently sold may become too strong to resist.

This is where the sellers usually takes a closer look at the language of their asset purchase agreement and employment agreements related to the sale to decipher what restrictions they actually agreed to.  And it is at this juncture that many conflicts between the sellers and the buyers arise, sometime resulting in an expensive litigation related to the scope of the non-compete restrictions.

General Rules Regarding Non-Compete Agreements in Texas

In a nutshell, non-compete agreements in Texas must be tied to a legitimate business interest and must be reasonable.  For example, a business that sells cars should not have a non-compete prohibiting the former owner from selling bicycles.  Similarly, if a business operates locally, a non-compete restriction that covers a territory outside of the area where the business operates would be unreasonable.  Such overbroad non-compete agreements typically get reformed in court, which is an expensive way of fixing an overbroad non-compete restraint since it involves litigation.

An Example of a Non-Compete Clause in an Asset Purchase Agreement

A typical non-compete clause included in an asset purchase agreement between a seller and a buyer of a business may look something like this:

7.1 Limitations. As a material inducement to Purchaser to enter into this Agreement, each Seller Party covenants and agrees to the following: (a) Restrictions. For a period of five (5) years beginning with the Closing Date (the “Restriction Period’), such Seller Party shall not, and shall not permit any of the Affiliates of such Seller Party to, directly or indirectly, either alone or in association or in connection with or on behalf of any Person now existing or hereafter created (except on behalf of Purchaser, or the Group or any of their Affiliates): (i) be or become engaged in, or participate in, the business of designing, developing, assembling, manufacturing, producing, testing, delivering, installing, marketing, selling or providing circuit solutions, power system and control semiconductor devices or designs (including firmware), reference designs as related to semiconductor devices or products, or semiconductor products for low power energy harvesting, solar power, wireless charging, isolated switching or any other power management application (“Restricted Business”) anywhere in the world (the “Restricted Area”), including being or becoming, directly or indirectly, an organizer, owner, operator, investor, lender, lessor, partner, joint venturer, equityholder, officer, director, employee, manager, representative, associate, advisor, consultant, or agent of, in, to or from any Restricted Business (including by virtue of holding any beneficial interest, or serving as a trustee or in a similar capacity, in any Person that is, directly or indirectly, any of the foregoing or otherwise engaged in any Restricted Business) . . .

Importantly, a non-compete clause in an asset purchase agreement will usually define what business is considered to be a “competing” business, what geographic area is covered, and how long the non-compete restraints will remain in place.

Considerations for a Buyer of a Business

One of the key considerations for a buyer in a non-compete clause is the scope of the prohibited activities and making sure that it is broad enough to include any possible competitive activity that the seller may decide to engage in after the sale, but is narrow enough to be tied to a legitimate business interest of the purchased company.  Going back to the earlier example, a business that sells cars may consider reasonable to prohibit the marketing of cars or repair of cars, if those are parts of the existing business, but it cannot prohibit bicycle sales.

A buyer should also put significant thought into what will be a reasonable geographic area for a non-compete agreement given the type of the business, the location of the clients, and other factors that may influence competition.  Asking for more than what a business needs to protect itself from unfair competition from the seller may backfire in the form of a lawsuit where the seller argues (yes, even after agreeing to the non-compete) that the geographic area to which he or she agreed is broader than necessary to protect the business and should be reformed by a court.

For example, most recently, a Texas Court of Appeals reformed a non-compete agreement related to a sale of a chain of grocery stores finding that at 10-mile radius from each location was unreasonably broad and reducing such radius to three miles, even though the seller and the buyer had originally agreed to a 10-mile radius.

A buyer should also vet with its legal team any anti-trust issues that may arise out of any non-competition restraints that are rolled into the purchase of a business. The U.S. Federal Trade Commission (FTC) has recently brought two cases alleging that noncompete and no-poach clauses contained in acquisition agreements violated antitrust laws.

Considerations for a Seller of a Business

If a seller does not intend to retire after the sale, he or she should make sure that any future business plans are clearly excluded from the non-compete restrains.  For example, a seller of a company that makes burgers could possibly want to create a vegan burger company after the sale.  Would a vegan burger business be a competitor to a regular burger business? Anyone operating a McDonalds or a Whataburger would tell you “no.” But could a buyer of the company take a position that operating a vegan burger business violates a prohibition on an operation of a “competing business” after the sale? It is possible.  Thus, it is upon the seller to make sure the scope of a non-compete agreement is as narrow as possible and specifically carves out those industries or businesses that the seller believes should not be covered by the non-compete.

BOTTOM LINE:  In a sale of business, there is a real risk to both the buyer and the seller that if a non-compete provision is not written correctly and is either too broad or too narrow, one of the parties will have to engage in litigation involving that provision within a few years of the sale. Thus, both parties should spend a significant amount of time contemplating, discussing and making sure that they understand the agreed-upon non-competition restraints that end up in the sale documents, and that such restraints are written clearly.

Leiza Dolghih is a Labor and Employment Board Certified partner at Lewis Brisbois Bisgaard & Smith LLP in Dallas, Texas and a Co-Chair of the firm’s Trade Secrets and Non-Compete Disputes national practice. Her practice includes commercial, intellectual property and employment litigation. You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108.

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

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