A standard inclusion in many sale of business contracts (or share sale agreements) is the promise of the vendor not to compete with the business post sale.
Whilst, generally speaking, non-compete or restraint of trade obligations in employment contracts can be notoriously difficult to enforce, in the context of a sale of business there is special reason for courts to uphold such obligations. In circumstances where a purchaser has paid good money for the right to carry on the business (and not to have to compete with the vendor) for a reasonable period after the sale, it makes sense that the purchaser enjoy some form of protection.
The enforcement of such non-compete obligations as a matter of public policy is somewhat long standing and was reiterated in the recent case of DXC Eclipse Pty Ltd v Wildsmith  NSWSC 512 where an injunction was granted to stop a former vendor competing after 4 years (where the parties had agreed to a non-compete obligation lasting 7 years).
This article is not a discussion of that decision or the case law (as that would be even more boring that reading an article about contract law!). The decision does however provoke the question of what key considerations, from a buyer’s perspective, should be taken into account when formulating post sale non-compete obligations. A basic shopping list of questions to ask are generally as follows:
- Who will the non-compete obligations apply to?
- How long should the non-compete obligations last?
- What geographic locations should be restricted?
- What type of conduct is to be specifically prohibited?
Who will the obligations apply to?
In circumstances where the non-compete obligation only applies to the vendor company, this can be problematic where the persons operating the vendor company might easily set up a new entity in order to start a competing business. Accordingly, it can be useful to rope in directors and officers of the vendor entity as well as any related bodies corporate. In addition, if there are key people in the organisation who possess intimate knowledge of business operations (and could be potential competitors themselves), it may be useful to check their contractual employment obligations during the due dilligence period to ensure they are subject to non-competition, confidentiality and preservation of intellectual property obligations.
How long is it for?
When formulating non-compete obligations, it is important to have regard to what is reasonable. This may vary depending upon the nature of the business and the potential for damage to a business’ goodwill that a vendor may cause by competing with the business post sale. Generally speaking, shorter periods are likely to be considered more reasonable. This will however depend upon the nature of the business. It is thus important to carefully balance the need to protect the goodwill of the particular business on one hand with the vendor’s need to be to free to pursue commercial interests on the other.
What geographic locations will they cover?
It is common in sale agreements for non-compete clauses to restrict competition within a geographic area. Again, the relevance of a geographic restraint will very much depend upon the business. With ever-increasing interconnectedness and the growth of truly global technology businesses, geographic restrictions can be less important. However, when say an electrical services business is being sold that derives 80% of its revenue from clients within 20km of its business premises, then a geographic restriction will be integral.
What conduct is to be restricted?
Whilst the concept of ‘competing’ with the business being sold seems relatively straightforward, it is important that formulation of the non-compete obligation is done so as to accurately capture all the types of conduct which may threaten the viability of the business. Many standard form/template sale of business contracts unfortunately fall short in this regard as they are not tailored to individual businesses and may not capture all forms of indirect competition which may potentially cause harm.
For example, in the above mentioned recent case of DXC Eclipse v Wildsmith, it was argued by the vendor that, because of the way that the ‘business’ was defined in the sale contract (and the fact that the new competing business proposed to offer different software products), the vendor was not technically competing. An issue in that case was that, whilst technically the software products were different, they could arguably serve the same purpose for potential clients. It is thus integral to ensure that a competing business as defined in the contract is not merely one offering the same products but also one that offers the same business solution or serves similar markets.
Another example of conduct which may not be caught is the making of certain announcements about an intention to compete (before the actual competition has begun) or the obtaining of employment with a competitor. In DXC Eclipse v Wildsmith, the offending conduct was the merely announcing of a competing enterprise in a LinkedIn post, rather than the actual competing (which had not yet occurred). Accordingly, a well formulated non-compete obligation should ideally cover off on preparatory conduct as well as the actual act of eventually competing.
Another type of post-sale conduct which can often cause tensions is the vendor providing consulting services to prospective competitors of the business. This of course has the potential to cause real harm in some industries and can often not be accurately covered off.
Of course, it’s important to be reasonable in not casting the net too wide in terms of conduct that is restricted but, at the same time, essential that conduct which may disproportionately affect a particular business is captured.
Prohibiting the poaching of employees, clients and suppliers through additional ‘non-solicitation’ clauses will also often be vital depending upon the nature of the business.
When purchasing a business, it is vital to obtain not only the value in the going concern but also the potential for future success. Appropriate non-compete and non-solicitation clauses play an essential role in this respect.
If you require assistance with assessing or formulating appropriate non-compete obligations in a sale agreement or assistance generally with business sales, contact Rankin Business Lawyers for practical, on-point commercial legal guidance.