Non-Compete Agreements (Part 2)

This article is a follow up to her article published in August on restrictive covenants between an employer and employee.

Under Minnesota law, restrictive covenants are legal and enforceable, so long as they meet certain requirements. As explained in my previous article, restrictive covenants are generally disfavored under Minnesota law because they are viewed as a restraint on trade. They will be enforced, however, if found reasonable in scope and duration. In the sale of a business, restrictive covenants are subject to less scrutiny and given greater latitude, and the requirements and the economic factors considered are different than in the employer-employee relationship.

When someone buys a business, the buyer will ask the seller to enter into a non-compete, confidentiality, and non-solicitation agreement as part of the sale. The purpose is to ensure the buyer gets the full benefit of the ‘deal’ – the intangible ‘goodwill’ the seller created in the business along with the tangible assets of the business. The relationships the business has developed with customers, vendors, and its employees are part of the value of the business. Restrictive covenants protect and preserve these relationships for the benefit of the buyer. If the seller of the business starts calling on these folks and competing with the buyer after the sale, the buyer may not realize the full value of the purchase price.

Typically, restrictive covenants included in the sale of a business can be more restrictive than those permitted in the employer-employee context. The seller and buyer of a business are considered to have equal bargaining power who are capable of hashing out mutually beneficial terms. Generally, courts will respect the terms of the contract between the two, so long as a ‘reasonableness’ standard can be met.

Minnesota courts will enforce such restrictive covenants, if they withstand the following 3-part analysis:

1. Does the restriction exceed the protection necessary to secure the goodwill purchased?
2. Does the restriction place an undue hardship on the covenantor, i.e. the seller making the promises?
3. Does the restriction have a deleterious effect on the interests of the general public?

If the answer is ‘yes’ to any of these questions, a Minnesota court may find the restrictive covenant either unenforceable or needing modification. The court will consider both the geographic and time limitations in conducting its analysis. If the court finds the restriction necessary to protect the buyer’s investment, does not impose an unreasonable restraint on the seller, and does not go against public policy, then the covenants will be upheld and enforced.

So, let’s say the restrictive covenants are reasonable and enforceable, what happens if the seller breaches them? The remedies available to the buyer for a violation of the restrictive covenants should be spelled out in the agreement. A buyer would want to stop the seller’s actions by obtaining an injunction and recover money for lost profits and other damages.

Ultimately, the facts and circumstances of the particular transaction are most important in analyzing the enforceability of restrictive covenants and determining the remedy a buyer may be entitled to. It’s important that these terms are carefully and clearly defined in a purchase agreement.

Any requests for topic suggestions may be sent to rene@breenandperson.com.  Although we cannot give you legal advice through the column, we can provide some general information that may be helpful for you to know. Our purpose is to educate and we hope that you can take something new away from this column each time you read it.