The Contract Adviser

Hello Entrepreneurs!

In yesterday’s column, I started my discussion of severability provisions.  These are typically found in the boilerplate or miscellaneous provisions section of the agreement, and unfortunately are mostly overlooked by businesspeople (and even lawyers) during business contract negotiations.

As discussed, severability clauses are useful to salvage contracts that have unenforceable, illegal or invalid provisions.  One area where the issue of severability comes up frequently is non-compete provisions.

Let’s say that you are negotiating an asset purchase agreement (APA) to purchase a one-store clothing retail business from Fred.  You want to include a non-compete provision in the agreement, which will prevent Fred from competing against you for a certain period of time after the closing.  Fair enough.  In fact, non-competes can be found in most sale of business agreements, and in concept are enforceable.

Acquisition agreements like APA are typically drafted by purchaser’s counsel.  This means that the purchaser’s lawyer prepares the first draft; the seller and its attorney review and make comments and the parties go back and forth, but the purchaser’s counsel “controls” the master copy in his or her computer and makes the agreed to changes.

Let’s put aside all other APA issues, including what portion of the purchase price will be allocated to the non-compete for tax purposes.  Let's say you want to max out because you don’t want Fred anywhere near clothing retail for a good long time; you figure why not?… you’re paying good money for his business.  You want Fred to stay away from all retailing for 10 years anywhere in the world.  Your attorney correctly tells you that the case law in this area is not clear cut as to the upper limits of duration and geographic scope, but that your proposal sounds “over-the-top”, and is most likely not enforcable.  You and your attorney finally agree to pare the restriction down a bit in an attempt to ensure its enforceability.

Here is the resulting provision…

“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”

*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.

Your attorney is still concerned about the impact of the non-compete on the enforceability of the entire agreement, so he or she inserts one of the following severability provisions into the agreement.

Choice A - “If any provision of this Agreement is unenforceable, the balance of this Agreement remains in full force.”

Choice B - “If any provision of this Agreement is unenforcable, then the entire Agreement is no longer in effect and no party has the right to enforce any provision of this Agreement.”

Choice C - “If a court of competent jurisdiction finds any provision of this Agreement to be unenforcable, then such provision remains in full force to the extent not held invalid or unenforcable.”

In upcoming columns, I’ll discuss the pros and cons of each of the above, and perhaps other solutions to this problem.

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