The Contract Adviser

Hello Entrepreneurs!

In this series of columns, we're looking at the impact of including severability language on a non-compete provision.  In my hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to a non-compete provision in the asset purchase agreement (APA).  In the first of these columns (October 1st column), I present a choice of three severability provisions - Choice A, Choice B and Choice C. 

Again, here is the hypothetical non-compete 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.

Today, let's look at an commonly found alternative to Choice C (discussed in my previous column).

Here is Choice C.

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

“In the event a court finds this non-compete provision unenforceable as to geographic scope or duration, then the court has the power to reduce the geographic scope or duration to the extent necessary to render the provision enforceable.”
 
Like Choice C, Choice D also works to salvage the non-compete provision if a court finds it to be overreaching in scope (that is, in duration or geographic scope).  And Choice D similarly allows a court to easily substitute a shorter duration if it finds that three years is too long.  It can replace “three (3)” years with, for example, “two (2) years” without changing the sentence structure.  If the court finds that 15 miles is too large in geographic scope, then it can replace “15 miles” with, for example, “5 miles”.  If you look closely, however, Choice D doesn’t cover the situation where the non-compete overreaches in terms of the scope of activity or other problems that a court may find with the non-compete provision.  Keep in mind also that Choice D is typically found directly in the non-compete provision (because it's intended to cover only problematic non-competes).  You’ll still need to have severability language in the boilerplate section of the agreement to cover the rest of the agreement.  Make sure your attorney confirms to you that the severability provision (typically one of Choice A, Choice B or Choice C) in the boilerplate section isn’t internally inconsistent with the Choice D language in the non-compete provision.

Good hunting.

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Hello Entrepreneurs!

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Hello Entrepreneurs!

In this series of columns, we're looking at the impact of including severability language on a non-compete provision contained in an asset purchase agreement (APA).  In my hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to a non-compete provision.  In the first of these columns (October 1st column), I present a choice of three severability provisions - Choice A, Choice B and Choice C.  In yesterday’s column, we looked at the impact of Choice A.

Today, let's look at Choice B, as follows...

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.”

Again, here is the hypothetical non-compete 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.

Truth be told, an asset purchase agreement is not the best hypothetical to use for Choice B because the sale of a business is not an on-going transaction.  Except for the non-compete, maybe a brief consultancy period, the survival of certain indemnities, and confidentiality obligations, the Seller and the Purchaser pretty much go their separate ways after the closing.  Choice B would have the court unravel the entire transaction if it finds any part of the non-compete unenforceable.  A court-ordered unravelling (in legal parlance, a "recission") of the asset purchase agreement (where the court makes Fred buy the business back) is highly unlikely, and in fact may not be desired by either party.

Choice B is not a great solution in general.  Here's why... most contracts have provisions that remain in effect (in legal parlance, "survive") after the contract's termination or expiration.  In fact, I've listed above some of the surviving post-closing provisions of the asset purchase agreement - things like confidentiality, etc.  Confidentiality is the kind of obligation most businesspeople want to maintain even after a business relationship is terminated (or gets unravelled).  So, the mostly negative impact of Choice B can best be summed up by this rhetorical question - do you really want your severability provision to undo the entire agreement, even provisions like confidentiality, which were meant to survive no matter what?

Hello Entrepreneurs!

In yesterday’s column, I offered three possible choices of severability language to include in a hypothetical asset purchase agreement.  In the hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to the following non-compete 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.
 
Let’s say that within 1 and 1/2 years, Fred starts another clothing retail store within 12 miles of the Retail Store.  You go to court to enforce the non-compete.  As luck would have it, now that Fred’s taken your money, he and his attorney will try to argue that the non-compete is not enforceable.  A court could agree; it could find any number of legal problems with the non-compete provision.  First, three (3) years might be too long.  And while the restriction against activities in clothing retail seems reasonable, the case law in your particular jurisdiction may favor less stringent geographic restrictions, for example, a 5 to 10 mile radius (maybe even 1 mile for dense urban areas).  In other words, there’s a chance the court might rule that the 15 mile radius is overly aggressive and not enforceable.
 
What is the impact of including severability provision Choice A in the agreement?
 
“If any provision of this Agreement is unenforceable, the balance of this Agreement remains in full force.”
 
By adding Choice A, you are inviting the court to completely sever (akin to physically redacting) the offending provision from the contract, and to enforce the balance of the Agreement.
 
If the court ultimately rules that the 15 mile radius is unenforceable, and agrees with the parties’ stated intent as reflected in severability provision Choice A, then it would treat the non-compete provision as though it was not in the APA, and enforce the rest of the APA.  You could try to argue that the balance of the APA should not be enforced either (i.e., that the entire contract should be void), but a court probably won’t buy that argument unless you can convince the court that striking the non-compete undermines the main purpose of the deal.  This is a bit of a stretch, but maybe you can attempt to argue that voiding the non-compete messes up the purchase price allocation of the APA for tax purposes, but I think most people who buy and sell small businesses do so for strategic, rather than purely tax purposes.   Note that it's a business decision, of course, whether you'd want to go for a rescission (i.e., an unraveling of the entire transaction) - except for the non-compete issue, things may be going very well for you with your new business.  In any event, it’s been a whole year and a half, so it’s not likely the court would rescind (unravel) the transaction and make Fred buy the business back.
 
Bottom line - With Choice A, Fred stands a good chance of being able to set up shop and compete despite the non-compete provsion.
 
We’ll examine Choice B and Choice C in upcoming columns.

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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.

For more information about me, or to contact me directly, please leave a post or visit ContractAdviser.com

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