M & A Roundup – Non-Competes Are A Hot Area of Litigation

It doesn’t pay to overlook the details of non-compete agreements, employment lawyers told M&A magazine recently, in what is often a rush to close a merger or an acquisition. “This is a hot area of controversy and litigation,” said Stephen Kayman, who practices employment law at the New York firm of Proskauer Rose LLP. “Whatever side of a transaction you’re on, it’s important to think through any non-competes because they’re generating more and more lawsuits.” In general, non-compete agreements prohibit employees and sellers of businesses from engaging in any post-employment activity that would compete with their previous employer or enterprise. Common elements of non-compete agreements include stipulations that cover duration, industry sector, and geographic limits. The most common element is a time constraint that can vary from six months to five years, with one or-two year periods being fairly standard. More elaborate clauses tend to be inserted in business owners’ or other senior management non-competes. “If you buy somebody’s business, part of the transaction is the goodwill that accompanies it, and you want to protect that with your non-competes,” said Neil Mullin, a specialist in employment law at Smith Mullin, Montclair, N.J. Variations in judicial approaches Kayman said there are three basic types of non-compete agreements: those that apply to the owner or senior management of a business that is being sold, those that are part of other employees’ contracts, and those that apply to other types of commercial relationships with the business, such as distributors or independent contractors. This third type differs from the first two because it applies to people who aren’t employees of the company per se. The enforcement of non-competes by the courts is not a given but varies according to jurisdiction and other factors. Ranked by type, Kayman said courts are most willing to enforce non-competes when they involve the seller or a senior executive of a business. Second most likely to be upheld are non-competes that involve independent contractors. Least likely are contracts that are applied to other employees of a company that is changing hands. Although Kayman said that individual employee non-competes are more difficult to enforce, they still play a role in m&a situations because as companies consolidate, they tend to create redundancies. “When there’s a merger or an acquisition, it often triggers non-compete clauses in an employee’s contract,” said Mullin. The New Jersey-based attorney agreed that the weakest of all employee non-competes are those that cover workers below a company’s upper echelon. “Often employees are given a pile of forms to sign when they are hired and these boilerplate non-competes can be hard to get upheld.” Interestingly, Kayman said that even in the absence of a formal non-compete, some courts have held that business owners have an implicit obligation not to compete. The basis of this type of passive competitive restraint is that someone who sells a business has an obligation not to take back or make less valuable what he or she sold. The role of part owners of a business is frequently a grey area, Kayman noted. In most states, non-competes apply to partial owners, although the terms of the agreement are normally not as broad as for owners. In all, Mullin said that non-competes are a valuable piece of any acquisition because if they have reasonable limits on time, courts do enforce them. On the other hand, he added, the judicial system does understand that a past business relationship shouldn’t be used to restrict someone’s business options “for the rest of their lives.”