“Buyer Beware: The Importance of Non-Competition Agreements” by John L. Waite III
Evaluating and negotiating the purchase of any business today requires a discussion of the company’s goodwill, which is partially defined by Black’s Law Dictionary as an indicator of a company’s “good customer relations, high employee morale, a well respected business name, etc. which are expected to result in greater than normal earning power.”
Goodwill is a difficult concept to quantify, and therefore, equally difficult to protect when buying a business. Take for instance a lawn care business that has an established and respected name within the community and an equally established clientele. What happens when the seller decides to open another lawn care business only weeks after selling the prior business to you? And is using his prior relationships and the contact list he kept to “steal” the clients you expected to service, and which provided the accounts receivable history that was relied upon to negotiate the company’s purchase price. Furthermore, the seller is hiring your best employees. What now?
The good news is that under Missouri law, and unlike the employee/employer context, non-competition agreements (also known as covenants not-to-compete) that are ancillary to the sale of a business are entitled to “substantially greater liberality in their enforcement.” See Hinderer, Covenants Not-To Compete, 41 Missouri Law Review 37, 44 (1976). The protection of a business asset, such as goodwill, customer lists, or contacts, can be accomplished through an appropriate non-competition agreement and should be commonplace in the purchase of an on-going business. Essentially, a non-competition agreement can be crafted to ensure that a seller does not improperly compete with the buyer or otherwise solicit the clients or even employees from the business that was sold.
In the prior example, had a non-competition agreement been utilized, the buyer could have prevented the seller from reentering the lawn care business for an appropriate period of time, thereby allowing the buyer to build his/her own relationships with existing clients and employees. Missouri courts recognize that “the spatial and time limitations required in covenants not to-compete accompanying the sale of a business are designed in part to protect the buyer from the seller’s encroachment on the goodwill transferred in the sale.” See Schnucks Twenty Five, Inc. vs. Bettendorf, 595 S.W.2d 279, 285 (Mo.App. E.D. 1979). Furthermore, where a covenant is given in connection with the sale of a business that is a service provider, the covenant itself is an asset of the business and is a material part of the purchase transaction. See Orthotic and Prosthetic Lab, Inc. vs. Pott, 851 S.W.2d 633, 643 (Mo.App. E.D. 1993).
Another interesting legal opinion comes from the Western District of Missouri Court of Appeals where the buyer of a funeral services company executed a promissory note, payable to seller, in the amount of $100,000 as consideration for the seller’s covenant not-to compete, separate and apart from the purchase of the company’s other assets. Within the terms of the non-competition agreement was a provision that provided for the forgiveness of the buyer’s payment obligations under the note in the event that seller breached his covenant. See Horizon Memorial Group, LLC vs. Bailey 280 S.W.3d 657 (Mo.App. W.D. 2009). The Appellate Court upheld the provision and relieved the buyer from approximately $80,000 that was still owed under the note.
The damages caused by or associated with a seller’s breach of a non-competition agreement are difficult, if not impossible, to determine at the time such an agreement is executed. And is a textbook example of the importance and purpose of a liquidated damages provision within a covenant not-to-compete.
The significance of non-competition agreements cannot be overstated and must be given appropriate consideration when negotiating the purchase of an on-going business. The use of non-competition agreements go hand-in-hand with the traditional documents involving the purchase of a business, especially those businesses that are service oriented. Such agreements should not be trivialized nor based upon a “form” agreement, but instead should be given extra and specialized attention.