Some jurisdictions, including California, permit only post-acquisition non-competes, in order to protect a purchaser’s interest in capitalizing on acquired goodwill for a limited period. If parties to an APA anticipate that the vendor may be employed by the purchaser, and the vendor resides in or the contract has a significant connection to a jurisdiction which prohibits or discourages non-competes on the grounds of public policy, the non-compete should be included in the APA.
In Ascension Ins. Holdings, LLC v. Underwood (January 28, 2015), the Delaware Chancery Court declined to enforce a non-compete contained in an employee investment agreement, despite the choice of Delaware as the governing law, where the employee lived and worked in California, and the geographic restriction of the non-compete applied to California. The plaintiff and defendant had entered into an asset purchase agreement for assets in California. This agreement did not contain any restrictions on competition. The parties subsequently entered into an employee investment agreement, which contained a non-compete.
In California, Section 16600 of the Business and Professions Code prohibits noncompetition covenants. Such prohibition is subject to narrow statutory exceptions such as Section 16601, which permits a person who sells the assets and goodwill of a business to be subject to a noncompetition covenant.
Despite that the contract specified a Delaware choice of law clause, the court declined to enforce the non-compete, because there was evidence that the parties had not discussed a non-compete at the time of the APA, and therefore the rationale for protecting the purchaser’s bargained-for interest in the goodwill of the business did not apply to the situation.
Takeaway:
- When considering an asset purchase followed by an employment contract with the vendor, any non-compete restrictions should be included in the APA so that it is therefore included as part of the sale of business consideration.