Nearly any deal regarding the sale of a business includes covenants prohibiting sellers from competing with the business they just sold. Most buyers (understandably) are nervous that a seller may decide to open up a new shop in the same industry – thereby materially devaluing the purchased company. This often leads to buyers looking for noncompete restrictions with the broadest scope possible. Be wary, however, because if a buyer overreaches, the seller’s noncompete obligations can be unenforceable. In this article, I will briefly explain the laws in Colorado and Delaware regarding noncompetes in connection with the sale of a business and the potential pitfalls if the terms go too far.
Noncompetes entered into in connection with the sale of a business are only enforceable in Colorado if they are reasonably tailored to protect the goodwill of the purchased business while imposing no restrictions greater than necessary to protect the value of that goodwill. This means that the definition of competitive acts, the geographic scope and the duration of the noncompete obligations must be tailored to the specifics of the transaction.
Similarly to Colorado, noncompetes entered into in connection with the sale of a business are only enforceable in Delaware if they are reasonable in duration and geographic scope, advance a legitimate economic interest of the buyer, and survive a balancing of equities. Delaware courts generally look at similar factors to determine whether non-compete obligations are enforceable.
Both jurisdictions have held that even if a purchase agreement explicitly directs the courts to rewrite a noncompete to the extent required to be enforceable, the courts are under no obligation to do so. In a series of recent decisions, Delaware courts have refused to modify noncompetes and have instead thrown them out in full.
While it is understandable buyers want as much protection as possible when purchasing a business; they must ensure that the terms of noncompetes are reasonably tailored to protect their investment. Noncompete obligations should be tailored only to cover the seller’s industry and the locations where it had material sales, and they should only last long enough to give the buyer a foothold in the seller’s market (typically no longer than five years). Otherwise, buyers risk losing noncompete protections in full. At Fortis, we deal with these issues regularly and can help buyers find an equitable balance that passes scrutiny if challenged. Feel free to contact me with any questions.