Month: June 2014

Top Ten Pitfalls In Negotiating And Drafting Business Contracts – Part III (Noncompetition Clauses)

Welcome to the third of my ten-part series that can show you how simple-looking parts of a business deal can come back to haunt you.  Thank you for staying with it – or thank you for being a new visitor – and read about how to avoid getting into trouble, instead of how to get out of trouble.  Parts I and II, which discuss letters of intent and due diligence, can be found elsewhere in this blog.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to be said than what you will see in that article!

Noncompetition Clauses

There are multiple pitfalls here – some are easier to spot than others.

When you buy a business, you don’t want the seller to turn around and open a competing business across the street, or across the county. Or if you hire a key employee and show him the ropes, you don’t want him to take that knowledge to a competitor later on. But if you don’t have a properly-drafted noncompetition clause in your contract, don’t expect a court to protect you.

Or, if you have a noncompetition clause that covers, for example, a 50-mile radius, and the other party sets up shop 50 miles plus one block away, don’t expect a court to give you that extra block.

The bottom line here is that our free enterprise system encourages competition, so courts are not looking to restrict people from running a business or earning a living, just to protect someone else who failed to bargain for that restriction in the first place. And in some states, such as California, many of those restrictions are void even if you have them in your contract.

On the other hand, what if you are the one who is being restricted? Do you know what you are getting yourself into? If you can’t have a competitive business or employment wherever the other party does business, that might seem OK when you sign the contract. But suppose the restriction lasts for two years and during that time, the other party expands its business geographically or is bought by another company with a nationwide presence. In that case, you may be restricted far more than you had imagined.

And all of the above assumes that the noncompetition clause is valid in the first place. That is a big, and maybe dangerous, assumption.

Before you get too aggressive about imposing restrictions, remember that courts generally evaluate noncompetition clauses for reasonableness and enforceability on a case-by-case basis. If a clause is deemed unreasonably broad, then even though your counter-party signed it, a court might invalidate it – entirely! So you could find yourself worse off if you were supposed to be the protected party, or better off if you were supposed to be the restricted party, than if you had negotiated a less restrictive clause in the first place.

There are ways to deal with these issues without falling into quicksand. Attorneys who are well-versed in this complex area can advise on what restrictions courts typically allow. And there are drafting methods to avoid having the restrictions struck down in their entirety even if they are too broad. If you are in a state that does not allow noncompetition restrictions (regardless of reasonableness), you need legal advice up front about that, so you can structure the other terms of your deal to make it worthwhile, knowing that you cannot restrict competition when the contract ends.

So given all of the surprises you could encounter when you try to negotiate or enforce a noncompetition clause (or try to avoid one), don’t be surprised if the noncompetition clause of your contract turns out to be the most time-consuming one to complete.