Restrictive Covenant Agreements
A Restrictive Covenant Agreement (“RCA”) is a common and important Agreement entered into to govern the rights and obligations of departing employees and shareholders.
As a corporate lawyer, I most often review and draft these in the context of a sale of a business – whether by the way of assets or shares.
A purchaser will not want to acquire a business only to finance a competitor. Much of the value of a business is its established relations with employees and customers. In the absence of an RCA, and depending on the circumstances, a departing shareholder may be entitled to set up shop and compete against the business, solicit its customers and employees and (mis-)use confidential information.
Considerations are different in the case of a non-owner employee who departs. In such instances, the courts have permitted competition but, depending on the employee’s fiduciary status, not solicitation.
In the case of an arm’s length sale of a business, the vulnerability of a departing shareholder (who may or may not be an employee) is far less apparent and the need for court protection accordingly less necessary. In such circumstances, it is imperative to have the party enter into an RCA.
RCA’s typically address three considerations: competition, solicitation and confidentiality.
The non-competition section of an RCA will preclude competition against the business (as defined) for a period of time and within a certain geographic radius.
The non-solicitation portion will enjoin solicitation of customers/clients/patients/employees for a period of time. Care must be taken to define the scope. For example, the Agreement might provide that a client is anyone who purchased from the business within the six months prior to the completion of the agreement of purchase and sale.
The confidentiality section will seek to define “confidential information”, either broadly or specifically, require that documents, including in electronic form, be returned, and provide that such information cannot be used by the departing shareholder.
The RCA will typically provides remedies for breach, including damages and an injunction. In the case of damages, a formula may be prescribed: for example, a certain dollar amount for every customer poached.
RCAs are a critical consideration in the sale of many, if not most, businesses and should be drafted or reviewed with the assistance of seasoned corporate counsel.
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Disclaimer: This article is for informational purposes only and does not provide legal advice, nor does it create a solicitor-client relationship with you or any other reader.