Crafting restrictive covenants is a tricky balancing act

When selling a business, it’s important to ensure restrictive covenants are not “unduly restrictive,” says Toronto business lawyer Anton Katz.

“As a departing owner, it’s important to make sure you’re not prevented from making a living in your chosen business or profession,” says Katz, principal of Anton M. Katz Barrister and Solicitor.

A restrictive covenant is a clause within the sale agreement. When purchasing a business, for example, it’s common to want to restrict the former owner from starting a new venture in the same line of work and from poaching former clients, he tells AdvocateDaily.com.

Katz says the buyer should also pay attention to those restrictions.

“The reason they’re used is to allow the purchaser to avoid having to finance a competitor. It’s bad enough having competition — let alone financing it,” says Katz.

“The whole value of the deal would be eviscerated if one were to allow the vendor to set up shop and compete against the business or solicit its customers or employees.”

While both sides naturally want to protect their own interests, Katz says there is a happy medium.

“The happy middle ground is ensuring the restrictive covenants are reasonable and strike the appropriate balance between the vendor’s desire to make a living and the purchaser’s desire to avoid financing a competitor,” he explains.

“The answer is not to dispense with restrictive covenants but to make sure that they’re tailored appropriately to the circumstances or the exigencies of the particular situation.”

If a dentist is selling her practice, for example, and plans to open a new dental office in a town 200 km away, “she may be quite content to have a non-competition
covenant which restrains her from competing within 150 km of her former practice,” says Katz.

“And she may be quite content not to solicit the patients of the practice or the employees because she knows they won’t travel that distance. And so, it may strike the appropriate balance to have a non-comp of 150 km and a non-solicitation.”

Katz says such conditions are usually put in place for 12 to 24 months but can extend to five years in some cases.

“Beyond spatial and temporal considerations, the third factor for a non-comp is to properly define the business,” he says. “If you’re the purchaser, you want to define the business as broadly as possible, and if you’re the vendor, as narrowly as possible.”

If you’re a chiropractor, for example, the covenant may only specify chiropractic work, which would allow the former owner to sell medical items related to the
practice or to perform massage therapy, Katz says.

“Another drafting consideration is to stipulate a remedy for breach of the restrictive covenants, which allows the purchaser to seek an injunction and maybe seek
liquidated damages. So, in the chiropractor example, for every patient that is stolen, the vendor has to pay a certain amount — $1,000 or $5,000, — or the value of services given to the patient during the restricted time — provided that these are a genuine pre-estimate of damages and are not a penalty.”

Katz says such agreements are “ubiquitous to the point of being almost standard” in the sale of a business. The trick is finding the right balance to protect the interests on both sides of the sale.