The sale of a company usually comes with its goodwill. In fact, in many cases goodwill is the crown jewel of the business.
The last thing a buyer wants, is to pay top dollar for the business only to have the seller’s owner after the closing start competing against the business. Therefore, the buyer wants the seller’s owner to agree to not compete for several years against the business. And so, the seller’s owner usually signs a covenant not to compete.
This case involved the $4 million purchase of the stock of a Fresno, California based trucking company that hauls nuts, wine and retail imports from the West Coast; operating mostly in California, but also Oregon and Nevada.
As part of the deal the owner, a California resident, promised not to compete in the trucking business anywhere in the United States for about 5 years.
The owner worked for the buyer after the closing. However, a dispute between the buyer and the owner broke out over the amount of the deal’s earn-out amount. This resulted in litigation and buyer terminated the owner’s employment.
The owner then went to work for a competitor during the 5 year noncompete period.
The buyer went into a California federal district court to stop the owner from working for the competitor. The owner challenged the legality of his noncompete.
The first battle was over which state law would apply to the noncompete. This is a “choice of law” dispute.
The choice of law language in the stock purchase agreement (which contained the owner’s noncompetition covenant) said that Delaware law applied. The buyer pushed for Delaware law because of California’s more restrictive law on the enforceability of non-competes.
The court held that the more favorable noncompetition law of Delaware would not apply to this case because the sold business was a California business; the owner was a California resident; and California has a strong public policy against enforcing agreements that restrain employment.
However, California does enforce noncompetition covenants given by the seller of the stock of a company to the extent necessary to protect the company’s goodwill purchased by the buyer from the seller.
The owner however, argued that the noncompete was unenforceable because it overreached. Specifically, the noncompete prohibited the owner from working in trucking nationwide, most of which was outside the sold company’s market area of California, Oregon and Nevada.
The court agreed with the owner that the noncompete was unenforceable as written. However, the agreement authorized the court to reform the noncompete by restricting the noncompete area to California, Oregon and Nevada, the area necessary to protect the good will of the purchased business. This the court did; thus, saving the enforceability of the noncompete.
This case is referred to Roadrunner Intermodal Services, LLC v. TGS Transportation, Inc., Nos. 1:17-cv-01207-DAD-BAM, 1:17-cv-01056-DAD-BAM (consolidated), United States District Court, E.D. California, (March 28, 2019)
The buyer was lucky here. The court once it decided California law applied could have declared the noncompete unenforceable and refuse to reform it by limiting the noncompete area to the 3 West Coast states.
The lesson is to not be aggressive in defining the noncompete area. Often buyers include all the buyer’s market area; even if buyer’s market area is much larger that the target’s market area. Doing that risks losing the benefits of the entire noncompete. And you can’t depend upon the court to save your bacon by reforming the noncompete.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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