Every day businesses across the country merge and consolidate their operations.  If your business acquires or merges with  another business, consider these issues when drafting the agreements to make sure that you will get the benefit of your bargain.

 1. Require a non-compete agreement: First and foremost, you’ll want to prevent the owners of the acquired business from competing with you by requiring restrictive covenants.  Without a restrictive covenant, the former owners can simply set up shop and compete with you immediately after selling you their company.  In drafting the restrictive covenants, consider not only what type of restrictions will protect you, but also what the courts will find enforceable.  In general, the prevailing test for enforceability in the sale of business context is reasonableness.  For example, if the business operated nationwide, then courts will be more likely to find that a nationwide provision prohibiting competition is reasonable.  However, if the company operated in a more limited area, then it may be unreasonable to demand a nationwide restriction and you may want to be more circumspect in the extent of the restriction.  Either way, it is advisable to include language in the agreement indicating that the company operated in a certain geographic area and that the seller acknowledges that a restriction covering that area is reasonable and necessary.

2. Be specific: When drafting the noncompete portion of the deal you should carefully define the prohibited activity.  Consider how the seller could hurt your business in the future and make sure that you draft the noncompete agreement to prevent activities that would enable the seller to resume activities that would harm the company.  This is normally done by delineating prohibited activities, which should include the seller not only acting as an employee in a competing business but also being affiliated with, controlling or having an interest in any competing business. 

3. Address key employees:  Are any of the principals of the business you’re buying going to continue on as employees?  If so then you will want to have two different agreements: one for the sale of the business and an employment agreement for key individuals.  Make sure that the provisions in these agreements begin to run from the right dates.  The purchase agreement should include restrictive covenants that begin to run from the closing date and the restrictions in the employment agreement should begin to run from the date that the employee’s employment terminates.  This will ensure that you are protected even if the noncompete associated with the sale of the business has long expired when the key employee resigns.  (See Non-competes in Fixed Term Agreements: Special Care Required).

4. Indetify value:  Don’t forget where the value of the deal lies.  While you will likely want the sellers and upper management to sign restrictive covenants, consider whether the company would lose a lot of its value if other employees left after the sale.  It may be that the real value of the company is in its sales force or research and development employees.  If so, consider having those employees sign restrictive covenants in connection with the purchase of the company.  In some cases, it might even make sense to offer those employees incentives to sign the restrictive covenants instead of jumping ship.

5. Include an agreement not to recruit employees:  Do the principals of the prior business have relationships with other employees?  If so, you may want to also include provisions in their employment agreements providing that they will not solicit, recruit or even hire other employees for a period of time after their employment ends.   If the benefit of the deal includes the employees, you don’t want the seller to act as a pied pier and lead these valuable employees away.

6. Address assignability:  Who will have the right to enforce the restrictive covenants in the future?  You may think that this should not matter to you but the restrictive covenants are important assets of your business, and you need to make sure that you will obtain the value of those assets if you decide to sell your business someday.  Therefore, any successor companies must be able to enforce the covenants and protect the business.  Add language indicating that the agreement is automatically assigned to a successor upon merger or acquisition to increase the likelihood that it will be enforceable.  (See Employee Retention & Attrition in Mergers/Acquisitions)

7. Don’t undermine your protectable interests:  Make sure that other aspects of your deal do not undermine the enforceability of your restrictive covenants.  For example, restrictive covenants in the sale of a business context are generally enforceable to protect good will.  It would undercut the claim that you needed protection of goodwill if your term sheet indicated that the value of the goodwill being purchased was zero. 

8. Make sure agreements are between the appropriate parties: What is the structure of the deal?  You will want to consider the structure because this can affect how the agreements are constructed.  For example, if the company being purchased will be merged into the buyer, then make sure that the employment agreements are between the individuals and the purchaser.  However, if the company will remain a separately existing entity, then those agreements should be with that company. 

9. Protect confidential information:  Don’t forget to protect confidential information and trade secrets.  In many sales, the information being purchased is a key element, but how to protect that information is not carefully considered.  This is surprising given that the misuse or disclosure of that information can do a lot of damage.  Make sure that the sale agreement provides that confidential information and trade secrets will not be “used or disclosed” after the sale.  Also make sure that you broadly define the confidential information that adds value to the business, but do not be gratuitously overbroad.

10. Draft agreements with teeth:  Finally, make sure that your agreements have teeth.  If the seller violates the restrictive covenants and you have to take steps to enforce his or her obligations, make sure that you have included an attorney’s fees provision so that the seller will have to pay the fees and costs that you had to incur in bringing litigation to stop competitive activities.  Also include terms providing that the seller agrees to injunctive relief – essentially a court order requiring that the competitive activity cease – if the provisions of the agreements are violated or there is a reasonable belief that they have been or will be violated.  This will help ensure that you do not have to pay more money to get the benefit of your deal.

Purchasing another business can be a great way to increase your market share, consolidate resources or buy out the competition.  However, you should consider these issues when crafting your deal so that you obtain all of the benefits of your new purchase.  For additional issues to keep in mind when drafting restrictive covenants, see Top Ten Things to Consider When Drafting a Non-compete Agreement.

Susan Guerette is a partner in the Employee Defection & Trade Secrets Practice Group at Fisher & Phillips.  Susan has litigated departing broker matters for nearly fifteen years.  To follow Ms. Guerette on LinkedIn, click here.

Previously, we have written about the Top Ten Things to do When an Employee Resigns to Join a Competitor and the Top Ten Mistakes Made by Departing Employees.  Given the favorable feedback, we continue with the following Top Ten Things to Consider When Drafting a Non-Compete  Agreement. 

1. Tailor restrictions to the jurisdiction in which employees work or reside.   In some states, an overly broad non-compete clause can be fatal because courts will refuse to enforce the entire agreement even if the non-compete is slightly overbroad.  In other states, courts will “blue pencil” overly broad provisions (i.e., simply strike the offending language).  Still, other state courts will modify overly broad language to make it enforceable.  If you are drafting agreements in a multi-jurisdictional context, generally a handful of versions – a few for “problem” states and others for “typical” states – will account for most variations in the law.

2. Include choice of law & venue provisions.  Many employers are tempted to choose the law and venue of the state where they are incorporated or headquartered.  If this requires the application of law contrary to the public policy of the state where the employee works or resides, or if it requires an employee to defend an action far from home, these provisions may not be honored.  In many instances, tying the choice of law and venue provisions to the state where the employee works or resides is a good choice because it may spread the risk of negative court decisions and minimize the chance that the choice of law or venue provision will be rejected. 

3. Tailor the contract to the employee’s position.  A common refrain among courts is that a non-compete or non-solicitation agreement must be no more burdensome than necessary to protect a legitimate interest of the employer.  Legitimate interests commonly recognized by courts include confidential information, goodwill, and/or unique training.  Tailoring the duration, scope, and geographic restrictions of the covenant to the particular position and circumstances of the employee (or category of employees) is likely to enhance the enforceability of the agreement.
  
4. Determine what constitutes sufficient consideration for the covenant.  Virtually all states agree that covenants executed prior to the start of employment are supported by consideration (note, however, some states say that an agreement is not supported by consideration if it is executed after the offer is accepted by the employee).  Other states hold that if execution of the agreement is followed by a substantial period of continued at-will employment, the employment will suffice as consideration.  But other states require specific, additional consideration for agreements signed after the start of employment. 

5. Determine what type of restrictions most appropriately protect the company.  Do you need a non-competition, non-solicitation of customers, non-solicitation of employees, non-disclosure provision, or all four?  Identify the legitimate interests that you seek to protect, and choose a restraint suited to protect each interest.

6. Include provisions regarding injunctive relief.  Consider including clauses providing for a presumption that any harm done is irreparable and difficult to quantify, and consenting to injunctive relief.  Including such a clause rarely makes injunctive relief a certainty, but the absence of such a clause can hurt even more.

7. Consider an attorneys’ fee provision.  You may be able to increase your leverage with a clause providing that the company will be reimbursed for reasonable attorney’s fees and costs in the event litigation is required to enforce the covenants.   However, be aware that some jurisdictions may not enforce a one-sided provision that purports to award fees only to the employer.  Some jurisdictions may convert such a provision to a “prevailing party” provision, meaning that the “loser” is required to pay the other side’s fees.  

8. Require return of confidential documents and information.  Contracts should require employees to return any information or documents relating to the company upon request or within a short time after their termination.  Don’t forget to cover copies, derivations of company documents, and information contained on electronic devices, such as cell phones, blackberries and the like. 

9. Include an assignability provision.  Many states will not enforce a restrictive covenant when the identity of the employer has changed (e.g., by an asset sale) unless an agreement includes a consent to assignability.  Where the jurisdiction permits and/or requires such a provision, make clear the company may assign the covenant to an affiliated company or successor in interest without notifying the employee.  Defining the "Company" at the beginning of the agreement to include the company, its successors and assigns is also a good idea.

10. Include language extending the term of the covenant in the event of a breach.  If the jurisdiction permits such a restriction, make sure your contract states that the period of the covenant is automatically extended for any time during which it was being violated. 

A merger that looks good on paper can lose value when too many employees in the target company get nervous about what life will be like after the deal closes -- Will the culture be different?  Is the acquiring firm too big?  Too rigid?  Will they understand how we do business?  These risks have had enormously negative impacts on many mergers.  Employee attrition following mergers and acquisitions is so common that it has been the subject of psychological studies, has been written about in Human Resources publications, and even has spawned its own name -- “Merger Syndrome.”  Back in 1986, Psychology Today published an article called, “The Merger Syndrome: When Companies Combine A Clash Of Cultures Can Turn Potentially Good Business Alliances Into Financial Disaster.”  What can an acquirer’s Legal Department do to manage this risk? 

            Check the Old Restrictive Covenants – Do They Exist?  Are They Enforceable?.  Start early in the process.  During due diligence, check whether the target company has its key people under enforceable restrictive covenants.  Don’t just inventory HR files.  Analyze what restrictions are in the contracts.  Where are the employees located?  Are those restrictions enforceable in those states?  Were the contracts signed at the inception of employment or later?  If they were signed later, then consideration may be an issue, depending on the state. 

            Will You Have Standing to Enforce the Old Covenants After the Deal Closes?.  Even if there are non-compete agreements in the file for the right groups of employees, you must determine whether you – as the acquiring entity – will have the right to enforce the old non-competes after the deal closes.  Do the covenants have clauses providing that the agreement is assignable, or better yet automatically assigned, to a successor upon merger or acquisition?  If the clauses are there, you probably can enforce.  If not, the question may be much trickier – it will depend on the state’s law that governs, and on the form of the transaction.  Mergers and stock purchases are more likely to transfer the right to enforce.  Asset purchases are less clear. 

            Think About New Covenants.  If you find that many of the old contracts are not enforceable, then you want to build into the negotiation a strategy for getting newer and better agreements from the key people, especially for executives you want to retain after the merger.  Everyone knows that.  But make sure you identify the types of attrition that can turn a great deal into a disaster.  Often the sales force is a key.  In September 2005, Wall Street giant Merrill Lynch agreed to purchase AXA’s Advest brokerage unit for $400 million.  By May 2006, it was being reported that 417 out of Advest’s total of 505 brokers had jumped ship.  See K. Burke, “Failure to Launch,” Registered Rep (May 1, 2006).  It literally became a case study of a failed merger.  See S. Grantham, Risk Assessment as a Function of a Successful Merger: Merrill-Advest Merger, 11 Journal of Communications Management 247-57 (2007). Mergers and acquisitions can be especially stressful for employees lower down the chain of control, who have access to less information.  As one study noted, mergers “can change an individual’s working life significantly but fail to provide the individual with any control over the event.”  Julie K. Anderson, “People Management: The Crucial Aspect of Mergers and Acquisitions,” Industrial Relations Centre, Current Issue Series (1999).  Don’t make the mistake of only worrying about the top few executive non-competes.  Carefully assess points of exposure to potentially damaging employee defection, and then craft restrictive covenants that will protect the company.

Consideration for New Agreements.  If new contracts are required, you must address issues of timing and consideration.  The demands of adequate consideration vary depending upon the form of your transaction, and the states in which key employees are located.  In a statutory merger or stock purchase situation, the employment of target-firm employees continues uninterrupted through and after closing.  In many states, simply agreeing to continue employing people is legally sufficient consideration to support execution of a covenant not to compete executed during the midst of employment – what some cases refer to as “mid-stream” covenants.  But in a substantial and important minority of states, merely keeping someone on the job is not sufficient consideration for a mid-stream covenant.  In these states – North Carolina and Pennsylvania are two examples – you must give each employee new and sufficient consideration.  Sufficiency will be measured in proportion to the employee’s pay level and duties.  A check that would be sufficient for one employee will not be seen as sufficient for a much higher compensated employee.    

Determine Whether Key Employees are Located in “Problem States”.  It is inconvenient, to say the least, that nearly all of the legal issues relevant to the risk of employee defection are governed by varying state laws, rather than by one consistent federal standard.  In fact, it is so inconvenient that many companies simply ignore this undeniable reality.  They do so at great risk to their ability to protect themselves against defections.  One size rarely fits all when drafting restrictive covenants.  If you roll out one version of your agreement, it may well fail in any number of key locations, including tricky states such as California, Georgia and others.  You probably can cover the national map with anywhere from three to six versions of an agreement, depending upon how many different types and levels of employees you are signing up.  You may be tempted to side step this problem by inserting choice-of-law/forum clause, but this often fails and is inadvisable in any case.  It is dangerous to put all your eggs in one basket.  If things turn bad in your chosen state, you are out of luck everywhere.    

Don’t Forget to Use Carrots with Your Sticks. The company of course is even better off if employees decide to stay on board, and are happy about doing so.  This is why the most effective method is to roll out an attractive employee retention plan designed to induce important players at all levels to stay around long enough get to know what is good about your company.  Consider stay-bonuses, with repayment obligations that kick in if an employee leaves within a year (or two or three  years, as the case may be) after receipt.  Salary or minimum bonus guarantees also can ease concern about transition into a new compensation environment.  At a minimum, you can use retention agreements to be sure key employees stay with you long enough to get through the transition period after the deal closes. 

Communicate Your Retention Offers Early.  Retention packages are more effective tools when deployed rapidly and when their benefits are communicated effectively.  Deal with this immediately after announcement of the pending merger.  Don’t wait until closing.  Headhunters will waste no time starting to recruit the most valuable employees from your target company.  The last thing you want is for the dominant voices to be those of recruiters calling in and reinforcing the natural fears of employees whose company is being acquired. “[T]he period following the announcement of the takeover is one of intense personal risk analysis, in which the individual decides whether s/he will leave the organization or stay.”  Gunter K. Stahl & Sim B. Sitkin, “Trust in Mergers and Acquisitions”, in Mergers and Acquisitions: Managing Culture and Human Resources (G.K. Stahl & M. Mendenhall, eds., Stanford University Press 2004).  Effective retention packages offer sufficient financial inducement for employees to remain on board, and ideally are communicated before the headhunters are out in full force.  You know the announcement is coming before they do.  Take advantage of that head start -- don’t announce until you are ready to convey information about retention packages almost simultaneously. 

Employee attrition will always be a risk factor in mergers and acquisitions, but careful attention to restrictive covenants and retention packages can go a long way toward minimizing those risks.   

For companies with employees in multiple jurisdictions, creating a single non-compete agreement for use by employees throughout the country can be tempting.  A single agreement is less expensive to draft than multiple agreements, and less cumbersome to distribute to employees in different states.  But will a single agreement be enforceable in multiple jurisdictions?  The answer:  it depends where the company’s employees are located.  The laws governing enforceability of restrictive covenant agreements vary by state, and an agreement that is enforceable in one state may well be unenforceable in another.  Depending upon the jurisdiction, the risk of attempting to use a single agreement in multiple states can vary from simple unenforceability to exposure to a claim for damages for requiring an employee to sign an unenforceable agreement. 

The following is a brief summary of some of the issues that vary from state to state and that should be considered when determining how many agreements a company needs and how to maximize the likelihood of enforcement of a company’s agreements across jurisdictions:

1.         The duration and geographic scope of the covenant.

In evaluating whether the terms of the agreement at issue are reasonable, most jurisdictions will scrutinize the duration and geographic scope of the covenant to determine whether it is reasonable.  What is reasonable in one state may not be reasonable in another.  Although the analysis will likely be fact-based in most states, in others, it may also be a matter of statute.  Some states specify, for example, that any covenant that is beyond two years in length is presumptively unenforceable.  Other states absolutely require that a covenant contain a geographic limitation in order to be reasonable.  In Louisiana, for example, a statute dictates that unless the restrictive covenant names the specific parishes to which it applies by name, it will not be enforced. 

2.         Does the state permit “modification” or “blue-penciling” of overly broad covenants?

Some states permit courts to revise overly broad covenants to make them enforceable.  For example, in Pennsylvania, a court has discretion to modify the terms of an overly broad covenant if they are unreasonable as drafted.  Other states, like North Carolina, follow a strict “blue pencil” approach, meaning that courts in those jurisdictions will not rewrite a contract if it is too broad, but will simply not enforce it.  In “blue pencil” states, if the contract is separable, and one part is reasonable, the courts are permitted to enforce the reasonable provisions.  Still other jurisdictions, like Georgia, do not permit courts to enforce any portion of an agreement if even one part is unenforceable as drafted.  Where courts will not modify an agreement, or will strike unenforceable provisions, it is particularly important to scrutinize every portion of the agreement to ensure that each provision is enforceable as written.

3.         What constitutes adequate consideration for the restrictive covenant?

As is the case with any agreement, a restrictive covenant must be supported by consideration to be enforceable.  In some states, if a restrictive covenant is signed after the commencement of employment, it must be supported by new and independent consideration, such as a promotion or a raise, in order to be enforceable.  In other states, the promise of continued employment constitutes sufficient consideration in exchange for execution of the covenant.  If covenants are being distributed to employees in multiple jurisdictions after the commencement of employment, the company should be aware of the law in each jurisdiction to determine whether new consideration is necessary to make the covenant enforceable.

4.         Is the covenant is assignable?

In some jurisdictions, corporate acquisitions and mergers can raise issues about the enforceability of a restrictive covenant.  Some states permit assignment of the covenant to the purchaser as a matter of course regardless of whether the employee consents to the assignment.  Other states, such as Pennsylvania, do not.  In Pennsylvania, the court will consider the nature of the transaction in determining whether the covenant is assignable without employee consent.  Still other states will require employee consent regardless of the nature of the transaction.   Employers should be aware of the requirements of the states in which they do business and should make efforts to obtain express consent where it is required.  In some jurisdictions, this can be accomplished through the incorporation of an assignment provision in the agreement.

5.         Is the covenant enforceable if the employee is terminated?

Even if the covenant is otherwise enforceable, some states will not permit enforcement of a restrictive covenant if an employee is terminated by his or her employer.  Other states, like Massachusetts, will examine whether the termination was conducted arbitrarily or in bad faith in determining whether the covenant is enforceable.  The company should be mindful of the requirements for the jurisdictions in which its employees are signing restrictive covenants and ensure that any terminations are conducted with knowledge of the impact they may have on an existing restrictive covenant.  Where the state in which the employee is located is likely to evaluate the circumstances surrounding the termination in determining whether the covenant is enforceable, special care should be taken to properly document the reasons for the termination. 

6.         When and how the covenant must be presented to be enforceable? 

Some states have specific requirements as to when and how a covenant must be presented to an employee.  In those states, an employer may be required to present the covenant at the time the offer is extended, or prior to the commencement or employment.  North Carolina has specific requirements for the timing and manner of presentation of restrictive covenants, for example.  Other states have similar requirements.  An otherwise enforceable agreement can be rendered unenforceable in these states unless it is presented to an employee at the right time and in the right manner.  It is therefore important to evaluate the requirements in each state in which the covenant is being presented to employees to ensure that the timing and manner of presentation of the covenant meets all applicable requirements.

7.         Does the state permit provisions extending the period of the restrictive covenant in the event of an injunction?

Many states permit provisions in agreements that purport to extend the period of a restrictive covenant by the amount of time in which it was violated prior to entry of an injunction.  For example, in those states, an employee with a one-year non-competition agreement who violates the agreement by working for a competitor for one month before being enjoined from further competition may be enjoined for the remaining duration of the covenant plus one month in order to account for the period in which the employee was violating the agreement.  While many states permit this type of extension of the covenant, some states expressly forbid it, and in other states, the court is unlikely to extend the covenant absent specific language in the agreement allowing such an extension.  It is important to consider the jurisdiction and tailor the language of the covenant and any provisions relating to injunctive relief accordingly if the company is interested in attempting to obtain an injunction that extends the period of the restrictive covenant to account for any period of non-compliance.

8.         Does the state permit non-competition agreements at all?

Some states, such as California, do not permit non-competition agreements in any form.  In those states, although the company cannot present employees with a non-competition agreement, the company may have reasonable alternatives that would still afford some protection.  In California, for example, while a non-competition agreement is not enforceable, a properly drafted confidentiality agreement is enforceable. 

9.         What types of employees will be signing the restrictive covenants?

Most states commonly ask whether a restrictive covenant contains restrictions that are reasonably necessary to protect one or more of an employer’s legitimate interests.  Commonly recognized legitimate interests include confidential information, customer relationships, and unique or unusual training.  Consequently, it is important to consider the types of employees who will be signing the restrictive covenants and to think about what interest the company seeks to protect.  It may be easier to justify a broad geographic restriction on competition for employees with access to confidential information that could be used throughout a geographic region.  Similarly, when an employer seeks to protect against the exploitation of customer relationships, a non-solicitation agreement may suffice. 

In sum, although the law can vary significantly from jurisdiction to jurisdiction, this does not mean that employers must have separate agreements for every state in which they do business.  Generally, a handful of agreements will suffice to address the variations in law between different jurisdictions, as there is significant overlap between the law of many jurisdictions.  The key to ensuring enforcement of restrictive covenants in multiple jurisdictions is to be knowledgeable about the differences in state law and to address those differences both in the agreements themselves and in the manner in which they are presented and enforced.