Don't Go There: The Agreement That Tells You What You Can't Do

Pen and InkFrom time to time owners will ask us if they will need to sign a non-compete agreement.  The answer stays the same:  "Yes, Yes, Yes. Buyers will always want a non-compete."

An essential part of every practice sale/purchase is the non-compete clause or, as it is sometimes called, the covenant not to compete.  This clause or agreement is essentially a protection for the buyer that spells out what a seller cannot do in regards to performing accounting, tax and related services after the sale. The non-compete clause can be a part of the purchase agreement or a separate document.

In some sense, owners are selling something that does not even belong to them-the clients and the likelihood those clients will return to the new owner for services.  There are a variety of reasons why a client might not want to go to the buyer.  But none is bigger than the scenario of a prior owner who either stays in business or who might soon return to that business.  Assuming that the clients are happy with the owner and satisfied with services provided, why would they go to a new buyer if the former owner is still providing the same services?  The best thing for the buyer is that the owner is completely out of the business and not even continuing to do work for any clients.  A non-compete spells that out and gives the buyer some legal recourse in the event a seller does become a competitor.   It is certainly hard to understand how a seller can justify selling something, in this case work for certain clients, then taking that back without compensation.  Unfortunately it does happen at times.

Courts require that non-compete agreements have limitations, usually in the form of both geographic and time limitations.  A buyer cannot prevent a person from ever plying his or her profession throughout the whole country!  Typically, a clause will say something to the effect that the seller is prohibited from doing tax and accounting services within 20-30 miles of the existing office.  Or the clause might specify a county-wide area.  In addition, there will usually be a time period like 3 to 5 years for the prohibition.

Exclusions can be included if agreeable to both parties.  For instance, sometimes a seller wants to be able to work as an accountant for another firm in industry or government but not on his/her own in public accounting.  That can be spelled out.  Another scenario would involve an exception to a type of related work.  Perhaps a seller wants to continue to do investment work but not accounting and tax services.  That too can be specified.  It is always important to be clear in the language.

Sometimes included as a part of the covenant not to compete or as a separate clause is a non-solicitation agreement.  While the non-compete clause prevents the seller from performing accounting and tax work in general the non-solicitation agreement specifically identifies that the seller will not do work for the existing clients being transferred.  It can also specify that the seller won't recommend or suggest that the clients go to someone besides the buyer.  In some cases the non-solicitation actually takes the place of the non-compete.  However, it is probably best to use both.

Sometimes a non-solicitation clause will spell out a penalty for breaking the agreement.  For example, there could be wording that if the seller does do work for or solicit work from an existing client that he/she would have to compensate the buyer 150% of one year's gross fees from that client.

While non-compete clauses and non-solicitation clauses are standard for the seller the matter gets stickier when it comes to employees.  Requiring such agreements from all employees or key employees before a deal can be made can get complicated.  One, the employees may never have had a non-compete with the owner so might become suspicious of having to do one for the buyer.  It may be like asking someone to sign a pre-nuptial agreement!  Two, often the employees have not even been told of a possible sale.  Three, it does happen sometimes that the employees can then hold the owner hostage in the deal by refusing to sign a non-compete agreement.  Four, such agreements for employees may require compensation or bonuses in order either to be enforceable and/or to entice the employee to sign them.

Buyers and sellers need to do their research on how much, if any, of the purchase price should be allocated to the non-compete agreement.  There are tax implications for both parties.

But there can also be legal implications tied to the enforceability of the agreement and the " cost" of the agreement. It is recommended that both sellers and buyers engage their own attorneys in regards to non-compete agreements and other legal matters associated with the sale/purchase.  Jurisdictions have different views and interpretations on non-competes, how they can be written and how they can be enforced.

Just from this it is easy to see that non-compete agreements and non-solicitation agreements are essential but also somewhat complicated.  Please use professionals in helping with your sale or purchase.