The Importance of Restrictive Covenants
By Jan H. Raymond
Since the most important part of a logistics acquisition to a buyer, regardless of whether the business is asset light (freight forwarding, customs brokerage, indirect carriage, etc.) or asset heavy (trucking, warehousing, etc.), is the revenue stream, every purchase and sale agreement will include “restrictive covenants” designed to protect the revenue stream going forward for the buyer.
There are three forms of restrictive covenants:
1. CONFIDENTIALITY AGREEMENTS
These are standard provisions prohibiting the seller from disclosing “confidential” information of the business to third parties. The objective is to prevent that information from falling into the hands of competitors who can use it in competition with the business and thereby put some of the revenue stream at risk.
What constitutes “confidential” information is hotly disputed and sometimes leads to litigation if the threat to the revenue stream is significant enough.
Sellers should be familiar with these restrictions as they are the crux of confidentiality and non-disclosure agreements (NDA’s) entered into by the buyer and seller at the outset of negotiations and are also typically included in employee handbooks.
In addition, there is a federal law called the Uniform Trade Secrets Act that restricts the procurement and dissemination of a company’s “trade secrets” to the detriment of the company. Unlike confidentiality agreements, the statute specifically defines what constitutes “trade secrets” for purposes of the statutory protections.
2. NON-SOLICITATION AGREEMENTS
These are provisions that prohibit, for a stated period of time after the Closing of the sale transaction (which period is a point of negotiation), the solicitation of the customers, and sometimes of the employees, of the business being sold.
Whereas in confidentiality agreements, the potential for dispute arises from what is considered confidential, with non-solicitation agreements, the potential for dispute arises from whether the alleged violator did the solicitation or some third party did it on their behalf or even whether it is a violation if the customer called the third party rather than them calling the customer. For this reason, these provisions sometimes include a prohibition against “accepting” the business of the company’s customers regardless of who did the solicitation.
3. NON-COMPETE AGREEMENTS
These provisions prohibit, for a stated period of time after the Closing of the sale transaction (which period is a point of negotiation), the signatories from working for a competitor of the business being sold. In order to protect the revenue stream, the scope of these provisions is usually very broad including not just employment but also consulting and investment or ownership (even passive). To avoid circumvention, these provisions often extend to immediate family members as well.
While it is standard for all three of these restrictions to be required of the owners of the business being sold, during due diligence the buyer may identify certain employees as key employees necessary for the retention of the customer base and therefore require as part of the transaction that those key employees sign one or more of the restrictive covenant agreements as well. While some companies may already have these employees subject to a written restrictive covenant agreement, for those who are not, this will become a negotiation between the sellers and their key employees that will necessarily require a financial remuneration thereby reducing the net proceeds to the sellers. In some cases, refusal by the key employee(s) may even result in termination of acquisition negotiations.
While the only federal law governing restrictive covenants is the Uniform Trade Secrets Act, most states have some laws (or court cases) regarding the enforceability of restrictive covenants. These regulations typically focus on the “reasonableness” of the restrictions. Obviously, confidentiality restrictions are less restrictive than non-solicitation restrictions and non-solicitation restrictions are less restrictive than non-compete restrictions. Likewise, the geographic scope and temporal length of the restrictions affect the determination of “reasonableness” as well as whether, and how much, “consideration” (financial or otherwise) was given in exchange for the restrictive covenants. Typically, because of the sale price, it is rare for any restrictive covenant by a selling owner to be considered unreasonable.
While Logisyn does not provide legal services or opinions, we work directly with the seller’s chosen attorneys to assist in the negotiation of the restrictive covenants in order to maximize the prospects for a successful closing of the transaction and the net proceeds ultimately received by the sellers.
© Copyright 2020 Logisyn Advisors, Inc. All Rights Reserved. This article is not to be duplicated or edited without written permission, unless used specifically as a quotation with author attribution.
