An entrepreneur acquiring a business wants to be certain that the seller will not immediately start a competing business after the transfer and take with them the customers and goodwill that the buyer has just paid for. The non-compete clause in the purchase agreement is the most important tool for this purpose. However, in practice, we regularly see that this clause is poorly drafted, with the result that the buyer is less protected than they thought.
What is a non-compete clause?
A non-compete clause is an agreement whereby the seller commits not to engage in any activities that compete with the sold business for a specified period, within a defined geographical area, and in a specified field of activity. The purpose is to enable the buyer to effectively utilize the transferred goodwill, customer relationships, and knowledge.
How long can it last?
As a buyer, you want the clause to last as long as possible. Legally, however, there are limits. As a general rule, a two-year term is permissible in most cases when only goodwill is transferred; if specific knowledge or know-how is also part of the transaction, a three-year term may be justified. Exactly what is permissible depends on the circumstances: the size of the company, the industry, and the geographic scope all play a role.
Important: A clause that exceeds the legal limits offers no protection. A judge may declare it wholly or partially void. As the buyer, you would then be left empty-handed, even though you may have paid a substantial purchase price based on the expectation that the seller would not compete with you directly.
Be specific
Draft the clause as specifically as possible. Refer to the actual business activities at the time of the transfer and limit the geographic scope to the markets in which the company is actually active. For the buyer, the rule is: the more specific, the less room for dispute. For the seller, the opposite applies: ensure that activities you wish to continue after the transfer are explicitly excluded, so that the clause does not become contestably broad. A clearly defined clause serves both parties.
Include a penalty clause
Always include a penalty clause in the non-compete agreement. The major advantage is that, in the event of a breach, you can immediately claim the penalty without having to prove damages and without court intervention.
Two points are important here. Be sure to explicitly state that the penalty does not affect the right to additional damages; without this clarification, the penalty could be interpreted as a comprehensive lump-sum settlement. In addition, ensure that the penalty is reasonably proportionate to the actual damages; if it is disproportionate, the court may reduce it. For the seller, it is worthwhile to stipulate that the penalty becomes due only after the buyer has been given written notice of default. This prevents the penalty from accruing in the event of a breach resulting from a misunderstanding.
Be aware of the liability cap
Purchase agreements often include a liability cap: a maximum amount for which the seller can be held liable. As the buyer, make sure that claims arising from the non-compete clause are explicitly excluded from this cap. If the clause is included under the cap, the seller can cap their total liability—for both warranty claims and breach of the non-compete clause combined—at the same maximum amount, which quickly renders the protection illusory.
Conflict with other agreements
In practice, a non-compete clause is sometimes also included in the management agreement or shareholders’ agreement. Ensure that these clauses are consistent with one another and include an anti-duplication provision to prevent the same violation from resulting in a double penalty. If the seller also becomes an employee after the acquisition, check whether the clause complies with the applicable employment law regulations.
A non-compete clause is not a standard provision that you simply tack on. By carefully considering its duration, scope, penalty clause, liability cap, and how it interacts with other provisions, you protect the value you have purchased or safeguard the freedom you will need after the sale.
