- Noncompetes Often "Stick" when Associated with Sale of a Business
- October 11, 2017 | Author: Joseph F. Spitzzeri
- Law Firm: Johnson & Bell, Ltd. - Chicago Office
In E.T. Products, LLC v. D.E. Miller Holdings, Inc., the 7th Circuit was asked to assess whether a non-compete included in the sale of a business was valid, and then if so, whether the defendant violated it.
The non-compete at issue had a five-year duration and was quite broad in geographic scope, and in the range of activities it proscribed. The agreement prohibited the Millers from assisting anyone involved in any company either directly or indirectly engaged in the same industry as E.T. Products anywhere in North America. The Millers were also forbidden to directly or indirectly own, operate, invest in, advise, render services for or otherwise assist any such competitor.
The 7th Circuit noted that one of the assets typically transferred in a business sale is goodwill, an intangible asset that includes the value of the company’s reputation and customer relationships. That value is diminished if the seller, who developed that reputation and those relationships, competes with the buyer after the sale. For that reason the buyer often pays a premium for a non-compete agreement that removes the seller from the market.
The 7th Circuit noted that Indiana generally disfavors non-compete agreements, but business-sale non-compete agreements, which usually involve parties with relatively equal bargaining power, “stand in better stead” than those in other contexts. Compared with
non-compete provisions in employment contracts—another common place to find them—those arising from business sales are “enforced on a more liberal basis.” Indiana courts recognize that in a business sale, “a broad noncompetition agreement may be necessary to assure that the buyer receives that which he purchased.”
Sitting in diversity, the court found that the non-compete was nearly identical in scope and breadth to other non-competes upheld by the Indiana Supreme Court, and therefore upheld the non-competes validity in this case. Indiana courts separate businesses into one of three categories
for purposes of evaluating whether a non-compete is too broad: service businesses, distributors of goods and manufacturers. Non-compete restrictions in service businesses “normally will be localized because services generally are performed within a small geographic area.” A company like E.T. Products that distributes or manufactures goods, on the other hand, can be expected to reach customers over a larger map, and a correspondingly broader geographic restriction may be necessary.
Thus, the court found the non-compete to be valid in both time and geographic restrictions. However, the conduct of the defendant did not violate the non-compete terms. The stated purpose of the non-compete was to prevent business competition. Read reasonably and in light of that purpose, the agreement did not prohibit the defendant from assisting Petroleum Solutions while it was an E.T. Products distributor or from continuing to honor Kuhns’s preexisting lease.This opinion is interesting for its treatment of non-competes in the business sale setting v. the employment setting. The court appears more amenable to finding broad non-competes valid in the business sale setting, as noted in the opinion. However, the court will continue to look closely at the conduct involved to determine if the agreement was violated.