The Contract Adviser

Hello Entrepreneurs!

In yesterday’s column, I offered three possible choices of severability language to include in a hypothetical asset purchase agreement.  In the hypothetical, you are purchasing a one-store clothing retail business, and want the seller, Fred, to agree to the following non-compete provision…
 
“For a period of three (3) years after the Closing, Seller shall not directly or indirectly (i) own, operate or otherwise engage in any clothing retail business in any location within 15 miles of the Retail Store*, or (ii) own an interest in, manage, operate, control or render financial assistance to, or become an officer, employee, partner, stockholder, or consultant of or otherwise participate in, any person that engages in a clothing retail business in the above-described restricted area.”
 
*"Retail Store" is defined elsewhere in the agreement as the store being sold under the APA.
 
Let’s say that within 1 and 1/2 years, Fred starts another clothing retail store within 12 miles of the Retail Store.  You go to court to enforce the non-compete.  As luck would have it, now that Fred’s taken your money, he and his attorney will try to argue that the non-compete is not enforceable.  A court could agree; it could find any number of legal problems with the non-compete provision.  First, three (3) years might be too long.  And while the restriction against activities in clothing retail seems reasonable, the case law in your particular jurisdiction may favor less stringent geographic restrictions, for example, a 5 to 10 mile radius (maybe even 1 mile for dense urban areas).  In other words, there’s a chance the court might rule that the 15 mile radius is overly aggressive and not enforceable.
 
What is the impact of including severability provision Choice A in the agreement?
 
“If any provision of this Agreement is unenforceable, the balance of this Agreement remains in full force.”
 
By adding Choice A, you are inviting the court to completely sever (akin to physically redacting) the offending provision from the contract, and to enforce the balance of the Agreement.
 
If the court ultimately rules that the 15 mile radius is unenforceable, and agrees with the parties’ stated intent as reflected in severability provision Choice A, then it would treat the non-compete provision as though it was not in the APA, and enforce the rest of the APA.  You could try to argue that the balance of the APA should not be enforced either (i.e., that the entire contract should be void), but a court probably won’t buy that argument unless you can convince the court that striking the non-compete undermines the main purpose of the deal.  This is a bit of a stretch, but maybe you can attempt to argue that voiding the non-compete messes up the purchase price allocation of the APA for tax purposes, but I think most people who buy and sell small businesses do so for strategic, rather than purely tax purposes.   Note that it's a business decision, of course, whether you'd want to go for a rescission (i.e., an unraveling of the entire transaction) - except for the non-compete issue, things may be going very well for you with your new business.  In any event, it’s been a whole year and a half, so it’s not likely the court would rescind (unravel) the transaction and make Fred buy the business back.
 
Bottom line - With Choice A, Fred stands a good chance of being able to set up shop and compete despite the non-compete provsion.
 
We’ll examine Choice B and Choice C in upcoming columns.