The Bite-Size Business Brief: post-sale restrictive covenants

Post-sale restrictive covenants

What are they and what restrictions should a seller accept?

During a sale process, a buyer will typically want to ensure that any seller or continuing shareholder is prevented from establishing a competitive business which could diminish the value and goodwill of its investment in the newly acquired business.

In M&A transactions it is common practice for the sale and purchase agreement (SPA) to include undertakings and covenants which restrict parties from carrying out certain activities following the completion of a sale. These are commonly referred to as restrictive covenants.

Common types of restrictive covenants

• Non-competition: prohibits creating or participating in a competing venture.
•  Non-solicitation/non-dealing: prohibits soliciting or canvassing clients or customers of the target business.
•  Non-poaching: prohibits poaching employees.
•  Reputation: prohibits using the same or a confusingly similar name used by the target business. 

Common law application

In the UAE (and wider Middle East region), it is common for SPAs to be governed by the law of a common law jurisdiction (such as the laws of England and Wales or the laws of the Dubai International Finance Centre or Abu Dhabi Global Market). Common law generally applies the doctrine of precedent and specifically the doctrine of restraint of trade in respect of disputes regarding restrictive covenants. A court or arbitral tribunal applying common law would ordinarily apply a “reasonableness” assessment to any dispute relating to restrictive covenants.

Drafting and negotiation

A buyer is expected to take a reasonable approach to drafting/reviewing non-compete provisions in order to avoid challenges relating to enforceability. Such restrictive covenants or undertakings provided by the seller should generally be no wider than is necessary to protect the buyer’s legitimate business interests and should be “reasonable”.

Restrictive covenants should be limited and tailored specifically to apply to the context of the transaction, including restricting such covenants to the relevant field of business or industry, an appropriate time period and a reasonable and relevant geographical scope. If, for example, supplier relationships in a particular country are key to the business, the restrictive covenants may be tailored to include non-solicitation of the existing or named suppliers in that country for a certain period of time that is otherwise reasonable and appropriate; or if in-house developed software is of material importance to the value of the business, restrictive covenants may be extended to restrict the seller from developing the same or similar software in respect of a competing business for a certain period of time.

Restrictions should generally be confined to territories in which the target business is operating and the clients/suppliers/employees who are engaged by the target business at the time of the transaction. That said, there is no one-size-fits-all approach and enforcement will be determined by the relevant court or tribunal on a case by case basis.

As such, a seller should carefully consider the ramifications of entering into restrictive covenants and whether it will be in a position to truly comply with the restrictions for the period of time stipulated and in the geographical scope covered. Relevant to this assessment will be whether the seller has any interest in any continuing business or third party which a seller may wish to expand or invest post completion. Carve outs from restrictions (including carving out other seller group entities if applicable) should be considered. Typical carve outs may include being permitted to hold a minor interest in a competing listed company or being able to advertise vacant positions and employing a target employee who has independently responded to an advertisement.

If a seller is an individual and agrees to stay on in the target business as an employee or director, a seller can expect their service/employment agreement will also include a set of separate post-termination restrictive covenants. Specific employment advice should always be sought when negotiating these.