Explore the complexities of M&A restrictive covenants in our latest blog post, “M&A Buyer’s Restrictive Covenants Tested Under Delaware Law.” This post delves into a recent case involving a strategic acquisition in the timberland management and forestry consulting industry. The discussion focuses on the enforceability of non-compete and non-solicitation clauses under Delaware law, examining how these covenants impact business transactions and legal disputes. Learn about the court’s reasoning in denying a preliminary injunction, the challenges of enforcing restrictive covenants across multiple regions, and the concept of “blue penciling” in contract law. This insightful analysis is essential reading for business owners, legal professionals, and anyone involved in M&A transactions, providing valuable lessons on drafting and enforcing restrictive covenants to protect business interests.
M&A Stories
August 03, 2024
In many M&A transactions, goodwill is a crucial asset, and restrictive covenants, such as non-compete and non-solicitation clauses, are key to protecting that goodwill.
This case involved the $1 million strategic acquisition of a Wisconsin-based timberland management, forestry consulting, and appraisal services business. As part of the deal, the principal seller owner, who continued in his role managing forests and natural resources and providing expert witness consulting, agreed not to compete with the Maine-based buyer for five years across the United States, Canada, South America, Central America, Australia, New Zealand, Europe, and Africa. Additionally, the owner promised not to solicit the company’s employees or customers for five years.
However, less than four months after the closing, the owner left the buyer and began working for a competitor. Subsequently, two former employees and at least one client joined him at the new company. In response, the buyer filed a lawsuit in a Maine federal district court, alleging the owner violated the restrictive covenants. The buyer sought a preliminary injunction to prevent the owner from competing and soliciting employees and clients pending the lawsuit’s outcome.
The central issue was whether the restrictive covenants were enforceable under Delaware law, as stipulated in the asset purchase agreement. The court denied the buyer’s request for a preliminary injunction, indicating that the covenants were likely unreasonable and, thus, unenforceable.
The court found the non-compete clause unreasonable because it covered regions where the seller had not operated, including South America, Central America, Australia, New Zealand, Europe, and Africa. While the seller’s owner had plans to expand into these areas, the lack of current operations, combined with the five-year duration, rendered the non-compete likely unenforceable. Similarly, the court questioned the reasonableness of the five-year non-solicitation clause, finding no Delaware court upholding such lengthy term.
Moreover, the court acknowledged its power to modify restrictive covenants to make them reasonable, a process known as “blue penciling.” However, it emphasized that Delaware courts rarely use this power, as it could encourage parties to draft overly broad covenants, relying on the courts to correct them.
Case Reference: Huber Resources Corp. v. Olson, Docket No. 1:23-cv-00410-NT , United States District Court, D. Maine, (July 19, 2024).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
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Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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