Non-Competes in the Sale of a Business

Why a seller's covenant is treated differently

Texas applies the same statute to every non-compete, Business and Commerce Code section 15.50(a): the covenant must be ancillary to or part of an otherwise enforceable agreement, and its limits on time, geography and scope must be reasonable and no greater than necessary to protect the goodwill or other business interest of the person the promise was made to. The words are the same for an employee and for a selling owner. The results are not, for three reasons.

The otherwise enforceable agreement is obvious. In employment the first part of the test is contested: at-will employment alone is not enough, and the employer must show it gave confidential information or something comparable. In a sale, the purchase agreement is the otherwise enforceable agreement, and the seller's promise not to compete is part of what the buyer bought.

The protected interest is the goodwill itself. A buyer pays for customer relationships, reputation and the expectation that the customers will keep coming. A seller who opens across the street takes back what was sold. Texas courts have long recognized that protecting purchased goodwill justifies restrictions that would be excessive if imposed on an employee, and the Texas Supreme Court's decision in Marsh USA Inc. v. Cook (2011), although an employment case, confirmed that goodwill is a protectable business interest under the statute.

The burden of proof flips. Under section 15.51(b), when the primary purpose of the agreement is to obligate the promisor to render personal services, the party seeking enforcement must prove the covenant meets the statutory criteria. When the agreement has a different primary purpose, such as the sale of a business, the promisor, the seller, has the burden of establishing that the covenant does not meet them. In a close case, that allocation decides it.

How broad can the covenant be?

Reasonableness is measured against the business sold. The usual markers:

• Time. Long enough for the buyer to make the customer relationships its own. Terms of several years are routinely accepted in business sales, where a comparable term for a line employee would be attacked. The longer the term, the more the buyer should be able to point to the price paid and the nature of the customer relationships to justify it.
• Territory. The area in which the business actually operated or sold at closing. A business with customers across Texas can support a statewide covenant; one that served Dallas County cannot support one that reaches Houston. Covenants written as “anywhere the buyer does business” invite trouble because they grow with the buyer rather than describing what was sold.
• Scope. The line of business sold, defined with care. A seller of a commercial HVAC service company may be kept out of commercial HVAC service, not out of all construction trades.

A covenant that fails this test is not void. Section 15.51(c) requires the court to reform it to reasonable limits and enforce it as reformed, but the buyer then recovers no damages for breaches before reformation and is limited to an injunction for that period. The fee-shifting provision that lets a court award attorney's fees against a party who knowingly overreached applies only to personal-services agreements, so a buyer who drafted too broadly risks the damages, not the seller's fees. The mechanics are covered in what a Texas court does with an overbroad non-compete.

The seller who stays on as an employee

Many deals keep the seller for a transition period as an employee or consultant, and many of those deals contain two non-competes: one in the purchase agreement and one in the employment agreement. The two are not interchangeable. The purchase-agreement covenant protects purchased goodwill, carries the seller's burden of proof, and is measured against the business sold. The employment-agreement covenant is a personal-services covenant: the buyer carries the burden, must show the otherwise enforceable agreement in the ordinary way, and faces the knowing-overbreadth fee provision.

The drafting choice that matters is which covenant governs after the seller's employment ends. If the only restriction is in the employment agreement, the seller who is terminated or quits two months after closing will argue that the covenant is a personal-services covenant with a short tail, and the buyer will have paid for goodwill it cannot protect. The purchase-agreement covenant should run from closing for its full term regardless of any later employment, and the employment covenant should be a separate, additional obligation.

The buyer's remedies

• Temporary injunction. The fastest and most important remedy. The buyer shows a probable right to relief and probable, imminent, irreparable injury, which in a goodwill case is the loss of customer relationships that damages cannot restore. The hearing comes within weeks of filing.
• Damages. Lost profits on the customers diverted, proved with the business's own records, and in some agreements liquidated damages for the breach, which must be a reasonable forecast of harm to be enforced.
• Contract remedies in the deal documents. Set-off against an earn-out, a seller note or escrowed funds is available only if the purchase agreement provides for it. A buyer who simply stops paying a seller note because the seller competed has breached the note, and the seller's counterclaim arrives with the answer. Read the set-off clause before withholding anything.
• Tortious interference and trade secret claims against the seller's new company and anyone who helped, where the facts support them.

Suits on the purchase agreement are contract claims with a four-year limitations period under Civil Practice and Remedies Code section 16.004, but the injunction that protects the customers has to be sought in weeks.

What the seller will argue

• It is really an employment covenant. The restriction appears only in the employment agreement, or the purchase agreement incorporates it by reference, so the personal-services rules and the buyer's burden apply.
• The buyer breached first. Unpaid installments, a disputed earn-out calculation, or a withheld escrow release, offered as a prior material breach that excuses the seller's performance. This is the most common defense in practice, and the buyer's payment record is the first thing a litigator asks for.
• Overbreadth. The covenant reaches markets, products or customers the sold business never had, often because the buyer's template described the buyer's business instead of the seller's.
• The conduct is not competition. The seller is consulting, investing passively, or serving a customer segment the agreement carved out. Carve-outs for existing side businesses and passive investments should be written precisely at signing.
• No goodwill was lost. The customers left for reasons unrelated to the seller, or the buyer's own service failures drove them away.

Example

Suppose a Dallas buyer acquires a regional commercial janitorial company for a price paid half at closing and half under a three-year seller note. The purchase agreement contains a five-year non-compete covering the four North Texas counties where the company had customers and recites that the buyer would not have paid the price without it. The seller stays on for six months as an employee under a separate agreement with its own one-year covenant, then leaves. Eighteen months after closing the buyer learns the seller is bidding on janitorial contracts in two of the four counties through a company in his brother-in-law's name.

The purchase-agreement covenant governs: five years from closing, four counties, the business sold. The seller has the burden of proving the limits unreasonable, and against a recital tying the covenant to the price, a territory matching the customer base and a term that fits a business built on multi-year service contracts, he is unlikely to carry it. The buyer should seek a temporary injunction against the seller and the new company, continue paying the seller note unless the agreement provides a set-off right, and pursue lost profits on any contracts the new company won. If the buyer had instead relied on the employment agreement's one-year covenant, the restriction would already have expired.

Before closing, and before suing

1. Put the covenant in the purchase agreement, running from closing, with time, territory and scope that describe the business being sold.
2. Keep any employment or consulting covenant separate and additional, so the end of the seller's employment does not end the protection.
3. Recite the connection between the covenant and the price, and decide deliberately whether to allocate value to it.
4. Write the set-off right expressly if the buyer wants to withhold deferred payments for a breach.
5. Before enforcing, confirm the buyer's own performance under the deal documents, because that is the seller's first defense.

Where the seller's conduct is also misrepresentation about the business sold, the claims are different and covered in claims against a seller who misrepresented the business. For disputes among co-owners over a buyout rather than a third-party sale, see how a partner buyout is priced and enforced in Texas. Tina Wysk represents buyers and sellers in post-closing disputes, including non-compete disputes, in Dallas state and federal courts.