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The Structure of a Business Purchase Can Impact the Enforceability of a Covenant Not to Compete

4.7.2014

The enforceability of covenants not to compete and other restrictions on employee actions are often critical in realizing the benefit of a business acquisition. The inability to limit post-closing activities of key employees can dramatically reduce the value of an ongoing enterprise and significantly change its prospects for success. The courts of North Carolina have generally not looked favorably upon restrictive covenants, but have been willing to enforce reasonable restrictions to protect legitimate business interests. Decisions addressing these covenants have also demonstrated that the way a business acquisition is structured can impact their enforceability.

To be enforceable in North Carolina a restrictive covenant must be supported by new material consideration and continuing employment is not considered new consideration. Thus it is important for parties to understand how the structure of a business acquisition (purchase of assets versus the purchase of the ownership interest) affects the employment status of someone subject to a post-closing restrictive covenant. The way the transaction is structured could act to terminate the employment status of existing employees or result in it continuing after the closing. This could in turn impact the enforceability of restrictive covenants of the selling company's employees.

This was a determining factor in the North Carolina Business Court's decision in the recent case of AmeriGas LP v. Coffey, 2014 NCBC 4. In the AmeriGas case, the court refused to enforce contractual provisions contained in a Post-Employment Agreement. In connection with the acquisition of the ownership of the operating entity, Mr. Coffey was to continue to work after closing, but was required to sign a new contract restricting his ability to solicit or sell to customers of AmeriGas. Judge John Jolly reasoned that the purchase of membership interests involved in the deal did not necessarily result in the termination of the existing employment relationship of Mr. Coffey, and thus there was no new employment to act as consideration for the restrictive covenants. He reasoned that an employment agreement signed at the time of the sale may only use employment with the purchaser as new consideration if the old employment is deemed terminated as a result of the transaction. On this point, North Carolina courts have ruled that, under the right circumstances, an asset purchase (as opposed to the purchase of an ownership interest) will result in the termination of existing employment of employees of the seller. (Better Bus. Forms & Prods, Inc. v. Craver, 2007 NCNC 34 (2007)). In further addressing the consideration issue in the AmeriGas case, Judge Jolly found that Mr. Coffey basically received the same benefits he was getting before the sale and nothing new was given him to support the restrictive covenants.

There are many issues to be considered in connection with buying a business. While the enforceability of covenants not to compete should not be the controlling factor, this topic should certainly be added to the list to be discussed with legal counsel in determining how to structure a deal.

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