The decision to sell a company involves many considerations. One important – but often overlooked – consideration is the value that should be derived from having enforceable employee and non-compete agreements.
However, all too often, due diligence fails to critically assess the enforceability or transferability of non-compete restrictions. As discussed below, the value of the business or the deal may be adversely affected if this issue is not properly addressed.
Purchasing Company in Asset Sale Cannot Enforce Non-compete Restrictions
Take for example a recent case in which the buyer’s due diligence appeared to have overlooked the critical issue of whether employee noncompete restrictions would be enforceable after the acquisition.
Specifically, in a recent lawsuit (Hedgeye Risk Mgmt., LLC v. Heldman, 7/8/16), an employee left his company to start his own competing business after the company’s assets were acquired by a purchaser. The purchasing company then sued to enforce the noncompetition restriction against the new business.
The purchaser alleged that it acquired the former employee’s contract as part of asset purchase agreement. However, the Court ruled that the asset purchase agreement’s (the “APA”) language did not assign the contract to the purchasing company because, among other things, the employment contract was not listed in the schedules of transferred assets. Also, the APA provided that the business shall, in its sole discretion, “offer employment” to firm’s employees.
The Court also concluded that there was additional language in the non-compete provision between employees and the seller’s firm with further exceptions that were inconsistent with the APA.
As a result, the value of the business the purchasing company thought it acquired was diminished in that it could not prevent (presumably) a key employee (i.e., an employee with a significant book of business or contacts) from starting a competing business.
Employment Law Considerations for Buyers and Sellers in M&A Transactions
The preparation for the sale of a business and closing involves numerous legal issues (see “Closing Considerations for Sellers and Buyers,” by John Carter, an M&A attorney we frequently collaborate with when it comes to employment law and non-compete law due diligence in business sales). But the above case illustrates specifically how failing to adequately address employment agreements and noncompetition restrictions, or other human resource liabilities may adversely affect the merger or acquisition transaction.
In our experience and from a seller’s standpoint, example employee/HR action items for the seller to consider before entering into negotiations for the sale of a company include:
- Assessing employment agreements, especially non-compete, confidentiality, and invention/intellectual assignment provisions – Are they enforceable? Can they be assigned to the buyer?
- Examine the company’s current compliance with minimum wage and compensation laws – Is your company up to date?
- Assess the company’s current compliance with state and federal anti-discrimination laws and other regulations applicable to the workplace – Any ticking time-bombs that may blow-up the deal or force you to take less as the purchase price?
Also in our experience and from the buyer’s perspective, it is important to examine the employment-related agreements and status of the workforce with an eye towards understanding the “good, the bad, and the ugly.” With that sort of insight, a buyer can make an informed decision as to whether to pull the trigger on the deal, re-structure it if necessary, or to negotiate a reduced purchase price that takes into consideration the potential liability discovered during the due diligence phase.
Contact Michigan attorney Jason Shinn for more information about conducting due diligence or presale assessment focused on employment law compliance and human resource issues. Mr. Shinn routinely works with buyers and sellers, as well as their attorneys or CPAs as a subject matter expert when it comes to Michigan and federal employment laws and non-compete issues involved in mergers and acquisitions.