Mergers & Acquisitions: Post-Employment Restrictive Covenants In the Acquisition Context

The logistics behind the merger and acquisition of a smaller firm requires a keen eye to ensure that all your ducks are in a row before making the deal final. One area where in-house counsel will want to pay extra close attention is post-employment restrictive covenants. If the acquiring company fails to fully analyze these clauses, they may not be worth the paper it is written on.

Post-employment restrictive covenants prohibit employees from competing with their employer’s business after the two sever ties. There is a balance that must be struck in order to make these types of covenants valid. In general, post employment restrictive covenants require:

  1. a limited duration,
  2. a limited geographical location, and
  3. that the entire clause is reasonable.

However, even if the clause states these limitations, the restrictive or non-compete covenant may still be considered invalid after a merger is complete.

Assignment Clauses

Assignment clauses are agreements in an employment contract that allow a successor corporation to enforce the entirety of the contract. In order for an assignment clause to be valid, it needs to be executed at the same time as the non-competition agreements and other post-employment restrictive covenants. It is also necessary that assignment clause is written in clear and understandable language.

Although the rules vary by state, most courts across the nation have held that unless there is a specific assignment clause in the employer’s contract the agreement is not enforceable by the acquiring firm. However, the inclusion of an assignment clause complying with these requirements is not necessarily the end of the matter. Even if an assignment clause is included, many courts find it inequitable to enforce post-employment restrictive covenants against an employee who did not bargain for it with the successor corporation. Because of this, it is essential that the assignment and the restrictive covenant clauses are diligently reviewed by the acquiring firm and that any issues are addressed at a time when the parties can openly bargain in good faith with the employees being acquired.

Adequate Consideration

In determining whether or not post-employment restrictive covenants will be valid post-acquisition, attorneys must also examine whether there was adequate consideration for the restrictive covenant when the contract was signed. If the underlying agreement would not have been enforceable by the company that was acquired, it will not be enforceable by the successor corporation.

When agreeing to a restrictive covenant, the employee must fully appreciate the consequences that the clause will have on his or her career. If an employee does not fully understand the extent of the clause or if the clause is simply non-negotiable, then a court is not likely to uphold the post-employment restrictive covenant. Therefore, before an acquisition is complete, figuring out whether or not a restrictive covenant holds any weight may affect the company’s overall decision in following through with the merger.

Other Enforcement Concerns of Restrictive Covenant

Another red flag that should raise concerns is whether the acquired company uniformly used restrictive covenants when signing employees and whether the covenants were enforced when used. Inconsistent use and enforcement of restrictive covenants may undermine their enforceability by the acquiring company when the situation arises.

Thoughtful consideration of the extent of a restrictive covenant can also prevent future problems with these clauses after acquisition. When larger, nationwide corporations swallow up smaller local businesses, the limitation of geographical location may affect the viability of these clauses. Since nationwide companies have a larger reach, a restrictive covenant may not be possible if it restricts similar employment in several different areas around the world. Also, if the substantive restriction of the original agreement had limited scope because of the limited product line of the original company, there may be inequities in enforcing these limitations if the acquiring company encompasses a much larger product line.

Finally, state laws relating to restrictive covenants will require careful examination since state law controls their enforceability. While most states follow the guidelines set above, some states also enact specific caveats that make certain type of restrictive covenants either enforceable or invalid.

Ensuring that mergers and acquisitions go smoothly can take a lot of time and effort. Learn more about post-employment restrictive covenants and other employment law issues through FindLaw.