Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

If you're buying a business, one thing you you really don't want is for the previous owner to go out and set up a competing business.  To avoid this, Purchase Agreements frequently contain a noncompetition clause or there is a separate Noncompetition Agreement to be signed by the principals or key personnel of the seller.  Question is: will this work?  ANSWER: Probably, based on a recent case.

I've previously made a post entitled "All About Enforceability of Noncompetes in Ohio" in which I explained how Ohio courts tend to reluctantly enforce noncompetition agreements. I've also previously posted on the answer to the question "Can a New Owner Enforce a Noncompete Made by an Employee with the Prior Owner?"'  Answer: probably, but not always.  And the answer revolves around whether it was contemplated that the noncompete would be assigned at some point and how big a burden does it place on the ex-employee purportedly subject to the non-compete.

So what about noncompetes signed contemporaneously with the sale of the business?  A recent case involving CPAs suggests that such provisions are likely to be deemed enforceable..

In Century Business Services, Inc. v. Urban, 179 Ohio App.3d 111, 900 N.E.2d 1048, 2008-Ohio-5744 (Cuyahoga Cty 8th Dist.) the purchaser of a CPA firm had obtained a noncompete agreement from the defendant ,who was the principal of the selling CPA firm, in conjunction with the execution of an Asset Purchase Agreement.  The defendant partner continued to work at the firm following the ownership change until he was eventually fired.  The matter came before the trial court in the form of a declaratory judgment action.  The trial court upheld the noncompete provisions, although it limited the geographis scope somewhat.

On appeal, the Court of Appeals framed the issue as follows:

At issue in this appeal is the freedom to contract and the enforceability of noncompetition and nonsolicitation  agreements associated with the sale of a business.  Significant to this analysis is whether these agreements when they are entered into contemporaneously with the sale of a business should be distinguished from ones that are entered into by employees as consideration for employment.

The Court of Appeals further emphasized the fact-specific nature involved in analyzing each case.  It concluded that "restrictive covenants entered into ancillary to the sale of a business should be afforded less scrutiny than ones entered into by employees as consideration for employment."  As long as they are "reasonable", judged by the same factors as ordinary noncompetes, but less rigidly, such noncompetes ARE ENFORCEABLE.  Among other reasons supporting the enforceability of such provision in the context of a sale of the business, the Court of Appeals pointed out that

• Sellers often receive a higher purchase price for agreeing to a noncompete than they otherwise would for the sale of their business.
• generally speaking, there is much more true freedon of contract between buyer and seller than between employer and employee

To me, this conclusion makes good sense.  It IS important to the buyer of a business to have the noncompete and Sellers really DO have more of an option about whether to agree to such provisions and what the geographic scope and duration should be than employees who know that the likely alternative if they don't sign is having their employment terminated..

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Is an employee with a non-compete or confidentiality agreement still bound by it after the employer sells the business to a new owner?  Can the new owner enforce such an agreement which was made between the employee who continues working for the company and the prior owner?

Everyone understands that before buying another company, lots of "due diligence" about finances, customers, products, and general business operations should be done.  While these are certainly important concerns, you must also not lose sight of the "human capital" in the form of employees that you will be inheriting regardless of whether you choose to structure the transaction as an asset or a stock transaction.  How can you be certain that key employees won't depart to work for a competitor?

You can of course "rehire" employees, taking care to have each of them sign new confidentiality and/or noncompete agreements.  But what about employees who simply decide they'd rather go work somewhere else than remain employed under new ownership?  In addition, inevitably, not all of the "rehires" will have signed the new agreements.  There may also be cases where it is simply not feasible to have everyone sign new agreements.  So the issue becomes whether the new owner can rely upon noncompetition and confidentiality agreements predating the change in ownership.

Ohio, like many other states, generally views noncompetition agreements with some degree of skepticism.  Confidentiality agreements must likewise be supported by good business reasons.  As a result, these agreements, while enforceable, will be strictly construed.

The same reluctant enforcement also applies to the ability of new owners to enforce noncompetition and confidentiality agreements made by the employee with the previous owner.  As one might expect, as long as a business merely changes its corporate form (as when a sole proprietor decides to incorporate), but otherwise remains the same with the same ownership  and operations, it has long been the law in Ohio that noncompetes remain enforceable.  Rogers v. Runfola & Assoc., Inc., 57 Ohio St.3d 5, 565 N.E.2d 540 (1991).  It's also fairly clear that if an employee simply chooses of his or her own accord not to work for the new owner, the new owner is permitted to enforce such covenants.  However, where there has been a change in ownership and the employee remains employed, it becomes more complicated.

When ownership of the business changes hands and the employee remains employed for a period of time, Ohio courts ask two basic questions: (1) whether it was contemplated that the noncompete/confidentiality covenant would be assigned; and (2) whether allowing the enforcement of the noncompete/confidentiality covenants against the employee is important to preserve the goodwill of the business sold.  See The Fitness Experience, Inc. v. TFC Fitness Equipment, 355 F. Supp. 2d 877 (N.D. Ohio 2004); Artommick Int'l v. Koch, 143 Ohio App.3d 805, 759 N.E.2d 385 (10th App. Dist. 2001). 

In answering the first question, it is not essential that the underlying noncompete/confidentiality covenant specify that it is assignable, but that is certainly helpful.  Courts have also found that a general assignment of the employment contract without specific mention of the noncompete/confidentiality covenant is sufficient.  In this regard, Ohio is more liberal than many other states which require affirmative provisions allowing assignment. 

In addressing the goodwill issue, Ohio courts may look at the underlying business as it exists following the change in ownership.  For example, in Relizon Co. v. Shelly J. Corp., the Court noted that the new owner had led the employee to believe that his customers would no longer be service dby the company and the Court thus concluded that since it was "unclear" what goodwill was being protected, the noncompete was unenforceable by the new owner.

For more information about how other jurisdictions address this issue, information can be found at 12 A.L.R.5th Enforceability, by purchaser or successor of business, of covenant not to compete entered into by predecessor and its employees.

 PRACTICAL COUNSEL:  

1. When preparing a noncompetition or confidentiality agreement to be signed by employees, be sure to include a provision allowing assignment of the agreement.  This can add value later if you want to sell the business.

2. Don't despair if there isn't a provision allowing assignment of the prior noncompete or confidentiality agreement, but recognize that this may be a loophole.  Some Ohio courts have also found the fact that the new owner tried in vain to have employees sign new noncompete agreements as supporting its conclusion that the prior agreements were nonenforceable so be careful about insisting on new agreements.

3. Don't give courts a reason to decide that allowing enforcement does nothing to preserve the goodwill of the business which has been purchased.  Consider adding something to the business purchase agreement recognizing the importance of the assignment of these agreements.  Be careful how quickly you phase-out marginal aspects of the business.

UPDATE: Murray v.Accounting Center & Tax Services, Inc., 178 Ohio App.3d 432, 2008-Ohio-5269 (Lucas Cty 6th Dist.) (discretionary appeal not allowed by Ohio Supreme Court) - Duration of noncompete agreement containing assignment clause allowing its transfer upon sale or merger of the company reduced to one year enforceability by new owner of company.

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