In connection with the purchase of a family-owned business, the buyer may seek a non-compete agreement from the selling owners and certain family member employees.  Such agreements are intended to protect the buyer from a seller’s competition with the business post-sale and from diversion of the customer relationships and goodwill that typically are part of the purchased assets.  Courts will generally enforce a non-compete agreement negotiated as part of a business sale as long as it is reasonable in geographic scope and duration.  What is reasonable will depend on factors such as the type of business being purchased, the pre-sale geographic reach of the business, and the consideration paid for the restriction on the seller’s future competition.  Parties to a non-compete should therefore carefully consider these factors when drafting the agreement.  The parties also should carefully define what type of “competitive” conduct will be restricted.   

In E.T. Products, LLC v. D.E. Miller Holdings, Inc., the United States Court of Appeals for the Seventh Circuit recently addressed the enforceability of non-compete agreements that had been negotiated in connection with a sale of a business.  Doug Miller owned two companies – E.T. Products, which blended and sold fuel additives, and Petroleum Solutions, which was a fuel additives distribution company.  Miller sold E.T. Products to an investor group in 2011.  In connection with that sale, Miller and his son each signed non-compete agreements.  Under these agreements, Miller and his son were prohibited from assisting anyone engaged in the same industry as E.T. Products anywhere in North America for a period of five years.  The Millers also were forbidden to own, operate, invest in, advise, or render services to any competitor of E.T. Products.

After the sale, Petroleum Solutions, while still owned by Miller, continued to distribute fuel additives manufactured by E.T. Products.  Miller later sold Petroleum Solutions to John Kuhns in 2012.  In connection with the sale to Kuhns, Miller provided financing for Kuhns’ purchase, leased the land on which the business operated, and provided training and consulting as Kuhns learned the business. Miller’s son also provided computer training to Kuhns after the sale.  In late 2012, E.T. Products stopped using Petroleum Solutions as its distributor.  Petroleum Solutions then found a new supplier and also began blending its own additive products.  When Miller learned that the companies were no longer doing business together, Miller told Kuhns that he could not assist further with Petroleum Solutions’ additives business due to his obligations to E.T. Products under the non-compete agreement.  While Miller ceased all assistance to Kuhns and the business, the lease of the business property continued.

E.T. Products then sued Miller and his son for breach of their non-compete agreements.   The Millers argued that the non-compete agreements were geographically overbroad and thus unenforceable.  The trial court judge rejected that argument, but the judge concluded that the evidence established that the Millers did not in fact breach the non-compete agreements because Petroleum Solutions did not directly or indirectly compete with E.T. Products during the period when the Millers were assisting Kuhns.

On appeal, the Court of Appeals confirmed that the agreements were enforceable.

In doing so, the Court, applying Indiana law, noted that in a business sale, “a broad noncompetition agreement may be necessary to assure that the buyer receives that which he purchased.”

In this case, the Court concluded that the territorial restriction of competition throughout North America was reasonable.  Even though E.T. Products was not, at the time of sale, active in many American states or in Mexico or Canada, the Court credited the buyer’s statements that he bought the company with plans to expand it throughout North America. The Court concluded that the buyer “bought the broad noncompetition restrictions at a price, and failing to enforce them would deny him the benefit of his bargain.”

Even after determining that the non-compete agreements were enforceable, the Court of Appeals agreed with the trial court that the Millers did not violate the terms of the agreements because they did not assist Petroleum Solutions in competing with E.T. Products.  During the time period of the Millers’ assistance to Petroleum Solutions, that company was E.T. Products’ distributor and not a competitor.  Thus, during that period, the Millers’ assistance could not violate the agreement.  Once Petroleum Solutions began blending its own additives, it did become a competitor to E.T. Products, but at that point the Millers stopped training and advising Petroleum Solutions and did not assist Kuhns further.

E.T. Products finally argued that the continuation of the lease between Miller and Petroleum Products, on its own, constituted assistance to a competitor in violation of the non-compete agreements.  The Court of Appeals rejected this argument, noting that “collecting rent payments on a preexisting lease isn’t the kind of assistance that the noncompete covers.”  To require Miller “to break the existing lease with Kuhns – itself a breach of contract – once Petroleum Solutions became E.T. Products’ competitor” would be “an overbroad and unreasonable reading of the agreement.”  The Court thus affirmed the trial court’s judgment in the Millers’ favor, concluding that the Millers did not assist a competitor of E.T. Products in violation of the non-compete agreements.

The E.T. Products case serves as a reminder of the need for careful negotiation and drafting of non-compete agreements in connection with the purchase and sale of family-owned businesses.  In the sale of business context, where the parties have relatively equal bargaining power, a court may be more lenient in enforcing such an agreement.  However, the duration and geographic restrictions on competition, even though agreed to in the documents, may still be reviewed later by a court for reasonableness.  Courts will also focus on the definition of “competition” in order to determine the scope of prohibited conduct.  Thus, parties will want to ensure that the restrictions are clearly described and reflect the intentions and expectations of the parties.  Finally, purchasers will likely want to obtain non-compete agreements not only from the principal owners of the selling entity, but also from key family member employees so the seller is not able to compete indirectly through his or her relatives.  Through consideration of these issues at the negotiation and documentation stage, both buyers and sellers of family-owned businesses can better ensure that they receive the benefits of their bargain.  Careful drafting will also allow a court, as necessary in the course of later litigation, to interpret the non-compete provisions in a reasonable manner, in the context of the entire purchase and sale agreement, and consistently with the intent of the parties.