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Non-compete Clauses – Staying Within the Boundaries
Non-compete clauses can provide important protection for purchasers who have a legitimate interest in maintaining the value of the business they are acquiring. However, careful consideration must be given to the drafting of non-compete clauses in order to avoid allegations of anti-competitive conduct – which is a criminal offence in Ireland – and scrutiny from competition regulators such as the Competition and Consumer Protection Commission (CCPC) and the European Commission.
In general, a non-compete will not raise concerns if it:
•is limited to a duration of two years (where goodwill is being transferred);
•is limited to a duration of three years (where know-how also transfers);
•relates strictly to the business being acquired; and
•is limited to the territory in which that business already operates.
Non-competes that are overly broad in scope, of excessive duration or aim to protect the seller are unlikely to be considered necessary for the implementation of a transaction and may therefore:
•attract regulatory attention;
•be rendered unenforceable; and
•be subject to penalties.
A recent case demonstrates the potential pitfalls when a non-compete strays beyond these safe harbours, in the CCPC merger control determination of Sean Loughnane/Crinkle non-compete clauses were scrutinised.(1)
Non-compete clauses background
Any sale agreement will typically include a number of restrictive covenants (also referred to as ancillary restraints) imposed on the seller such as:
•a non-compete clause (ie, restricting the seller from setting up a business that competes with the buyer's newly acquired business for a specified period of time after closing);
•non-solicitation clauses; and
•purchase and supply obligations.
However, such clauses are permitted only in specific circumstances.
The European Commission has issued a notice providing valuable guidance on ancillary restraints, which includes non-compete clauses.(2) According to the notice, non-compete clauses must be "directly related and necessary to the implementation of the transaction". Non-compete clauses should be limited to the target's activities (ie, the products or services that make up the target business) and restricted in geographical scope to the territories in which the target business is operating at the time of completion. Therefore, the scope (product and geographic), duration and subject matter of the clause must not go beyond what is reasonably necessary to achieve the legitimate aim of implementing the transaction.
In terms of duration, the notice states that a three-year period is generally acceptable if both goodwill and know-how are acquired and two years if only goodwill is acquired.
Further, in transactions notifiable to the CCPC, parties must provide details of any ancillary restraints agreed between the parties or anticipated to be agreed between the parties. The CCPC will closely scrutinise any such agreements during its review and may raise questions where it believes that the scope of the clause goes beyond what is reasonably necessary to achieve the legitimate objective of implementing the transaction.
Outside of the merger control process, there is a potential risk that affected third parties (eg, a competitor or customer) or a disgruntled party, which is aware or suspects that an agreement or arrangement between parties to a transaction may be anticompetitive, can report or make a complaint to the CCPC or the European Commission, prompting the relevant authority to investigate.
The recent Sean Loughnane/Crinkle decision reaffirmed that non-compete clauses are permitted only when they are appropriately limited in accordance with the above rules.
The CCPC granted merger clearance on the condition that the parties delete a non-compete clause (in its entirety) from the asset purchase agreement. The transaction concerned the purchase by Sean Loughnane of business assets from Crinkle Fine Foods, from its parent, O'Brien Fine Foods. During its assessment of the transaction, the CCPC discovered that the parties' proposed agreement would prevent Sean Loughnane from competing with O'Brien Fine Foods in Ireland and the United Kingdom for two years following completion.
The CCPC found that, as O'Brien Fine Foods was not involved in the transaction and did not offer products and services that were part of the economic activity of the target assets, the non-compete clause was not directly related to and necessary for the implementation of the transaction and was potentially in breach of Section 4 of the Competition Acts 2002 and 2017 (as amended). To address the concern, the parties to the transaction agreed to vary the agreement and delete the non-compete clause (and non-solicitation clause) imposed on the purchaser in its entirety.
The CCPC allowed the non-compete obligation imposed by the agreement on Crinkle Foods and in assessing the permissibility of the clause, it followed the general European Commission approach set out in its notice on ancillary restraints.
A non-compete clause can have a valid part to play in transactions in protecting the purchaser's interest in the target business. Its role may be small in the context of a large M&A deal, but the consequences of a poorly drafted clause can raise unwanted attention from the competition authorities, potentially causing delays to a transaction or even resulting in damages. Competition authorities take a strict approach to clauses that go beyond the scope required to legitimately preserve the value of an acquired business.
This article was first published by The International Law Office and co-authored by EU Competition associates Ronan Scanlan and Liam Heylin.