Protecting Goodwill When Buying A Business

One of the most important features of a prospective business is its goodwill, which has sometimes been described as the very ‘sap of life’ of it.

As a potential buyer, what would you do if you bought a business with significant goodwill, only to have the seller open up a competing business nearby and trade off the goodwill of the business that was sold to you? How would you react if the seller used confidential customer lists of the business to peach your customers for their newly-created business?

This is where ‘restraint of trade’ clauses in contracts can help protect you as a buyer. Unless you have a reasonably effective restraint of trade clause in the business sale contract, or as a separate agreement, you may not be able to do anything. Consequently, you would not be getting what you bargained for.

Issue

As a buyer you may be presented with a standard contract, such as the REIQ contract, that provides a standard restraint of trade by geographic area and time only. This may not be enough, For example, such restraints provide that the seller cannot start a competing business to the one sold within a defined radius of say, five kilometres, for a defined period of say two years.

While this may be useful when a majority of the business’ customers are within a certain distance from the business premises, as is the case with takeaway shops, grocery stores and newsagencies, it will not be satisfactory when the customers are spread far and wide, in the case of professional service firms, manufacturing businesses and specialised retail shops. Therefore, a buyer also needs to consider restraining other conduct by the seller after settlement, for example:

1. Restraining competition: the seller providing competing goods and services;
2. Assisting competitors; the seller promoting or assisting another competitor;
3. Soliciting customers; the seller soliciting the customers of your new business;
4. Interfering with employees: the seller attempting to poach the employees of the business:
5. Disclosing confidential information:  the seller using confidential business and financial information of the business.

It may also be the case that restraining the seller alone is insufficient.

For example, if the seller is a company, a director or shareholder who is not personally restrained may start a competing business in their own right or in another company they control.

Therefore, restrains of shareholders, managers and key employees of the seller might also be necessary in order to protect the goodwill of the prospective business.

Solution

Unless the contract provides sufficient restraints against the seller, you might not be protecting your interests. However, not all restraints are valid at law and you have to get them right by ensuring that the restraint clause covers your practical needs, without being at risk of being too wide and unreasonable, it will be invalid and therefore unenforceable. The three main limitations that are required in most types of restraints to ensure reasonableness relate to:

1. The scope of the activity prohibited:
2. The duration of the restraint, for example time, and
3. The area within which the restraint operates, for example geography.

The total restraint should be reasonable in the interests of both the buyer and the seller.

Restraints of trade clauses are important and often critical to the deal, so if you are in any doubt as to what is reasonably necessary, you should discuss it with your lawyer as early as possible to protect you interests and avoid any unnecessary delays.

Unless you have a reasonably effective restraint of trade clause in the business sale contract, the goodwill of your new business might be seriously undermined and you will not be getting what you bargained for.