March 30, 2015
By Jacob Ecker, Executive Senior Editor

Introduction

Imagine a business sale contract between Buyer and Seller for the transfer of Seller’s business assets and goodwill.[1] Seller is a natural gas well servicing company active in the Haynesville Shale in North Louisiana. Seller is looking to get out of that business, and Buyer, a private equity firm,[2] is looking to purchase Seller’s assets and set up a management team to run its newly acquired company.

As part of this deal, the parties agree that the Seller will not compete in the Haynesville Shale area, with the agreement listing those parishes specifically. Considering the continuing interest that Buyer will have in making sure that Seller does not come back into the area and start competing after having sold off its assets and goodwill—including all of its customer lists—the parties want to agree to a term of five years of restraint from competition in the area. However, the parties’ attorneys tell them that unlike in most states, Louisiana only allows the restraint to last for two years.[3] Because of this limitation, Buyer wants to reduce the price of the sale on the theory that without a longer protection period, Buyer will be subject to the risk of Seller coming back into the area and recapturing the goodwill he sold to Buyer.[4]

Whereas most other states have recognized a distinction between the more frequently litigated employment noncompetes and noncompetes in the sale of a business by providing for more lenient rules in the latter context,[5]  Louisiana has failed to do so.[6] The reason for this difference in other states is clear—sale of business noncompetes just seem more fair.[7]

The boom of the oil and gas industry and investment by private equity funds in oil and gas services[8] expose a fundamental problem with the current formulation of sale-of-a-business noncompete rules in Louisiana. Under the current regime, these businesses are left without the tools necessary to protect the legitimate business interests surrounding their investments—the purchase of goodwill—which, in many cases, need protection well beyond the two years that Louisiana currently allows. The current version of Louisiana Revised Statutes section 23:921(B) is too restrictive given the looser policy imperatives in this context as compared to employment noncompetes. The Louisiana Legislature should reevaluate these differences and modify the temporal restraint in business-sale noncompetes to allow for restraints of up to five years from the date of the sale.

Part I of this Post examines the policy rationale for Louisiana Revised Statutes section 23:921(B), concluding that the actual policy considerations in business-sale noncompetes with respect to duration do not correspond with the formal rules in the statute. Part II then proposes a solution to the inequitable duration rules in Louisiana and examines a possible repercussion of that solution, providing guidance for the courts in dealing with that possibility.

I. Rules and Policy—Why a Two-Year Maximum Duration Is the Wrong Rule for Business-Sale Noncompete Policy

A noncompete is “[a] promise, [usually] in a sale-of-business, partnernship, or employment contract, not to engage in the same type of business for a stated time in the same market as the buyer, partner, or employer.”[9] The policies differ somewhat depending on the type of noncompete at issue.[10] In Louisiana, though the policy interests for noncompetes in business sales are quite different from other contexts, the rules are identical across the board.[11]

A. Rules of Enforceability for Louisiana Business-Sale Noncompetes

Business-sale noncompetes are allowed under certain circumstances as an exception to the general rule of unenforceability of noncompete agreements.[12] People, including juridical persons, “who sell[] the goodwill of a business may agree with the buyer that the seller or other interested party in the transaction[] will refrain from” certain competition.[13] Specifically, the parties can agree that the seller will not “carry[] on or engag[e] in a business similar to the business being sold,” or solicit customers of the business being sold.[14] However, for such an agreement to be enforceable,[15] the agreement must list the parishes and/or municipalities constituting the geographic scope of the restraint and may not “exceed a period of two years from the date of the sale.”[16]

Under current law, these requirements are identical regardless of the type of noncompete, such that courts often use employment noncompete jurisprudence in examining business-sale noncompetes.[17] One example of this type of crossover is Boswell v. Iem, where the seller of a drapery business agreed “not [to] compete in this or any similar business with purchaser for a period of three (3) years in the Shreveport-Bossier City area, and in the area within the radius of 50 miles thereof.”[18] In coming to the conclusion that such an agreement was unenforceable as overly broad both with respect to duration and geography,[19] the court cited several employment cases in stating that “[c]ourts strictly construe agreements limiting competition.”[20]

B. Employment Noncompete Policy “Encroachment”[21]

Although crossover like that demonstrated by the Boswell case is necessitated by the current statute’s identical duration requirement[22] in business-sale and employment noncompetes, the underlying policy considerations for these two contexts are vastly different. Examining the interests at play in the two types of agreements illustrates this difference. These policy considerations show that the Louisiana Legislature failed to consider these disparate policies, such that the valid interests of both buyers and sellers of a business’s goodwill are unjustly hampered.

Courts all across the country subject employment noncompetes to strict interpretation. The basic policy reasons for this position are (1) the unequal bargaining power inherent in the employment relationship, (2) the short-lived nature of the value given in exchange for a noncompete agreement, and (3) the idea that noncompetes require employees to surrender the only asset of value that they possess—their labor.[23] These considerations lead to the idea that specific limitations should be placed on the scope of allowed agreements because the employees have no real control over the end agreement (reason one), the employer has no legitimate interest in requiring that the employee not compete past a certain period of time and outside a certain area (reason two), and the employee has a significant countervailing interest in a narrow restriction (reason three).[24]

In the context of the sale of a business, none of these fundamental rationales hold true. Instead, buyer and seller are usually on relatively equal footing with respect to bargaining power,[25] the consideration is often more valuable and longer lasting, and the noncompete does not hinder the seller’s fundamental ability to earn a living.[26] With respect to bargaining power, it is usually the case that the noncompete provision is negotiated between the parties, both of whom are fully represented.[27] In terms of value, business-sale noncompetes provide much more substantial value for both buyers and sellers than in the employment context. Specifically, the consideration, part of the total sale price for the business, is often quite substantial. In one Louisiana case, for example, the sale price with which the noncompete was associated was $1.6 million.[28] Additionally, noncompetes, as components of these sales, add value to the sales themselves because for the goodwill to have value to the buyer and for that value to translate into a high sale price, the risk that the goodwill might be taken from the buyer by the seller soon after the sale must be eliminated.[29] Without a noncompete, the seller could potentially sell something (the goodwill) and take it back without having to pay for it.[30] Finally, the concern in employment noncompetes that the employee is restricting his or her only valuable asset is not implicated in this context because the seller is receiving a sale price for what he or she is voluntarily alienating.[31]

This policy distinction, though not recognized in Louisiana, has been well developed in other states across the country. In Texas, a state similarly situated to Louisiana with respect to oil and gas investment, courts have found lifetime noncompetes within limited geographic scopes valid in situations similar to that in Boswell.[32]  In one such case, the Texas Court of Appeals for the First District found that a party’s reliance on employment noncompete case law “[was] misplaced . . . [since] the case does not involve the sale of a business.”[33] Even beyond the context in which Texas courts will allow noncompetes of unlimited duration, which are usually situations with very limited geographic scopes,[34] courts allow business-sale noncompetes to last far longer than employment noncompetes.[35] Even California, an outlier state that completely bans employment noncompetes, allows business-sale noncompetes.[36] Moreover, California courts routinely allow duration of greater than that allowed in Louisiana. In Laird v. Steinmann, for example, a California appellate court a noncompete of five years for the sale of an industrial laundry business in Los Angeles County.[37]

II. Applying the Proper Policy in Louisiana—A Legislative Solution

One commentator proposed in a 2012 article that courts no longer use the strict interpretation rule adopted from employment noncompetes in the business-sale noncompetes.[38] However, it is unlikely that the courts will move from their current position without legislative change, especially given the nature of the business-sale noncompete rules as an exception to the general rule that noncompetes are unenforceable as against public policy.[39] Thus, this Post offers a modest legislative amendment that lawmakers and interested parties can all support—an extension of the permissible duration from two to five years.[40] Such an amendment, though it would not fix all problems of “encroachment” in courts’ analyses, would be an important first step in that direction and one that would be likely to garner support from industry groups.[41]

Although it is unlikely that this amendment would face significant opposition, one problem might arise in the courts. Amending the statute to have different requirements in subsection B and C,[42] the business sale and employment noncompete rules, respectively, will mean that courts will have to distinguish between situations in which to apply subsection B and those in which to apply subsection C. In many circumstances, the distinction will be clear because the seller will not subsequently go to work for the buyer. In circumstances where this does occur, however, some guidelines will help courts to decide which rules to apply.

Assuming that one owner of the seller entity (i.e., a shareholder, partner, etc.) transitions into a managerial or other employment role with the buyer, which is the only time these guidelines should be necessary, the first thing that courts should examine is the location of the noncompete agreement—whether it is contained in the sales contract or in a separate employment agreement. Although not dispositive, this consideration could be helpful in cases where there is only a single owner of the seller entity and that owner is going to work for the buyer. Another consideration should be the existence of two separate noncompetes. There is nothing in the statute that prevents the parties from agreeing to a noncompete ancillary to the sale of the business. Under this Post’s proposal, agreeing to a business-sale noncompete would be allowed to continue for five years from the time of the sale. The statute would also not prevent parties from agreeing to an employment noncompete, which would be allowed for up to two years after termination of the employment.[43] Finally, if all other considerations fail to prove helpful, courts should simply look to all the circumstances surrounding the sale and employment negotiations to determine whether the parties intended the agreement to protect the goodwill being sold or whether it was to protect the buyer from competition for any other reason. If a court should find that the agreement is not to protect goodwill, it should treat the agreement as an employment noncompete.

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[1] Goodwill is defined as “[t]he value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology.” Definition of Goodwill, Investopedia.com, http://www.investopedia.com/terms/g/goodwill.asp, archived at https://perma.cc/XXB9-JXTE (last visited Mar. 17, 2015).

[2] This type of transaction is very common in today’s oil and gas market. See Refilling the Pipeline: The Plunging Oil Price Has Pummelled Private Equity But May Now Help It, The Economist (Feb. 14, 2015), available at http://www.economist.com/news/finance-and-economics/21643066-plunging-oil-price-has-pummelled-private-equity-may-now-help-it-refilling, archived at https://perma.cc/U62P-94TX.

[3] See La. Rev. Stat. Ann. § 23:921(B) (Supp. 2015) (two year rule).

[4] See discussion infra Part I.B.

[5] Hosp. Consultants, Inc. v. Potvka, 531 S.W.2d 657, 663 (Tex. Civ. App. 1975) (“[A] restrictive covenant in connection with the sale of a business or goodwill is quite different from a post-employment restriction. A transfer of goodwill cannot be accomplished effectively unless the transferor agrees not to diminish the value of the thing transferred by refraining from competing with his transferee.”); Siobhan Ray, Don’t Hop on the Bandera Wagon Just Yet: Enforcing Sale-of-Business Covenants Not to Compete in Texas, 65 Baylor L. Rev. 682, 686 (2013).

[6] La. Rev. Stat. Ann. § 23:921(B)–(C) (Supp. 2015). The other requirements of a valid noncompete are also the same between the two types. Id. In the context of these other requirements, though—that the agreement specify the “parish or parishes, or municipality or municipalities, or parts thereof” in which the putative competitor “carries on a like business”—there is no need to distinguish between the two types. See id.

[7] See discussion infra Part I.B.

[8] Haynesville Shale: News, Map, Videos, Lease and Royalty Information, Geology.com, http://geology.com/articles/haynesville-shale.shtml, archived at https://perma.cc/Z99Z-5KRP (last visited Mar. 9, 2015).

[9] Black’s Law Dictionary 420 (9th ed. 2009).

[10] See id. (discussing enforceability in these various contexts).

[11] See generally La. Rev. Stat. Ann. § 23:921 (Supp. 2015).

[12] See id. § 23:921(A)(1), (B).

[13] Id. § 23:921(B).

[14] Id.

[15] Id. § 23:921(A)(1).

[16] Id. § 23:921(B). One important aspect of all noncompetes in Louisiana is that the geographic scope can be reduced to an acceptable area if that specification is found to be overbroad when the parties include a severability clause within their noncompete agreement. See SWAT 24 Shreveport Bossier, Inc. v. Bond, 808 So. 2d 294, 308–09 (La. 2001); AMCOM of La., Inc. v. Battson, 666 So. 2d 1227, 1227, 1229 (La. Ct. App. 1996), rev’d, 670 So. 2d 1223 (La.) (mem.). However, this nuance is not discussed in detail here. For a more detailed discussion of the doctrine of reformation, see Albert O. “Chip” Saulsbury, IV, Devil Inside the Deal: An Examination of Louisiana Noncompete Agreements in Business Acquisitions, 86 Tul. L. Rev. 713 (2012).

[17] For a thorough discussion of cases that apply the general policy against noncompetes in the context of employment to business-sale noncompetes, see Saulsbury, supra note 15, at 730–37.

[18] Boswell v. Iem, 859 So. 2d 944, 945 (La. Ct. App. 2003) (internal quotations omitted).

[19] It appears that the court refused to reform the geographic scope of the agreement since the noncompete did not contain a severability clause. Id. at 945.

[20] Id. at 947. Although some of the cases that the court cited involved business sales, the courts classified them as employment noncompetes by applying the strictures of the employment noncompete subsection.  See id.

[21] Chip Saulsbury used the term “encroachment” in this context in his 2012 article. Saulsbury, supra note 16, at 730.

[22] Although the conflation of these policies is not limited to the duration limitation, this Post focuses primarily on the duration requirement as its target for legislative reform and thus, limits its consideration to that requirement here.

[23] Harlan M. Blake, Employee Agreements Not to Compete, 73 Harv. L. Rev. 625, 647–48 (1960). Many employment noncompetes have only continued employment as consideration, though some have more valuable things, such as expenses on training, provision of customers, etc. See id. However, in these situations, the value of the consideration deteriorates relatively quickly. Cf. id.

[24] Id.

[25] Saulsbury, supra note 16, at 740–42.

[26] Id. at 738–740, 743–44.

[27] Blake, supra note 23, at 647; Saulsbury, supra note 16, at 741.

[28] USI Ins. Servs., LLC v. Tappel, 28 So. 3d 419, 421 (La. Ct. App. 2009).

[29] Plunkett v. Reeves Apothecary, Inc., 351 So. 2d 867, 868 (La. Ct. App. 1977).

[30] This is especially true in Louisiana, where there is no implied warranty against competition. Saulsbury, supra note 16, at 742–43. See Barrera v. Ciolino, 636 So. 2d 218, 224–25 (La. 1994) (“Sale of a business and its good will does not preclude the seller from competing in a similar business, not even shortly thereafter and in the immediate vicinity.”).

[31] See Saulsbury, supra note 16, at 738–42.

[32] See, e.g., Oliver v. Rogers, 976 S.W.2d 792, 801 (Tex. App. 1998) (holding lack of time limitation did not render noncompete unreasonable as a matter of law); Clay v. Richardson, 290 S.W. 235 (Tex. Civ. App. 1926) (upholding lifetime noncompete in the town on seller of a theater).

[33] Oliver, 976 S.W.2d at 801. For other Texas business-sale noncompete cases, see Heritage Operating, L.P. v. Rhine Brothers, LLC, No. 02-10-00474-CV, 2012 WL 2344864, at *5 (Tex. App. June 21, 2012); Bandera Drilling Co., Inc. v. Sledge Drilling Co., 293 S.W.3d 867, 874–75 (Tex. App. 2009); Farmer v. Holley, 237 S.W.3d 758, 760 (Tex. App. 2007); York v. Dotson, 271 S.W.2d 347, 348 (Tex. Civ. App. 1954); Greenstein v. Simpson, 660 S.W.2d 155, 159 (Tex. App. 1983); Randolph v. Graham, 254 S.W. 402, 403–04 (Tex. Civ. App. 1923).

[34] See, e.g., Oliver, 976 S.W.2d at 801 (agreement limiting scope to a three-mile radius out from the office location); Clay, 290 S.W. at 235 (agreement limiting scope to one town).

[35] See supra note 31.

[36] Cal. Bus. & Prof. Code § 16601 (Westlaw 2014) (“Any person who sells the goodwill of a business . . . may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carried on a like business therein.”).

[37] Laird v. Steinmann, 218 P.2d 780 (Cal. Ct. App. 1950).

[38] Saulsbury, supra note 16, at 750.

[39] La. Rev. Stat. Ann. § 23:921(B)–(C) (Supp. 2015). Saulsbury also proposes separating the business-sale rules into a separate statute so that they no longer fall as an exception to the general policy against noncomepte  as a way to instruct courts that they should not be interpreted as strictly as employment noncompetes. Saulsbury, supra note 16, at 747–48. Although this approach might yield better results, such a comprehensive reform might not be necessary because lengthening the duration for business-sale noncompetes would likely alleviate many of the problems that these transactions face in Louisiana.

[40] Five years of enforceability has become the standard duration in this context. Cf. Steven E. Runyan, Employment Non-compete Agreements: Disfavored Does Not Mean Not Enforceable, KGRLaw.com (Feb. 24, 2014), http://www.kgrlaw.com/employment-noncompete-agreements-disfavored-mean-enforceable-2/, archived at http://perma.cc/2THK-RJPD (“[W]here a non-competition agreement is entered into in conjunction with the sale of a business, courts have regularly upheld give year non-competition agreements for the selling party.”).

[41] Cf. Saulsbury, supra note 16, at 740–41.

[42] See La. Rev. Stat. Ann. § 23:921(B)–(C) (Supp. 2015).

[43] This author recommends that counsel adopt this practice to avoid any doubt as to whether a noncompete should be analyzed under subsection B or subsection C.