Virtually every jurisdiction is in accord with the notion that non-compete agreements in the sale-of-business context are more readily enforced than those incidental to an employment relationship. Courts legitimately recognize that covenants are part of a bargained-for exchange and that compliance with them by the seller allows the buyer to realize the benefit of its bargain.
Though challenges to enforceability of a sale-of-business non-compete are far less common, they do occur and the arguments raised in trying to invalidate a freely negotiated covenant often strain common sense. One contention often argued by a seller trying to wiggle out of a non-compete involves the allocation of purchase price.
When parties enter into an asset purchase agreement, they need to determine the adjusted basis for the assets included in the sale. Sometimes this can be a point of contention, as the buyer and seller need to agree what portion of the purchase price must be allocated to equipment, fixtures, and intangibles - like goodwill.
Goodwill is the most often cited interest that justifies a non-compete in a sale-of-business. It is strictly intangible, representing the reputational value a going concern has built up over time. That value is expressed through repeat business or a particularly strong brand for key products. The buyer, who benefits from a seller's non-compete, faces somewhat of a paradox: It wants to allocate as little of the purchase price to "goodwill" as possible. It would rather allocate the purchase price to hard assets that can be expensed. (Goodwill can no longer be amortized.) If buyer and seller shove very little of the purchase price into goodwill, a seller could raise the argument - as it did (unsuccessfully) in RSG v. Sidump'r Trailers - that a sale-of-business non-compete's protectable interest was worth very little and disproportional to the impact of the restraint of trade.
Courts seem to see right through this argument, perhaps recognizing that an accounting methodology should not mask the realities of a business transaction. An allocation of purchase price has no bearing whatsoever on the protections offered by a seller's non-compete. During this phase of an acquisition, the non-compete likely has already been agreed upon, and the accountants (not the lawyers) have been left with the task of agreeing on a Form 8594 for the purchase price allocation.
Court: United States District Court for the District of Nebraska
Opinion Date: 1/29/10
Cite: RSG, Inc. v. Sidump'r Trailer Co., Inc., 2010 U.S. Dist. LEXIS 8206 (D. Neb. Jan. 29, 2010)
Goodwill (and customer records and other intangibles) CAN be amortized (deducted) over 15 years by the Buyer under IRC Section 197 and are eligible for (possible long term) capital gains treatment by the Seller. The problem is with Non-compete allocations, that must be treated as regular income to the Seller but must be amortized over 15 years by the Buyer - it's a lose/lose taxwise. So, allocations to non-competes get shifted to goodwill as "no harm" to the Buyer and a big tax benefit to the Seller. The IRS is thinking about requiring equality between the goodwill and non-compete allocations.ReplyDelete