McBride Law Blog

Covenant Not To Compete When Buying or Selling a Business (Part V)

McBride Law Blog

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Texas.

In Texas, as in many other states, a covenant not to compete is enforceable if: (i) it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made; (ii) it is reasonable as to time, geographic area, and scope of activity to be restrained; and (iii) the restraint imposed is no greater than is necessary to protect the goodwill or other business interests at issue.[1]  If the first two conditions are met but the restraint imposed is greater than necessary, Texas courts have the authority to reform the covenant to the extent necessary to make it reasonable as to time, geographic area, and scope of activity.[2]

In determining the enforceability of a non-compete, Texas courts will also look beyond the label to ascertain the true nature of the transaction.  Bandera Drilling Co., Inc. v. Sledge Drilling Corp. involved an asset purchase and sale transaction between two drilling companies in Texas.[3]  Under the agreement, labeled “Bandera Drilling Company, Inc. Six Drilling Rigs and Three Pieces of Equipment Purchase Agreement,” Bandera Drilling Company (“Bandera”) sold six drilling rigs and some equipment to Sledge Drilling Corp. (“Sledge”) and agreed not to compete in the oil or gas well contract drilling business in a specifically defined area for five years.  Bandera then introduced some of its employees to Sledge, transferred at least a portion of their employment files (allegedly so they could obtain health insurance), and introduced Sledge to its customers, even though Bandera was not obligated to do so under the agreement.  Subsequently, Sledge was acquired by another company and Bandera tried to sell them another rig.  When this did not work out, Bandera decided to test the non-compete provision by going back into the business in West Texas.  Sledge filed a lawsuit, claiming that the non-compete was enforceable because the purchase and sale transaction transferred goodwill of the business, as reflected by the employee and customer introduction and the transfer of employee files.

The court found that the agreement between Bandera and Sledge was an otherwise enforceable agreement, as required by Texas law.  Whether the non-compete was ancillary to or part of that agreement, however, was not an easy question to answer because it was not clear whether goodwill of the Bandera business was transferred at the time of the purchase and sale transaction.  Specifically, the agreement contained no reference to business goodwill.  Indeed, Bandera argued that the transaction was a mere equipment sale, as opposed to a sale of the business as a going concern.  The court said that goodwill was unquestionably transferred to Sledge by Bandera’s actions—introduction of its employees to Sledge as the new owner, transfer of employee files, and personal introduction of its customers to Sledge, among other things.  Nevertheless, the court said, if Bandera was required to do none of these under the written agreement, and there was nothing unique about the physical equipment Sledge purchased that would otherwise provide a competitive advantage, the non-compete was a naked restraint of trade.  Accordingly, the court held that the non-compete was unenforceable.

This post was part of a multi-part series on covenant not to compete in the context of buying or selling a business.  You can find the other posts by searching our blogs at www.mcbrideattorneys.com.  If you have any questions about the content of this blog or other business law issues not discussed here, please contact us.

If you have any suggestions for blog topics, please send them to info@mcbrideattorneys.com.

This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein.  This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances.  This article should not be treated as legal advice to any person or entity.

Steps have been taken to verify the contents of this article prior to publication.  However, readers should not, and may not, rely on this article.  Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.

[1] Tex. Bus. Comm. Code § 15.50(a).

[2] Id. § 15.51(c).

[3] See generally Bandera Drilling Co. v. Sledge Drilling Corp., 293 S.W.3d 867 (Tex. App.—Eastland 2009).  Unless otherwise noted, all references to the case are from this citation.

Posted In: Business Management, California Law Update, New York Law Update, Texas Law Update, Uncategorized

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