The $20 Million Asset Purchase Agreement Non-Compete Problem (AKA the Death Star Non-Compete)

Today’s topic: The APA Death Star Non-Compete Agreement. You sell your company to venture capitalists for $20 million. You get some money immediately, some money in deferred compensation and some (restricted) shares in the new company. And you already know what else: You get the most hyper-aggressive, insane, worldwide, 5-year non-compete restriction. In the 5 years post sale, you cannot engage in any business that competes with the Company’s current business, past business or contemplated business. Contemplated business!

You know what’s wild? I’ve seen so many of these exact situations that all of this is old news to me. I’ve seen dozens of asset purchase agreements involving venture capitalists or serious and serial investors, with the Death Star of non-compete agreements attached. I’ve seen every version of that “contemplated business” provision imaginable. I don’t even have to look at the relevant APA to tell you what else is probably in there: Requirements for presentation of corporate opportunities. Offset rights that operate like this: The Buyer can simply say, “We declare you in breach of Provision A. We reasonably believe that this may cause us $3.75 million in damages. We claim a right to indemnification and offset. We intend to offset these damages against the remaining Deferred Compensation and your shares in the Company.” The $1 million (or $10 million) question: What are your options? We’ll get to that.

First, let’s start with some background. I’m Jonathan Pollard. Competition lawyer. Started my career at Boies, Schiller & Flexner doing mostly complex antitrust and securities litigation. Spun out into my own shop several years ago and started doing non-compete cases. Started small, because that’s where you start when you do it from scratch. And I clawed my way up from there. At this point, I have been involved in 500+ non-compete matters. That includes reviewing non-compete agreements and giving strategic advice; responding to cease and desist letters and negotiating pre-suit resolution; litigation; arbitration; and appeals. I have defended numerous complex, ugly, high-stakes non-compete matters. I have successfully defended a C-level executive of a publicly traded company and beaten the preliminary injunction. I have represented a partner in a partnership break up, and gotten him a final arbitration award declaring his non-compete agreement completely unenforceable and awarding him $1 million. I’ve defended sale of a business non-compete cases. I’m routinely in litigation with large, national law firms.  I have been quoted on non-compete issues by the New York Times, Bloomberg, Law360, PBS News Hour and more. Why do I mention all of this? Not because I’m a bald-headed, jerk-faced meanie. But because certain people deride my style as unorthodox and claim that I’m an unmitigated crazy person.

People can think whatever they like. I’m really not in a position to offer any assurances about my sanity or lack thereof. I’ve been stabbed. I’ve wandered around the country sleeping in my car. I walked away from being an associate at a great law firm to hang my own shingle in my third year of practicing law. I went broke twice and nearly went back to, yes, sleeping in my car. I’m obsessed with my work. I spend a lot of time reading cases, studying the law, and trying to figure out these questions. And now that you have some idea of who is writing this, back to the topic de jour:

The Death Star APA Non-Compete Clause. As noted above, this is the broadest non-compete ever. It extends to contemplated business, reasonably contemplated business, and ventures in which the Company potentially may engage. It requires you to present any and all possibly competitive business opportunities to the Company. Also, because you’re an employee, you owe the company certain fiduciary duties. (Gotcha). As a hammer to enforce all of this, the APA almost certainly comes with offset rights. Two years elapse. You, our serial entrepreneur, are at odds with your new VC overlords. You’re working for the company, but you’re miserable. You’ll be parting ways with the Company in short order. At that point, even though your employment will end, you will still be bound by the APA non-compete restrictions for the remainder of the term. It could be another 3 years. It could be another 5 years. You’ve got other options on the table. You’ve got other business ventures. You’ve got other opportunities in play. What do you do? That’s a serious question. A serious answer is going to implicate all of the following:

  • Choice of law (FL, DE, NY, NJ, CA, etc.). It’s probably DE but you never know. It makes a huge difference.
  • Forum: Are you locked into state court in an unfavorable jurisdiction? Can you get into federal court per the APA forum selection clause and diversity? Or is it subject to arbitration? Where’s the arbitration? Florida? New York? Delaware? Again, it makes a difference. Which arbitrating body? AAA? JAMS? Again, it matters. In certain jurisdictions, the roster of available arbitrators is trash. You better have a handle on all the possible arbitrators. Is there a carve-out for injunctive relief?
  • Pre-sale carve outs for your other existing businesses. Check the schedules. This is huge. What you THOUGHT you were negotiating/getting often doesn’t match the reality (i.e. the language of the APA/schedule). I saw this in Lehman Brothers v. Barclays when I was at Boies Schiller (but on the other side). It doesn’t matter if you have a team of 30 big firm lawyers working the deal. This sort of disconnect happens all the time. You THOUGHT you were getting X carve out. But the APA doesn’t say that. It says Y.
  • Indemnification process. Notice of claim. Offset rights. Order of offset. Scheduled payments. Deferred compensation. Stock redemption and liquidation. Demand for payment above that number.
  • Any limitations on liability per the APA that are mutual. Possibly a huge loophole depending the language.
  • Corporate opportunity doctrine / breach of fiduciary duty. You’re an employee, so that’s a problem at least until you break free.
  • The LLC operating agreement. Could be a gotcha with additional fiduciary duties imposed and additional limits on competitive activity.
  • Cost/benefit analysis of entering new markets/product lines. Probably don’t want to enter a clearly competitive market. That’s a nuclear option. But “contemplated” competitive markets? Potentially worth the risk depending on the upside. Certainly worth the analysis.
  • Action for declaratory judgment (always consider it). Hinges on literally every other factor in this list.
  • Counterpunches: Breaches by the Buyer. Any other dirt you can muck up = possible leverage. Wildcards: Fraud in the inducement (always consider) vs. merger clause. Lanham Act false advertising claims (always consider). Whistleblowing on illegal conduct (always consider). Antitrust issues (the Company using the acquisition of one company in one market space to freeze the owner of that one company and his other companies out of multiple other markets) (sometimes consider depending on market dynamics).

But I’m just an unmitigated crazy person. You’re welcome.

Jonathan Pollard is a competition lawyer based in Fort Lauderdale, Florida. His practice is focused on complex non-compete, trade secret, trademark and unfair competition disputes. His main office can be reached at 954-332-2380.