by Hank Jackson

Page 22

The business with two principals sharing equal ownership rights has an inherent problem from its inception — how eventually to part ways. Two commonly used strategies in managing a separation are buy/sell provisions and noncompetition restrictions. A buy/sell provision creates a method to determine which of the two principals will continue with the business, as well as the consideration to be paid for the other’s interest. A noncompetition restriction enables the principal continuing with the business to retain the customers and goodwill that may be the most important asset of the business, especially in the increasingly predominant service sector in our economy.

These two legal tools have been around for some time, and their use in combination would appear to be ideal. But the inclusion of a noncompetition restriction in an offer under a buy/sell provision has proven to cause uncertainty and unintended consequences — the proverbial throwing in a monkey wrench.

Background of Buy/Sell Provisions
A buy/sell provision as used in this article refers to the principals’ agreement entered into at the inception of the business that either principal may initiate an offer to purchase the interest of the other principal during the course of the venture. Additionally, upon receiving an offer from the initiating principal (offeror), the receiving principal (offeree) has only two options: 1) accept the offer and, thus, sell to the offeror, or 2) purchase the offeror’s interest on precisely the same terms as the initial offer — a mirror or symmetrical offer. Typically, the parties agree in the buy/sell provision to a strict deadline (commonly 30 days) for the offeree to accept the initial offer or make a symmetrical offer. If the offeree fails to act timely, the buy/sell provision provides that the offeree accepts the initial offer by default.

The rationale behind a buy/sell provision’s symmetrical aspect and severe deadline is to prevent the offeror from making a low-ball offer to the other principal and to complete the separating transaction quickly. A strong incentive is created for the offeror to make carefully the initial offer on terms that are fair. Indeed, the offeror will become either the buyer or seller on those terms at the sole option of the offeree. Since there are no negotiations or multiple offers and counteroffers, this procedure prevents delay and transfer of the business occurs quickly.

Background of Noncompetition Restrictions
Noncompetition restrictions are contractual arrangements in which one party agrees not to compete with another party for a specific period of time. Such agreements are often used in employment agreements to prevent employees from competing with their employers, as well as to protect a buyer of a business from competition from the seller after the purchase.

In most jurisdictions, including Florida, noncompetition agreements have historically been subject to attack for being void as against public policy — an improper restraint of trade. However, Florida, along with most other states, has enacted statutes explicitly authorizing noncompetition restrictions and setting forth the requirements of such agreements.¹ Florida’s most recent noncompetition statute provides that such agreements must be supported by a “legitimate business interest,’’² as well as the requested restrictions must be reasonably necessary to protect those interests.³ The legitimate business interests that are commonly used to justify noncompetition restrictions relating to the sale of a business are 1) trade secret information; 2) confidential information; 3) customer relationships; and 4) goodwill.⁴

Despite the considerable specificity of Florida’s noncompetition statute, there is substantial litigation regarding the enforceability of noncompetition restrictions. What factual evidence is sufficient to prove a legitimate business interest and the degree of restraint that is reasonably necessary is inherently fact specific to the particular case.⁵

The Monkey Wrench
The buy/sell provision assures that when one principal buys the other’s interests, it occurs fairly and quickly. And noncompetition restrictions provide the purchaser of the business with the ability to protect the business’ critical assets — often its customers and goodwill. An offer pursuant to a buy/sell provision that includes as a term a noncompetition restriction would appear to be an ideal combination. But traditionally terms of an offer under buy/sell provisions are limited to only monetary terms and no other conditions. As a result, the noncompetition restriction becomes the monkey wrench.

The inclusion of noncompetition restrictions (a nonmonetary term) in an offer pursuant to a buy/sell provision can destroy the symmetrical aspect of the buy/sell. Although its inclusion might be symmetrical in a technical sense (apply to both parties), the effect on each principal may be drastically different. For example, one principal may have much stronger relationships with the business’ customers (“customer schmoozer”). The other principal may have virtually no relationships with the business’ customers, but provides standard backroom operations (“backroom operator”). Customer schmoozer, as a buyer, has the ability to retain and protect the business’ customers without noncompetition restrictions as part of the purchase. Consequently, customer schmoozer, as a buyer, will place no value on having noncompetition restrictions against backroom operator. On the other hand, backroom operator, whose relationships with the customers are weak, will as a buyer place a very high value on the inclusion of noncompetition restrictions against customer schmoozer. Backroom operator needs the noncompetition restrictions to assure that customer schmoozer does not divert the business’ customers to another business after backroom operator purchases the business. Simply stated, an offer that includes a noncompetition restriction is significantly unsymmetrical as a practical matter as applied to principals such as customer schmoozer and backroom operator.⁶

A Case in Point — P&O Ports of Florida
The inclusion of noncompetition terms in an offer under a buy/sell provision became a monkey wrench in P&O Ports of Florida, Inc. v. Continental Stevedoring & Terminals, Inc., 904 So. 2d 507 (Fla. 3d DCA 2005). The buy/sell provision in the parties’ initial agreement provided that the offer “shall be at such price and upon such terms and conditions as the [o]ffering [m]ember deems appropriate.”⁷ The parties’ agreement also provided that the noncompetition restrictions entered into at the business’ inception were to “survive any transfer or other disposition by any member of its [m]embership [i]nterest….”⁸ Under the buy/sell provision in the parties’ agreement, one of the principals initiated an offer of $7.2 million with the condition that the noncompetition provision in the parties’ agreement be waived.⁹ The trial court first found the parties’ agreement ambiguous as to whether the noncompetition restriction could be waived.¹⁰ After considering extrinsic evidence, the trial court then ruled that it was the intent of the parties that waiver of the noncompetition restrictions could not be a condition of an offer under the buy/sell provision.¹¹

Further complicating P&O Ports of Florida was the procedural quagmire caused by the inclusion of the improper condition (waiver of the noncompetition provision) in the offer under the buy/sell provision. Upon receiving the initial offer, the offeree under the parties’ agreement had 30 days either to accept the offer or purchase the offeror’s interest upon the “same terms and conditions.”¹² Faced with what the offeree believed was an improper offer, the offeree sought an emergency injunction and declaratory relief to preclude the offeror from enforcing the proposed offer.¹³ The trial court extended the offeree’s time to respond to the offer by 90 days, during which time an evidentiary hearing was held.¹⁴ The trial court’s ultimate ruling was that the noncompetition restrictions in the parties’ agreement was intended to survive the termination of the agreement and could not be waived as a term of an offer under the buy/sell provision.¹⁵ The trial court then struck the waiver condition from the offer, and the offeree accepted the judicially altered offer.¹⁶

On appeal, the appellate court affirmed that the condition was improper, but reversed the trial court’s holding that the judicially altered offer could be accepted.¹⁷ It held that the offer, which waived the noncompetition restriction clause, was void from its inception, and it was judicial error to modify material terms of the offer in order to turn an otherwise invalid offer into a valid one.¹⁸ In short, if the condition is invalid, then it follows that the entire offer is also invalid.¹⁹ The appellate court reversed and remanded. ²⁰

P&O Ports of Florida illustrates the complications involved in including noncompetition restrictions as terms in offers pursuant to buy/sell provisions. Importantly, the case can be read to hold firmly that parties may contractually agree in advance that noncompetition restrictions cannot be altered or terminated through an offer pursuant to a buy/sell provision. The issue, however, was not resolved regarding whether parties who have failed to agree in advance may create or waive noncompetition restrictions in an offer under a buy/sell provision.

The Meaning of “Price and Terms”
Many buy/sell provisions provide that the initiating offer must set forth the “price and terms.” The courts have interpreted such language to be limited and to exclude nonmonetary conditions.²¹ Again, the concept is that an offer must be symmetrical so that it is fair, regardless of which principal ultimately becomes the buyer or seller.

The Florida Fourth District Court of Appeal in McTeague v. Treibitis, 388 So. 2d 309 (Fla. 4th DCA 1980), was presented with whether an offer that included a condition pertaining to paying off the company’s debts was a proper term under a buy/sell provision. The buy/sell provision required the initiating party to set forth the “price and terms.”²² The court, in holding such a condition was improper, concluded that the word “term” as relates to the sale of property had a restrictive meaning — namely, the amount, time, and manner of payments.²³ This narrow reading of “price and terms” in McTeague suggests that issues relating to noncompetition restrictions would fall outside of permissible “price and terms” in a buy/sell provision.

Also, in McTeague, the inclusion of the improper condition in the offer caused procedural uncertainty similar to the situation in P&O Ports of Florida. Instead of seeking an emergency injunction upon receiving an offer with improper terms, the offeree in McTeague simply notified the offeror of his acceptance of the offer without the improper or invalid terms.²⁴ The trial court ruled that such acceptance was permissible and enforced the sale absent the improper terms.²⁵ This holding is contrary to the ruling and rationale in P&O Ports of Florida that an offer containing an invalid term is void at its inception and in its entirety.

The case of McTeague was cited in Harris v. Ahtna, Inc., 107 P. 3d 271 (Alaska 2005), which commented extensively on what terms may be properly included in offers pursuant to buy/sell provisions. In Harris, the court invalidated an offer pursuant to a buy/sell provision that contained nonmonetary conditions. Those nonmonetary conditions included assumptions of loans and liability for guarantees of the “selling” principal.²⁶ The court analyzed the effect of the nonmonetary terms on the price that each principal would effectively pay depending on which principal became the “selling” principal.²⁷ It found the price to be substantially unequal.²⁸ The court explained that “nonmonetary conditions often will not burden the parties equally.”²⁹ If nonmonetary conditions are permitted, each party has an incentive to make the initial offer so as to take advantage of the ability to craft favorable conditions that benefit only itself. ³⁰ Such incentive is contrary to a central purpose of a buy/sell provision — fairness regardless of which principal is the buyer or seller. Although Harris cites McTeague as support that nonmonetary conditions cannot be part of an offer pursuant to a buy/sell provision, the court refused to follow McTeague to the extent that McTeague can be read as permitting the offeree to accept the initial offer absent improper conditions.³¹ Instead, Harris followed common law contract principles, which require an acceptance of an offer to be in exact compliance with the terms of the offer.³² Similar to P&O Ports of Florida, the court therefore reasoned that no contract was formed between the parties as a result of the improper condition in the offer.

Drafting Noncompetition Restrictions in Initial Agreements to Apply Post-sale
To avoid confusion created by a principal’s offer under a buy/sell provision that includes a noncompetition term, the principals should determine at the inception of the business whether noncompetition restrictions will survive the transfer of the business from one principal to the other. The parties’ agreement should be conclusive on this issue and strictly prohibit the parties from creating, enhancing, modifying, or waiving noncompetition restrictions as a term or condition of an offer under a buy/sell provision. Although a symmetrical effect as relates to noncompetition restrictions upon the transfer of the business may be unobtainable, such unsymmetrical effect should be caused only as a result of negotiated terms between the principals at the inception of the venture — not because of nonmonetary and non-negotiated terms in an offer under the buy/sell provision. The determination of noncompetition restrictions (if any) at the inception of the venture provides the parties an opportunity to evaluate and value such restrictions before the possible unsymmetrical effect occurs. Also, the parties can modify their behavior during the duration of the venture to mitigate any unsymmetrical impact.

Additionally, to prevent procedural uncertainty if an arguably improper condition is included as a term in an offer, the parties’ agreement should provide that offers containing improper conditions (unless accepted in full, in writing by the offeree) are void from inception and in the entirety.

Situations in Which the Monkey Wrench Still Exists
As to parties’ agreements where post-sale noncompetition restrictions are not clear and definite, the inclusion of noncompetition restrictions or waiver of such restrictions in offers under buy/sell provisions remain problematic. The central purpose of buy/sell provisions indicates that such offers are improper. And the general principles of contract law support the conclusion that offers with improper conditions are not binding on the offeree or offeror either in whole or in part. The courts, however, have not held as a general rule that noncompetition restrictions can never be part of a proper offer under a buy/sell provision. Additionally, as in Teague, it can be at least argued that offers including improper conditions may be accepted absent the improper condition. Consequently, if one receives an offer under a buy/sell provision with terms relating to noncompetition restrictions, it may be advisable to seek immediate injunctive and declaratory relief.

¹ Fla. Stat. §542.335 (2006).
² Fla. Stat. §542.335 (1) (b) (2006).
³ Fla. Stat. §542.335 (1 )(c) (2006).
⁴ Fla. Stat. §542.335 (1) (b) (1 through 4) (2006).
⁵ See, e.g., University of Florida, Board of Trustees v. Sanal, 837 So. 2d 512 (Fla. 1st D.C.A. 2003); Supinski v. Omni Healthcare, P.A., 853 So. 2d 526 (Fla. 5th D.C.A. 2003).
⁶ It should be acknowledged that the differences in the principals’ assets and skills are not inherently a detriment. During the course of the venture, the division of labor or expertise between the two principals may have increased the overall value of the business. Indeed, principals often bring different assets and skills to the business, and the success of the venture depends on effectively using each principal’s strengths. The problem only arises when it is time for the principals to part ways based on an offer under a buy/sell provision that includes noncompetition restrictions.
⁷ P&O Ports of Florida, Inc. v. Continental Stevedoring & Terminals, Inc., 904 So. 2d 507, 508 (Fla. 3d D.C.A. 2005).
⁸ Id. at 508.
⁹ Id.
¹⁰ Id. at 509.
¹¹ Id. at 510.
¹² Id. at 511.
¹³ Id. at 510.
¹⁴ Id. at 511.
¹⁵ Id. at 510.
¹⁶ Id.
¹⁷ Id. at 511.
¹⁸ Id.
¹⁹ Id. at 510, citing Zalis v. M.E.J. Rich Corp., 797 So. 2d 1289 (Fla. 4th D.C.A. 2001).
²⁰ Id. at 511. After remand and a new judgment by the trial court, the case was again appealed. See Continental Stevedoring Terminals, Inc., v. P&O Ports Florida, Inc., 943 So. 2d 305 (Fla. 3d D.C.A. 2006) (entry of new judgment by trial court did not exceed authority on remand).
²¹ McTeague v. Tribitis, 388 So. 2d 309 (Fla. 4th D.C.A. 1980); Harris v. Ahtna, Inc., 107 P.3d 271 (Alaska 2005).
²² McTeague v. Tribitis, 388 So. 2d 309, 311 (Fla. 4th D.C.A. 1980).
²³ Id. at 313, citing Murphy v. Green, 135 So. 2d. 531 (1931).
²⁴ Id. at 312.
²⁵ Id. at 312-313.
²⁶ Harris v. Ahtna, Inc , 107 P.3d 271, 273 (Alaska 2005).
²⁷ Id. at 276.
²⁸ Id. at 276. The principals did not have identical obligations under the loans and guarantees. As a result, which party became the “selling” principal would have a tremendous effect on the amount of assumed loans and liability for guarantees that would occur.
²⁹ Id. at 276.
³⁰ Id.
³¹ Id. at 278.
³² Id. at 279.

Hank Jackson practices in the area of business litigation with a particular concentration in noncompetition and trade secret litigation. He is a partner with Holland & Knight, LLP, in West Palm Beach.

This column is submitted on behalf of the Business Law Section, Merrick Gross, chair, and Melanie Damian, editor.