By Leonard A. Bellavia, Esq., Bellavia Blatt, PC
Covenants restricting a seller’s ability to compete against the buyer after closing are key provisions for protecting an auto dealership’s goodwill in a buy-sell agreement. It is important to obtain necessary protection for the buyer in the non-compete and non-solicitation covenants so that a seller has no opportunity to erode that goodwill after closing.
As terms are being negotiated and a buyer is looking to get the agreement executed, it is very easy to lose sight of all the ways a buyer’s rights can be compromised if the attorney draftsman relies on standard boilerplate provisions of a non-compete agreement.
Seller’s Affiliated Dealerships
When purchasing a dealership, certain individuals and business entities may need to be subject to restrictive covenants pertaining to competition and solicitation of customers and employees. For instance, when the seller has multiple dealerships, a buyer should subject all the seller’s affiliated stores that are in the dealership’s market area to non-compete and non-solicitation covenants.
This is true regardless of whether those affiliated stores sell different makes of vehicles. Any of these stores could devalue the dealership’s purchased goodwill by hiring away talented staff and executives from the dealership. A buyer might have also counted on certain managers continuing to operate and achieve further growth for the dealership.
Buyers also need to restrict affiliated dealerships from soliciting customers of the dealership. This becomes a concern when these affiliated stores have shared customer lists with the dealership for marketing purposes. For example, if a buyer purchased a Honda store and the seller had a nearby Chevrolet dealership, the Chevrolet store could undermine the Honda store’s ability to sell new cars to its current customers by actively trying to convert these customers into Chevrolet owners.
Buyers also need to be on alert regarding dealership websites, email addresses, 800-numbers, Facebook pages and other sales channels the seller has that jointly promote the dealership and the seller’s other stores. A buyer will want to restrict the seller’s use of websites that are affiliated with the dealership, especially if a website has proven to generate sales for the dealership.
Key Managers and Employees
Beyond affiliated stores, non-compete and non-solicitation covenants should also apply to the principal owner of the business. While it is common to limit a principal from owning any competing dealership, it is also important to limit a principal from being employed at a competing nearby dealership. Once a deal is completed, it is an occasional occurrence for the principal of the selling company to be hired as a general manager at a nearby competing dealership. For a buyer, this situation could lead to diminished value in the goodwill of the dealership considering the former-principal-turned-general-manager has knowledge and experience of the local market and its consumer base.
In addition to former dealer principals, there are other individuals involved with the dealership who may also need to be subject to restrictive covenants due to their familiarity with dealership operations and the market factors which impact dealership performance. When they have been involved in the development and proliferation of the dealership, family members such as spouses, siblings and adult children should be subject to restrictive covenants because they possess valuable experience and employee-consumer relationships which would allow them to compete unfairly.
Even for family members who do not possess such experience and knowledge of the automotive industry, there is still reason to consider subjecting them to restrictive covenants. For example, a seller subject to a non-compete can use a family member as a proxy when establishing a competing dealership. The seller can use his or her own knowledge, experience and capital to help develop a competing dealership without actually owning part of the business.
Presenting a Fair, Reasonable Restrictive Covenant to the Seller
Keep in mind that buyers can place reasonable limits upon these restrictive covenants to make them more palatable to sellers. For instance, a covenant for non-solicitation of dealership employees could be limited just to those employees that are hired by the buyer or who are later terminated by the buyer. The buyer could be promised the right to interview employees prior to closing and then have the non-solicitation apply only to employees that the buyer desires to retain. This gives the seller a more definitive list of employees he can solicit for other dealerships or ventures prior to closing.
Additionally, we recommend that sellers request certain dealership employees to be exceptions to non-solicitation covenants. Frequently, these are family members or long-time employees. If done on a limited basis, singling out specific employees could allow the buyer to more easily review, on a case-by-case basis, whether such an exception makes business sense.
It is important to have objective ways to set reasonable geographic restrictions for non-compete covenants. The non-compete covenants that we have seen in franchise dealership buy-sell agreements have a wide range of geographic limits – from a ten-mile radius in urban and suburban areas to geographic limits designated by county.
While each limit is different based on the unique circumstances of the market area, there is objective franchisor data that a buyer can use to justify the specific limits it is proposing. For instance, if a dealership generates a lot of sales in specific areas outside of its relevant market area, a buyer may want to add those areas to the geographic area which is covered in the non-compete covenant. Conversely, the dealership may be underperforming in several census tracts within the dealership’s relevant market area where the buyer feels it can improve sales performance. Either way, it is helpful for the buyer to have this information at its disposal to identify what geographic areas really need protection from any future competition by the seller.
Forum Selection Clauses
To reduce aggravation and attorney’s fees, all buyers – especially those involved in buy-sell transactions with parties from multiple states – should consider which state they will choose to enforce the seller-restrictive covenants in the agreement. For instance, a New York buyer and New Jersey seller begin negotiations regarding a buy-sell involving a Connecticut dealership. In such a transaction, there are three possible jurisdictions which could potentially all have different interpretations of the same agreement or provision.
One court may be more willing to strictly enforce a restrictive covenant, while another court may see flaws with a particular provision which they are unwilling to enforce. To avoid such risk and confusion, buyers are advised to consult their attorneys when choosing the best available forum for disputes and reference said forum in the agreement as the forum where any dispute arising from the agreement will be heard.
Leonard Bellavia is the founding partner of Bellavia Blatt, PC, with offices in New York, Illinois, New Jersey and Connecticut. He can be reached at (516) 873-3000 or LBellavia@Dealerlaw.com.
