Sale of Business Noncompete Agreements in Texas
In Texas, non-compete agreements that arise from the sale of a business are relatively more enforceable than those that are contained in an employment agreement. For example, Texas courts have held that covenants not to compete may be significantly broader in scope if they arise from the sale of a business. However, as a recent case demonstrates, from the buyer’s point of view, getting an enforceable non-compete agreement can sometimes be more difficult than it appears.
In the case, two men, Sledge and Armour, purchased some oil drilling rigs from a West Texas oil company (Bandera Drilling). The purchase price was approximately $34 million.
The purchase agreement was signed by the buyers, Bandera Drilling, and Bandera Drilling’s individual owner (Brazzel). The agreement contained a covenant not to compete which prohibited both Bandera Drilling and Brazzel from competing with the buyers for five years.
After the agreement was signed, Bandera Drilling’s employees were introduced to Sledge and Armour as the new owners. Bandera Drilling’s rig hands went to work for Sledge and Armour, and Bandera Drilling transferred some of those employees’ employment files to Sledge and Armour so that the employees could have health insurance. Moreover, Bandera Drilling’s salesman introduced Sledge and Armour to Bandera Drilling’s customers.
Shortly thereafter, Brazzel began competing with Sledge and Armour in West Texas. Sledge and Armour filed suit to enforce the non-compete agreement. The trial court enforced the non-compete agreement (after reforming its geographic scope), but the court of appeals reversed.
On appeal, Brazzel characterized the transaction as a simple of purchase of assets (“the naked purchase of rigs and equipment”). Brazeel contended that because Sledge and Armour only purchased assets—oil rigs—and not goodwill, the non-compete agreement was not supported by adequate consideration.
In assessing the enforceability of the non-compete agreement, the court believed it significant that, after the purchase agreement was signed by the parties, Bandera Drilling (a) introduced Sledge and Armour to its employees as the new owners, (b) gave Sledge and Armour information from the employees’ personnel files; and (c) introduced Sledge and Armour to Bandera Drilling’s customers. As the court noted, “These [customer] introductions undercut Bandera Drilling’s future competitiveness in West Texas because they encouraged customers to transition to another drilling company.” These factors could lead to the conclusion that Sledge and Armour purchased not just oil rigs, but the business as a whole, including the goodwill. Purchase of the goodwill would justify a promise not to compete.
After listing these factors, though, the court concluded that the non-compete covenant was unenforceable. The court based its decision on the following:
Even though Bandera Drilling did introduce its customers to Sledge and Armour, it was not contractually obligated to do so. It was also not contractually obligated to facilitate the transition of its employees to Sledge Drilling. Because the contract did not obligate Bandera Drilling to take such actions, the contract could not be said to have involved the purchase by Sledge and Armour of Bandera Drilling’s goodwill. Rather, the contract merely involved a sale of assets—oil rigs—and such sale could not justify a non-compete agreement.
The takeaway from this case is that if a buyer wants to have an enforceable non-compete agreement, it needs to purchase the seller’s goodwill, not just his assets. If I start a restaurant and buy some used tables and bar stools from a competitor, that will not justify a promise by my competitor not to compete. However, if I buy his entire business, including the goodwill that he has established in the community over several years, that will justify a covenant not to compete. In this case, the buyers just bought assets, not goodwill, and thus did not have an enforceable non-compete agreement.