The importance of non-compete clauses in business transfers
In the context of business acquisitions, non-compete clauses are an essential covenant to protect the purchaser. These agreements stipulate that the seller will refrain, for a defined period and within a specified territory, from engaging in activities that compete with the transferred business.
Their primary purpose is to prevent the seller, after completion of the transaction, from using the proceeds to establish a new competing entity or to solicit the acquired clientele. Without such a restriction, the purchaser could swiftly lose the customer base for which they paid a price, thereby undermining the very purpose of the investment.
From a practical perspective, these covenants safeguard the purchaser by granting them a reasonable period in which to consolidate the transaction and strengthen the acquired business. They prevent the seller from approaching customers, suppliers or key employees of the transferred undertaking during the agreed term. In short, such clauses are designed to preserve the investment made and the integrity of the goodwill acquired.
Protective function of non-compete clauses
The non-compete clause operates as a form of insurance for the purchaser. By setting out clear obligations for the seller, confidence is reinforced that the acquisition of customers, suppliers and know-how will remain intact. These clauses typically include the following practical restrictions:
Prohibition on engaging in the same activity: the seller is prevented from operating, directly or indirectly, in the same sector as the transferred company.
Prohibition on servicing former clients: the seller may not supply products or services to the former customer base.
Liquidated damages for breach: a financial penalty is agreed, payable in the event of breach.
Nominated list of clients: a schedule of protected clients is annexed to the contract to avoid subsequent disputes.
These obligations apply during the agreed term, offering the purchaser a period of stability in which to consolidate their investment. Moreover, in the event of breach, the purchaser need not prove the precise loss suffered, which strengthens their position.
For validity, such clauses must be clear, reasonable and proportionate. The courts may declare void any clause that is excessive in duration or scope. Case law requires that their duration, geographical reach and content be strictly necessary to protect the legitimate interests of the purchaser.
Reasonable duration of non-compete clauses
The term of the covenant must strike a balance between the purchaser’s rights and the seller’s freedom to trade. In Spain, there is no strict statutory limit, but Article 20 of the Agency Contracts Act is often used by analogy, setting a maximum of two years.
Accordingly, two years is the usual standard, unless objective grounds justify a longer term (for instance, products with a long maturation period or highly specialised know-how).
In such cases, it is advisable to:
- Provide express justification for the extended term.
- Define clearly the geographical scope of application.
- Establish mechanisms for review or extension, depending on the achievement of objectives.
These measures reinforce the proportionality of the covenant and reduce the risk of invalidity.
Risks of not including non-compete clauses in a business transfer
Failing to agree a non-compete clause entails significant risks. The seller may regard themselves as free to trade and to solicit former clients without any explicit legal restriction.
Moreover, neither the Companies Act nor the Commercial Code expressly regulates this issue, creating a legal vacuum. In its absence, the purchaser would have to rely on the principle of contractual good faith as a protective mechanism, which, while possible, is more uncertain and costly to enforce judicially.
The courts have on occasion recognised an implied duty of non-compete, but this route cannot substitute for a clear and properly drafted covenant.
Conclusion: non-compete clauses as a strategic safeguard
Non-compete clauses in business transfers are fundamental to protecting the purchaser’s investment. Their absence exposes the acquirer to the risk of the seller re-establishing the transferred business.
A clear, reasonable and well-drafted covenant is the best tool for securing the transaction and avoiding future litigation. Although case law may offer implicit protection, relying solely upon it is precarious.
In essence, these clauses are a key strategic element in ensuring the viability and profitability of a business acquisition.
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