What action do you take if the former owner of the business you just acquired sets up as competition?

The answer to this question may be absolutely nothing. Hopefully that will not be the case and you should read on to ensure that if you encounter the problem in the future, you will have a different answer.

What action do you take if the former owner of the business you just acquired sets up as competition?

The answer to this question may be absolutely nothing. Hopefully that will not be the case and you should read on to ensure that if you encounter the problem in the future, you will have a different answer. This article looks at some of the options available where you (the Buyer) have purchased a business from its former owner (the Seller) who is now trading in competition with the business sold to you. 

Prevention is better than cure

Cliched but true. In this field, prevention genuinely is better than cure and a cure may be entirely dependent upon you having taken preventative measures at the point of acquiring the business. That is because, setting up in competition may be entirely lawful if there are not (amongst other things) enforceable restrictions making competition unlawful.  

You would expect a Share (or Asset) Purchase Agreement to include enforceable restrictions on post-acquisition competition. That of course is a matter of negotiation between the parties and something that may impact the purchase price.  Typically we see restrictions on: (1) engaging or having an interest in a competing business, usually for a fixed period for a time limited period; (2) soliciting or dealing with certain customers of the acquired business; (3) poaching key employees; and (4) interfering with supply chains. These restrictions are often supported by clauses protecting the confidential information of the acquired business.      

If you are purchasing a business, it is likely because it has a proven track record for profitability or at least decent potential. That can change rapidly if the former owner of the business, with all of the knowledge, expertise and skill acquired in building that business, sets up in competition. The good news is that the Courts will uphold well drafted restrictions designed to protect the value of the business in these circumstances.

What about cure?

Almost always, the answer to this question will be to act quickly. The law recognises that awarding a party damages after it has taken as long as 18 months to get to trial may be too little too late and the acquired business may even be driven into insolvency in that time as a result of the unlawful competition. As such, the most powerful tool available to the Buyer is an interim injunction from the Court which orders the Seller to stop competing, followed by a speedy trial to determine whether there has been a breach and if so what damages must be paid by the Seller. However, the Courts will likely refuse to impose an interim injunction if the Buyer has unreasonably delayed in taking action. 

Before going to Court for an interim injunction, the Buyer is expected to have set out their position in writing (known as a Letter before Action or LBA). That LBA should set out (and evidence) why the Seller is in breach and will usually demand that the Seller give undertakings to stop acting in breach. The Seller may well deny they are acting in breach or perhaps try to argue that the restrictions are too wide to be enforceable. Nevertheless, in the majority of cases the parties will reach a resolution without the need to issue Court proceedings.

Where Court proceedings are necessary, it is common for the parties to be in front of a Judge within weeks for the first hearing to determine whether or not an interim injunction will be granted. If it is granted, the Seller will be restricted from the competing activities complained of and likely be ordered to pay a significant contribution to the legal costs of the Buyer (as well as paying their own lawyers) with the prospect of more legal fees and a damages payment if the Court rules against them at trial. As such, if the dispute did not settle before legal proceedings were issued, the immediate period after obtaining an injunction often leads to settlement.

Things to look out for

Breaches of these type of restrictions often go hand in hand with breaches of confidentiality and Intellectual Property infringements. They often involve third parties acting with the Seller so conspiracy claims or claims based on the Seller being induced by a third party to breach the restrictions are often pursued, raising the stakes for everyone involved. 

When you first suspect a breach, avoid relying on leaps of faith as the Court may not share your suspicions without reliable evidence. In Court, documentary evidence of breach is key. It is often impossible for the Seller to hide what they are doing so you should make sure you have as much evidence as possible to support your position. 

Evidence is often uncovered by chance. A common example occurs where the Buyer is alerted to a breach by an existing customer sending an email to an old email address about a recent sales meeting with the Seller in relation to the Seller’s new venture. Monitor those email accounts.    

Back to prevention  

Whist the entrepreneurial nature of a successful business owner may mean that it is inevitable in some cases that the Seller already has their sights set on the next venture, even before the ink is dry on the Share Purchase Agreement, competition can be mitigated in ways other than contractual restrictions. Often the Seller may be retained by the acquired business post-sale as an employee or consultant to lead the growth of the business or just to help with a period of handover. This can often fortify the acquired business and give the Seller a vested interest in its continued success. 

Additionally, the deal may be structured such that there is a deferred element of payment or an earn-out. Again the Seller retains a vested interest in the success of the business and if the deferred consideration is subject to compliance with the terms of the Share Purchase Agreement, there is a vested interest in complying with its terms.

The period following the acquisition of a business is critical to its future success. That success can be quickly derailed if the most qualified competitor (being the Seller, who often grew the success from a small start-up) starts competing, targeting customers or poaching key employees in order to replicate the business and springboard off the goodwill sold to the Buyer. This situation should be tackled urgently and decisively on the back of well drafted restrictions and good evidence of breach in order to protect the business and the value of the investment.

Liam Tolen
Liam Tolen

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