Private equity update: restrictive covenants and penalty clauses
Buyers of businesses are often anxious about what the sellers will do after completion of a deal. Where proprietors have already built up a successful business (particularly one based largely on personal contacts) and sold it, it is clearly possible that they may want to repeat the success. This would mean competition for the original business, possibly reducing its value.
Public policy dictates that competition is a good thing, as it means choice and competitive pricing for customers. However, those paying substantial sums to acquire businesses sometimes, understandably, take a different view.
There is a long line of cases covering the extent to which buyers can legitimately keep sellers out of the same market following a sale. This is usually done by contractual covenants, whereby the seller agrees not to take certain actions for a defined period. These restrictions may be backed up by provisions entitling the buyer to payment of specified amounts if the seller later breaches the covenants…
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