Restrictive Covenants in M&A: What to Know
- Brandon Chicotsky
- Apr 2
- 12 min read
Restrictive covenants in mergers and acquisitions (M&A) are legal agreements that protect the buyer's investment by limiting the seller's actions post-sale. These agreements ensure that the goodwill, customer relationships, and trade secrets acquired by the buyer remain secure. Here's what you need to know:
Types of Covenants:
Non-Compete Clauses: Prevent sellers from starting or joining competing businesses for a set time (usually 3-5 years) and within a specific geographic area.
Non-Solicitation Agreements: Stop sellers from targeting former customers, suppliers, or employees.
Confidentiality Obligations: Prohibit the use or disclosure of sensitive business information.
Enforceability:
Courts are generally more lenient with M&A restrictive covenants compared to employment contracts.
State laws vary significantly. For example, California heavily restricts non-competes, even in M&A deals, while other states allow them under specific conditions.
Agreements must be reasonable in scope, duration, and geography to hold up in court.
Key Considerations:
Tailor covenants to match the business's operations and jurisdiction.
Use clear definitions to avoid disputes, especially for non-solicitation agreements.
Include remedies like injunctive relief or fee-shifting clauses to enforce compliance effectively.
Restrictive covenants are vital in preserving the value of an acquisition, but they must be carefully drafted to ensure they are enforceable and aligned with legal standards.
Types of Restrictive Covenants
M&A agreements often include three main types of restrictive covenants designed to protect the value of the business and compensate sellers for any post-closing restrictions. Let’s break down each type and its role in safeguarding the transaction's success.
Non-Compete Clauses
A non-compete clause prevents the seller and their affiliates from starting or joining a competing business within a specific geographic area and for a defined period. This ensures the goodwill purchased by the buyer remains intact. Without such a clause, the seller could potentially re-enter the market, leveraging their industry knowledge and reputation to compete directly, which could diminish the buyer's acquired goodwill.
In M&A deals, courts typically allow non-compete clauses to last between three and five years, as these agreements are tied to significant financial compensation for the seller [3]. Unlike non-competes in employment contracts, M&A non-competes are given more leeway by courts because they directly protect the buyer's investment. As Mayer Brown explains:
The purpose [of M&A non-competes] is to protect the goodwill or ownership interest acquired by the buyer [2].
The geographic scope of these clauses is also crucial. Courts generally require non-compete agreements to align with the areas where the target company operates. For instance, a worldwide restriction might be deemed excessive if the business primarily serves a regional market.
Non-Solicitation Provisions
Non-solicitation provisions take a narrower approach compared to non-competes. Instead of prohibiting all competitive activity, these clauses focus on safeguarding specific business assets, such as customers, suppliers, or employees. They typically fall into two categories:
Customer and supplier non-solicitation: Prevents the seller from disrupting the company's existing relationships or revenue sources.
Employee non-solicitation: Prohibits the seller from recruiting key employees, ensuring the workforce critical to the business remains intact.
These provisions work alongside non-compete clauses by focusing on maintaining essential relationships rather than banning broader competition. As Baker McKenzie notes:
A buyer will typically require a seller to agree to refrain from soliciting any current or former employee of the target company for a specified period of time post-closing [3].
Non-solicitation agreements are often easier to enforce since they are based on specific lists of affected parties rather than geographic restrictions. However, it’s essential to clearly define what constitutes "solicitation" to avoid disputes or legal challenges.
Confidentiality Obligations
Protecting sensitive information is just as important as limiting competitive activity. Confidentiality obligations prevent the seller from using or disclosing trade secrets, proprietary business data, or other confidential information after the deal closes. These provisions are standard in nearly all M&A agreements because they safeguard intangible assets like intellectual property and competitive advantages.
In many cases, confidentiality obligations remain in effect indefinitely for true trade secrets, ensuring critical information stays protected long after the transaction is complete.
Factor | Non-Compete Agreement | Non-Solicitation Agreement |
Scope of Restriction | Prohibits engaging in direct competition | Prohibits targeting specific parties |
Industry Employment | Seller cannot compete directly | Seller can work in the industry but not poach relationships |
Geographic Limit | Must align with the business’s operations | Often defined by specific lists |
Enforceability | Subject to strict scrutiny for fairness | Easier to enforce due to narrower focus |
Primary Goal | Protects goodwill and market share | Preserves business relationships and stability |
To maximize protection, buyers often use both non-compete and non-solicitation provisions. This "belt and suspenders" approach ensures that even if one clause is deemed unenforceable, the other can still provide a safeguard against competitive threats.
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Legal Requirements and Enforceability
Courts tend to evaluate restrictive covenants in M&A transactions with less scrutiny than those in employment contracts. This approach acknowledges the buyer's legitimate interest in protecting the goodwill they've acquired [2][8]. However, enforceability largely depends on state laws, which vary significantly. While most states rely on common law principles, others - like California, Colorado, Illinois, and Texas - use specific statutes [1]. These state-specific differences play a crucial role in shaping how enforceable these agreements are.
State-by-State Differences
As of March 2026, six states - California, Minnesota, Montana, North Dakota, Oklahoma, and Wyoming - prohibit non-compete agreements outright [6]. Washington will join this group on June 30, 2027, under HB 1155 [12]. However, exceptions often exist for business sales and partnership dissolutions [1][6][2]. This highlights the importance of aligning covenants with the buyer's goal of protecting goodwill.
In states where non-competes are allowed, wage thresholds often determine who can be restricted. For example:
The healthcare sector faces even tighter restrictions. States like Arkansas, Colorado, Indiana, and Texas have passed laws limiting physician non-competes to ensure public access to medical services [11]. Florida's CHOICE Act, enacted in July 2025, strengthens non-compete enforcement for high-wage earners and allows durations of up to four years [6][7].
It's also worth noting that relying solely on a choice-of-law provision can be risky. Courts may reject it if the seller resides in a state with strict public policies against non-competes [13][9]. To avoid issues, draft agreements that comply with the seller's state laws [9].
Reasonable Scope and Duration
When evaluating restrictive covenants, courts use a "Reasonableness Test" to ensure the agreement protects legitimate economic interests without being overly restrictive. This involves assessing the geographic scope, duration, and overall balance of the covenant [8]. Vice Chancellor Laster explained:
A court must not tick through individual features of a restriction in isolation, because features work together synergistically [8].
This means that a broader geographic reach might be acceptable if paired with a shorter duration, and vice versa. For example, a nationwide restriction could work for a company with a customer base across all 50 states but would likely be rejected for a business with a strictly local market. In Kodiak Building Partners v. Adams, Delaware's Court of Chancery struck down a non-compete that extended beyond the seller's specific business line [11].
To improve enforceability, it's essential to demonstrate a legitimate economic interest - such as protecting trade secrets, confidential information, customer relationships, or goodwill [1][8]. The purchase agreement should clearly state that the restrictive covenant is a key part of the consideration for these assets [2].
However, don't assume courts will modify overly broad agreements. Many jurisdictions, including Delaware, are moving away from the practice of "blue-penciling", where judges revise unreasonable terms to make them enforceable. As J. Scott Humphrey of Benesch Friedlander Coplan & Aronoff LLP noted:
The 'Delaware advantage' is no longer a guarantee of restrictive covenant enforcement, and companies should take note that 'Judicial blue-penciling' of overbroad restrictive covenants is no longer the norm [11].
In some cases, courts may void an overly broad covenant entirely rather than attempt to fix it [8][10][11].
State | 2026 Wage Threshold | M&A Exception |
California | Total ban (all wages) | Permitted to protect goodwill in business sales [2] |
Colorado | $130,014 [7] | Must comply with reasonableness standards |
District of Columbia | $162,164 [7] | Higher threshold ($270,274) for medical specialists [7] |
Illinois | $75,000 (non-compete) / $45,000 (non-solicit) [7] | Allowed for sale of goodwill or ownership interest [2] |
Washington | Total ban (effective June 30, 2027) [12] | Exempts sales of 1% or more of a business |
To draft enforceable restrictive covenants, tailor them to the jurisdiction where they'll be enforced, narrowly define the restricted business based on the company's actual operations, and clearly show how the covenant protects the acquired goodwill. If you're unsure, consider using non-solicitation provisions instead, as courts generally view these more favorably than broad non-competes [9].
How to Draft and Negotiate Covenants
When it comes to protecting goodwill in a transaction, drafting and negotiating restrictive covenants requires precision. These provisions aren’t just about legal language - they’re tools to safeguard specific assets and mitigate competitive risks. As Prof. Chad D. Cummings aptly stated:
In M&A, there is rarely a 'simple' covenant; there are only covenants that appear simple until they are tested [5].
Below, we’ll explore practical steps to ensure your covenants are clear, enforceable, and aligned with your transaction's goals.
Identifying Conflicts During Due Diligence
Before finalizing covenant terms, it’s critical to conduct a detailed review of the target company’s existing obligations. This includes examining customer concentration, key employee roles, and any current restrictive agreements [5]. Overlooking these factors could lead to conflicts that undermine your protections.
Pay special attention to "springing license" provisions - these grant third-party IP rights upon closing. Confirm that all employees and consultants have signed invention assignment agreements [14]. Without proper ownership of the intellectual property you aim to protect, even the best-drafted covenants become ineffective [14].
Once potential conflicts are identified, you can focus on tailoring the covenants to the specific needs of the transaction.
Customizing Covenants to Your Business
Generic, one-size-fits-all restrictions are rarely effective. Instead, craft covenants that reflect the unique characteristics of the target business. For instance:
Scope of Activities: Rather than broadly defining the industry, specify the exact products, services, and channels the business operates in at the time of closing [5]. For example, if acquiring a regional distributor of industrial equipment, limit restrictions to the products and markets the company currently serves, not the entire manufacturing sector.
Geography: Tie any geographic restrictions to the actual markets served by the target. A nationwide restriction might be reasonable for a business with customers in all 50 states, but it would likely be excessive for a company operating in just a few states.
Employee Restrictions: Focus on role-specific restraints. Target individuals who are integral to the business, such as those with access to sensitive information or key customer relationships [9]. As Robert W. Horton of Bass, Berry & Sims explains:
The most enforceable noncompetes align with the employee's role, state laws, and a clearly defined protectable interest [9].
Documenting Competitive Risks
To strengthen enforceability, clearly link each restriction to the goodwill or assets being acquired. Courts look for evidence that ties covenants to specific competitive risks, such as customer relationships, trade secrets, or other proprietary advantages [5].
Build this factual record during negotiations by documenting critical details like customer renewal cycles, the time required to transition key relationships, and proprietary processes that could be exploited by competitors. This not only justifies the restrictions but also provides a foundation for enforcement.
Consider including carve-outs for certain scenarios, such as:
These exceptions demonstrate that the covenant is narrowly focused on protecting legitimate interests rather than simply stifling competition.
Lastly, when asking key employees to sign new covenants at closing, offer fresh consideration - such as bonuses or equity grants. In many jurisdictions, relying solely on continued employment may not hold up [5].
Enforcement and Remedies
The strength of a covenant lies in how enforceable it is. When a breach happens - or even looms - you need tools to protect the goodwill and assets tied to the agreement. Knowing what enforcement options are available and structuring agreements to make them effective is key.
Injunctive Relief and Litigation
When a breach is on the horizon, injunctive relief becomes critical. Why? Because monetary damages often fall short when it comes to covering lost customer relationships or trade secret violations. Injunctive relief - a court order that halts competitive activity immediately - is a cornerstone of enforcement in M&A deals [4].
To secure an injunction, the process usually begins with filing for a Temporary Restraining Order (TRO) or a preliminary injunction [17]. As Mintz attorneys explain:
In breaches... where a seller is threatening to breach, money damages in the event of a breach would be difficult to enumerate and would not be sufficient to compensate the non-breaching party for the severe impact to its business [4].
But it's not as simple as requesting an injunction. Courts will carefully evaluate whether your covenant is reasonable in its scope, duration, and geographic reach - even if you’re not pursuing damages. This principle was reinforced in February 2026 by the Delaware Supreme Court in Fortiline, Inc. v. McCall. In this case, the company tried to sidestep reasonableness scrutiny by seeking only monetary damages instead of an injunction, but the court refused to bypass the review [16].
This highlights the importance of crafting a defensible covenant from the outset. Overly broad restrictions, like a nationwide non-compete for a business with a regional footprint, are likely to be struck down, even in the context of a business sale.
A case from March 2026 underscores the risks. The Delaware Supreme Court overturned a lower court’s dismissal in Payscale Inc. v. Erin Norman and BetterComp, Inc. Here, a former Senior Director of Sales had signed an 18-month nationwide non-compete tied to profit interest units and later joined a competitor. The Supreme Court determined that evaluating the nationwide scope and the adequacy of the consideration required a full factual review, rather than dismissing the case early on [15].
While injunctions are a powerful tool, adding financial consequences can make enforcement even more effective.
Fee-Shifting and Damages Provisions
The cost of enforcement itself can act as a deterrent. Many M&A agreements include fee-shifting clauses, which require the breaching party to cover the non-breaching party’s attorney fees if they lose [4]. This levels the playing field and raises the financial stakes for violations.
Another effective method is the Forfeiture-for-Competition (FFC) provision. These provisions allow for automatic clawbacks of deferred payments if the seller engages in competitive activity [16]. For instance, a portion of the purchase price might be structured as an earnout payable over several years, with a clause stating that any competitive behavior results in immediate forfeiture.
In Delaware, well-designed FFC provisions can avoid strict reasonableness reviews because they act as financial disincentives rather than outright bans on competition [16]. As Mayer Brown legal experts explain:
Reasonableness review is required any time a provision restrains an individual from competing, including by subjecting them to an unliquidated obligation to compensate the company for any harm suffered from the competition [16].
Conclusion
Restrictive covenants play an essential role in preserving the value of an M&A transaction. Whether it's safeguarding customer relationships, protecting trade secrets, or maintaining the goodwill you've acquired, tools like non-competes, non-solicitation agreements, and confidentiality clauses act as critical barriers against competitive threats.
The enforceability of these covenants hinges on their reasonableness. Courts closely examine factors such as the duration, geographic scope, and the specific activities being restricted. Overly broad provisions are at risk of being invalidated. While M&A-related agreements often receive more leniency than standard employment contracts, recent rulings - like the 2026 Delaware decision in Fortiline, Inc. v. McCall - highlight that even buyers seeking monetary damages face scrutiny if their restrictions are deemed excessive [16].
Tailoring covenants to the jurisdiction is equally important. Relying solely on choice-of-law provisions can backfire, particularly in states like California or Minnesota. Narrower alternatives, such as customer non-solicitation agreements, may be a better option since courts often view them as less restrictive on an individual's ability to earn a living [9].
Forfeiture-for-Competition clauses provide another effective strategy. By tying part of the purchase price to deferred payments that can be reclaimed if the seller competes, these provisions sidestep the unpredictability of reasonableness reviews while still offering solid protection for your investment [16]. Ultimately, the most enforceable non-competes are those that align with the employee's role, comply with state laws, and focus on a clearly defined protectable interest.
FAQs
What makes an M&A non-compete enforceable?
An M&A non-compete agreement can be enforceable, but it depends on meeting specific legal standards, which vary by state. Generally, it needs to be reasonable in terms of its scope, duration, and geographic reach. Additionally, it must protect a legitimate business interest, such as safeguarding confidential information or preserving goodwill. Courts assess these agreements through the lens of public policy and state-specific laws. For instance, states like California impose strict limits on non-competes, while states like Texas permit them when they are considered reasonable.
How do I choose the right state law for the covenant?
Choosing the right state law is crucial because the enforceability of restrictive covenants differs widely across the United States. For example, some states, such as California, outright ban non-compete agreements, while others, like Texas, permit them under specific conditions. When deciding on the applicable law, consider where the business operates or where the employee works. To ensure the agreement aligns with local regulations and holds up in court, it's wise to consult legal counsel.
What can a buyer do if a seller breaches after closing?
If a seller violates restrictive covenants, such as non-compete or non-solicitation agreements, after the deal is finalized, the buyer has the option to take legal action. Potential remedies include pursuing injunctive relief to halt the violation or seeking damages to address any resulting harm. The exact legal approach will vary based on the agreement's terms and the specifics of the breach.
