Dental and Medical Counsel Blog

Enforcing Non-Competition Provisions in Asset Purchase Agreements

April 14, 2021
Enforcing Non-Competition Provisions in Asset Purchase Agreements

If you are a physician, dentist, optometrist, or veterinarian, you may find yourself entering into an Asset Purchase Agreement when purchasing a practice. That agreement should include a non-compete provision that will have a significant impact on the value of the assets you are selling or purchasing. While it is always best to consult with an experienced healthcare or dental attorney before entering into any binding legal agreement, you should have a basic understanding of the enforceability of non-competition provisions in an Asset Purchase Agreement (APA) if you are contemplating the sale or purchase of a medical or dental practice.

What Is an Asset Purchase Agreement?

From a legal perspective, a medical, dental, optometry, or veterinary practice is a business entity formed for the purpose of making a profit. Just like any business, it can be bought or sold. Unlike other types of businesses, however, the value in a professional practice is often found in the intangible assets owned by the business. For example, imagine that a group of dentists decides to go into business together by forming a legal business that they name ABC Dental Practice. Several years later, they want to disband their practice. A potential buyer (or buyers) would find value in the equipment, established patients, and the “goodwill” owned by the practice; however, they might not want to purchase the entire practice outright. An APA would allow the buyer to purchase the tangible and intangible assets and property owned by ABC Dental Practice without becoming an owner of the business entity itself. Legally, ABC Dental Practice remains a separate legal entity while the new buyer acquires the value of the purchased assets.

What Is a Non-Compete Agreement?

Although an Asset Purchase Agreement is specifically tailored to facilitate the purchase of the valuable assets owned by a business without purchasing the corporation outright, it can fail to serve its intended purpose if the seller continues to benefit from those assets. By way of illustration, assume that XYZ Dentists enter into an APA to purchase the dental practice of ABC Dentist. Part of the assets being purchased includes the established patients of ABC Dental Practice and the goodwill of the business. Those assets lose most of their value if ABC Dentist can solicit those patients for dental services at another location or if ABC Dentists competes in another way with XYZ Dentists after the sale. A non-compete provision within the Asset Purchase Agreement is a common solution to this potential problem.

A non-compete agreement, also known as a covenant not to compete or a restrictive covenant, is a stand-alone agreement or a provision within a purchase agreement that prohibits one party from engaging in designated services or practices. In short, a non-compete agreement in the context of an APA for a medical, dental, optometry, or veterinary practice is intended to prohibit direct competition between the parties post-sale.

There are limits to any non-competition agreement. In the dental and medical fields, a non-compete agreement may impose restrictions related to time, location, and/or patients. A time restriction might prohibit the seller from operating a similar practice for two to five years after entering into the APA while a geographic restriction could prohibit opening a practice within 10-25 miles of the buyer’s practice. The terms of the non-compete can vary by State. A non-compete agreement will also typically prohibit the seller from servicing or soliciting existing patients and may even extend to a restriction that prevents the seller from hiring or retaining any existing staff.

Is a Non-Competition Agreement Enforceable?

The benefit of including a non-competition agreement in an Asset Purchase Agreement is lost if the non-compete provision is not enforceable. Therefore, it is imperative to know whether a court will enforce a non-compete agreement should it become necessary to do so. The enforceability of a non-compete agreement is governed by state law. As such, it is crucial to know what the law is regarding enforceability in the applicable state.

California, for instance, does not view non-compete agreements favorably if they have a “restraining effect” on an employee’s ability to practice his/her profession. California Business and Professions Code (CBPC) Section 16600 states “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Despite how it sounds, that does not mean that every non-compete agreement is unenforceable.

Although California typically will not enforce non-competition agreements that are part of an employment contract, Section 16601 of the CBPC provides an important exception to the general rule of unenforceability when the non-compete provision is part of an Asset Purchase Agreement. That section states that:

“Any person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity, or any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein.”

A Non-Competition Agreement Must Be Reasonable

A non-competition agreement may still be rendered unenforceable if a court finds the terms of the agreement to be unreasonable. When part of an APA, this usually means that the time and/or location restrictions are too broad. For example, a prohibition of one year would likely be enforced; however, a prohibition of ten years would probably not be enforced because it is unnecessarily restrictive. Likewise, a geographic restriction of ten miles would be more likely to be enforceable than a 50-mile restriction. The “reasonableness” test also requires a public policy analysis, particularly when applied to medical, dental, optometry, or veterinary care. In an area where access to these services is scarce, a court may be less inclined to enforce a non-competition agreement.

How Can I Protect My Interests in an Asset Purchase Agreement?

If you are planning to enter into an Asset Purchase Agreement that involves a medical, dental, optometry, or veterinary practice, you need to ensure that your interests are protected. If you are the seller, you need to have a clear understanding of how the non-competition provision of the agreement will impact you after the sale is completed. If you are the purchaser, you need to be certain that you will receive the full benefits of the assets you are purchasing. To ensure that your rights are protected, contact Dental & Medical Counsel to schedule a complimentary consultation with healthcare attorney Ali Oromchian.

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