Common in veterinary practice transactions, restrictive covenants are designed to prevent the seller from soliciting clients and competing with the buyer after the sale. Through such restrictions, buyers aim to protect themselves and ensure that the acquired business does not lose value due to the seller’s re-entering the market. To fulfill those objectives, a purchase agreement’s restrictive covenants should be negotiated, clearly stated, endure for a reasonable period (for example, two to five years) and be practical in geographic scope.
Ensuring Enforceability
For a buyer to truly benefit from non-solicitation and non-competition provisions, both parties should engage attorneys familiar with the relevant state laws. One case decided by a Pennsylvania appeals court in 2017 illustrated this point and underscored the importance of negotiating an effective restrictive covenant.
In Joseph v. O’Laughlin, the buyer and seller executed an agreement for the $750,000 purchase of a veterinary hospital. A five-year restrictive covenant prohibited the seller from directly or indirectly engaging or participating in competitive business within a 50-mile radius of the hospital. The seller also was prohibited from soliciting past, present or future clients of the practice during those five years.
However, six months after the transaction closed, the seller asked the county zoning board to approve a veterinary hospital eight miles from the buyer’s. The seller’s other steps included:
- Forming a limited liability company on behalf of the hospital he intended to open.
- Creating a social media page for the new hospital and using the account to connect with former clients.
- Purchasing veterinary equipment.
The social media page announced that the new hospital was “Coming soon.” A web link directed visitors to the hospital’s map location and written driving directions.
When the buyer learned what had happened, she sued and requested an injunction to enforce the restrictive covenant, permanently restrict the seller from operating the planned veterinary hospital and prohibit him from seeking zoning approval. The trial court agreed and awarded a permanent injunction.
Unhappy with the outcome, the seller appealed, arguing that he did not violate the restrictive covenant because his actions were “preparatory” and did not constitute practicing veterinary medicine. The appeals court rejected the arguments, concluding that the seller’s social media posts, “Coming soon” announcement, map directions and communications were for the sole purpose of informing followers and former clients that he intended to open a hospital and solicit their business.
Key Takeaways
The Joseph case offers veterinarians and their legal counsel this advice about restrictive covenants in practice transactions:
- In some states, organizational and preparatory measures related to the future operation of a veterinary hospital and done before the expiration of a restrictive covenant could violate the covenant.
- Veterinarians and their legal counsel should consider negotiating any inclusion of preliminary and preparatory activities in a covenant.
- The use of social media to communicate with the public about veterinary services can violate a restrictive covenant.
- Social media comments made by the seller’s former clients hurt his case and highlighted that the pet owners intended to renew their commitment to him when he opened his practice. For example, one former client wrote that the seller was the only veterinarian she had ever used and that she was hopeful he would be back soon. Another client “couldn’t wait for the new hospital to open” and thought the seller was a “super great vet.”
- Non-compete covenants ancillary to the sale of a business serve a useful economic function. Courts recognize that sellers receive a premium in exchange for their promise to not interfere with a buyer’s new business.
- A buyer looking to enforce a covenant must prove that a seller’s conduct caused harm. For example, the buyer in the Joseph case showed that the seller’s social media account hindered her opportunity to retain clients.
- A seller planning any activity that might be considered remotely competitive should ensure that the restrictive covenant contains a clear exception. For example, a seller might want to treat a particular animal species, do house calls or relief work, consult for a pharmaceutical company, or provide off-hours emergency services.
- The purchase agreement should fully inform the buyer if a seller has a second veterinary practice within or near the restricted region.
- A court does not want to guess what is and isn’t restricted. Therefore, carefully crafted, detailed covenants are crucial in any purchase agreement.
- The most critical point is that the enforceability of a restrictive covenant depends on your state’s laws.
YOU’RE TOO CLOSE
The appropriate scope of geographic exclusivity in a restrictive covenant depends largely on a veterinary practice’s locality and state. For example, a 25-mile radius might be reasonable in upstate New York but certainly not in Manhattan.