Insurance · 17 January 2018

Can a non-compete clause protect the exclusivity of our product?

Selection of gourmet flavours of Italian ice cream in vibrant colors served in individual porcelain cups on an old rustic wooden table in an ice cream parlor, angle view
If someone is buying a business, there could be a restriction preventing the seller from setting up a competitive company

Business Advice legal expert, and Grid Law founder, David Walker responds to one reader considering buying out a small café business, but has concerns over how its sellers could compromise the exclusivity of its flagship product and the café’s competitiveness.

Question

I am looking at buying an ice cream parlour and coffee shop in a small market town. The current owners manufacture the ice cream sold in the café, and have built up the ice cream brand and café over the past 30 years.

Currently they don’t sell ice cream to any other cafés or retailers. But, they are unwilling to sign a non-compete clause which would prevent them selling ice cream to others upon selling the café, as they wish to build up their client base and sell more ice cream.

They are happy to not sell ice cream in the immediate vicinity, i.e. five miles of the café, but as it’s a rural area, five miles doesn’t take you to much other than a field.

I’m keen to protect the status quo and current exclusivity of the product as I am being tied into a five-year supply agreement to purchase their product.

I’d be happier with a 20-mile radius for three years, dropping to ten for the remaining two years of the supply agreement. The sellers consider this unreasonable and unenforceable. Our legal advice thus far differs – what would you advise?

Answer

As I said in my article, there’s a presumption that non-compete clauses are unenforceable unless you can show that three criteria have been fulfilled.

  1. There must be a legitimate business interest to protect;
  2. the restrictions must be reasonable; and
  3. the public mustn’t be adversely affected by the restrictions.

There appears to be a legitimate business interest to protect here, but you must take a really close look at this. What is the interest you are trying to protect? Are customers being attracted to the café because of the particular brand of ice cream, or would they be quite happy with another brand?

If the attraction is the brand of ice cream, then your arguments for a wider ranging non-compete clause will be stronger. If clients are more attracted by the location, the premises, the friendly staff etc., then there is less need for a strong non-compete clause.

The public are unlikely to be adversely affected by these restrictions, so the enforceability of the restrictions will ultimately come down to their reasonableness.

Assuming that the brand of ice cream is important, time and geography are obvious ways in which restrictions can be placed on a business. However, in your case I would try to be more specific.

What is the competition?

To start with, think about who your competitors really are. For example, are your competitors any outlet that sells ice cream or is it just cafes that sell ice cream? If your business is open only during the day, a restaurant that is only open in the evening and sells ice cream as a desert option is unlikely to be a competitor. This means the restriction and non-compete clause can be specific to a type of business.

Then, see how many competitors there actually are in a five, ten or 20-mile radius etc. Again, by way of an example, you may find that your competitors are based within your market town and a neighbouring market town. So, rather than negotiating over a five-mile or 20-mile radius you can negotiate over specific localities.

You also need to be realistic about how far customers will travel to get to your business. This may be where a 20-mile restriction is unreasonable. If a customer is not prepared to travel 20 miles to get to the café, then it would be unreasonable to prevent another café 20 miles away from selling the ice cream.

However, if you’re planning to quickly expand your business and open a chain of cafés in the wider area then a 20-mile restriction might be more reasonable.

When you take all of these points together you can then be very specific about how far reaching the restrictions need to be and for how long they need to be in place.

Supply agreements

Also, be careful about the terms of the supply agreement that you are signing up to. Make sure they are reasonable compared to other brands of ice cream. If the manufacturer is expanding, can they guarantee that they can meet your demands?

For example, during the busy summer months you don’t want your sales being restricted because their production facilities are already at capacity.

If they can’t keep up with your demands, you should be free to sell competitor products without restriction.

Take a careful look at what they consider to be competitive products. For example, you may accept a restriction to sell only tubs and cones of their ice cream but insist on being free to sell popular branded ice lollies. Do you make a distinction between what can be sold to eat in and what can be sold to take away?

All of this is going to have a significant impact on the value of the business you are buying and the price you are prepared to pay, so it is well worth looking at these issues very carefully.

Catch up on some of David’s recent Business Advice articles:

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ABOUT THE EXPERT

David Walker is the founder of Grid Law, a firm which first targeted the motorsport industry – advising on sponsorship deals, new contracts and building of personal brands. He has now expanded his remit to include entrepreneurs, aiding with contract law, dispute resolution and protecting and defending intellectual property rights.

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