PPCW - Buyer and Seller Beware

THE POTOMAC PEST CONTROL WEEKLY

THE

POTOMAC Buyer and Seller Beware: The Assignability
COMPANY
of Contracts in the Context of M&A
December 28, 2009 It’s the morning of closing and excitement is VP of HR reviewed the key employees’
in the air. You are a few hours away from employment, non-solicitation and non-
acquiring your first pest control company competition agreements prior to the closing
KEY POINTS which will add a nice chunk of sales and and advised you that they are standard and
technical expertise to your current enforceable in the state.
• Buyers can destroy their operations. So far, you’ve done everything
investment by not by the book. You and your advisors have Can you enjoin these employees from
scrutinizing contracts negotiated a fantastic price for the target, competing against you and soliciting your
properly you’ve completed extensive due diligence recently acquired customers? Do you have
and your attorney has advised that all you any recourse under the agreements that these
• Sellers who institute non- need to do now is show up at the closing, employees signed with their former
competition and non- sign a few documents and fund the deal. employer, and that you believed would be
solicitation agreements transferrable to you?
with transferability A week after the trouble-free closing you
provisions prior to the receive a desperate call from your manager The situation above, while hypothetical for
sale, can preserve wealth who informs you that three of the key the purposes of this article, is based on an
and decrease anxiety employees from the target (the company you actual incident that I just learned about from
throughout the sell-side just acquired) have tendered their an attorney here in Philadelphia. Although
process resignations. While on your way back to the the acquirer was not a pest control company,
office you get an email on your Blackberry it was a residential services company that
• Proper contracts in place from an old friend in the industry who tells operates in a very similar fashion to a pest
you that your three former employees are control company and therefore it is very
prior to the sale may allow
now working for your biggest rival, and will relevant to all acquirers and sellers in the
sellers to tell employees
most likely be stealing the same customers pest control industry.
about the sale much later
that you just wrote a check for the week
in the process
before. In order to answer the questions raised
above, we need to delve a little deeper into
When you hear that, the pit in your stomach the fact pattern of the case. Needless to say,
Q&A: When Should You grows, but then it hits you, as you say to however, these are all questions that should
Tell Your Employees yourself, “well, thank God they are all under have been asked prior to closing the deal, not
About the Sale of Your non-competition, non-solicitation and a week later when the acquirer has a million
confidentiality agreements…. At least they dollars on the line.
Business?
won’t be able to steal business from me.”
(see page 4) In the US, the question of enforcement of
Many an inexperienced acquirer have uttered assigned contracts depends entirely on state
those very same words, only to find out that law (or provincial, cantonal, etc, depending
the agreements that were in place at the time on what country you are in). In this
of the acquisition are not worth the paper situation, under PA state law, the acquirer
they are printed on. In this situation, when seems to have absolutely no recourse
you made the acquisition, your attorney whatsoever and will be losing a lot of money.
advised you to structure the transaction as an Depending on your state (or country), non-
asset purchase, as opposed to a stock competition and non-solicitation agreements
purchase. He reasoned that not only will might be entirely unenforceable as a matter
The Potomac Company
you be able to write-up the acquired assets of public policy (such as California),
www.PotomacCompany.com and get better tax treatment, you will also be however the gene ra l theme of the
+1-215-268-7586 able to avoid any hidden liabilities that might assignability of contracts, whatever those
not have been uncovered in diligence. Your

© Copyright 2009, The Potomac Company, LLC. All rights reserved. www.PotomacCompany.com

2 THE POTOMAC PEST CONTROL WEEKLY
contracts may be, in the context of an 31667316 (Ohio Ct. App. November 27, 2. If the seller does have agreements in
M&A transaction might still apply to 2002). See also, Reynolds & Reynolds v. place, are they presently enforceable
you. Hardee, 932 F. Supp. 149 (E.D. Va. 1996) by the current employer? If they are
(employment agreement is based on not enforceable by the seller, they are
In the example above, the acquirer mutual trust and confidence; non- certainly not going to be enforceable
purchased the target’s assets, which is the compete is not assignable). by you the acquirer. Some questions
same way that the extreme majority of your legal counsel will need to answer
pest control acquisitions are structured. The PA Supreme Court offers further are:
Under an asset purchase, contracts need guidance, “.... it is the employer that
to be assigned to the acquirer, whereas drafts an employment agreement that is a. W a s t h e r e a d e q u a t e
under a stock purchase, the acquirer is executed by both parties for the benefit consideration to induce the
buying the target’s stock and therefore and protection of the employer. It is a employees to enter into the
most, if not all (unless there is a change simple matter for the employer to insert contracts in the first place? If
of control provision), of the target’s an assignment clause into the agreement not, you may need new
contracts stay in force. at the time that the agreement is drafted agreements.
to cover future contingencies, such as
In a 2002 case, the PA Supreme Court those that occurred here. The failure of b. Are the covenants overly broad,
opined, “We hold that a restrictive an employer to include specific which will allow the courts to
covenant not to compete, contained in an provisions in an employment contract strike down the whole
employment agreement, is not assignable will not be judicially forgiven or agreement or “blue pencil” the
to the purchasing entity, in the absence of corrected at the expense of the documents thereby limiting
a specific assignability provision, where employee.” Hess v. Gebhard & Co., 808 their effectiveness? Again, your
the covenant is included in a sale of A.2d 912 (Pa. 2002). attorney may advise you that
assets” This view however, should not be brand new agreements are
surprising, as most courts tend to view Lessons for the Acquirer necessary.
covenants not to compete as contrary to Most sellers do not want acquirers talking
public policy in that they act in “restraint to their employees until the acquisition 3. Was the target consistent in the
of trade.” matter in which it obtained
proceeds have cleared their bank
accounts. However, when I advise on restrictive covenants? If the
So by taking the cautious approach and the buy-side, under no circumstances employees can argue that the selling
acquiring assets and not stock, the company was not consistent in
would I allow my client to fund an
acquirer needs to make sure that there is acquisition without determining which obtaining restrictive covenants, this
valid assignability language in the employees are staying, which employees may weaken your ability to enforce
original agreements executed by and them.
are going, and what the employment
between the employees of the selling relationship between the employees (of
company and the selling company. In an the seller) and the new employer (the 4. Did the selling company enforce its
asset purchase, you are not buying the restrictive covenants? If the seller
acquirer) will be going forward. There
employment relationship, per se, you are some very basic due diligence items did not enforce its agreements, you
must hire the employees of the selling in regard to the target’s employees that shouldn’t expect the court to allow you
company upon consummation of the sale. to enforce them either.
should be handled during the diligence or
Therefore, if any employment contracts legal documentation stages of the
do not have an assignment clause, the 5. Is the geographic scope of the
transaction, these include:
courts will often view those to be target’s business different than that
unenforceable. In late 2002 the Ohio 1. D o t h e e m p l o y e e s h a v e a n y of the acquirer? Did the employees
Court of Appeals opined that, "the execute the agreements in Maryland,
employment, non-solicitation, or
employment relationship is a personal b u t a r e n o w w o r k i n g i n PA ?
non-competition agreements in place
matter between an employee and the with the selling company? If they Restrictive covenants and employment
company who hired him and for whom agreements are state law issues, so
don’t, the solution is very simple, have
he chose to work. Unless an employee them sign these agreements prior to make sure that the scope of the
explicitly agreed to an assignability the closing of the sale. The acquirer agreements are appropriate. Discuss
provision, an employer may not treat him your operational plans with your
should work with the seller to make
as some chattel to be conveyed, like a sure all employees sign these attorney and make sure that you are
filing cabinet, to a successor firm." Cary agreements. covered. This is important when
Corp. v. Linder, No. 80589, 2002 WL operations cross state lines.


This is clearly legal diligence and should now and provide adequate consideration
be conducted by a competent attorney in to them for entering into the agreements. Author
that specific jurisdiction. When you Remember, this is something that should Paul Giannamore
paul@PotomacCompany.com
acquire a pest control company, you are be done solely through the advice of an
“acquiring” an employee base, and if you attorney who can advise you on such
don’t pay very close attention to these issues as adequate consideration and About The Potomac Company
The Potomac Company is a Philadelphia-
issues, you might as well just give the enforceability.
based mergers & acquisitions and
money away.
valuation advisory firm with a transaction
Final Thoughts group dedicated exclusively to the pest
If you are contemplating an asset Buyers will want to talk to the target’s control industry. The Potomac
purchase and are uncomfortable with the employees at the very early stages of the Company advises pest control companies
seller’s agreements, or through your due acquisition process and sellers will not in North America, South America,
diligence, you’ve uncovered issues, such want the acquirer talking to their Europe, Africa, Asia and the Middle East.
as no assignability clause, you need to employees at all until the acquirer owns
enter into new agreements with the the target. Buyers and sellers need to Our Services & Consultations
employees prior to the close of the find a common ground, usually in the late The Potomac Company provides world-
acquisition. If the seller won’t cooperate class M&A, valuation, and exit planning
stages of diligence, where the buyer is
with this, you might need to establish a able to meet with, at minimum, the key advice to pest control companies. If you
sizable holdback or escrow to protect employees of the target. Seller’s need to are interested in a free, no-obligation
your interests, or even revise the purchase consultation, call Paul Giannamore at
feel confident that the deal is all but done
price downward to compensate for the before allowing the buyer access to 215-268-7586 or fill out and fax back the
increased risks in doing the deal. convenient form located at the back of
employees and the buyer will not want to
this article.
invest a lot of time and money into the
Finally, if the employees won’t sign up deal process if the seller’s employees
with you prior to the closing, this should Disclaimer
may walk out the door upon the sale.
be a big red flag. If they won’t do it This report is published by The Potomac
before the closing, you have no assurance C o m p a n y. All content is for
Through careful planning, a seller can
that they will do it after, and you need to informational purposes only and is not to
greatly decrease the risks that both sides
proceed with extreme caution. At this be construed as legal, financial or tax
will face in dealing with employees on
point, you need to ask yourself whether advice. You are strongly advised to
the potentially life-changing topic of the consult a competent attorney when
or not it makes sense to proceed with the sale of their employer. By working with contemplating the purchase or sale of a
acquisition… and at what price? competent advisors before the sale business.
process to make sure that consistently-
Lessons for the Seller obtained, enforceable non-solicitation Copyright & Reprint Rights
Many of you might not be contemplating and non-competition agreements with No reproduction of this article, in whole
an acquisition whatsoever and find transfer provisions are in place, the seller or in part, is authorized without explicit
yourself solely on the sell-side of the will generally have more leverage in permission from The Potomac Company.
equation, so what’s this got to do with holding the acquirer off until much later If you would like to reprint this article,
you? stages in the acquisition process before please contact Rewaa Alhasani at
getting his or her employees involved. 215-268-7586.
First off, any sophisticated acquirer is
going to ask the very same questions that Waiting until you are on the verge of Subscriptions
I’ve highlighted in the section above selling your company, your life’s work, to To subscribe to this and future
upon the acquisition of your business. If deal with these issues is inexcusable. publications, call 215-268-7586 or send
you are in a jurisdiction that recognizes Getting competent M&A and legal an email to pco@potomaccompany.com
and enforces these covenants and advisors involved in the planning stages
agreements, you might want to consider is your best weapon against sophisticated The Potomac Company
getting them in place now, before you acquirers, against whom sellers are at a 1650 Market Street, 36th FL
commence a sell-side process. natural disadvantage from the very Philadelphia, PA 19103
Furthermore, If you don’t have non- beginning of the process. 215-268-7586
compete agreements with assignment www.PotomacCompany.com
provisions, you might want to negotiate
new agreements with your employees



Q&A
Ask the Advisor: When to Tell Employees You Are Selling
Q: I’ve decided to sell my business, when should I Get Your Story Straight
tell my employees? I don’t want to lie to them, I think it’s important to be honest with your employees,
but I don’t want them to quit on me either. because they will come to know the truth in the end and

Jeff (from Florida) you’ll lose face. That doesn’t mean, however, you should
give them the straight scoop. Instead of mentioning an
A: When selling your business, there will come a time outright sale, you might let them know that you are
when you will need to tell your employees, the people that exploring strategic alternatives, such as seeking financing
you’ve relied on for years, if not decades, that you are or an equity infusion, and when the day of the sale comes,
selling your business. This is certainly one of the aspects of you’ve ultimately decided that a sale is the best way to
the sell-side process that causes a tremendous amount of maximize firm value.
anxiety for sellers, but through proper preparation, you’ll
be able to tell your employees on or immediately before Set Up an Offsite Data Room / War Room
the closing, which is the best time to tell them. Your advisor should be on this one from the word go. By
setting up a room in a local hotel or offsite office, you’ll be
Some owners decide to tell employees at the beginning of able to hold all meetings offsite, and avoid prospective
the process and most of the time, this is a big mistake. buyers from showing up at the office during business
Once the employees know, they will do one of the hours and drawing unwanted attention.
following: 1) take a wait-and-see attitude and react to
every single hiccup in the deal (and believe me, there will Bring a Few Insiders into the Tent
be many hiccups); or 2) prepare their resumes and It’s a lot of work selling a business and you’ll probably need
preemptively jump ship. The sale of a company is an the help of a key person or two. Bring these individuals in
emotionally taxing event for the seller in and of itself, so up-front and have them sign a confidentiality agreement
think very hard before you invite the additional stress of (and if they breach it, they’re history… no more job and
having your employees scrutinize every buyer and ride no more stay bonus).
along with you on the emotional roller coaster.
Be Prepared for the Worst
Although it is very easy to stay quiet during the initial Although you may do everything possible to stay tight-
stages of a deal, once the suits start showing up to the lipped, be prepared for a leak. When someone confronts
office, anyone there with an IQ above 20 will start piecing you with the news, the worst thing you can do is go hide
things together. Successful sellers do the following: in your car while you figure out how to deal with it.
Prepare an internal memo for employees and an external
Get Stay Bonuses and Contracts Negotiated in Advance memo for key customers early on in the sale process.
Get all employees under non-competition agreements Prepare fact sheets and rehearse talking points with your
with assignability provisions in place prior to the sale advisors at the early stage of the sale process. When the
process. Negotiate stay bonuses with your key employees rumors start flying, poor communication and delay creates
before you even mention the word “sale.” anxiety among employees… be prepared.



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