Non-compete provisions in M&A and Private Equity transactions are usually seen as a “must have” due to the significant commercial importance to the parties involved. A recent decision by the French Commercial Supreme Court (the “Supreme Court”) highlighted the French Law requirements to ensure the validity and enforceability of such agreements.

Background

Until recently, French Courts considered that in the M&A or Private Equity context, the validity of a non-compete agreement was only subject to the respect of three following cumulative conditions:

  1. the non-compete agreement must be necessary to protect, and proportionate to, the legitimate interests of the beneficiary;
  2. the non-compete agreement must be limited in its duration; and
  3. the non-compete agreement must be limited in its geographical scope.

In a decision of March 15, 2011, the Supreme Court decided that in a case where a shareholder (who also appeared to be an employee of the company) subscribed to a non-compete agreement,  such provision was null and void since no financial compensation had been granted to the shareholder. In this decision, the Supreme Court basically extended the validity requirements usually applied in the employment contracts’ case law.  The Court stressed the fact that in addition to the 3 usual requirements (see above) such a commitment shall:

  1. not prevent the Seller/Employee from finding a new job by taking into account his or her position and qualifications with regard to the relevant industry; and
  2. provide for a financial compensation for the duration of the non-compete agreement.

As a result of this decision, it was unclear as to whether or not such validity requirements shall be applied to non-compete agreements subscribed by all shareholders (e.g. within shareholders agreements or share purchase agreements) or shall only be limited to obligations already subscribed by shareholders that are also employees.

Supreme Court Decision of October 8, 2013

In its October 8, 2013 decision, the Supreme Court made clear that when a Seller/Shareholder is not an employee, only 3 validity requirements shall be applied (protection of the legitimate interests of the beneficiary, limitation of its duration and geographical scope) and that when a Seller/Shareholder is also an employee 2 additional requirements shall be applied (ability of the employee to find a new job and financial compensation).

In this case, a shareholder subscribed a 3 years non-compete agreement within the sale of the shares he held and became an employee of this company after completion of the sale. Less than 3 years later, the seller incorporated a competing company. The Purchaser filed for damages and to cease the competing activity.

The Court of Appeals to which the complaint was submitted rejected the purchaser’s request to have considered that the non-compete agreement was null and void since no financial compensation had been provided for. The Supreme Court overruled the Court of Appeals by considering that the non-compete agreement was valid due to the fact that at the time of the completion of the sale and of the subscription of the agreement, the seller was only a shareholder and became an employee only after the sale.

Takeaways

While in most M&A and Private Equity transactions, it is market practice for a Purchaser/Investor to provide for a non-compete and non-solicitation agreement from the Seller, parties involved shall keep in mind that the quality of the seller upon completion of the transaction (i.e. employee or not) is a key factor.

If upon completion of the transaction, the seller is only a shareholder and is not an employee, the non-compete agreement shall only be:

  1. justified by the necessity to protect the legitimate interests of the beneficiary;
  2. limited in its duration (usually a maximum of 2 or 3 years depending on the specifics of the transaction);
  3. limited in its geographical scope of application (i.e. not too wide and consistent with the company’s market, e.g. if the company operates in a French Region, the non-compete agreement shall not be extended to entire French territory).

If upon completion of the transaction, the seller is not only a shareholder but also an employee, the non-compete shall:

  1. not prevent the Seller/employee from finding a new job (i.e. not too wide so that it does not enable the employee, with his current qualification, to find a new job); and
  2. provide for a financial compensation for the duration of the non-compete agreement (usually around 30% of the gross salary unless an applicable collective bargaining agreement requires a higher amount).