Restrictive covenants – protecting your investment
Restrictive covenants – protecting your investment
Every business has elements that are invaluable to its on-going success, and this is no different in the dental sector. Katie Taken of law firm Cripps explains the role of restrictive covenants when selling or buying a dental practice.
The buyer will be paying the market value for the dental practice and will want to prevent the seller from setting up a new practice as this could erode the goodwill of the newly acquired practice. The way this is achieved is by ensuring the seller enters into provisions known as “restrictive covenants” in the sale and purchase agreement.
What is a restrictive covenant?
Broadly speaking, restrictive covenants fall into two main categories:
Non-competition: to stop the seller competing with the dental practice by setting up or working in a rival dental practice;
Non-poaching: to prevent the seller from approaching patients or staff. A restrictive covenant is a contractual term restricting an associate’s activities after their engagement has come to an end.
Is the restrictive covenant enforceable?
A restrictive covenant will be unenforceable and considered a restraint on trade unless the buyer can demonstrate the restriction is:
- Not drafted too widely; and
- Designed to protect a legitimate business interest.
The reasonableness of any restriction is ultimately determined by the courts and turns on the individual facts of any given matter. The courts have offered guidance on the meaning of “reasonable” – that it means providing no more protection than is relevant and necessary to protect a legitimate business interest.
What is a legitimate business interest?
The court will only accept a restriction that is designed to protect a legitimate business interest. For example:
- The goodwill of the practice, for example the investment that it has made to build up its trade connections (e.g. with suppliers or patients);
- Confidential information (e.g. patient lists) or other trade secrets.
It will not be enough for the buyer simply to say that it does not want the seller competing with its newly acquired practice, and it is important to tailor these restrictions so they do not go further than is necessary to protect the buyer’s new interest in the practice.
What is reasonable?
What is reasonable will depend upon the circumstances and will be considered at the time the agreement is signed. Some important points to consider are:
- Time – the general guidance from the Office of Fair Trading is that the restriction period should not exceed three years. We tend to find the usual period of the restriction is around two years but this does depend on the facts of the matter. Restrictive covenants do not tend to be unrestricted in time as they are likely to be deemed an unreasonable restraint on trade and therefore unenforceable on the part of the buyer.
- Geographic range – most dental practice sale agreements are likely to only cover a limited geographic area. The seller cannot be prevented from practising as a dentist ‘full stop’ and the restriction should be limited to a geographic location around the practice. As a guide, most dental sale agreements contain restrictive covenants covering an area within a one and five mile mile radius of the practice as this area would usually cover the majority of addresses of the practice’s patients. In instances where the practice operates from more than one location it may be wise to impose certain restrictions from each of those locations. Similarly, if the dental practice is in a rural area then the range of the restriction may well need to be further.
Ultimately, what may be reasonable may change over time and will vary based on the individual facts of each matter.
We always recommend that if you are thinking of buying a dental practice you discuss with the seller (and the seller’s family members or other business partners, if relevant) involvement in the practice and the seller’s future plans. Matters that should be at the forefront of any such discussions include:
- Are family members involved in the practice? If so then the restrictions may need to extend to those individuals.
- Does the seller (or any close family members) have an interest in or work for any other nearby dental practice? Will they continue this involvement? Will this affect the existing practice?
- Where do the majority of the patients live and will the proposed geographic range ensure all patients are caught by the restriction being imposed on the seller?
While restrictive covenants protect the investment being made in purchasing a dental practice, they are not guaranteed to fully protect the buyer. For instance, they are only enforceable for a certain period of time, within a certain geographic range and only restrict those individuals who are the subject of them. It is for this reason we recommend buyers discuss certain commercial points with the sellers at the outset of the transaction.
This article first appeared in The Dentist.