What Happens to the Restrictive Covenants in Employment Contracts During a Merger or Acquisition?

What if the employer that signed a contract is acquired by or merges with another company? Are restrictive covenants such as non-competition and non-solicitation clauses still enforceable? 

Many employers bind their employees to restrictive covenants in their employment contracts. Restrictive covenants are promises to refrain from taking a specific action. In healthcare, restrictive covenants often appear in the form of non-competition and non-solicitation clauses. 

A non-competition clause (non-compete) prohibits the employee from working with a competing business or starting a similar practice for a specified period and within a certain distance of the employer.

A non-solicitation clause prohibits the employee from soliciting the employer’s clients and personnel for other business or work opportunities.

If you’re an employer, restrictive covenants are a helpful tool for protecting your business interests. If a former employee breaches a valid covenant, you have the option to bring suit to enforce it. Conversely, to an employee, restrictive covenants can be a major factor in determining the appropriate future course of action if leaving a job.

View our related video, “Employment Breaches of Contract.”

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How are restrictive covenants affected if my company is acquired or merged?

The answer is dependent on several factors, including the state’s laws, the specific contract at hand, and whether the transaction was a merger or an acquisition.

A merger occurs when two or more companies combine to form a single new business — a “survivor” company. Contrast this with an acquisition, where one purchasing company buys another company’s stock or assets. The purchased company ceases to exist and is enveloped by the purchasing company, commonly referred to as the “successor.” The distinction between a merger and an acquisition can have different legal implications. But for simplicity, we’ll refer to the merged or acquired company as the “new entity.”

The new entity may be legally distinct from the company that entered into the employment contract. Therefore, it can be difficult to interpret what happens to the provisions in that contract. However, asking a few questions can help clarify whether or not the restrictive covenant may still be at play after a merger or acquisition. 

Was the restrictive covenant enforceable by the company before it was acquired or merged? 

If the underlying agreement (or its restrictive covenants) would not have been enforceable by the original company, it will not be enforceable by the new entity.

Whether the agreement’s covenants are enforceable is highly state-specific. California, for example, forbids non-competition agreements. Restrictive covenants in Illinois must be reasonable and, as of recently, only apply to individuals meeting specific qualifications.

In short, start by determining whether the restrictive covenant was valid in the first place. A healthcare attorney can help you understand your state’s laws and how they affect the contract at hand.

Was there an assignment or anti-assignment provision?

Let’s say that you’re working with a restrictive covenant that was enforceable before the acquisition or merger. Next, you’ll want to determine if the right to enforce it has been assigned to the new entity.

Assignment clauses allow a contracting party to confer their rights and obligations in a contract to a new party, with the new party assuming these rights and obligations. 

In contrast, anti-assignment clauses state that the rights and obligations given to a party by a contract cannot be “assigned” to any other party. You’ll see wording like this: “Assignment. Company may not assign any right or delegate any obligation under this Agreement to any other person.”

Although the rules vary by state, many courts have held that unless a specific clause allows assignment in the employer’s contract, the agreement is not enforceable by the new entity. Moreover, if there was a specific anti-assignment provision, this can prevent the new entity from assuming and enforcing covenants.

For these reasons, many non-competes do contain specific provisions allowing for assignment. When these provisions exist, the new entity can enforce a valid restrictive covenant.

Was there a survival provision?

A survival provision indicates which provisions of an agreement will remain in effect after some event that would ordinarily terminate the agreement and its provisions. Here’s an example:

Survival on Merger or Acquisition. In the event the Company is acquired during the Term, or is the non-surviving party in a merger, or sells all or substantially all of its assets, this Agreement shall not automatically be terminated, and the Company agrees to use its best efforts to ensure that the transferee or surviving company shall assume and be bound by the provisions of this Agreement.

In sum, contracts can be drafted to address the possibility of a merger or acquisition. The presence of a survival provision can clarify whether the original company intended for the agreement to “survive” a merger or acquisition.

Is the restrictive covenant still reasonable even after a merger or acquisition?

When a new entity assumes the restrictive covenants in an agreement, the new entity’s size and scope could change the “reasonableness” of those restrictive covenants. 

For example, say that a small local healthcare practice imposes a non-competition clause upon its employees. The non-compete forbids them from practicing within a 10-mile radius of any practice location. However, if a large national chain of healthcare clinics acquires this company, it could change the covenant’s enforceability. Why? In this situation, the courts may determine that it’s unreasonable for a former employee to find work more than 10 miles away from any of the chain’s locations.

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These are just a few considerations that go into determining whether restrictive covenants remain enforceable after a merger or acquisition. In short, it can be complicated!

Whether you’re an employer looking to make sure your contracts stay enforceable or an employee trying to understand which restrictions you must heed, Jackson LLP’s experienced healthcare lawyers can help. If you operate in any of the states where we have licensed attorneys, schedule a free consultation to learn more.

This blog is made for educational purposes and is not intended to be specific legal advice to any particular person. It does not create an attorney-client relationship between our firm and the reader. It should not be used as a substitute for competent legal advice from a licensed attorney in your jurisdiction.