Protect all your assets: making effective us of restrictive covenants - The Legal Buzz

Modern Brewery Age, Jan 26, 2004

Beer distributors spend a lot of money on inventory, and for good reason. Obviously, inventory is one of the most important and valuable assets of any distributorship. As a result, you protect your inventory. You insure inventory against loss, you maintain inventory controls, and you lock your warehouse tight when your business is closed. You don't want your hard earned money walking out the door. Certainly the last thing in the world that you would want to happen would be for your competitors to be able to grab your inventory for free and use it to compete against you. Unthinkable! Yet, we'll bet that many of you have had other assets "walk out the door" and, unfortunately, these assets may have ended up in the hands of your competitors. Impossible you say? Read on.

Beverage distribution, and particularly alcoholic beverage distribution is an incredibly competitive industry. Gaining a competitive edge is, or should be, the goal of every wholesaler. While companies may differ as to the best method to gain a competitive advantage, one thing is typically constant; successful companies devote substantial time and expense developing proprietary information and implementing their competitive strategies. This information and strategy may range from specific customer information and market knowledge developed over many years, to marketing strategies to future business plans; basically anything that you believe gives your company an advantage over your competition. This information and these strategies are valuable assets, and as such should be protected like any other valuable asset. One of the keys to securing such competitive advantages is properly drafted restrictive covenants.

What is a Restrictive Covenant?

As the name implies, a restrictive covenant is any agreement which prevents one party from engaging in conduct that he or she would otherwise have the right to engage in. Restrictive covenants may take the form of a prohibition against competing with another company, a restriction against using confidential information of the company, a restriction against soliciting customers of the company, a restriction against soliciting employees of the company; or any combination of the above. Typically restrictive covenants are used in two independent situations. The first is in the context of employment agreements. The second is in the context of a purchase of a business or in the purchase of brand distribution rights. In either case, the appropriate use of properly drafted restrictive covenants is essential to protect legitimate interests of the employing or purchasing company.

Why Should I Use Restrictive Covenants?

Consider the following examples: Scenario 1: After attending a seminar expounding the merits of consolidation you determine that to be more competitive you have to acquire more brands. You devote a substantial amount of time and money locating a potential company to purchase which you believe will be complimentary with yours. You spend more money on legal and accounting services, doing due diligence, negotiating and drafting the necessary acquisition documents. Finally, you close on the purchase of a competitor's multi-brand distributorship. You walk out of the closing, proud that you have taken a major step towards financial independence. The next day, however, you discover that the prior owner has acquired another competitor's business in your territory. You next find out that the entire sales force (including managers) of the business that you bought has quit and gone to work for the prior owner. Soon you discover that they are aggressively and successfully soliciting your customers, convincing them to buy their new brands instead of your brands.

Scenario 2: Your general manager who, for ten years, has enjoyed full access to all of your most confidential and proprietary information including, pricing, marketing strategies, and sensitive customer information such as timing of orders and purchasing contracts, decides to go to work for a competitor. Within a short time you discover that your ex-employee is soliciting some of your other employees, including managers, to go to work for your competitor. You also discover that your sales have declined precipitously, you believe this is because your ex-employee, having developed many strong customer relationships and equipped with a vast knowledge of your customers' businesses and needs (all developed, of course, while being paid by you) was able to convince many of your customers to buy his new products rather than yours.

You frantically dial Ettelman & Hochheiser and ask us if the seller in Scenario 1 and the ex-general manager in Scenario 2 can compete against you. Can you guess what our first question is? Of course you can; did either the seller or the ex-general manager sign any restrictive covenants? If the answer is yes, then your ability to stop these folks from walking out your door with your assets and hand delivering them to a competitor will be greatly enhanced.