Conditions for validity of non-competition clauses in share purchase agreements and mitigation power of the court

As set out in a former blog article (“Non-competition clause in acquisition agreements: a necessity?” – Matthias Jans, 14 April 2016 – see link), the buyer of shares who wants to prevent that the seller conducts competing activities after the transfer, must explicitly include a non-competition clause in the share purchase agreement.

Pursuant to the French d’Allarde Decree of 1791, the freedom of trade and industry prevails. This principle is now included in Book II of the Code of Economic law, Title 3 (Freedom of enterprise). As a non-competition clause restricts this freedom, the parties have to consider a certain number of limits while drawing up such clause.

As such, a non-competition clause must be restricted (1) in time; (2) in space and (3) with regard to its object[1].

Firstly, the clause must be restricted in time. The non-competition period must be restricted to the period that the buyer needs to build out its customer base or to develop customer loyalty. This period of time must be assessed according to the specific activities of the company whose shares will be transferred, which implies that this period varies from one case to another. As clear guidelines in this matter are lacking in the Belgian law, reference can be made to the principles regarding the non-competition clauses set out in the Commission Notice on restrictions directly related and necessary to concentrations (2005/C 56/03) (OJ 5 March 2005)), which provides that a non-competition clause is justified for a period of up to three years when the transfer of the undertaking includes the transfer of customer loyalty in the form of both goodwill and know-how, and for periods of up to two years when only goodwill is included. In specific cases, a longer non-competition clause will have to be justified by the requester.

Secondly, the clause must be restricted geographically. This also has to be evaluated by taking into account the target company’s specific situation. The geographic scope of the non-competition clause must be limited to the area in which the transferor of the shares could potentially set up actual competitive activities. In principle, this is the territory in which the company offers its products or services or was planning to do so at the time of the transfer of shares.

Thirdly, the object of the non-competition clause must remain limited to the relevant activities, more in specific the products and services constituting the economic activities of the company whose shares are transferred. This implies that the clause must be restricted to the specific activities that could actually be competitive, whether with the real activities of the company at the date of the share transfer, whether with the activities that the company is planning to exercise at the moment of the transfer. The description of the purpose (“voorwerp”) of the transferred company, defined in the articles of association, could serve as a guideline, but is not decisive (the statutory purpose is most of the times defined so broadly that it does not correspond to the company’s real activities).

For a long time, the legislator considered that a clause that restricted the transferor’s freedom of competition in an excessive manner (by not or insufficiently limiting the non-competition obligation in time, in space or with regard to the object), was absolutely null and void. Any possible mitigation of the clause was in principle excluded. In practice, the nullity of the non-competition clause resulted into the non-existence of the latter, enabling the transferor as such to conduct any form of competition, anytime, anywhere.

In two judgments rendered in 2015, the Court of Cassation acknowledged the court’s possibility to limit the nullity of a non-competition clause by mitigating the latter (Cass. 23 January 2015 and Cass. 25 June 2015). In the first judgement, the Court decided that the court is allowed to mitigate a non-competition clause that is too broad by reducing it to its legally permitted scope, provided that the parties have included the possibility of reduction in the contract. In this particular case, the contracting parties had included into the contract a severability clause, providing that the legally permitted part of the null clauses continued to be binding. In the second case, the judgment was unclear as to whether the contract provided the possibility of mitigation. The judgement suggests that this was not the case. However, the Court ruled that, when a partial nullity is possible, a non-competition clause that is null in principle, can be mitigated, provided that it was the parties’ intention that the (reduced) clause would continue to exist. In our opinion, a party can hardly pretend never having had the intention to enter into a non-competition obligation.

In any case, if the parties want to prevent the nullity and allow the mitigation of a non-competition clause, we recommend that they explicitly include a severity/mitigation clause in their share purchase agreement.

Kim Van Herck, intui attorneys

[1] P.M.: These are the general conditions that a contractual non-competition clause has to comply with, according to the prevailing case-law and doctrine, such as non-competition clauses used in share purchase agreements, shareholders’ agreements, consultancy agreements, management agreements, …. For other, more specific, cases, the legislator provides for the validity and enforceability conditions of a non-competition obligation, such as the one imposed on employees or trade agents. These specific cases are out of scope of this blog article.