The intent of drafting business agreements is often to avoid disputes. One cannot always anticipate every type of dispute that can arise. This is where experience comes in, as some disputes are recurring and can be avoided.
A buy-sell agreement that is not coordinated with the terms of a non-compete agreement is an example. This type of dispute often leads to disputes between partners. The recent Bihner v. Bihner Chen Eng’g, No. 01-21-00086-CV (Tex. App.–Houston [11th Dist.] 2021) case provides an opportunity to consider this issue.
Facts & Procedural History
This case involves a Texas limited partnership formed by a father and his business partner. The father passed his interest in the partnership to his son. Eventually, the business partner decided to exercise his option to buy out the son’s interest.
The buy-sell provision provided that either partner could either sell his interest in the partnership to the son for $600,000 or purchase the son’s interest in the partnership for the same price.
The partner opted to buy the son’s interest. This was not well-received by the son. The son quit his position and stated that he intended to start a competing business.
The partner’s attorney sent a demand letter reminding the son about his non-compete agreement. The son disregarded the letter, started a competing business, and allegedly used the partnership’s customer list to solicit the partnership’s clients.
About Buy-Sell Agreements
A buy-sell agreement is a legally binding contract between the owners of a business that lays out the terms and conditions for the sale of ownership interests in the company.
Under Texas law, the terms of a buy-sell agreement can vary depending on the specific circumstances of the business and the parties involved. Common terms of a buy-sell agreement include:
- The price and terms of payment for the sale of ownership interests, including any financing arrangements.
- The method for determining the value of the business, such as a fixed price, a formula, or an appraisal.
- The procedures for handling disputes or disagreements between the parties, such as mediation or arbitration.
- Restrictions on the transfer of ownership interests, such as a right of first refusal or a requirement for approval by the other owners.
- Provisions for a buyout in case of death, disability, or retirement of an owner.
While most buy-sell provisions provide for these terms, they may or may not address how and when the departing partner can and cannot compete with the partnership.
About Non-Compete Agreements
A non-compete agreement, also known as a restrictive covenant, is a legally binding contract that prohibits an individual from competing with the company or partnership for a certain period of time after the individual’s departure.
Under Texas law, non-compete agreements for partnerships are enforceable if they are reasonable in terms of time, geographical area, and scope of activity restricted. The Texas Covenants Not to Compete Act (Tex. Bus. & Com. Code § 15.50 et seq.) applies to non-compete agreements for partnerships.
For a non-compete agreement for a partnership to be enforceable under Texas law, it must meet the following criteria:
- The agreement must be ancillary to or part of an otherwise enforceable agreement.
- The agreement must not impose an undue hardship on the individual restricted from competing.
- The agreement must not be injurious to the public.
- The agreement must not be greater than necessary to protect the goodwill or other legitimate business interest of the partnership.
- The agreement must not impose a restraint on the individual restricted from competing that is greater than necessary to protect the goodwill or other legitimate business interest of the partnership.
- The agreement must be reasonable in terms of time, geographical area, and scope of activity restricted.
There are a number of court cases that help define the contours of these rules.
The Lack of Coordination
This brings us back to the Bihner case. The Bihner case is unique in that the non-complete was found in an agreement that was separate from the buy-sell agreement. The case suggests that this is why the two provisions were not coordinated with each other.
The result of such an agreement is that the partner who acts first, by exercising their option to purchase the other partner’s interest in the partnership, can not only gain full ownership and control over the partnership but can also prevent the other partner from competing with them.
This creates a strong incentive for the partner with the financial means or credit to exercise the option to purchase first, as failure to do so presents a risk that the other partner will exercise the option first.
With the hindsight of reading the facts in this case, one can see that this setup could be seen as unfair and could lead to tension and disputes between partners. It is not conducive to a long-term partnership.
The Takeaway
The Bihner case highlights the importance of coordinating the terms of a buy-sell agreement and a non-compete agreement. The case shows that when these provisions are not coordinated, it can lead to confusion and disputes between partners. This can lead to an unfair and unbalanced partnership that is not conducive to a long-term relationship. It is important for partners to consider these issues when drafting and negotiating these agreements.