Being the creator and author of the Allstate Agency Value Index has afforded me the opportunity to write countless articles and to travel on behalf of PPC LOAN to speak to both Allstate Management and the Agency force. In the process, I have learned of the issues often faced at loan closing, such as the restrictive covenant.
So, this quarter I have asked Tabitha Hughes to share her many years of experience in the area of non-competes. She has written an insightful article with many points to ponder when selling your Allstate business. We are pleased to share this information and hope it will help many of you in the near future.
Paul Clarke
President of PPC LOAN
Non-Competes Revisited
This article appeared previously in the Second Quarter of 2013
In closing loans for Allstate agents over the last 15 years, one of the biggest points of contention that comes up during the loan closing process is the restrictive covenant. Many buyers and sellers don't understand why a lender would care about their agreement. The reason is simple: Allstate's non-compete doesn't protect an agency buyer, and the lender has a vested interest in wanting the person to whom they are lending hundreds of thousands of dollars to be protected.
ALLSTATE IS NOT A PARTY TO YOUR PURCHASE AGREEMENT
Sometimes sellers are hesitant to sign a strong restrictive covenant because their R3001 Agreement with Allstate only stipulates that they not compete for one year and within one mile of their agency location. While this is true, they are not selling their agency back to Allstate (taking TPP). The agency buyer should remind the seller that while Allstate approves the transfer, the company is not a party to their purchase agreement, and the buyer is paying the seller a price for the agency that is higher than the TPP value Allstate would give them. In exchange for the higher price, the buyer is entitled to and should expect protection from competition by the seller. If after discussing these points, the seller continues to resist entering into a strong restrictive covenant, the buyer should investigate the seller's motivation behind this reluctance. As a general rule, sellers acting in good faith who have no intention of competing with their buyer also have no objection to signing a strong restrictive covenant.
WHY DOES IT MATTER?
Steve purchased an Allstate agency from Greg and paid him $500,000 at closing. Steve didn't hire an attorney to draft a formal purchase agreement - they simply signed Allstate's required transfer documents. Greg didn't discuss his future plans in detail with Steve; he only mentioned he was going to pursue another business venture. A few months after closing, Steve discovers the other venture is an independent agency just a few miles away from his newly acquired agency. Greg has a great new Yellow Pages ad, website, and nicely appointed office he purchased with the funds from his agency sale to Steve. Greg is also contacting his former customers, and Steve begins to lose business. Steve is angry and wants to sue Greg, but he has no legal recourse because he doesn't have a written contract stipulating Greg could not compete with him. Steve is left to repair the damage done to the agency on his own, as well as repay the $500,000 loan he secured to purchase it.
DUE DILIGENCE
Most agency buyers don't have Steve's bad experience, but the potential damage a seller can do to a buyer's agency is a serious risk, and buyers have a responsibility to conduct their own due diligence prior to completing an agency purchase. Buyers should speak with their sellers early in the negotiation process to determine their future plans, engage an experienced agency transition consultant, and have an attorney familiar with Allstate agency purchases (or at the very least small business acquisitions) draft a purchase agreement with an appropriate, enforceable restrictive covenant. With an adequate restrictive covenant, a buyer can sue for damages and recoup some of their lost investment. Furthermore, sellers are less likely to violate a written contract.
ENFORCEABILITY OF RESTRICTIVE COVENANTS
Often, a seller's resistance to signing a restrictive covenant, as well as a buyer's resistance to pushing the issue, is due to the preconceived notion that they are unenforceable. Contrary to popular belief, restrictive covenants are generally enforceable when the purchase of a business is involved, as long as they are reasonable. Restrictions against competition and solicitation that would normally not be enforceable in an employer/employee situation are often allowable when those restrictions are bought and paid for as part of an agency purchase. In an acquisition, the restrictive covenant is considered an intangible asset and can be given a value, just like the goodwill the covenant protects has value. This is necessary for the ongoing success of the business, as a breach of the covenant by the seller could cause irreparable damage to the buyer's agency. Thus, agency buyers can justify asking for a strong restrictive covenant in order to protect themselves and the health of their business from interference by the seller.
THE SCOPE OF RESTRICITVE COVENANTS
Your attorney can help decide what types of restrictive covenant terms are reasonable for your specific situation, but most address:
1. Non-Competition
a) What the seller and/or its representatives are specifically prohibited from doing - such as owning another agency, being employed by another agency, or being in any way involved with a business similar to the one that is being sold.
b) The time period over which the restrictions will be in place.
c) The geographic area for which the restrictions will be in place.
2. Non-Solicitation
a) Direct or indirect solicitation of the customers transferred to the buyer.
b) Direct or indirect solicitation of former employees of the seller that are being retained by the buyer.
c) Direct or indirect solicitation of any key referral sources.
3. Confidential information
a) Disclosure of customer lists or other confidential information to 3rd parties.
4. Damages
a) Monetary amounts the buyer can recover.
b) Injunctive relief (such as a cease and desist order).
THINGS TO CONSIDER
Some things you may want to consider when having your attorney draft your restrictive covenant:
1. Who has the potential to harm my agency?
a) Seller/Key Agent.
b) Seller's spouse or other family member(s).
c) Key Agency employees.
2. How could this person harm my agency?
a) Directly taking agency customers.
b) Taking customers through other individuals/companies.
c) Taking key agency employees.
d) Competing in my market area and interfering with my ability to write new business.
PROTECTING YOUR INVESTMENT
The above lists address just a few things that a restrictive covenant can cover. Not all agency purchases are the same, and not all restrictive covenants should be the same either. There may be a key agency employee that has the "real" customer relationships. Will you restrictive covenant cover that? Every buyer should seek the counsel of an experienced business attorney when purchasing an agency. An attorney can give advice and draft an agreement that is appropriate for your unique agency purchase and protect your valuable investment.