Summary. Restrictive covenants outside employment are governed by different rules, judged more forgivingly, and drafted for different purposes than the employee non-compete that dominates commentary. A covenant given by a seller of a business protects goodwill the buyer paid for, and is enforced in nearly every state — including states that prohibit employee non-competes outright. A franchise covenant protects a system and a territory. A covenant among partners or members protects a firm each of them owns. This article covers how those contexts differ from employment, how antitrust constrains them, why choice of law is the most consequential drafting decision, and what forfeiture provisions accomplish where injunctions cannot.

A dentist sells her practice for $2.4 million. The purchase price is allocated with $1.9 million to goodwill. She signs a five-year covenant not to practice dentistry within fifteen miles, and agrees to work for the buyer for two years during a transition.

Eighteen months later she opens a new practice four miles away. Two-thirds of her former patients follow.

In California, where a non-compete signed by an employee is void by statute, this covenant is enforceable. Business and Professions Code § 16600 voids restraints on lawful profession, trade, or business — but § 16601 expressly excepts a covenant given by a person selling the goodwill of a business or all of an ownership interest, permitting a restraint within the geographic area where the business was carried on, so long as the buyer carries on a like business.

The rationale is not employment law but property law. The buyer paid $1.9 million for goodwill — for the reasonable expectation that patients would continue to come to that practice. If the seller may immediately reclaim those patients, the buyer purchased nothing. Every state recognizes some version of this reasoning, and courts apply it far more generously than they apply the employee non-compete standard.

But there is a complication that decides this case. The seller also became an employee. Is the covenant enforceable as a sale covenant or void as an employment covenant? Courts look to substance: what was actually paid for, whether the consideration was allocated to goodwill, whether the covenant was negotiated as part of the sale, and whether the parties had comparable bargaining power. A covenant contained in the purchase agreement, supported by purchase price, given by a genuine owner is a sale covenant. One contained only in an employment agreement executed at closing, given by a minority holder receiving nominal consideration, is far more vulnerable.

That distinction — sale versus employment — is the single most important classification in this area, and it is decided by how the deal documents were drafted.

Why context changes the standard

The employee non-compete is disfavored because of the asymmetry between employer and employee, the employee's need to earn a living, and the absence of meaningful negotiation. Legislatures in a growing number of states have banned them outright for some or all workers, imposed wage thresholds, required advance notice and consideration, and mandated garden leave. The FTC's rule purporting to ban most employee non-competes nationwide was set aside by a district court and remains the subject of litigation and possible reconsideration — but it is worth noting that the rule, like nearly every state statute, contained a sale-of-business exception.

None of those rationales applies with the same force in the contexts this article covers:

A seller received money for the goodwill being protected, negotiated at arm's length, usually with counsel, and can quantify what the covenant was worth.

A franchisee received a license to a proven system, training, and a protected territory, and the franchisor's interest in preventing the franchisee from converting the location into a competing independent business is substantial and obvious.

A partner or member owns the firm the covenant protects, participated in adopting it, benefits from its application to everyone else, and can exit with a capital account.

Courts therefore apply a reasonableness standard in these contexts that is genuinely more forgiving on duration, geography, and scope — and, importantly, apply it in states whose employment non-compete law is restrictive or prohibitive.

Sale-of-business covenants

What the buyer is protecting. Goodwill — the customer relationships, reputation, and going-concern value it paid for — and, secondarily, confidential information and the workforce.

Reasonableness factors applied more permissively than in employment:

  • Duration. Three to five years is routinely enforced; longer terms have been upheld where the purchase price and the nature of the business justify it. Employment covenants beyond one to two years are frequently struck in the same jurisdictions.
  • Geography. The area where the business actually operated, plus in some cases the area of planned expansion. Nationwide restraints are enforceable for genuinely national businesses.
  • Scope of activity. The business sold, defined by reference to what the target actually did rather than to everything the buyer does. Overbreadth here is the most common defect: a covenant barring the seller from any activity in which the buyer's entire enterprise engages generally fails, because it protects more than the goodwill purchased. See Kodiak Building Partners, LLC v. Adams, where the Delaware Court of Chancery declined to enforce a covenant extending to the acquirer's other business lines rather than the acquired company's.

Who signs. Every selling equity holder, every key employee whose relationships constitute the goodwill, and — through a separate agreement — the seller's principals in their individual capacities. In an asset deal, the entity and the individuals; in a stock or unit deal, the sellers. Do not rely on a covenant given only by an entity that will be dissolved.

Consideration. Allocate purchase price to the covenant in the purchase agreement, or at minimum recite that the covenant is a material inducement and that a portion of the consideration is attributable to it. The allocation has tax consequences — amounts allocated to a covenant not to compete are amortized by the buyer over 15 years under § 197 and are ordinary income to the seller, rather than capital gain — which creates a genuine tension between tax efficiency and enforceability. Address it deliberately rather than by default.

The employment overlay. Where the seller stays on, use two documents: the sale covenant in the purchase agreement, running from closing, and any employment covenant in the employment agreement, running from termination — with the sale covenant expressly surviving independently and with a provision stating that the covenants operate cumulatively rather than in substitution.

Earn-outs complicate everything. A seller with an earn-out has an interest in the business's performance, which supports the covenant, but also has an argument that the buyer's conduct frustrated the earn-out — a claim frequently asserted as a defense to enforcement. Draft the earn-out's operating covenants carefully.

Assignment. Ensure the covenant is expressly assignable, since the buyer may itself be sold. Courts have refused to enforce covenants in favor of assignees where the agreement was silent, particularly in states that treat non-competes as personal.

Franchise covenants

Franchise agreements contain two distinct restraints, and they are analyzed differently.

In-term covenants prohibit the franchisee from operating a competing business during the term. These are routinely enforced — they are essentially exclusive dealing provisions, the franchisee agreed to devote itself to the system, and the franchisor's interest is plain.

Post-term covenants prohibit competition after the relationship ends, typically for one to three years, within a defined radius of the former location and sometimes of other system locations. Enforcement rates are high, but the analysis is more contested.

What the franchisor is protecting: the system's confidential operating methods; the trademark's association with the system rather than with a location; the territory, so a successor franchisee can be recruited; and the integrity of the network, since a franchisee that can convert to an independent competitor at term end has an option that undermines every other franchisee's investment.

Where post-term covenants fail: duration or radius disproportionate to the business's actual trade area; scope covering activities the franchisee performed before joining the system; application after a franchisor's breach or wrongful termination; and state franchise relationship statutes, several of which restrict post-term covenants or condition termination and non-renewal in ways that affect enforcement.

The no-poach problem. Franchise agreements historically contained no-hire clauses prohibiting franchisees from hiring each other's employees. State attorneys general pursued these aggressively, obtaining removal of the clauses across most major systems, and private antitrust litigation followed. The Seventh Circuit's decision in Deslandes v. McDonald's USA, LLC, 81 F.4th 699 (7th Cir. 2023), reversed a dismissal and held that the no-hire clause should be analyzed under the rule of reason with a proper market analysis rather than dismissed outright, and declined to treat it as automatically ancillary and lawful. The practical guidance is unambiguous: remove intra-system no-poach clauses, and do not replace them with informal understandings, which are worse.

Related franchise restraints worth distinguishing: territorial exclusivity granted to the franchisee, which is a grant rather than a restraint and is generally lawful; customer allocation among franchisees, which is horizontal and dangerous; resale price maintenance, judged under the rule of reason federally but per se unlawful under several state statutes; and tying of required supplies to the trademark license, which requires market power in the tying product and has generally failed where the franchisee knew the requirements before investing.

Partnership, LLC, and equity-holder covenants

Covenants among owners occupy a middle ground and are generally enforced more readily than employment covenants.

Statutory recognition. California, again the strictest jurisdiction, expressly permits covenants among partners (§ 16602) and members of an LLC (§ 16602.5) in connection with dissolution or dissociation, and in connection with the sale of an interest. Most states have no separate statute and apply reasonableness with attention to the owner's role.

Common structures:

  • Non-competition during ownership and for a period after withdrawal.
  • Client non-solicitation, which in professional firms is frequently the operative restraint and is more likely to be enforced than a flat practice ban.
  • Non-solicitation of firm personnel.
  • Forfeiture provisions — the most powerful tool, discussed below.
  • Notice periods for withdrawal, and provisions governing what a departing owner may say and when.

Professional firms face limits. Rule 5.6 of the Rules of Professional Conduct prohibits an agreement restricting a lawyer's right to practice after the relationship ends, other than in connection with retirement benefits, and courts have applied it to invalidate law firm non-competes and, in many jurisdictions, forfeiture provisions that function as one. Medical practices are constrained in a number of states by statutes voiding physician non-competes on public policy grounds. Accounting firms have generally fared better.

Fiduciary duties supplement the contract. A partner or member preparing to leave owes duties during the transition, and the recurring litigation concerns what a departing owner may do before withdrawal: taking client lists, soliciting clients or employees, and using firm resources to prepare a competing venture. Meehan v. Shaughnessy, 404 Mass. 419 (1989), is the classic treatment — logistical preparation to compete is permitted; using the firm's confidential information and pre-emptively soliciting clients with unfair advantage is not.

Forfeiture for competition

Where an injunction is unavailable, forfeiture frequently is.

The structure: a departing owner who competes forfeits deferred compensation, a capital account balance, unvested equity, or future payments — but is not prohibited from competing.

Why it works. Under the "employee choice" doctrine, followed in a number of jurisdictions, a provision conditioning a voluntary benefit on refraining from competition is not a restraint of trade at all, because the person retains the choice. Courts applying it generally decline to review the provision for reasonableness.

Delaware's treatment is significant because so many agreements select Delaware law. In Ainslie v. Cantor Fitzgerald L.P., the Delaware Supreme Court reversed the Court of Chancery and upheld a partnership agreement's conditioned-payment provision, applying contractual analysis under the Delaware Revised Uniform Limited Partnership Act's policy of freedom of contract rather than subjecting the forfeiture to reasonableness review. That decision — read alongside Chancery's willingness in Kodiak and related cases to decline to blue-pencil overbroad covenants — means Delaware now offers a notably favorable environment for forfeiture provisions and a less predictable one for injunctive covenants.

Limits. Forfeiture provisions may be unenforceable as to lawyers under Rule 5.6, may be restricted by ERISA where the forfeited benefit is a pension plan benefit, may run into state wage payment statutes where the forfeited amount is earned wages, and are not available at all against a person with no deferred entitlement.

Practical guidance. Where the covenant protects a firm whose owners have capital accounts or deferred compensation, a forfeiture provision is frequently worth more than an injunctive covenant — it is more likely to be enforced, it requires no showing of irreparable harm, and it self-executes without litigation.

Antitrust

Every restrictive covenant is an agreement not to compete, and § 1 of the Sherman Act reaches agreements in restraint of trade. Three doctrines keep ordinary covenants lawful.

The ancillary restraints doctrine. A restraint that is ancillary to a legitimate procompetitive transaction — subordinate and collateral to it, and reasonably necessary to achieve its benefits — is analyzed under the rule of reason rather than condemned per se. The doctrine descends from United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir. 1898), and its modern articulation is well captured in Polk Bros., Inc. v. Forest City Enterprises, Inc., 776 F.2d 185 (7th Cir. 1985): a restraint that makes a cooperative venture more effective is judged by its overall competitive effect.

A sale-of-business covenant is the paradigm ancillary restraint — without it, the transaction could not occur on the same terms, because no buyer would pay for goodwill the seller could immediately reclaim.

The naked restraint distinction. A covenant not ancillary to any legitimate transaction — an agreement between competitors to allocate customers or territories, or a naked no-poach or wage-fixing agreement between employers — is horizontal and is treated as per se unlawful. The Department of Justice has stated that naked no-poach and wage-fixing agreements are subject to criminal prosecution, and has brought such cases, with mixed trial results but with the enforcement posture unchanged.

Where the line gets crossed in practice:

  • Horizontal no-poach agreements between separate businesses, whether formalized or informal. This includes agreements among franchisees, agreements among competitors met at a trade association, and side agreements between a company and a competitor during an aborted acquisition.
  • No-poach clauses in commercial agreements — vendor, joint venture, staffing, and outsourcing contracts — which are ancillary and lawful if reasonably necessary and narrowly tailored to the collaboration, and unlawful if broader than the collaboration requires. Narrow them to employees actually working on the engagement, limit the duration, and exclude general solicitations.
  • Information exchange about compensation among competitors, which is a separate and independently actionable theory.

In due diligence and integration, a buyer must not obtain competitively sensitive information or coordinate with the target before closing — gun-jumping — and clean team protocols exist for exactly this reason.

Drafting: what actually determines enforceability

Choice of law is the most consequential decision in the agreement. The variation among states is enormous — some void employee non-competes entirely, some reform overbroad covenants to make them reasonable (reformation), some strike only the offending words (blue-pencil), and some void the entire covenant if any part is unreasonable (red-pencil). A covenant drafted for a reformation state and litigated in a red-pencil state can be lost entirely.

But choice of law is contested. Courts apply the forum's conflicts rules, which typically enforce the parties' choice unless the chosen state has no substantial relationship to the parties or the transaction, or applying it would violate a fundamental public policy of a state with a materially greater interest. Non-compete policy is the paradigm fundamental policy, and several states have enacted statutes expressly voiding choice-of-law and choice-of-forum clauses in agreements with their residents. The result is a race to the courthouse: the employer files in the chosen forum seeking enforcement while the departing party files at home seeking a declaration of unenforceability, and the first-filed rule and anti-suit injunctions decide it. Sale and equity-holder covenants fare much better in this analysis than employment covenants, because the public policies at issue do not apply with the same force.

Tailoring. Define the restricted activity by reference to what the business actually did. Define geography by reference to where it operated. Define duration by reference to how long the goodwill or confidential information retains value.

Definitions matter more than the operative clauses. "Competing Business," "Restricted Territory," "Customer" (limited to those with whom there was actual contact in a defined lookback period), and "Confidential Information" carry the entire agreement. Most overbreadth findings trace to a definition rather than to the covenant itself.

A tiered structure improves survival: a narrow customer non-solicit, a broader employee non-solicit, a confidentiality provision, and — where appropriate — a non-compete, each severable and each independently enforceable. If the non-compete falls, the rest survive.

Provisions to include:

  • Severability, with an express request for reformation where permitted.
  • Tolling — extending the restricted period by the duration of any breach, without which a violator can run out the clock during litigation. Note that a minority of states refuse to enforce these.
  • Injunctive relief acknowledgment — a stipulation that breach causes irreparable harm and that injunctive relief is appropriate. Not binding, but useful.
  • Liquidated damages, carefully — a genuine pre-estimate of loss, not a penalty, and drafted so that it does not become the exclusive remedy and thereby defeat an injunction.
  • Attorney's fees to the prevailing party, which changes settlement dynamics substantially.
  • Assignability.
  • Survival of the covenant beyond termination of the broader agreement.
  • Consideration recitals, and in a sale, price allocation.
  • Notice of obligations to a new employer, requiring the covered person to disclose the covenant to any prospective employer — which both deters and creates the predicate for a tortious interference claim.

Trade secret protection as the alternative and the complement. The Defend Trade Secrets Act, 18 U.S.C. § 1836, and state Uniform Trade Secrets Act analogues protect information regardless of any covenant, are unaffected by non-compete bans, and support injunctive relief and, for willful misappropriation, exemplary damages and fees. Every program should include: identification of what is actually a trade secret; reasonable measures to protect it (access controls, marking, confidentiality agreements, exit interviews, device return, and forensic imaging where warranted); and the DTSA whistleblower immunity notice required by § 1833(b), without which exemplary damages and fees are unavailable.

The inevitable disclosure doctrine — enjoining employment where the person would inevitably use trade secrets — is recognized in some states, rejected in others, and expressly rejected by statute in a few. It is not a substitute for a covenant.

Enforcement

Move fast. Delay undermines the irreparable harm showing that supports a preliminary injunction, and courts read it as evidence the harm is compensable in damages.

The sequence:

  1. Investigate — what did the person take, contact, or solicit? Forensic imaging of devices and email, review of access logs and downloads in the departure window, and identification of specific customers contacted.
  2. Cease and desist to the covered person and, where appropriate, to the new employer, whose knowledge of the covenant is an element of a tortious interference claim and whose insurer will take notice.
  3. Preliminary injunction — likelihood of success, irreparable harm, balance of hardships, public interest. Present specific evidence of solicitation and lost customers, not the covenant alone.
  4. Expedited discovery, targeted at devices, communications, and customer contacts.
  5. Claims to plead alongside — breach of contract, breach of fiduciary duty and duty of loyalty, trade secret misappropriation under the DTSA and state law, tortious interference with contract and with prospective economic advantage, unfair competition, and where applicable computer fraud statutes.
  6. Damages — lost profits, unjust enrichment, and where the covenant provides, fees. Prove them with customer-level data.

And weigh the decision. Litigating a covenant is expensive, public, and read by every remaining employee or owner. A negotiated resolution — a shortened period, a customer carve-out, a payment — is frequently the better outcome, and is available only if the covenant is credible enough to bring the other side to the table.

Conclusion

Three points carry the practical weight.

Classification determines the standard. A covenant given by a seller of goodwill, a franchisee, or an equity holder is judged by a materially more forgiving standard than an employee non-compete — and is enforceable in states where employee non-competes are void. Whether a particular covenant is classified as a sale covenant or an employment covenant turns on the deal documents: where the covenant sits, what consideration supports it, and whether purchase price was allocated to it.

Tailoring to what was actually purchased is the recurring failure point. Covenants that reach the acquirer's whole enterprise rather than the acquired business, that cover activities the franchisee performed before joining the system, or that define "customer" without regard to actual contact are the ones that fail. Definitions do more work than operative language.

Where injunctions are uncertain, forfeiture may be better. Conditioning deferred compensation or capital account payments on refraining from competition is analyzed as a contract term rather than as a restraint in a growing number of jurisdictions, it self-executes, and it requires no showing of irreparable harm. For firms whose owners hold economic entitlements, it is frequently the most valuable provision in the agreement.

A worked example: the roll-up

A private equity-backed platform acquires eleven regional HVAC contractors over three years. The covenant architecture determines whether the platform actually owns what it paid for.

Deal one. The founder owns 100 percent, sells for cash and rollover equity, and signs a five-year covenant in the purchase agreement covering commercial and residential HVAC services within the three counties the company served, with $250,000 of the price allocated to the covenant. He also signs an employment agreement with a one-year post-termination covenant. Both are drafted to operate cumulatively. This is the clean case.

Deal two. The target has four owners: the founder with 70 percent, and three service managers with 10 percent each. All four sign. Counsel resists the buyer's request for identical five-year covenants from the minority holders — a 10 percent holder receiving $180,000 is not selling the goodwill of the enterprise in the same sense, and an identical covenant invites a challenge that weakens the whole set. The minority holders sign three-year covenants with narrower geography, supported by allocated consideration.

Deal three. The seller is a corporation whose sole shareholder is a trust. The entity signs, and the buyer nearly stops there. Counsel catches it: the entity will be dissolved after closing, and a covenant from a dissolved entity is worthless. The trust's beneficiaries and the individual who actually ran the business sign in their individual capacities.

Deal seven introduces the drafting error the platform will regret. The buyer's form defines "Competing Business" as any business in which the Buyer or any of its affiliates engages. By deal seven the platform also owns plumbing and electrical companies. The covenant now bars a departing HVAC founder from plumbing work he never performed, in territories the target never served. Applying Kodiak's reasoning, that covenant protects more than the goodwill acquired, and a court declining to blue-pencil could void it entirely. The form is fixed for deals eight through eleven; deals one through seven carry the defect.

The equity layer. Rollover holders receive units in the platform under an LLC agreement containing a member non-compete and — more valuably — a forfeiture provision: a member who competes forfeits unvested units and any unpaid deferred consideration. Delaware law governs, and after Ainslie that provision is analyzed as a contractual condition rather than as a restraint, which makes it substantially more reliable than the injunctive covenant sitting next to it.

The no-poach question. Operations proposes that the acquired companies agree not to hire each other's technicians. Counsel refuses. Once acquired and under common ownership they are a single enterprise and internal transfers are a management question, not an agreement between competitors — but any similar understanding with companies not acquired, including targets in diligence, would be a naked horizontal restraint with criminal exposure. The clean-team protocol for diligence is documented and enforced.

The exit. Three years later the platform is sold. Because every covenant was drafted as expressly assignable, the acquirer receives them. Had they been silent on assignment, a meaningful share of the goodwill being sold would have been unprotected — a diligence finding that reduces price.

Frequently asked questions

Can a non-compete be enforced in a state that bans them? A sale-of-business covenant, usually yes — every state ban and the vacated FTC rule contain a sale exception. An employment covenant, generally no, and choice-of-law clauses selecting a permissive state are increasingly voided by statute.

How long can a sale covenant last? Three to five years is routinely enforced, and longer terms have been upheld where the price and the nature of the goodwill justify it. Duration is judged against how long the goodwill purchased would otherwise persist.

Should we allocate purchase price to the covenant? It strengthens enforceability and it costs the seller capital gain treatment on that amount while giving the buyer a 15-year amortization. Decide it deliberately with tax counsel; a recital that the covenant is a material inducement supported by a portion of the consideration is a middle course.

Is a franchisee's post-term covenant enforceable? Usually, within a reasonable radius of the former location for one to three years. It is far more vulnerable where the franchisor terminated wrongfully, where a state relationship statute restricts it, or where it reaches activities the franchisee performed before joining the system.

Are no-poach clauses lawful? Between separate businesses standing alone, no — treat them as per se unlawful and potentially criminal. Ancillary to a genuine collaboration and narrowly tailored to it, they are analyzed under the rule of reason and are commonly enforced. Remove intra-system franchise no-hire clauses.

What if the covenant is too broad? It depends entirely on the state. Reformation states will narrow it; blue-pencil states will strike offending words if the remainder stands on its own; red-pencil states will void it. Draft to the strictest state you might litigate in, not the most permissive one you selected.

Is a forfeiture provision better than a non-compete? Frequently, where the covered person has deferred compensation or a capital account. It requires no injunction, no irreparable harm showing, and in a growing number of jurisdictions no reasonableness review — and it leaves the person free to compete, which courts find far more palatable.

What should a seller negotiate? Four things, in order of value. Narrow the definition of the competing business to what the target actually did, not to the buyer's enterprise. Carve out passive investments below a stated percentage, existing unrelated ventures identified on a schedule, and general advertising that is not targeted solicitation. Add a release trigger — the covenant terminates if the buyer fails to pay the note, breaches the employment agreement, or ceases to operate the acquired business, since a buyer that has abandoned the goodwill has nothing left to protect. And cap the remedy, or at minimum resist a liquidated damages figure that exceeds any plausible loss.

And what should a buyer insist on? That every person whose relationships constitute the goodwill signs — not just the entity, and not just the majority holder. That the covenant is expressly assignable. That it survives independently of any employment agreement. That a tolling provision extends the period during any breach. That the agreement provides for attorney's fees to the prevailing party. And that the covered person must disclose the covenant to any prospective employer, which supplies both deterrence and the knowledge element of a tortious interference claim if it comes to that.

One last observation. The most common reason these covenants fail is not aggressive drafting but inattention — a form reused across deals it was not written for, an entity signatory that dissolves, a silence on assignment, a definition that grew with the acquirer. Each of those is caught by a thirty-minute review at the right moment, and none of them is recoverable afterward.

Related articles

This article is provided for general informational purposes and does not constitute legal advice. Restrictive covenant law varies dramatically by state and by context, several statutes and rules discussed here are subject to pending litigation, and antitrust exposure for no-poach agreements can be criminal. Consult qualified counsel in the relevant jurisdiction before drafting, signing, or enforcing a covenant.