Non-compete clauses in a business sale: rules and content

If you sell your business, in almost every transaction one question arises quickly: what stops you from starting a new, competing business the day after the sale? The answer is a non-compete clause in the transfer agreement.

But the rules for non-compete clauses in a business sale are fundamentally different from the well-known employment-law rules. You are not bound by the Employment Clauses Act with its strict requirements on compensation and maximum period. You are instead within contract law and competition law. That gives far more flexibility, but also different pitfalls.

The Employment Clauses Act does not apply here

When an employee is subject to a non-compete clause in an employment relationship, the Employment Clauses Act applies with its clear requirements: a specially trusted position, compensation of 40 to 60%, and a maximum duration of 12 months.

If you sell your business, you are not an employee. You are a self-employed businessperson entering a commercial agreement. That means:

• No statutory duty of compensation: the price for the clause is typically built into the sale price
• No fixed maximum limit: in a commercial context, clauses of 2 to 5 years can be valid
• No requirement of a "specially trusted position": it is simply an agreement between two parties

Instead of the Employment Clauses Act, the framework is:

1. Section 38 of the Contracts Act (and the general unreasonableness rule in section 36): a competition-restricting clause can be set aside or narrowed if it goes further than necessary or is unreasonable in light of the content of the agreement, the parties' position and the circumstances generally
2. Competition law (Article 101 TFEU and the corresponding national rules): clauses that significantly restrict competition can be invalid

When is a non-compete clause in a business sale lawful?

The European Commission and the Danish Competition and Consumer Authority have set out guidelines for when a non-compete clause in a business transfer is lawful under competition law, the so-called doctrine of ancillary restraints.

A non-compete clause in a business transfer is lawful if it:

Is necessary for the transaction

The clause must protect the buyer's real investment. If you have bought a business's customer base, know-how and goodwill, it is reasonable that the seller cannot start a competing business and take it all with them. The clause must be necessary for the transaction to make sense at all.

Is proportionate to the scope of the transaction

The clause may not be broader than necessary to protect what is transferred:

• Duration: up to 2 years is normally acceptable when the transfer only covers goodwill. If the transaction also covers a transfer of know-how, 3 years can be approved. Clauses over 3 years require special justification and are rarely proportionate.
• Geographic scope: the clause should cover the market the business actually operated in, not the whole world, unless it is documented as necessary.
• Activity scope: the clause should limit itself to the activities actually transferred, not all commercial activity whatsoever.

Is limited in time

Open-ended non-compete clauses are as a rule invalid. A clause saying "you may never start a competing business" will hardly hold.

Typical clause types in a business sale

Non-compete clause

The classic clause: the seller may not run, be employed in or otherwise take part in a competing business within the agreed geographic area and period.

Example wording:

"For a period of 2 (two) years from the Takeover Date, the Seller is obliged not directly or indirectly, whether as owner, co-owner, director, employee, consultant, adviser or otherwise, to take part in a business that competes with the Company within [describe activity area] in [geographic area]."

Customer clause (non-solicitation)

A milder clause that only prohibits the seller from approaching or serving the Company's existing customers. The seller may start a competing business but may not actively solicit the transferred customers.

Employee clause (non-solicitation of employees)

Prohibits the seller from recruiting the business's employees during the clause period. Protects the buyer against the seller taking the team with them and using it in a new competing business.

Combined clauses

Most professional transfer agreements combine all three: a non-compete clause, a customer clause and an employee clause. The duration can vary.

Contractual penalty: make enforcement simple

A non-compete clause without a sanction is an empty promise. Always include a contractual penalty (konventionalbod), a pre-agreed penalty amount for a breach.

With a contractual penalty you do not have to prove a specific loss. The breach is documented, and the penalty is claimed. That is far cheaper and faster than a damages case requiring documentation of lost profit.

The amount of the penalty should:

• Be high enough to have a deterrent effect
• Not be so unreasonably high that it risks being reduced by the courts under section 36 of the Contracts Act
• Ideally have a daily-penalty component for a continuing breach

Example:

"On a breach of the clauses in point [X], the Seller pays a contractual penalty of DKK [amount] per breach. For a continuing breach, a daily penalty of DKK [amount] is also paid per commenced calendar day the breach continues."

Negotiation: the seller's perspective

The seller should not accept clauses uncritically. Here are the most important points to negotiate:

Definition of the activity area

Is "competing business" defined narrowly enough? If you sell a software business in HR tech, the clause should not prevent you from working with unrelated software. Require a precise definition.

Geographic limitation

Does the company operate primarily in Denmark? Then the clause need not cover the EU. Clauses broader than the market the company actually operated in are easier to challenge.

Duration

2 years is the norm. 3 years can be defended for a particularly know-how-intensive business. Require 2 years as a starting point and let the buyer argue for more.

What does "participation" cover?

The clause should precisely define what constitutes "participation" in a competing business. A passive investment holding below 5% in a listed competitor should not be caught.

An exception for existing activities

If the seller already runs other businesses that are related but not directly competing with what is transferred, these should be explicitly excepted.

Share sale vs. asset sale: does it matter?

Yes. The starting points are the same, but:

Asset sale: the company sells its assets (customers, contracts, goodwill, plant). The seller is the company and typically the owners or the director personally. The non-compete clause normally binds the owners personally.

Share sale: the buyer takes over the company as such. The clause is typically directed at the selling shareholders and must ensure they do not restart the company in a new guise.

In both cases the key is: who actually holds the know-how and customer relationships? The clause must target them, and only them.

What if the clause is breached?

Injunction: the buyer can seek an injunction to immediately stop the competing activity. It requires that it is made probable that the clause has been breached.

Contractual penalty: claimed directly, without a requirement to document a specific loss.

Damages claim: can be brought for the actual documented loss if the loss exceeds the contractual penalty, or as a supplement.

Invalidity: if the clause is too broad, the seller can argue that it is wholly or partly invalid. The courts can reduce an excessively broad clause to a valid scope rather than set it aside entirely.

Checklist: a non-compete clause in a business sale

Use this list before you sign:

• Is the clause limited in time (typically 2 to 3 years)?
• Is the geographic area proportionate to the company's actual market?
• Is the activity prohibition defined precisely enough?
• Is "participation" defined with clear exceptions?
• Is there a contractual penalty with sufficient deterrent effect?
• Are the seller's existing side activities excepted?
• Is the clause personal, so it binds the right individuals?
• Has the clause been assessed under competition law if the transaction is large enough to affect the market?

Frequently asked questions

Does the non-compete clause apply automatically in a business sale?

No. Non-compete clauses only arise if they are agreed explicitly in the transfer agreement. There is no automatic clause in a business sale.

Can a non-compete clause in a business transfer run for 5 years?

It is possible but risky. The competition authorities' general guidance points to 2 to 3 years as acceptable. 5 years would require special justification and documentation that it is necessary to protect what was transferred.

What about clauses where know-how is also transferred?

The European Commission has recognised that know-how-intensive transactions can justify up to 3 years. Always relate it to what is actually transferred.

Can the clause be settled with a fixed amount rather than a period?

Yes. In a commercial context it is possible to agree that the seller can buy out of the clause by paying an agreed amount. That gives flexibility for both parties.

What is the difference between a confidentiality agreement and a non-compete clause?

An NDA (confidentiality agreement) prohibits the disclosure of confidential information. A non-compete clause prohibits competing activity. Both are typically relevant in a business sale, and they complement each other.

Conclusion

A non-compete clause in a business sale is a completely different legal instrument from an employment-law non-compete. You have more freedom in the drafting, but the clause must still be proportionate, precise and lawful under competition law. Make sure to delimit the scope, period and geography carefully. Include a contractual penalty, and define precisely what is prohibited. A poorly worded clause is either an enforcement burden or invalid, and both are bad outcomes.

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The content of this article is for guidance only and does not constitute legal advice. Consult a lawyer for advice on your specific situation.