The non-competition obligation in business transfer agreements. What is it and how to protect oneself in case of breach?

by Vanessa Gagliano | Aug 31, 2021 | Blog

What is it

Pursuant to Article 2557 of the Civil Code, a person who sells his business or a branch of it must refrain, for a period of five years after the transfer, from starting a new business which, by its object, location or other circumstances, is likely to divert customers from the transferred business or branch. The five-year limit for non-competition cannot be increased, but only decreased.

 

The purpose of the non-compete obligation

The purpose of Art. 2557 is to protect the interest of the purchaser of a business (or branch) in acquiring that part of the value of the goodwill which are customers and, at the same time, to allow the seller to undertake an activity without compromising its freedom of economic initiative for an excessively long period of time.

 

What activities constitute a breach of the non-compete obligation

The commencement of a new activity at a date subsequent to the transfer of the business does not in itself constitute a breach of the non-competition obligation under Article 2557 of the Civil Code, since such commencement of a new activity must be accompanied by other elements, such as its object, location and any other circumstances that make it likely to divert the customers of the transferred business. For the non-compete obligation to be considered breached, it is not necessary for the seller to have actually diverted the customers of the transferred business, the suitability of his conduct to cause such diversion being sufficient.

The non-competition provision of Art. 2557 of the Civil Code does not apply to activities which the seller was already carrying on before the date of the transfer of the business other than the branch or business transferred, since the rule expressly refers to the commencement of new activities after that event. However, the parties may extend the scope of the non-competition obligation by contractually providing that it should also apply to pre-existing activities which, therefore, cannot be continued, provided that the seller is not absolutely precluded from employing its professional skills in the relevant economic sector.

In fact, the rule in question may be contractually derogated from by the parties which may expressly provide for a less stringent prohibition of competition than that provided for by the rule, up to the point of excluding it completely, or more stringent, with the limit of not providing for clauses such as to effectively prevent any professional activity by the seller.

 

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Remedies available to the purchaser of the business in case of breach of the non-competition obligation by the seller

Article 2557 of the Civil Code does not rule the consequences of any breach of the non-competition obligation, leaving the purchaser to decide how to protect itself. Where, on the basis of the circumstances of the case, it should be appropriate or necessary to take legal action against the seller for breach of the non-competition obligation arising from the transfer of the business (e.g. because the situation cannot be settled amicably between the parties or because there is an urgent need to inhibit the continuation of the competing activity by the seller or for any other reason), the purchaser may take the following actions, which may be cumulated:

  • action for injunction (also by way of urgent injunction, pursuant to Art. 700 of the Code of Civil Procedure), aimed at obtaining the cessation of the prohibited conduct. An action for injunction may also be brought in the presence of merely potential damage. For the purposes of the acceptance of an action for an injunction, in fact, it is sufficient that a new activity likely to divert customers has been started, since it is not necessary that customers have actually been diverted;
  • an action for damages, aimed at obtaining compensation for the loss suffered as a result of the prohibited conduct. In this case, it is necessary to prove that damage has actually occurred and its extent, it not being sufficient that the damage is potential. The harm may consist, by way of example, in a decrease in the value of the business, in lower revenues due to the diversion of part of the clientele, in pecuniary losses in general resulting from the diversion of customers due to the violation of the prohibition of competition;
  • termination of the business transfer contract by the purchaser for breach of contract by the seller.

 

In conclusion, in order to better protect the purchaser of the business or business branch, it is recommended to expressly regulate in the contract of sale of the business the extent and the limits of the non-competition obligation to be borne by the seller, also providing for a penalty in the event of its breach, without prejudice to compensation for greater damages. In fact, the provision of a penalty, on the one hand, may act as a deterrent for the seller, encouraging him to comply with the non-compete obligation, and, on the other hand, facilitates the purchaser who, in a potential lawsuit, may request the payment of the penalty, without having to provide evidence of the damage suffered (evidence which, on the contrary, must be provided in the event of a claim for damages greater than the amount of the penalty), but provided that it proves that the seller has actually failed to comply with the non-compete obligation.

 

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