Insight

THE IMPORTANCE OF COVENANTS IN A BUSINESS TRANSACTION TO PROTECT YOUR INTERESTS

THE IMPORTANCE OF COVENANTS IN A BUSINESS TRANSACTION TO PROTECT YOUR INTERESTS

Gary R. Pannone

Gary R. Pannone

March 28, 2022 10:17 AM

In a business transaction in which either stock or assets are being transferred, the parties to the transaction rely upon representations, warranties and covenants to protect their interest, whether it is the buyer or seller. Representations and warranties essentially address an information gap between the time the purchase and sale agreement is executed and when a closing takes place. Covenants also assist in addressing the information gap once the transactional documents have been executed to prevent one side or the other from acting in a way that might devalue the assets or stock being purchased. Covenants address this issue by defining the scope of what is actually being agreed upon and defining the conduct expected prior to the closing whether it is affirmatively or negatively. The primary purpose of the covenant is to provide the parameters of conduct that will assure that the parties receive the full benefit of the transaction.

How Covenants Serve to Protect Each Party’s Interests

In many business transactions, the purchase agreement should include terms that limit the seller’s ability for a reasonable period of time to compete with

the business sold, which would be included in a covenant not to compete. This type of covenant provides protection to the buyer to receive the benefit deserved that would be reflected in the purchase price for the business or assets. It essentially serves to limit the activity of the seller such that the buyer is receiving the benefit of the bargain and in the event of a breach, the buyer would have a remedy in damages or through injunctive relief. The scope of the covenant and amount of damages resulting from a breach would be negotiated during the process of finalizing the transactional documents.

In order for a covenant to be effective, there must be a way for the beneficiary of the covenant to monitor compliance. For example, in the case of an employment agreement, periodic performance reviews would serve this purpose. If a covenant exists not to compete or solicit the seller’s customers post-closing, the buyer would have the right to pursue damages and/or obtain an injunction against the seller for breaching the covenant.

Another example of a covenant in the sale of a business relates to the operation of the business by the seller after executing the purchase and sale agreement. This type of covenant stating that the seller should operate the business in the ordinary course and in a manner consistent with industry practice and standards protects the buyer between the time the purchase agreement is executed and when the closing takes place. Basically, the seller is obligated to operate the business in a manner consistent with past practice prior to executing the purchase agreement.

Finally, to protect the buyer in a business transaction, a covenant may provide that the buyer has full access to books and records during the due diligence process, which would include a physical inspection of assets prior to the closing. In the event of a material breach, the buyer would have the right to withdraw from the transaction or negotiate an adjustment to the purchase price.

Covenants exist to provide parameters for each party to protect and ensure that each party receives the full benefit of the transaction. Both the buyers and sellers in a business transaction, along with their attorneys, must exercise caution in finalizing the covenants that will be included in the purchase agreement because the failure to be diligent may result in significant costs and damages to either side of the deal.

If you have questions regarding covenants or any other business matter, please contact PLDO Managing Principal Gary Pannone at 401-824-5100 or email gpannone@pldolaw.com.

Related Articles

Staunch Competition


by Andrea E. Nieto, Catherine H. Molloy and Jennifer W. Corinis

On the other side of the pandemic, after record numbers of employee resignation, protecting trade secrets is both challenging and being challenged.

Protecting Trade Secrets During Period of Res

Working With Changes


by Best Lawyers

Carolyn Pugsley, the Joint Global Head of Practice for Corporate, Australia at Herbert Smith and Freehills, discusses policy changes affecting the M&A market in Australia as well as the impact of the pandemic on the practice.

An Interview With Herbert Smith and Freehills

From Russia, With Law


by Best Lawyers

The bite of U.S. sanctions aside, Cleary Gottlieb partner Yulia Solomakhina sees great promise for commerce and the law as Russia increasingly embraces markets and technology.

An Interview With Cleary Gottlieb

How This Firm Is Shaping the Economic Future of Ukraine


by Best Lawyers

Denis Lysenko discusses how AEQUO has helped build a new business environment.

An Interview With AEQUO

How Russia's Global Policy Is Impacting Mergers and Acquisitions


by Best Lawyers

Alexei Zakharko and Mathieu Fabre-Magnan disscuss how they are preparing for emerging trends in the next couple of years.

An Interview With Dentons Russia

How Corporate Law in France Is Navigating the Trade Wars


by Best Lawyers

Bertrand Cardi and Cyril Bonan discuss M&A, protectionism, and the trade wars' impact in France.

An Interview With Darrois Villey Maillot Broc

Hengeler Mueller on How German Firms Can Compete in the Global M&A Arena


by Best Lawyers

Germany's 2020 “Law Firm of the Year” honoree in Mergers and Acquisitions Law

An Interview With Hengeler Mueller

Merging Business and Responsibility: Gilbert + Tobin


by Best Lawyers

Attorneys Costas Condoleon and Sam Nickless from the Australian firm Gilbert + Tobin discuss the firm's 2020 award, how Australia’s Corporate Law practice is preparing for the world’s transforming economic landscape, and the international community’s demands of its businesses.

Gilbert + Tobin 2020 LFOTY Interview

Trending Articles

The Real Camille: An Interview with Johnny Depp’s Lawyer Camille Vasquez


by Rebecca Blackwell

Camille Vasquez, a young lawyer at Brown Rudnick, sat down with Best Lawyers CEO Phillip Greer to talk about her distinguished career, recently being named partner and what comes next for her.

Camille Vasquez in office

Announcing The Best Lawyers in The United Kingdom™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from the United Kingdom.

The Best Lawyers in The United Kingdom 2023

Johnny Depp and Amber Heard: The Best Lawyers Honorees Behind the Litigation


by Gregory Sirico

Best Lawyers takes a look at the recognized legal talent representing Johnny Depp and Amber Heard in their ongoing defamation trial.

Lawyers for Johnny Depp and Amber Heard

Announcing The Best Lawyers in France™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from France.

Blue, white and red strips

Announcing The Best Lawyers in Germany™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from Germany.

Black, red and yellow stripes

Education by Trial: Cultivating Legal Expertise in the Courtroom


by Margo Pierce

The intricacies of complex lawsuits require extensive knowledge of the legal precedent. But they also demand a high level of skill in every discipline needed to succeed at trial, such as analyzing technical reports and deposing expert witnesses.

Cultivating Legal Expertise in the Courtroom

Announcing The Best Lawyers in Belgium™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from Belgium.

Black, yellow and red stripes

Announcing the 2022 Best Lawyers® in the United States


by Best Lawyers

The results include an elite field of top lawyers listed in the 28th Edition of The Best Lawyers in America® and in the 2nd Edition of Best Lawyers: Ones to Watch in America for 2022.

2022 Best Lawyers Listings for United States

Announcing the 2022 Best Lawyers™ in France


by Best Lawyers

The results include an elite field of top lawyers and firms, including our inaugural Best Lawyers: Ones to Watch recipients.

Announcing the 2022 Best Lawyers™ in France

Choosing a Title Company: What a Seller Should Expect


by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller

We Are Women, We Are Fearless


by Deborah S. Chang and Justin Smulison

Athea Trial Lawyers is a female owned and operated law firm specializing in civil litigation, catastrophic energy, wrongful death and product liability.

Athea Trial Law Female Leadership and Success

Announcing the 2022 Best Lawyers™ in Germany


by Best Lawyers

The results include an elite field of top lawyers and firms, including our inaugural Best Lawyers: Ones to Watch recipients.

Announcing the 2022 Best Lawyers™ in Germany

U.K. Introduces Revisions to Right-to-Work Scheme and Immigration Rules


by Gregory Sirico

Right-to-Work Scheme and Immigration Rules in

Famous Songs Unprotected by Copyright Could Mean Royalties for Some


by Michael B. Fein

A guide to navigating copyright claims on famous songs.

Can I Sing "Happy Birthday" in Public?

Destiny Fulfilled


by Sara Collin

Was Angela Reddock-Wright destined to become a lawyer? It sure seems that way. Yet her path was circuitous. This accomplished employment attorney, turned mediator, arbitrator and ADR specialist nonpareil discusses her career, the role of attorneys in society, the new world of post-pandemic work and why new Supreme Court Justice Ketanji Brown Jackson represents the future.

Interview with Lawyer Angela Reddock-Wright

What the Courts Say About Recording in the Classroom


by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?