When negotiating a purchase agreement, a core objective is to safeguard the value of the target asset through well crafted protective covenants. These covenants are promises that govern ongoing behavior and discrete actions by the seller or buyer after closing. They can limit activities, require ongoing disclosures, or establish thresholds for performance and compliance. The drafting challenge lies in balancing specificity with flexibility, so covenants remain enforceable but not overly burdensome. A strong covenants framework will anticipate common post closing disputes and provide objective criteria for compliance. Thoughtful language reduces ambiguities and positions the contract to withstand scrutiny from regulators, auditors, and potential successors.
A practical starting point is to categorize covenants by purpose and timing. Interim covenants address actions around closing, while long term covenants govern post closing conduct. Financial covenants set performance benchmarks, while non financial covenants constrain competition, change of control, or use of confidential information. Each covenant should tie to a measurable standard, include a defined term, and specify remedies if breached. Clear remedies—monetary damages, specific performance, or termination rights—help deter violations and provide predictable recourse. A robust draft also contemplates exceptions, carve outs, and notice procedures to avoid accidental breaches.
Structuring covenants to govern disclosures and information flows
The most effective protective covenants are grounded in a precise assessment of business risks and the asset’s value drivers. Before drafting, counsel should enumerate critical factors such as customer concentration, supplier dependencies, key personnel, and intellectual property protections. Coventant language can then be tailored to address those vulnerabilities. For example, if customer relationships drive value, a non solicitation clause or non poaching restriction may be appropriate, paired with a robust non compete provision where permitted. A well calibrated covenant framework helps preserve value by preventing leakage of know how, goodwill, or long standing commercial relationships that underpin the deal price.
Beyond safeguarding know how, covenants can support continuity in operations. Post closing, buyers require assurances that the target’s strategic plans remain viable. Covenants can obligate the seller to cooperate during transition periods, provide access to records, or participate in handover activities for a defined period. Such provisions reduce the risk of disruption and enable seamless integration. Drafting these commitments involves clear timelines, specific deliverables, and defined points of contact. When crafted carefully, transition covenants align interests, minimize disputes, and sustain the enterprise’s momentum during the critical post closing phase.
Balancing restrictive covenants with enforceability and remedies
Information asymmetry is a frequent source of post closing disputes, so a covenant regime addressing disclosures is essential. The agreement should specify ongoing reporting obligations, material adverse events reporting, and the scope of information to be shared. To limit ambiguity, the covenant should enumerate the form and frequency of disclosures, define what constitutes a material event, and identify confidential handling requirements. Including a workflow for notice and cure ensures a structured process for addressing issues before they escalate. Thoughtful disclosure covenants foster trust between parties and support accountability, which in turn stabilizes value by preventing unexpected surprises.
Another key area is data governance and compliance. In today’s environment, covenants often require compliance with privacy laws, anti corruption statutes, and trade controls. The drafting should specify permissible data uses, access rights, and restrictions on data transfers to affiliates or third parties. If data assets are central to value, include restrictions on migration, duplication, or decommissioning without consent. Defining penalties for noncompliance and setting reasonable cure periods creates a practical framework for enforcement. Altogether, data centric covenants reduce regulatory risk and preserve the integrity of the acquired assets.
Crafting carve outs, exceptions, and transition protections
Enforcement considerations shape how protective covenants are written. Courts scrutinize reasonableness, scope, duration, and geographic reach. To improve likelihood of enforcement, align covenants with legitimate business interests, use precise definitions, and avoid overbreadth. Incorporate objective standards wherever possible, such as revenue thresholds, customer count limits, or defined markets. The remedy framework should be clear and proportionate to the breach. Whether damages, injunctive relief, or termination rights are pursued, the agreement must provide a path for prompt remedy. A well reasoned enforcement plan reduces the chance of protracted litigation and preserves deal value.
It is prudent to build in cure periods and step in rights for the buyer. If a covenant is breached, allow a defined cure window, during which the breaching party can remedy deficiencies. If cure is not possible, provide for remedies that minimize disruption, such as temporary injunctive relief or escrowed funds. Step in rights should be reserved for serious breaches that threaten the value of the business, and only after notice and a reasonable opportunity to address concerns. This disciplined approach supports fair process while deterring repeated violations that would erode post closing value.
Practical tips for drafting durable protective covenants
Carve outs are essential to preserve operational practicality and to reflect legitimate business needs. For example, covenants may exclude ordinary course activities or actions expressly approved by both parties. Exceptions should be clearly described and bounded by objective criteria to avoid open ended discretion. Transition protections provide a bridge during integration, ensuring essential activities continue and key personnel are not disrupted. The drafting should specify who oversees transitions, what tasks are to be performed, and by when. When these provisions are concrete, they reduce ambiguity and help the parties maintain momentum through the post closing period.
Transition protections also frequently cover wind down or continuity of supplier and customer relationships. The agreement may require the seller to support joint customer communications, maintain pricing during a defined period, or assist in onboarding new management. Aligning these duties with measurable milestones helps quantify expectations and supports enforcement if performance lags. Effective transition covenants translate strategic planning into actionable steps, ensuring the business remains stable as ownership changes hands. They create a predictable post closing environment for customers, employees, and lenders.
A durable covenant framework starts with precise definitions. Define terms such as confidential information, competitive activities, and restricted areas with careful attention to legal nuance. Ambiguity invites disputes; precision curbs litigation risk. It is also helpful to include a compliance program as part of the covenants, detailing who bears responsibility for monitoring, what reports are required, and how enforcement will be coordinated. Consideration for change, such as adding or removing covenants as the business evolves, should be built into the agreement. A flexible yet disciplined approach improves resilience against unforeseen post closing challenges.
Finally, the drafting process benefits from practical governance. Involve cross functional teams, including legal, finance, operations, and human resources, to ensure covenants reflect real world needs. Conduct scenario planning to test how covenants would function under different post closing realities. Seek external counsel with experience in similar deals to validate reasonableness, enforceability, and alignment with corporate policy. Clear negotiation levers, well defined remedies, and robust transition planning collectively safeguard value and reduce the likelihood of costly disputes after the deal closes.
