Negative Covenant

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Related to Negative Covenant: Negative pledge, Affirmative Covenants

Negative Covenant

A provision found in an employment agreement or a contract of sale of a business that prohibits an employee or seller from competing in the same area or market.

A negative covenant is commonly used by businesses, particularly those that depend upon trade secrets for their success. An employer wants to ensure that a former employee will not parlay information, skills, customer lists, and personal relationships with clients acquired on the job to gain a better position with a competitor or to start his or her own business. An employer also wants to protect his or her business in the competitive marketplace against the use of the unique personal skills of a former employee. An employer can achieve these objectives by including a negative Covenant in the employment contract. Such a provision specifies that the employee will not work for a competitor or start a competing business for a period of time after leaving the employer. The covenant must be reasonable in its scope and duration. It cannot bar the employee from working at all, anywhere, or for an unreasonable length of time.

A court enforces a negative covenant by granting an Injunction prohibiting the employee from working in a competitive enterprise as described in the covenant. It will do so only when necessary to protect the former employer's legitimate interests.

A contract for the sale of a business often includes a negative covenant at the insistence of the buyer. A buyer wants to protect and capitalize on the good will of the business he or she buys. He or she must have an opportunity to get to know and serve the customers if the business is to continue to be successful. The value of the business is undermined if the seller can open a competing enterprise next door, thereby keeping some of the good will that was sold to the buyer. A negative covenant under which the seller agrees not to open a competing enterprise for a reasonable period of time within a reasonable distance from the original business is a frequent provision in a sales contract.

References in periodicals archive ?
Negative covenants are usually limited but may state that the buyer does not want the seller to adopt any more plans or make any amendments to the existing plans before the transaction is complete.
Negative covenants prohibit the borrower from doing something, such as borrowing more money or selling the business without payoff of the loan.
The facility comes with some financial covenants, negative covenants and restrictions.
In addition, they will seek positive and negative covenants from the managers to ensure they have control over the more important decisions of the company.
People think compliance is mostly financials compliance and a couple of very big negatives," says Jim Simpson, managing partner of Corporate Finance Solutions, citing negative covenants such as restrictions on asset sales or mergers.