BUSINESS

A LORD’S COVENANT

He calls it routine. They call it illegal. But just what is a non-compete clause?

KATHERINE MACKLEM December 12 2005
BUSINESS

A LORD’S COVENANT

He calls it routine. They call it illegal. But just what is a non-compete clause?

KATHERINE MACKLEM December 12 2005

A LORD’S COVENANT

BUSINESS

He calls it routine. They call it illegal. But just what is a non-compete clause?

KATHERINE MACKLEM

In the fall of 2000, as part of the back-and-forth dealing to sell some community newspapers, a Hollinger International executive named Mark Kipnis told the buyers he wanted a change in the purchase agreement. The price had already been set at US$90 million; the issue he wanted to open was how much of that would go toward keeping the publishing company from competing against the new owners, and who would receive it.

Initially, the parties agreed that US$3 million would be allocated to what’s called the non-

The rationale is logical. The buyer of a business doesn’t want the vendor to set up shop next door.

competition covenant. The buyer, an Alabama-based company called Community Newspaper Holdings Inc., which had struck a much larger, US$472-million deal almost two years earlier with Hollinger International Inc., had requested that International be named in the non-compete covenant, just as it had in its earlier deal. But Kipnis had already stipulated that 25 per cent of the US$3 million would go to International’s parent company, Hollinger Inc. And according to the U.S. indictment of Conrad Black, Kipnis, who is one of three close Black associates also named in the indictment, returned to the table to advise CNHI’s representatives that International wanted Black and three deputies (Kipnis was not one of them) added to the non-compete agreement. As well, without affecting the already established purchase price, US$9.5 mil-

lion of the total was to be allocated to the four individuals. It is this non-compete covenant, along with similar agreements in a series of other deals, that is at the heart of the criminal charges Black is facing.

The case is complex, of course. While the covenants are at its core, the defence and prosecution will want to cast them in entirely different fashions. The prosecution will attempt to show that Black and his co-defendants used the non-competes fraudulently; meanwhile, Black will want to have them seen as standard business practice. Which they are: non-competition covenants are widely used in two areas—employment contracts and purchase agreements.

It is common, particularly for high-ranking executives, to agree to not compete against a former employer when they leave an organization. This fall, Nortel was forced to pay a US$11.5-million settlement on behalf of its new CEO, Mike Zafirovski, after he was sued by his former employer, Motorola Inc., for going to work for the competition. In an agreement covering the purchase of assets, like the Hollinger transactions, non-competes almost always form part of a negotiated deal. The rationale is logical: a buyer of a business doesn’t want the vendor to set up shop next door. The covenant doesn’t add to the purchase price, it simply designates a portion of it for the vendor staying out of the market. For the vendor, the non-compete money is compensation for not being in business. Usually an agreement will set limits on the time frame and geographic area covered.

The indictment, which names Black, the three deputies and the Toronto-based holding company that he controls, Ravelston Corp. Ltd., spells out charges related to a series of transactions where Hollinger sold newspapers in North America, including the deal in 2000 to sell 149 of its Canadian papers and half of the National Post for US$2.3 billion to the Asper family-controlled Can West Global Communications Corp. For that deal alone, the U.S. Department of Justice alleges that the onetime media mogul and his co-defendants fraudulently diverted US$51.8 million, plus interest, from Hollinger International using a non-compete covenant. It accuses them of siphoning more than US$80 million in total out of Hollinger International’s coffers. “The indictment charges,” said Patrick Fitzgerald, the U.S. attorney leading the prosecution team, “that the insiders at Hollinger-all the way to the top of the corporate ladder-whose job it was to safeguard the shareholders, made it their job to steal and conceal.”

From 1998 to 2001, Hollinger International pursued a strategy to sell most of its U.S. community newspapers. In addition to the Can West transaction, it made six sales, ranging in value from US$14 million to US$472 million. As the deals progressed, the indictment charges, the Hollinger International executives created an increasingly sophisticated scheme to allocate money to themselves. In the first deal, they diverted all of the noncompetition payment from International to Hollinger Inc. Then, according to the indictment, they created a template that allocated 25 per cent of International’s non-compete money to Hollinger Inc. The reason for doing so was because the controlling shareholders of the parent firm were Black and David Radler, his one-time close deputy who pleaded guilty in September to a fraud charge and agreed to help U.S. authorities. As the controlling shareholders of Hollinger Inc., they owned more of its wealth than they did of Hollinger International, where they had a minority ownership. The result of International’s ownership structure was that every $100 transferred from it to the parent company would effectively cost Black and Radler $19, but it gave them $62 as Hollinger Inc.’s controlling shareholders, “thereby tripling their funds at the direct expense of International’s non-controlling shareholders,” the indictment says. In later deals, such as the second CNHI transaction, the in4M dividuals charged had their names added to the list of non-compete promisors. Part of their motivation, the indictment continues, was that because non-compete payments were tax-free in Canada during this time, the defendants used them to avoid Canadian taxes.

In the context of mergers and acquisitions in the U.S., non-compete payments are almost always inevitable, say U.S. corporate lawyers, because the value of assets for a buyer

would shrink drastically if the vendor went back into business. And because corporations are entities and it is the individuals who do the competing, it’s very common that non-compete agreements also name executives of the business that is selling the assets. Part of what a buyer of a business is buying, explains Robert Schwimmer, a partner practising in Chicago with Greenberg Traurig LLP, a law and consulting firm with offices across the U.S. and Europe, is protection from business affiliates of the seller, whether they be key em-

Some of those who signed the noncompete also owned the company that bought the papers

ployees or key owners. “In order to get the benefit of the bargain that they are putting out all this money for, the buyer will insist that those key people enter into non-competition agreements.”

David Asper, executive VP of CanWest, has been clear that it was Black he wouldn’t want to compete against. As Asper wrote in the National Post in 2003, when the scandal was first unfolding, “If Lord Black ever decided to sell his interest in Hollinger, it is he—and not Hollinger—with whom we did not wish to compete.” When they return to court, Black, and his lawyers, may be making this argumentas may the lawyers of his co-accused—that not

only it is common practice in the U.S. to name senior people in a non-competition covenant, but that it is the individuals who built a company who are the threat to a new owner.

As much as Black will want to keep the arguments in court focused on whether it was appropriate for him and his colleagues to receive non-compete payments—and he will argue that it was—the prosecutor in the case is likely to push the discussion in a different direction. He’s expected to argue that the covenants did not reflect actual business realities and were used fraudulently. In one transaction, a US$43.7-million deal struck in the spring of 1999 to sell papers to Horizon Publications Inc., some of the Hollinger executives who had signed non-competes were also owners of the company that bought the papers.

“In the Horizon transaction,” the indictment says, “Ravelston’s agents, including Black, [John] Boultbee and Radler, had, in essence, negotiated an agreement with themselves (Inc.) not to compete against themselves (Horizon), resulting in them paying themselves (Inc.) approximately $1.2 million.” In other transactions, including the CNHI deal, the executives did not disclose the changes in the purchase agreement to International’s audit committee, according to the indictment. The claim calls the US$9-5 million paid to the four officials “bonus compensation” that was mischaracterized as non-competition payments. It accuses the parties of breaching their fiduciary duties—harsh words guaranteeing that when the parties finally get to court, which observers say might not be before 2007, the battle will be fierce. M

CNN OPERATOR LEARNS LIMITS OF FREE SPEECH

When CNN recently broadcast a speech by Dick Cheney with an X accidentally superimposed over the U.S. vice-president’s face, complaints poured into the network. A besieged phone operator finally snapped, telling one caller the X was an expression of “free speech,” and “if you don’t like it, don’t watch. Tell your president to stop lying!” It may have seemed a clever rejoinder at the time, but the call was recorded and the operator was fired.