Non-compete vs NDA in a business sale

Sellers meet both documents in the same sale, and they are easy to mix up because both restrict what a person may do after learning about a business. They restrain different things. A non-disclosure agreement (NDA) limits what a person may do with information. A non-compete limits whether the seller may compete. They can also start at different times and bind different people. This page compares the two as the sources describe them. It does not say which a given sale needs.

What an NDA does

BDC describes a confidentiality agreement as a document prepared before or alongside the letter of intent in which a party undertakes not to use, disclose or permit the disclosure of confidential information transmitted during the negotiations and the due diligence process, except to evaluate its participation in the proposed transaction. So it operates before the sale closes, and it is aimed at information. The Canadian Intellectual Property Office lists non-disclosure or confidentiality agreements, and confidentiality clauses in employment agreements, among the ways to keep business information secret. It says there is no formal application or registration process for trade secrets in Canada.

What a non-compete does

A non-compete is a covenant about competition, not about information. The Canada Revenue Agency says restrictive covenants may frequently be found in the terms of an agreement for the sale or acquisition of a business, corporate shares or a partnership interest. In a sale, the covenant may be a term of the sale agreement, so check who gives it and when it starts, whereas BDC places the confidentiality agreement before or alongside the letter of intent. For a comparison with the closely related non-solicit covenant, see non-compete vs non-solicit.

Where they differ

• What is restrained: an NDA restrains using or disclosing information; a non-compete restrains the seller’s competing activity.
• Who is bound and when: an NDA binds the party receiving information from the negotiations; a non-compete binds whoever gives it, so check whether it is the seller.
• Tax: the CRA says any amount received or receivable for a restrictive covenant is treated as ordinary income, subject to listed exceptions. The CRA page does not address NDAs, so ask an accountant whether an amount allocated to one is caught.
• Enforceability: check which province’s law governs each document, and ask a lawyer how that law treats it.

The tax rule and the court

The CRA’s exceptions to the ordinary-income rule apply only to a seller who deals at arm’s length with the buyer, and some require the seller and buyer to make a joint election. The CRA also states that its page on the topic is under review. On enforceability, the Supreme Court of Canada decided Payette v. Guay, a Quebec case under Quebec civil law. The Court assessed restrictive covenants tied to the sale of a business as a commercial matter and looked at whether they were limited in term, territory and activities. That is a Quebec decision, so it should not be read as the rule in other provinces.

Factors to weigh

If the exposure is the seller’s information, such as financials, customers or know-how, an NDA is the document that speaks to it. If the exposure is the seller going on to compete, a covenant is the document aimed at it. If the purchase agreement allocates an amount to a restrictive covenant, ask whether the seller and buyer deal at arm’s length and whether an election applies. The CRA’s exceptions also differ between a sale of a business and its underlying assets and a disposition of shares or a partnership interest. A purchase agreement or letter of intent may carry one, the other or both, so check what each document actually says. A lawyer and an accountant can confirm how both apply to your sale. On how far an NDA limits a buyer’s later use of information, see can a buyer use NDA information to compete with me later.