February 4, 2014

Noncompetition Agreements in Business Transactions

Unlike the employer-employee situation, a business merger or acquisition is likely to involve the sale of assets which includes the goodwill of the business. Noncompetition agreements entered into as part of a sale of a business are designed to protect this goodwill from the sellers or the owners of the acquired company.

Since the seller receives consideration as part of the sale, agreements not to compete entered into as part these arms-length transactions are more likely to be enforced than those in the standard employment context. Courts also recognize it is more likely that there will be equal bargaining power between the parties to a sale transaction, and that the seller is often paid a premium for agreeing not to compete with the purchaser.

Courts also are more inclined to enforce longer temporal restrictions in noncompetes negotiated as part of a business transaction. Where the sale of a business specifically includes goodwill, courts have found that enforcement of the terms of the agreement are necessary to ensure that "the buyer receives that which he purchased."

Many states also have statutes which specifically provide for broader enforcement of noncompetes negotiated in a sale of business context.  For instance, California, which prohibits the use of noncompetes in the ordinary employment context, allows them when the individual is selling the assets of his/her business. Cal. Bus. & Prof. Code §16601.

If the seller of the business is going to continue employment with the purchaser, then the purchaser may want to consider using two forms of noncompete provisions: one in the sale agreement and one in an employment agreement. This allows the purchaser to obtain the benefit of the more enforceable sale-of-business noncompete provision, while still requiring noncompete obligations from the employee once the sale-of-business provisions expire.

January 29, 2014

Survey of Chancery Court Cases Shows Most Litigants Obtain Expedited Relief

A recent survey conducted by several of my colleagues demonstrates the speed in which litigants can obtain preliminary relief from the Court of Chancery. The survey included a sampling and analysis of approximately 200 cases between 2009 and 2011, in which the court ruled upon a motion for temporary restraining order or a motion for preliminary injunction. The results reflect the frequency and speed at which the court has granted injunctive relief in recent years:

  • For cases in which the court ruled on a motion for temporary restraining order, the court granted the motion 58 percent of the time. On average, the court granted the motion 7 days after its filing.
  • For cases in which the court ruled on a motion for preliminary injunction, the court granted the motion 30 percent of the time. On average, the court granted the motion 26 days after its filing.
  • The survey also looked at cases from the sample that involved trade secret claims and in which the court ruled on a motion for temporary restraining order or preliminary injunction. In those cases, the court granted the motion for temporary restraining order 88 percent of the time and granted the motion for preliminary injunction 75 percent of the time.

Based on these statistics, there seems to be little doubt that the court will order injunctive relief on an expedited basis in cases where circumstances require expedition, including those involving noncompete agreements and misappropriation of trade secret.

A copy of the full article drafted by my colleagues and published by BNA can be obtained on the Young Conaway Stargatt & Taylor website.

January 16, 2014

Young Conaway Publishes Bloomberg BNA Series on Noncompetes

bloomberg.pngPartners Scott Holt, Barry Willoughby, and William Bowser recently co-authored Bloomberg BNA's Corporate Practice Series on Noncompetition Agreements. The publication provides an in-depth review of the use and enforcement of noncompetition agreements, including practical tips for prosecuting and defending noncompete cases.

The publication is available through the Bloomberg BNA web site

July 11, 2012

Pros and Cons of Suing the Ex-Employee’s New Employer

When a company pursues a former employee for violating a noncompete agreement, one of the first decisions may be whether to include the ex-employee’s new employer in the lawsuit.  While attorneys who practice in noncompete litigation differ in their views on this issue, a number of factors are usually relevant.

For instance, will suing the new employer interfere with the ability to obtain jurisdiction over all of the parties?  In situations involving a contractual forum selection clause, the court may not have personal jurisdiction over the new employer.

Another issue is whether the new employer might be more inclined to pay the ex-employee’s litigation costs if it were a defendant.  In many cases, individual defendants do not have the resources to defend these types of suits, and without their new employer’s assistance, they will often want to resolve the case early (and more favorably to the plaintiff’s advantage).

But there are also reasons to include new employers as defendants where possible.  In the case involves potentially significant damages, the new employer is usually in a better position to pay than the ex-employee.  This added liability also may help foster settlement discussions prior to trial.

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March 16, 2012

Settlement Discussions Not An Excuse for Delayed TRO Application To Enforce Noncompete

One of the most critical points in the enforcement of a noncompete is when a company first learns that a former employee may be engaging in unfair competition.  Indeed, the steps taken by the company in the first few days can often determine whether it will be successful in limiting the amount of harm done.

In many case, the company will act quickly and seek emergency injunctive relief to stop imminent irreparable harm to its business.  In other cases, the company may try to resolve the dispute with the competitor by engaging in settlement discussions at the outset.  The benefit of the latter strategy, of course, is that a business resolution is often preferable to the expense and uncertainty of litigation. 

But companies that chose the settlement route need to be aware that the passage of time can compromise their ability to get relief from a court should discussions break down, particularly if it needs an emergency injunction.  In a recent Chancery Court hearing on an application for a temporary restraining order, the court was quick to point out plaintiff’s apparent four month delay after learning of the defendants activities before seeking the TRO.  The plaintiff responded that the delay was due in part to its efforts to work out a standstill agreement with the defendants.  As noted in the transcript excerpt below, the court was not sympathetic to this argument:

You can't have a problem in November and come running in here [in March], you know, two days after you file your papers, and say all of a sudden you need a TRO. We don't operate like that. 

And the fact that you tried to … negotiate a standstill, that's great, but if you think that your rights are really being harmed to the extent that you say they are, you have to go on a parallel path to get some judicial relief. You haven't moved fast enough, and I'm not giving you a TRO.

Prompt action is the keystone for any company needing to enforce a noncompete agreement.  Even if those efforts involve an attempt to settle the matter, the company is well advised not to delay seeking emergency judicial relief that may be necessary to prevent ongoing irreparable harm.  By dual tracking enforcement efforts with settlement talks, companies can not only avoid prejudicing their legal rights, but can use the specter of an impending injunction hearing to foster an even quicker resolution of the dispute.

March 1, 2012

American Lawyer Pens Insightful Article on Chancellor Strine

For those of you interested in learning more about the chief judge for the Delaware Court of Chancery, there’s a great article about the Chancellor in this month’s American Lawyer.

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February 17, 2012

Protecting Trade Secrets In Delaware

Employers frequently confront the problem of theft or misappropriation of trade secrets and confidential, proprietary information by departing employees. While employers have an arsenal of legal weapons at their disposal to protect their most valuable business assets, it is critical that they take proactive steps to protect against the disclosure of important business information and prevent unfair competition. From a practical standpoint, failure to implement basic security measures makes it easier for an unethical employee or competitor to misappropriate confidential business information. From a legal perspective, absent efforts to preserve the secrecy of such information and avoid unfair competition, a court is unlikely to respond favorably to an employer request for relief.Delaware

Trade Secret Protection

Delaware, like most states, has enacted the "Uniform Trade Secrets Act" providing employers with legal protection for trade secret information even in the absence of contractual agreements with employees. While many people may believe that "trade secret" status is only afforded to scientific data such as the formula for Coke, in reality, trade secret protection is available for a much broader array of information. The statutory definition for a trade secret is "information" that "derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use." To be protected by the statute, the information must be "the subject of efforts that are reasonable under the circumstances to maintain its secrecy."

Trade secret protection is available to business information other than scientific data such as formulas and chemical compounds. The Uniform Trade Secrets Act specifically extends protection to a "compilation," "program," "method," "technique," or "process" that has independent economic value to a company arising from its secrecy.

Customer lists may be subject to trade secret protection if the employer expended substantial resources and time in developing information that is not generally known to the public or competitors. Further, even if the customer list itself is not trade secret, information the employer compiled as part of its marketing efforts may be protected. For example, the courts have found that a "rankings report" kept by company sales representatives concerning the amount of sales to clients and ranking the company's customers by sales volume is sensitive financial information that may be subject to trade secret protection. Likewise, while an idea such as linking a savings program to an affinity group may not be a trade secret, the means by which such a program is implemented may be.

Even if business information does not meet the definition of a "trade secret," it still may be confidential, proprietary information subject to other legal protections.

Computer Fraud Act

Employers have a potentially powerful weapon to combat improper access and misappropriation of electronic data and information stored on a computer. We are all familiar with cases in which an unethical employee downloads company electronic information to a thumb drive for later use and/or sends such information via email to his or her personal computer in preparation for leaving employment and competing with their employer. The federal Computer Fraud and Abuse Act ("CFAA") may be used to hold employees liable both civilly and criminally for such misconduct. Although the CFAA was originally passed to target computer "hackers", not disloyal employees, some courts have applied the statute to employee misconduct. The CFAA also has criminal provisions. For example, former news anchor, Larry Mendete, plead guilty under the CFAA to intentionally accessing the private email account of his former co-anchor, Alycia Lane.

Delaware has a state counterpart to the CFAA.  The Misuse of Computer System Information Statute, 11 Del. C. § 935 et seq., makes it a crime to knowingly access a computer system without authorization. The statute prohibits not only the unauthorized copy and disclosure of electronic data, but the knowing deletion of data from a computer system.  The statute also has a civil component to this law which allows an aggrieved party to bring an action in the Delaware Court of Chancery for injunctive relief, restitution, treble damages, and attorneys' fees.  For more information see our earlier blog post on this statute.

Common Law Claims

There are many other legal claims that the company may assert to protect its business assets if an employee improperly uses or discloses its confidential, proprietary, or trade secret information. Employees who are given access to such information may be treated as fiduciaries with a duty of loyalty to protect it from disclosure during their employment. A competitor who knowingly participates in improper disclosure may be charged with "aiding or abetting" a breach of fiduciary duty or illegally participating in a civil conspiracy. In addition, a competitor who unfairly competes through the acquisition and intended use of such information may be sued for tortious inference with contract or business relations.

Contractual Protections

Aside from statutory and common law protections, there are contractual safeguards available to help employers stop the inappropriate disclosure of the business information and prevent unfair competition. At a minimum, all employers should consider requiring key employees who have access to confidential, proprietary, and trade secret information to sign Confidentiality and Non-Disclosure Agreements. A company may legally require employees who have access to confidential, proprietary information to sign such an agreement. If drafted properly, such agreements have "teeth" when enforcement action is necessary. Confidentiality agreements may provide not only for emergency injunctive relief, but also for an award of damages from the improper disclosure of company information. Importantly, in appropriate circumstances, Delaware courts will enforce a provision in a confidentiality agreement providing that an individual who violates its terms is subject to paying the company's attorneys' fees and costs in bringing enforcement action.

For certain classes of employees, employers should consider broader contractual protections beyond a simple confidentiality agreement. Employees in sales and marketing or high-level management positions may be in a position to seriously damage the company's business if they leave to work for a competitor. A non-competition agreement or restrictive covenant is valid and enforceable in Delaware so long as the agreement is not overly broad and is necessary to protect the company's legitimate economic interests.

Delaware courts will generally enforce a non-competition agreement that is reasonable in geographic and temporal scope. The non-competition agreement must contain a geographic restriction tied to the areas where the company does business and where the employee works to establish that the Company has a legitimate business interest in restricting competition in those locations. Delaware courts, like most courts throughout the United States, also require that the restriction against competition have a reasonable time limit. Typically, a Delaware court will find a two-year restriction to be reasonable.

Since enforcement of a non-competition agreement prohibits an employee from working in a specified field in competition with his or her former employer, courts are careful to balance the equities. The court will consider the employer's reasonable business needs versus the impact of the enforcement of such agreements on an individual's ability to earn a livelihood. Upon a showing of a need for such relief, however, courts will enforce non-competition agreements and may even issue an order prohibiting a former employee from working for a competitor.

An alternative to a non-competition agreement is a "non-solicitation" agreement. Non-solicitation agreements are narrower than non-competition agreements. A non-solicitation agreement restricts a former employee from soliciting a company's clients or customers. Like a non-competition agreement, a non-solicitation agreement must include a reasonable time limit. Instead of a geographic limitation, however, a non-solicitation agreement may restrict an employee from solicitation or business dealings with certain customers such as those with whom the employee had direct contact or about whom the employee received confidential information. Non-solicitation clauses may also include potential customers or prospects. Of course, as with other contractual provisions, careful drafting is necessary to ensure the enforceability of such contractual restraints.

In appropriate cases, employers may include confidentiality, non-competition, and non-solicitation clauses in the same agreement. As a rule of thumb, the need for such protections and the likelihood of successful enforcement increases with the amount of access an employee has to valuable business information and his or her level in the organization. In addition, employee misconduct, such as misappropriation of a customer list or other sensitive information, increases the likelihood that a court will award relief to the employer.

Posted by Barry M. Willoughby
February 16, 2012

Overbroad Forum Selection Clause Dooms Effort to Enforce Noncompete

Many businesses include Delaware choice-of-law and forum-selection clauses in their contracts to take advantage of Delaware law and the Court of Chancery’s strong reputation for reliable and well-balanced decision-making. However, in order to take advantage of Delaware’s judicial system, the forum selection clause must be drafted so that it confers personal jurisdiction over all of the parties. In a recent ruling, the Court of Chancery struck down a plaintiff’s attempt to enforce a noncompete agreement in Delaware because of a poorly worded forum selection clause.

In the case of Georgia-Pacific Consumer Products LP v. Jadczak, C.A. 6695-VCL, the plaintiff brought suit in Delaware to enjoin its former employee from working for a competitor in violation of his employment agreement. In addition to various restrictive covenants, the defendant’s employment agreement included the following personal jurisdiction provision:

Employee consents to and waives any objection to personal jurisdiction and venue in any federal and state courts having jurisdiction in any dispute arising out of the terms of this agreement.

Defense counsel moved to dismiss the case for lack of personal jurisdiction, arguing that the clause was over broad. They emphasized that the employee worked in Georgia when employed by Georgia-Pacific, and later accepted a job with a competitor in Kentucky. By contrast, the clause would allow him to be sued anywhere in the United States. In response, plaintiff’s counsel argued that Georgia-Pacific is a national company whose financial interests could be impacted in any state.

After lengthy arguments, the Court granted the motion to dismiss, providing three reasons for its decision. First, the Court noted that while parties may contractually accept the jurisdiction of Delaware’s courts, any such agreement must be clear and express. The Court found the language used by Georgia-Pacific to be ambiguous in its second use of the term “jurisdiction,” and therefore concluded that it did not meet the standard of a clear and express agreement.

Second, the Court found the provision to be so broad as to be unreasonable. Indeed, the Court noted that the language is not even limited to the United States, but could include any country that has a system of state and federal courts. The Court concluded that “a provision this general gives the employee insufficient notice of where the employee could be sued.”

Finally, the Court relied on issues of comity. In other words, the Court was hesitant to impose its will where other states had a much stronger interest in the outcome of the case. Noting that “Delaware does not have a significant interest in this dispute,” the Court instead deferred to the “paramount interests” of Georgia and Kentucky. Vice Chancellor Laster opined that “it risks giving offense to other states and it risks overstepping Delaware’s role in our federal system for Delaware to take ownership of this type of dispute involving an employee.”

This decision reinforces the need for companies to have well-drafted venue selection provisions, particularly if they wish to have their noncompete agreement enforced in Delaware. For Delaware choice of venue provisions, companies should also consider taking advantage of Delaware’s choice of law / venue statute, 6 Del. C. § 2708, which provides that the parties “shall conclusively be presumed to be a significant, material and reasonable relationship with this State and [the agreement] shall be enforced whether or not there are other relationships with this State.”

February 9, 2012

Court of Chancery Continues To Question Blue Pencil Rule

The Delaware Court of Chancery has once again indicated a reluctance to invoke the Blue Pencil Rule to reform overly broad restrictive covenants. Approximately 10 months ago, in his opinion in Delaware Elevator, Inc. v. Williams, Vice Chancellor Laster expressed his unwillingness to reform overbroad covenants, noting that “doing so puts the employer in a no-lose situation.” We discussed the opinion on this blog, urging drafters to exercise caution when drafting non-competition agreements and to give serious consideration to surrounding business circumstances when drafting. More recently, on December 21, 2011, during oral argument in Chesapeake Insurance Advisors, Inc. v. Williams Insurance Agency, Inc., et al., Vice Chancellor Noble echoed Vice Chancellor Laster’s position, quoting directly from Delaware Elevator.

In Chesapeake, the plaintiff-former employer sought to enforce a non-competition and non-solicitation agreement against several former employees, including the company’s former President. Oral argument was held to address the plaintiff’s dual motions for expedited proceedings and a temporary restraining order. In order to succeed on its motion for a temporary restraining order, plaintiff had to demonstrate, among other things, a colorable claim to relief. In order to demonstrate a colorable claim, the plaintiff had to present evidence that the underlying covenants are enforceable under Delaware law. Valid covenants must include reasonable temporal, geographic, and subject-matter restrictions.

Of significance here is the non-solicitation restriction, which prohibits the plaintiff’s former President from soliciting any of the plaintiff’s customers for 36 months following the termination of his employment. Delaware law has long recognized a presumption of reasonableness for restrictions extending no more than 24 months. Consequently, the plaintiff had an up-hill battle to convince the Court of the reasonableness of a 36-month restriction.

In an effort to cover his bases, the plaintiff’s counsel noted that in the absence of evidence justifying a 36-month restriction, the Court could always reform the covenant under the Blue Pencil Rule to limit the temporal restriction to a reasonable time period. Relying upon Vice Chancellor Laster’s decision, the Court stated that it would not “use the blue pencil to say ‘let’s make it 12 months or 18 months or 24 months.’ It’s not there. It’s gone.” Plaintiff’s counsel pointed out that the contract at issue had been fully negotiable, and that both parties had been represented by counsel. The Court was undeterred. While the Court recognized that “there is something of a divergence of opinion on that topic” between the Court of Chancery and the Delaware Supreme Court, it nonetheless indicated its intent to interpret the contract as written without modification.

Like the dicta in Delaware Elevator, the Court’s discussion in Chesapeake Insurance is not precedential. However, it provides a stronger indication (if one were needed) that the Court has little patience for needlessly broad restrictive covenants. Moreover, the relative bargaining positions of the parties is of little significance to the Court. Consequently, drafters should heed the Court’s warnings, and carefully consider the attendant business circumstances when drafting restrictive covenants. Among the issues to consider are: (1) the employee’s relative position within the company; (2) the extent of the employee’s business-related contacts; (3) the employee’s establishment within the field of business and the surrounding community; and (4) the realistic possibility of relocating or working outside of the geographical scope of the restrictive covenant. As an employee’s position within the company and access to customers and trade secrets increases, so does the employer’s ability to restrict his ability to compete and solicit current and prospective customers.

January 19, 2012

Court of Chancery Issues New Guidance for Practitioners

 

The Delaware Court of Chancery has issued new guidelines to assist those practicing before the Court. This guidance may be particularly helpful to attorneys unfamiliar with the level of civility expected of the Delaware Bar. The guidelines also include advice on “best practices” that will be informative for seasoned attorneys who have not mastered the nuances of Chancery Court practice:

· All cellphones and PDAs are strictly prohibited in the courtroom, even if silenced. Failure to comply with this rule may result in confiscation of the device and/or sanctions.

· Plans for the use of technology during a hearing or trial should be made approximately one week before the proceeding.

· Where Delaware attorneys are acting as local counsel, letters to the Court from lead counsel should not be forwarded to the Court under a cover letter saying, in substance, “Here is a letter from my co-counsel.”

· Letters to the Court should be short. If a letter exceeds 5 pages, double-spaced, counsel should consider whether a motion is more appropriate. Submissions of up to 15 pages may be filed as speaking motions. Submissions longer than 15 pages should be submitted as motions with supporting briefs.

· Minor changes to scheduling orders that do not affect the date of the last brief or the hearing do not require a stipulation. An agreement reached by letter or email will carry the same import as a formal stipulation.

· Parties should include in their standard interrogatories a request that the other party(ies) identify prospective trial witnesses. If a party fails to include such an interrogatory, the Court will not look favorably on complaints of unfairness when counsel is unable to depose all trial witnesses before the close of discovery.

· Answers should repeat the allegations of the Complaint and then set forth the response below, mirroring the practice used in discovery responses.

· The Court takes issue with parties (1) aggressively denying basic facts without a good faith basis to do so, and (2) reciting a laundry list of affirmative defenses without consideration of the applicability of each defense to the case.

· Rule 12(b)(6) and 12(c) motions should be accompanied by two bound copies of the Complaint and its exhibits to facilitate review of the motion.

· Parties should confer to reduce the number of motions where cross-motions are filed. A series of four motions (opening and answering) is preferred to a series of six motions (opening, answering, and reply).

· The Court requests that key non-Delaware decisions be included in the Compendium of Unreported Cases, even if the decisions are published and available on Westlaw or Lexis. Note, however, that large and unwieldy compendia are not appreciated, and counsel should feel free to leave out insignificant cases, such as those cited for basic principles of law.

A series of sample documents reflecting the Court’s recommended practices are also available from the Court’s website.

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October 5, 2011

Chancery Court Decision Provides Insight Into Drafting Enforceable Forum Selection Clauses

The Delaware Court of Chancery is nationally respected for its consistent and conscientious decisions in cases involving complex business issues. As a result, many legal practitioners recommend that contracting parties include a forum selection clause requiring that any disputes arising from a given contract be heard by a court of competent jurisdiction in the State of Delaware, including the Court of Chancery. A recent case in the Delaware Court of Chancery provides insight into the effective enforcement of a forum-selection clause.Delaware

In the daintily-named case of ASDC Holdings, LLC v. The Richard J. Malouf 2008 All Smiles Grantor Retained Annuity Trust, two parties entered into an agreement regarding the sale of equity in a Texas business. The agreement contained both an arbitration and a Delaware forum-selection clause which provided that any actions “with respect to any claim or cause of action arising under or relating to this Agreement” must be brought in a Delaware state or federal court with jurisdiction.

After the deal was executed, both parties became unhappy and sought legal relief: Plaintiff initiated an arbitration proceeding, and Defendant brought suit in a Texas court. Plaintiff thereafter filed papers in the Delaware Court of Chancery, seeking a preliminary injunction to prohibit the Texas action from moving forward in violation of the forum-selection clause.

The first question before the Court was whether it had jurisdiction to grant a preliminary injunction. The Court of Chancery is a court of limited jurisdiction—it does not have jurisdiction where there is an adequate remedy at law for the damages alleged. Defendant asserted that Plaintiff had an adequate remedy at law because it could assert the forum selection clause as an affirmative defense in the Texas action. Rejecting this argument, the Court held that where the underlying forum-selection clause is valid and broad enough to arguably reach the underlying claims, litigating the applicability of the forum-selection clause in another state deprives the parties of the benefit bargained for and does not constitute an adequate remedy at law.

Having established that it had jurisdiction, the Court moved on to address the Plaintiffs’ Motion for Preliminary Injunction. In order to obtain a Preliminary Injunction, the moving party must show (1) a reasonable probability of success on the merits, (2) an imminent threat of irreparable injury, and (3) that the balance of the equities favors the issuance of the requested relief. Defendant raised several arguments as to Plaintiff’s probability of success. First, it argued that several defendants in the Texas action are not signatories of the contract at issue, and therefore may not invoke the forum selection clause. The Court noted that, as wholly-owned subsidiaries, officers, and directors of the contract signatory, the third-party defendants are closely related to the signatories and may invoke the clause. Regarding the remainder of Defendant’s contentions, the Court concluded that the forum-selection clause was broad enough to give rise to a colorable argument that all of the claims raised in the Texas action fall within the scope of the clause.

As to the second element of Plaintiff’s claim, the Court held that proceeding on a claim in an unwarranted forum constitutes irreparable harm. Finally, the Court concluded that the balance of the equities favored Plaintiff, although the Court did not elaborate.

The Court’s opinion raised two key points to drafting a forum selection clause that may be successfully enforced through a Motion for Preliminary Injunction. First, the forum selection clause at issue must be valid. This means that the clause must permit claims to be brought in the appropriate Delaware Court.  A clause requiring that any claim be brought in the Court of Chancery, regardless of whether the Court has subject matter jurisdiction, may not be enforceable. 

Second, the clause should be drafted as broadly as possible, to ensure that any claims raised in a foreign jurisdiction will be governed by the clause, and subject to dismissal under the forum-selection clause. If the causes of action are not arguably within the ambit of the forum-selection clause, the party seeking to enforce it may not be entitled to a preliminary injunction. The language used by the parties in this case—governing “any claim or cause of action arising under or relating to this Agreement”—was found to be sufficiently broad enough to cover the claims at issue.

September 27, 2011

Court Denies Preliminary Injunction Based on Insufficient Record

While the Court of Chancery will frequently enjoin parties from engaging in unfair competitive activities, the standard for obtaining preliminary injunctive relief remains high.  It is important for parties seeking injunctive relief to be able to provide the court with specific, admissible evidence of unfair competitive activities.  Generalized allegations normally will be insufficient to allow the court to grant relief. Take for example a recent case involving the purchaser of a company’s assets who sought to enforce a noncompete against one of the company’s former employees.

In that case, Geovesi Holdings, Ltd. purchased certain assets of Earthwater Global, LLC as part of a court-ordered liquidation. The purchased assets include “all employment, non-disclosure agreements and  confidentiality agreements entered into by [EW Global].”  Following the sale, Geovesi filed suit in Chancery Court against one of EW Global’s former employees, Robert Bisson, to enforce noncompete and non-solicitation covenants in his employment agreement.  There also was pending litigation between Bisson and Geovesi in Virginia and an arbitration proceeding.

As evidence of Bisson’s competitive activities, Geovesi relied exclusively on allegations in Bisson’s Virginia pleadings that he competed with Geovesi.  The Court noted that while these generalized allegations are admissible evidence of competition, they did not provide a sufficient evidentiary foundation to support injunctive relief.

The Court also found that Geovesi’s allegations that Bisson wrongfully solicited its employees was too general to support injunctive relief.  As evidence, Geovesi had pointed to names mentioned on Bisson’s website and made generalized allegations about other solicitation efforts.  Bisson, on the other hand, responded with an affidavit explaining the names listed on his website and denying any prohibited solicitations.  The Court found that on the present record it could not predict with any degree of confidence how this issue would be resolved at trial, making it inappropriate to issue injunctive relief.

Genovesi Holdings Ltd v. Bisson, 6780-VCL, (Del. Ch. 9/19/2011).

July 27, 2011

Using Survival Clauses in Employment Contracts to Shorten Employer Liability

A recent Court of Chancery opinion, addressing survival clauses in transactional contracts, provides guidance on the use of contractual statutes of limitations in employment contracts. In the case of GRT, Inc. v. Marathon GTF Technology, Ltd., the Court ruled on a contract governing a joint venture between two businesses in the natural gas industry. The Plaintiff, an investor, contracted with the Defendant to build a testing facility to allow the Plaintiff to conduct research related to new technologies. Because the testing facility involved the Defendant’s proprietary technology, the Plaintiff was not permitted to inspect the facility until the contract establishing the joint venture had been executed. In order to protect the Plaintiff’s investment, the parties’ contract included a Survival Clause.

Pursuant to the Survival Clause, any claim related to design specifications for the testing facility would survive for one year after execution of the joint venture agreement. The Survival Clause thereby preserved the Plaintiff’s rights, while shortening the three-year statute of limitations on contract claims to one year. The joint venture contract was executed in July 2008, but the Plaintiff waited until June 2010 to bring suit regarding alleged design problems and the Defendant’s failure to remedy the problems. The Defendant moved to dismiss the suit as barred by the Survival Clause.

In response to the Motion to Dismiss, the Plaintiff argued that (1) the Survival Clause limited the period during which the Defendant could breach the contract, but did not limit the period for enforcement and (2) it was not suing for failure to comply with design specifications—an issue governed by the Survival Clause—but was instead suing for over the Defendant’s failure to remedy the alleged design flaws. The Court rejected both arguments.

In addressing the Defendant’s contentions, the Court noted that Delaware has long recognized parties’ right to shorten statutes of limitations. Such limitations do not violate legislative prerogatives because they do not exceed the prescribed statutes or limitations, and in fact are seen to support the purposes of a statute of limitations—preventing plaintiffs from bringing stale claims. Moreover, there may be sound business reasons for such agreements. Consequently, so long as the limitation imposed is a reasonable one, parties are free to contractually shorten a statute of limitations. Significantly, the Court rejected the standard of review applied in New York and California, which requires that the parties’ intent to restrict the statute of limitations be “clear and explicit.” Instead, the Court applied the traditional standard of contract interpretation: the language at issue must be unambiguous.

Although it deals with the survival of contractual representations and warranties, the Court’s opinion bears two lessons for employers. First, clauses limiting the period in which employees or executives may bring suit are enforceable under Delaware law, so long as the contractual statute of limitations is a reasonable one. Second, if you are not already utilizing contractual statutes of limitations, it is time to start. In light of recent Court of Chancery opinions, there is some doubt as to whether such a provision would be enforceable against low-level employees, where the bargaining power is particularly uneven between employer and employee. However, such provisions are much more easily justified in contracts with senior employees or executives, whose employment is more closely tied to operational success.

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June 1, 2011

Misclassification of Employee May Impact Employer’s Ability to Enforce Non-Compete Agreement

In order to enforce a noncompete agreement, the party seeking to enforce the agreement must first show that a valid contract exists. Usually this requirement is easily satisfied, but employers not take it lightly. For instance, some employees have successfully argued that their former employer’s failure to fully compensate them prevented the employer from enforcing the non-competition agreement. This outcome is premised on the principle of contract law that ‘a material breach by one party to a contract entitles the non-breaching party to suspend performance. A recent Third Circuit opinion indicates that in some cases, an employer’s misclassification of an employee as an independent contractor may result in a breach of contract, which can similarly prevent enforcement of a non-competition agreement.

In Figueroa v. Precision Surgical, Inc., the employer had an independent contractor agreement (“ICA”) with Joseph Figueroa and a medical equipment supplier called Precision Surgical, Inc. The ICA included several restrictive covenants, including non-solicitation, confidentiality, and non-competition provisions.

Figueroa worked for Precision from 2004 through September 2010. During those years, Precision began to treat Figueroa as an employee, rather than an independent contractor. Among Precisions requirements were (1) that Figueroa devote 100% of his energy to selling products offered by Precision, (2) that he report to his supervisors daily and attend monthly meetings, (3) that he abide by a dress code, and (4) that Figueroa obtain permission from Precision before giving quotes to certain prospective customers.

As Precision’s supervision and reporting requirements became more onerous, Figueroa objected. He eventually requested a new independent contractor agreement that clarified his relationship to Precision and would eliminate the conduct to which Figueroa objected. Precision refused, instead informed Figueroa that it wanted to move its salesmen toward an employment relationship, eliminating all independent contractor positions. When Figueroa refused to become an employee, Precision terminated his independent contractor agreement.

After Precision terminated his contract, Figueroa brought a lawsuit seeking a declaratory judgment that the non-competition provisions in his independent contractor agreement were invalid. Precision brought a counterclaim seeking a preliminary injunction enforcing the non-competition provisions. Precision alleged that Figueroa was actively violating the non-compete by working as an independent sales representative for one of Precision’s direct competitors.

Figueroa alleged two breaches of the ICA: he alleged that he had been treated as an employee rather than an independent contractor, and that he had not been fully compensated according to the terms of the ICA. After briefing by the parties, the District Court denied Precision’s Motion for Preliminary Injunction on the basis that Precision had more likely than not breached the ICA. The Third Circuit affirmed.

In upholding the District Court’s ruling, the Third Circuit noted specific requirements imposed by Precision. Among them were (1) the establishment of primary and secondary levels of reporting authority, (2) dress requirements, (3) training obligations, (4) sales goals, and (5) the requirement that Figueroa devote 100% of his time to Precision. These requirements, the Third Circuit concluded, were not consistent with the title of an independent contractor. Consequently, Precision breached the ICA by treating Figueroa as an employee, instead of an independent contractor.

Most employers are aware—and all employers should be aware—that properly classifying workers as employees or independent contractors is significant for multiple reasons, including proper income tax withholding and liability under the Fair Labor Standards Act. However, employers should now consider an additional consequence for misclassifying their workers—treating an independent contractor as an employee may result in a court’s determination that the employer has breached the independent contractor agreement, rendering the restrictive covenants unenforceable. Based on the Third Circuit’s holding, employers should review independent contractor agreements to ensure that the requirements imposed on independent contractors are consistent with the terms of the agreements.

Figueroa v. Precision Surgical, Inc., No. 10-4449 (3rd Cir. April 12, 2011)

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April 25, 2011

Chancellor Chandler to Leave Bench in June 2011

The head of Delaware’s Court of Chancery announced today that he will be stepping down from the bench effective June 17, 2011.  William B. Chandler, III has served as Chancellor since 1997.  He joined the Court of Chancery in 1989, and prior to that served as a judge in Delaware’s Superior Court. 

In 2009, Chancellor Chandler had been reconfirmed for a second 12 year term, and his announcement comes as a surprise to some.  In a letter to Governor Jack Markell, the Chancellor, age 60, indicated he wanted to pursue new opportunities that were available to him.

A more complete story is available at the Delaware News Journal website.

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