Delaware Non-Compete Law Blog

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.

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.

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).

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.

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)

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.

When enforcing covenants not to compete, Delaware has long been viewed as a “reformation” state – meaning that when faced with an overbroad covenant, Delaware law allows the court to reduce the scope of the covenant and enforce it to the extent that the court deems reasonable. This view has developed among the lower courts in a number of decisions, but has never been fully addressed by the Delaware Supreme Court.

However, as we noted in an earlier article, it is important to make certain the restrictive covenant you draft is reasonable both in its scope and duration. Employers should not count on a court to "reform" a poorly drafted restrictive covenant that is overly broad or vague. A recent case from the Court of Chancery demonstrates why.

In the case of Delaware Elevator, Inc. v. John Williams, No. 5596-VCL (Del. Ch. March 16, 2011), the plaintiff-employer sued its former employee alleging a violation of the employee’s non-competition agreement. Because the employee admitted that he had engaged in conduct that violated the terms of the non-competition agreement, the only question before the Court was whether the non-competition agreement was overly broad, and therefore unenforceable.

The non-competition agreement at issue had both a non-competition and a non-solicitation provision, each of which restricted the employee’s conduct for 3 years after he left his employment. The non-competition provision prohibited the employee from competing with the employer within 100 miles of its Newark, Delaware office. Under the non-solicitation provision, the employee was prohibited from soliciting any customer who had been a current or prospective client of the employer during the last 6 months of the employee’s employment.

The employee resigned his position with the employer in 2010. Shortly thereafter, the employer discovered that he was competing within 100 miles of the Newark Office, and that he was using a customer list that he developed while he was employed by the employer. When the employee refused to cease and desist, the employer brought suit, seeking to enjoin his violation of the agreement.

The non-competition agreement included a Maryland choice-of-law provision, so the Court’s analysis was conducted under Maryland law. After determining that the 3-year, 100-mile restriction was overly broad, the Court was faced with the question of whether to strike or reform the provision. The Court concluded that Maryland law required reformation under the blue pencil rule. However, the Court declared that it would have handled the question differently under Delaware law.

The Court stated that reformation of overly broad contracts puts an employer in a no-lose situation. If the agreement will be enforced to some lesser extent even if overly broad, an employer has no incentive to draft a reasonable provision in the first place. The Court also noted that for every employee who challenged the provision, others would choose not to, thereby harming consumers and interfering with labor and product markets.

The Court was further troubled by the disparity in bargaining power between low and mid-level employees and their employer. Where such employees are involved, the Court noted, there is no real choice as to whether to sign the non-competition agreement. Moreover, even if there were a choice, most employees do not have the savvy or access to legal advice to bargain effectively. As a result, the Court noted that Delaware law might require that an unreasonable restrictive covenant be struck in its entirety.

While the Court’s statements regarding Delaware law are dicta, they provide a strong indication that overly broad restrictive covenants might not be enforced in any manner by the Delaware Court of Chancery. As a result, employers should exercise caution when drafting non-competition agreements. These agreements should consider, among other things, (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 competition and solicitation of current and prospective customers.

By Scott Holt and Lauren Moak

While we are all familiar with the use of preliminary injunctions in aid of litigation, they also have a place in alternative dispute resolution. In Chartis Warranty Guard, Inc. v. National Electronics Warranty, LLC, the Delaware Court of Chancery issued a preliminary injunction pending the outcome of contractually mandated arbitration. The inclusion of a clause allowing issuance of a preliminary injunction prior to binding arbitration is a wise move if a contract includes non-competition or confidentiality provisions, the violation of which would lead to irreparable harm.

In Chartis Warranty, the plaintiff was a joint venture formed between the defendant, National Electronics Warranty, LLC (“NEW”) and Chartis Insurance. The purpose of the joint venture was to provide retailers with consumer warranty programs. Pursuant to the contracts governing the parties’ responsibilities, NEW received a designated fee for administering the retailer warrant programs, and Chartis received all profits earned above the fee owed to NEW.

In the course of its administration, NEW gathered a variety of data relating to the consumer warranty programs. Some of this information was publicly available, and some was sensitive. Among the move sensitive information was loss ratios, profitability, and earnings curves, which would be valuable to Chartis’s competitors. In the process of reorganizing certain programs, NEW provided this sensitive information to some of plaintiff’s competitors, leading to a dispute about whether the data was subject to various confidentiality provisions contained in the contracts governing the parties’ relationship. NEW maintained that it owned the data, and was permitted to disclose it—Chartis disagreed, asserting that it maintained exclusive ownership over the relevant information.

Both parties agreed that any dispute regarding the terms of the contract were subject to binding arbitration. However, the contract also permitted the parties to seek a preliminary injunction pending arbitration. Consequently, the plaintiff filed suit seeking an injunction to protect its interests in the allegedly confidential information that it claimed the defendant was disclosing to its competitors.

Under Delaware law, a preliminary injunction is appropriate it the moving party can demonstrate (1) a reasonable probability of success on the merits; (2) that they will suffer irreparable injury if the injunction does not issue; and (3) that the balance of the equities favors issuance of an injunction. In this case the Court, applying New York law as required by the contract, found that the plaintiff was likely to succeed on its arbitration claims because the terms of the confidentiality provision, indicating that the plaintiff owned “all books and records,” was broad enough to include the disputed data. In so finding, the Court rejected NEW’s argument that, at most, the plaintiff had a non-exclusive ownership interest. In the absence of any information limiting the plaintiff’s ownership right, the Court declined to find such a limit. The Court also concluded that the disputed data might constitute trade secrets.

Regarding irreparable harm, the Court reached two conclusions. First, it determined that the harm done to the plaintiff by NEW’s previous disclosure of the disputed data could be reduced to monetary damages, and therefore was likely reparable. However, the Court noted that NEW had expressed an intent to continue disclosing the disputed data. This on-going disclosure, the Court concluded, was irreparable because continuing harm to the plaintiff’s competitive position is much more difficult to quantify. Consequently, the Court found that the plaintiff had demonstrated a likelihood of irreparable injury.

Finally the Court concluded that the balance of the equities favored the plaintiff, considering the difficulty in quantifying the damage to plaintiff, and the short-term nature of the injunctive relief, which will terminate upon completion of the arbitration proceedings.

Delaware law clearly recognizes a business’s interest in the protection of its client contacts, confidential information, and good will. Consequently, where these types of information are at issue in a contract with an arbitration provision, including a clause allowing for a preliminary injunction is a good way to protect your interests.

Chartis Warranty Guard, Inc. v. National Electronics Warranty, LLC, No. 5764-VCP (Del. Ch. Jan. 28, 2011).

A purchaser of a business often require the seller to agree to a non-compete agreement as part of the sale terms.   This not only has tax benefits (the agreement can be considered an acquired intangible asset and and amortized for tax purposes), but it can protect the buyer from future competitive activities of the seller in the same marketplace.

Delaware courts have tended to enforce noncompetition agreements arising out of the sale of a business.  Sale transactions are normally conducted at arms-length, and the courts are reluctant to strike down noncompete provisions that were negotiated as part of the sale price.  A recent case decided in the Delaware Superior Court adhered to this view.

In O’Leary v. Telecom Resources Service, LLC et al., the plaintiffs sold their telecommunications business to Telecom Resources – a wholly owned subsidiary of NAL Worldwide.   As part of the sale, both the asset purchase agreement and the plaintiffs’ employment contracts with the buyer contained noncompete provisions.  After the plaintiffs were terminated from employment (for allegedly operating several competing business ventures), they sued Telecom Resources seeking, among other things, a declaration that the noncompete provisions were unenforceable.

The plaintiffs made several arguments, including (1) the noncompete was not designed to protect legitimate business interests, (2) it was not reasonably limited in both geography and duration, and (3) that defendants had breach the underlying agreements.  The applicable language of the noncompete provided that the plaintiffs were barred from rendering services for “any entity competitive with the Business of [Telecom Resources] anywhere in the United States for a period of four (4) years from the closing date of [the sale].”

Plaintiffs first argued that the noncompete provision did not protect a legitimate interest, because Telecom Resources was not in operation.  The Court disagreed, noting that while Telecom Resources might not have been in operation, its owner NAL Worldwide was in operation, and that it had rights to enforce the noncompete.

The court also rejected plaintiffs’ argument that the 4 year restriction was too long, noting that Delaware court have upheld as reasonable non-compete provisions for the sale of a business for as long as 10 years.  The court also rejected the plaintiffs’ argument that the nationwide prohibition on competition was overbroad.  The court found that the plaintiffs’ business operated on a nationwide basis before and after the sale, and that both plaintiffs acknowledged the national scope of the business in the agreements. 

Finally, the court noted that the restrictions were reasonable especially considering the benefits the plaintiffs received from the sale.  The sale price was $1,000,000, and both plaintiffs received executive positions with six-figure salaries in exchange for the agreement not to compete.  The court observed that “Delaware courts are strongly in favor of enforcement of contracts freely entered into by the parties, and the Court will only set aside the agreement ‘upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than the freedom of contract.’” (citing Libeau v. Fox, 880 A.2d 1056 (Del. Ch. 2005).

O’Leary v. Telecom Resources Service, LLC et al., No. 10C-03-108-JOH (Del. Super. Jan. 14, 2011)

Disputes involving non-compete agreements more often than not become dependent upon information that is or was stored electronically. It is not, therefore, surprising that Delaware’s Court of Chancery, the trial court where most disputes involving non-compete agreements are filed, posted important Guidelines for Preservation of Electronically Stored Information on its website yesterday. (See www.courts.delaware.gov/Chancery.) Anyone involved in a matter before Delaware’s Court of Chancery must pay particular attention to the Court’s guidelines.

It is clear from the guidelines that the Court considers the preservation of electronically stored information (“ESI”) a very important task that, if performed incorrectly, will have consequences. The first paragraph of the guidelines reminds “all counsel (including Delaware counsel) appearing in any case before the Court of their common law duty to their clients and the Court with respect to the preservation of electronically stored information.” (emphasis added.) Specifically, “a party to litigation must take reasonable steps to preserve information, including ESI, that is potentially relevant to the litigation and that is within the party’s possession, custody, or control.” If a party has not made a good-faith effort to preserve ESI, it is likely that the Court will issue sanctions.

Despite the use of the term “litigant” throughout the guidelines, the guidelines impose particular responsibilities upon counsel that should not be ignored. According to the guidelines, “at the very minimum,” counsel’s common law duty to take reasonable steps to preserve ESI includes but is not limited to developing and overseeing a preservation process that includes the dissemination of a litigation hold notice to custodians of potentially relevant ESI.

Counsel is strongly encouraged to: take a collaborative approach to the process, develop written instructions for the preservation of ESI, and document the steps taken to preserve ESI. Counsel is also advised to pay close attention to preserving ESI from laptop computers, home/personal computers (desktop or laptop), external and internal (and certainly portable) storage devices (e.g., USB/flash drives) and personal electronic mail accounts.

The Court’s approach to the issue of e-discovery is not unexpected. Vice Chancellor Laster’s bench ruling on a discovery dispute in Roffe v. Eagle Rock Energy GP, et al., C.A. No. 5258-VCL (Del. Ch. Apr. 8, 2010) has been the subject of much discussion within the Delaware Bar. During that conference, Vice Chancellor Laster told the litigants before him that “First of all, you do not rely on a defendant to search their own e-mail system…There needs to be a lawyer who goes and makes sure that the collection is done properly.” Vice Chancellor Laster went on to question whether the ESI had been adequately preserved, protected, and produced. For this case, he believed that a proper collection of ESI could be accomplished within thirty days, “based upon the assumption that there had been appropriate litigation holds put in place when this action was filed, that there would be responsive efforts made by the defendants to get this stuff done.”

The bottom line for litigants, and particularly attorneys practicing in Delaware’s Court of Chancery, is that the Court is taking a party’s duty to preserve ESI very seriously. Indeed, the guidelines specifically state, “While the development and implementation of a preservation process after litigation has commenced may not be sufficient by itself to avoid the imposition of sanctions by the Court if potentially relevant ESI is lost or destroyed, the Court will consider the good-faith preservation efforts of a party and its counsel.” (emphasis added.) Finally, the Court leaves counsel with an important reminder: the duty to preserve ESI starts when litigation is “reasonably anticipated, which could occur before litigation is filed.”

Disputes involving non-compete agreements more often than not become dependent upon information that is or was stored electronically. It is not, therefore, surprising that Delaware’s Court of Chancery, the trial court where most disputes involving non-compete agreements are filed, posted important Guidelines for Preservation of Electronically Stored Information on its website yesterday. (See www.courts.delaware.gov/Chancery.) Anyone involved in a matter before Delaware’s Court of Chancery must pay particular attention to the Court’s guidelines.

It is clear from the guidelines that the Court considers the preservation of electronically stored information (“ESI”) a very important task that, if performed incorrectly, will have consequences. The first paragraph of the guidelines reminds “all counsel (including Delaware counsel) appearing in any case before the Court of their common law duty to their clients and the Court with respect to the preservation of electronically stored information.” (emphasis added.) Specifically, “a party to litigation must take reasonable steps to preserve information, including ESI, that is potentially relevant to the litigation and that is within the party’s possession, custody, or control.” If a party has not made a good-faith effort to preserve ESI, it is likely that the Court will issue sanctions.

Despite the use of the term “litigant” throughout the guidelines, the guidelines impose particular responsibilities upon counsel that should not be ignored. According to the guidelines, “at the very minimum,” counsel’s common law duty to take reasonable steps to preserve ESI includes but is not limited to developing and overseeing a preservation process that includes the dissemination of a litigation hold notice to custodians of potentially relevant ESI.

Counsel is strongly encouraged to: take a collaborative approach to the process, develop written instructions for the preservation of ESI, and document the steps taken to preserve ESI. Counsel is also advised to pay close attention to preserving ESI from laptop computers, home/personal computers (desktop or laptop), external and internal (and certainly portable) storage devices (e.g., USB/flash drives) and personal electronic mail accounts.

The Court’s approach to the issue of e-discovery is not unexpected. Vice Chancellor Laster’s bench ruling on a discovery dispute in Roffe v. Eagle Rock Energy GP, et al., C.A. No. 5258-VCL (Del. Ch. Apr. 8, 2010) has been the subject of much discussion within the Delaware Bar. During that conference, Vice Chancellor Laster told the litigants before him that “First of all, you do not rely on a defendant to search their own e-mail system…There needs to be a lawyer who goes and makes sure that the collection is done properly.” Vice Chancellor Laster went on to question whether the ESI had been adequately preserved, protected, and produced. For this case, he believed that a proper collection of ESI could be accomplished within thirty days, “based upon the assumption that there had been appropriate litigation holds put in place when this action was filed, that there would be responsive efforts made by the defendants to get this stuff done.”

The bottom line for litigants, and particularly attorneys practicing in Delaware’s Court of Chancery, is that the Court is taking a party’s duty to preserve ESI very seriously. Indeed, the guidelines specifically state, “While the development and implementation of a preservation process after litigation has commenced may not be sufficient by itself to avoid the imposition of sanctions by the Court if potentially relevant ESI is lost or destroyed, the Court will consider the good-faith preservation efforts of a party and its counsel.” (emphasis added.) Finally, the Court leaves counsel with an important reminder: the duty to preserve ESI starts when litigation is “reasonably anticipated, which could occur before litigation is filed.”

Wal-Mart Stores Inc. scored a second victory in its case against a former executive by convincing the Delaware Court of Chancery to extend the injunction preventing him from joining CVS Caremark Corporation.  The world’s largest retailer had sued to prevent Hank Mullany, a former executive vice president, from joining CVS based on the restrictions in his noncompete agreement and the possibility that confidential information involving sales and growth initiatives would be disclosed to its rival. 

In a hearing held on December 15, 2010, Vice Chancellor J. Travis Laster sided with Walmart and agreed to convert the temporary restraining order into a preliminary injunction, noting that Mullany took a calculated risk by accepting employment with CVS and that he could have gone to work for a non-competitor.   Vice Chancellor Laster also recognized that Mullany’s knowledge of Walmart’s small store strategy would prove valuable to CVS if it was disclosed.

The new injunction prohibits Mullany from employment or association with any general or specialty retail, grocery or merchandising business with sales in excess of five billion dollars, and enjoins CVS from employing or using Mullany in any capacity.  The order also prohibits Mullany from disclosing any of Walmart’s confidential or proprietary information.

The injunction is effective until the Court issues a final decision on the merits.  A trial is scheduled to take place in March 2011.  The Court also order Walmart to post $1 million bond. 

A copy of the Court’s order granting the preliminary injunction can be found

Wal-Mart Stores obtained a temporary restraining order on December 3, 2010 from the Court  of Chancery in Delaware enjoining a former executive vice president from commencing employment with CVS Caremark Corporation. The former executive, Harry S. Mullany, had been president of Walmart North and was scheduled to start work at CVS on December 6, 2010.

According to the verified complaint, Mullany had oversight of Walmart’s operations for over 1,300 stores in nineteen states and has extensive knowledge of Walmart’s confidential and proprietary information and trade secrets. Walmart alleges that Mullany executed a covenant not to compete in 2009 which prohibited him from working for a competing business for a two (2) year period or participating in any activity that risks the use or disclosure of Walmart’s confidential information.

On October 24, 2010, Mullany apparently informed Walmart that he was resigning his position effective November 5, 2010. Walmart subsequently learned that Mullany had accepted a position with CVS beginning December 6, 2010 as president of its retail division. The parties purportedly had discussions to resolve the dispute prior to the filing of the lawsuit but these proved unsuccessful.

Walmart asserts three claims in its complaint. It first claims Mullany breached his noncompete agreement by accepting employment with CVS, a direct competitor. It also alleges that since Mullany has extensive and intimate knowledge of Walmart’s business and strategies this confidential information will necessarily be used and inevitably disclosed during his employment with CVS. Walmart alleges that the Court of Chancery has jurisdiction to enforce the noncompete agreement because it contained a Delaware forum selection clause.

Walmart also alleges that the confidential information acquired by Mullany constitutes trade secrets as defined by Delaware’s Uniform Trade Secrets Act. It claims both CVS and Mullany will use and disclose Walmart’s trade secrets, and CVS will further violate the Trade Secrets Act by inducing Mullany to breach his duty to keep Walmart’s confidential information secret. Finally, Walmart alleges that CVS tortiously interfered with Walmart’s contractual relationship with Mullany by inducing him to breach his noncompetition agreement.

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery issued the temporary restraining order. A preliminary injunction hearing has been scheduled for December 15, 2010.

With the increasingly rapid changes in today’s technological business world, companies are  faced with many new challenges to protect their intellectual property from competitors. This includes developing measures to protect the intellectual property and work created by employees. To this end, many employers require employees to assign over all of their intellectual property rights. These so-called “work made for hire” agreements generally grant the employer ownership of any intellectual property applicable to the employer’s business and developed by the employee during his employment.

A recent case decided by Delaware’s federal district court illustrates the importance of such agreements. In Le v. City of Wilmington, C.A. No. 08-615-LPS, a City employee sued the City for copyright infringement. The employee’s suit related to an Instant Ticketing program designed by Le for the City’s Department of Licensing and Inspection. The program was designed to allow the City to track license violations electronically, rather than through paper tickets. Le alleged that he had developed the program at home, on his own time, with the intention of marketing it to the City and other municipalities.

Subsequently, the City eliminated Le’s job, and Le sued the City for copyright infringement when it continued to use the Instant Ticketing program. While the lawsuit was eventually resolved in favor of the City, it likely could have been preempted entirely by a well-drafted intellectual-property-assignment agreement. In the absence of such an agreement, the City was forced to rely upon federal copyright law to prove that Le’s program was a “work made for hire.”

While targeted intellectual-property-assignment provisions are important to many businesses, there is an increasing trend to draft broad provisions, granting the employer ownership of all intellectual property developed by the employee during his employment, regardless of its applicability to the employer’s business. These broad ownership provisions pose considerable legal problems, and should be avoided, particularly in Delaware.

Delaware law prohibits employers from requiring assignment of employee work that is created entirely on the employee’s time without use of any employer resources unless the work (1) relates to the employer’s business or research and development, or (2) results from work performed by the employee for the employer. 19 Del. C. § 805. Any policy in violation of this statute is expressly declared to be void as against public policy.

Only one case has addressed the restrictions imposed by 19 Del. C. § 805. In Agilent Technologies, Inc. v. Kirkland, C.A. No. 3512-VCS, the Delaware Court of Chancery cited the statute as providing the outer limits of an acceptable assignment agreement. The Court then went on to find that the employee-defendants had violated their contractual obligations to assign work-related inventions to their employer. The Court then ordered the defendants to either (1) withdraw their pending patent applications covering the relevant work, or (2) assign the patents to their former employer.

The Le and Agilent cases illustrate the benefits provided by a targeted intellectual-property-assignment agreement. However, employers should be careful not to get overly ambitious with such agreements. A proper assignment agreement will grant the employer ownership of all employee-created work, related to the employer’s business, research or development, and created during the period of employment. Anything broader may be unenforceable under Delaware law.

Lauren Moak

Hiring an employee who is subject to a non-competition agreement can be a risky venture.  In many instances, the new employer can find itself on the receiving end of an expedited lawsuit along with the new hire.  But there are a few simple measures new employers can take to reduce the chances of being named as a co-defendant in a lawsuit. 

First, make certain your new hire has “clean hands” before commencing employment.  This means that all documents, computers, PDAs, flash drives, and any other property arguably belonging to the former employer has been returned intact.  The employee needs to be aware that erasing hard drives and databases before returning equipment (even if inadvertent) can often result in a negative ruling from the court or even a spoliation finding.  Once completed, the employee should confirm in writing that all property in his possession has been returned to his former employer. 

Next, make sure the potential new hire does not engage in competition while still at his old job.  In Delaware, it is generally permissible to make preparations to compete while still employed, which would include discussions with other companies about possible employment opportunities.  But employees often cross the line when these discussions develop into actual competition, and if there’s evidence the new employer encouraged these acts, it may open the door for a civil conspiracy claim. 

Finally, before the employee commences work, there should be a written agreement confirming that the employee has returned all property to his former employer, that he will not to disclose any protected confidential information or trade secrets, and address any limitations that will be placed on his job functions and/or ability to solicit past / current customers.  This last point will likely require some analysis of the employee’s agreement not to compete and a decision about which provisions are and are not enforceable.

While new employers cannot totally eliminate the risk of being named a co-defendant in a noncompetition lawsuit, the above steps should help lower the risk associated with hiring a new employee.  These steps also will prove invaluable should the employer have to defend against a noncompete case.

Vice Chancellor Chandler recently stayed, sua sponte, an action commenced in Delaware's Court of Chancery by a company seeking a declaratory judgment against a former employee.  The decision reiterates the importance of bargaining for consent to the jurisdiction of Delaware's Court of Chancery in any contract. 

Online Resources Corp. sought a declaration regarding the meaning of a severance agreement with a former employee.  The employee, however, commenced an action against Online Resources Corp. in a Virginia trial court, alleging that the company breached the agreement and wrongfully terminated him.  Online Resources Corp. sought to have the Virginia action dismissed because of the pending Delaware Court of Chancery Action, and because the claims raised by the employee in his Virginia action arose from the same facts and circumstances as those set forth in the company's Delaware Court of Chancery action.

The subject of Vice Chancellor Chandler's opinion was whether the employee's motion to dismiss the company's Delaware action should be granted.  After fully briefing the issue for the Virginia court, that court rejected Online Resources Corp. arguments and sua sponte stayed the case indefinitely in favor of allowing the case to proceed in Virginia. 

The Court cited several important key factors in support of its decision.  First, it found there were no important or novel issues of Delaware corporate law raised in Online Resources Corp.'s action.  Second, based upon the Virginia court's decision, there is no question that Online Resources Corp. would be required to defend the wrongful termination action in Virginia.  Finally, because the Virginia action was still pending, the Court found that Online Resources Corp. could bring its declaratory judgment claims in the Virginia litigation.  As a result, the Court stayed Online Resources Corp.'s Delaware action, citing the interests of comity and judicial economy.

Vice Chancellor Chandler did, however, agree to consider lifting the stay if Online Resources Corp. is unable to assert as a counterclaim in the Virginia action its claims involving the severance agreement or if the Virginia action is not prosecuted diligently by the employee.

The lesson from this short opinion is that, as we have previously posted, to the extent a party wants to ensure that it can sue a nonresident in Delaware based on a contract, it should bargain for consent to jurisdiction in Delaware's courts in the contract. This includes including Delaware’s statutory choice of law and venue provision in employment and severance agreements.

By Maribeth Minella