Court Doesn’t Buy Sellers’ Effort To Get Out Of Noncompete Agreement

February 11, 2011
By Scott Holt on February 11, 2011 9:07 AM |

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)