Articles Posted in Defenses

Most agreements not to compete provide for injunctive relief as the primary remedy against a departing employee who joins a competitor.  In some cases, however, companies will condition the payment of post-employment or deferred compensation on the employee’s compliance with a noncompete agreement.  These arrangements are often referred to as the “employee choice” doctrine. Under this doctrine, an employee who departs and subsequently violates his noncompete obligations will forfeit any right to the post-employment compensation. The doctrine is based on the premise that a departing employee is given the choice of either preserving his right to compensation by refraining from engaging in competitive activities, or forfeiting that right by choosing to compete with the former employer.

Although Delaware courts have not specifically addressed this doctrine, a recent New York decision applying Delaware law applied the doctrine and refused to grant the former employer’s request for injunctive relief. In NBTY, Inc. v. O’Connell Vigliantethe plaintiff NBTY was a vitamin and nutritional product distributor. Beginning in 2014, a number of NBTY employees resigned and went to work at Piping Rock Health Products, LLC – a competitor run by NBTY’s former CEO. All of the departing NBTY employees had signed stock-option agreements with NBTY’s parent which allowed them to purchase stock options over a period of time, and the agreements contained restrictive covenants prohibiting them from competing with NBTY for a one-year period following the end of their employment. Notably, the agreements all contained Delaware choice of law provisions.

After the employees resigned and went to Piping Rock, NBTY sued to enforce the non-compete agreements and sought to permanently enjoin the employees from working at Piping Rock. The defendants moved to dismiss the complaint, arguing that they had not exercised any of the stock options in question and thus there was no consideration.

Significant time, money and resources often goes into developing client relationships. To protect these relationships, more companies are requiring managers and other employees who have significant contact with clients to sign non-solicitation agreements.

However, requiring an employee to sign a non-solicitation agreement and being able to enforce that agreement are two completely different matters. Customer non-solicitation agreements, like traditional non-compete agreements, are considered restraints on trade, and thus most courts, including those in Delaware, will enforce them only if they are “reasonable.”

Courts will traditionally assess the reasonableness of a non-solicitation agreement by evaluating the scope of the restriction as it relates to three factors: 1) the employer’s interest in protecting its business; 2) the employee’s right to work and earn a living; and 3) the public’s interest in free trade and competition. What follows are four points to consider when drafting a non-solicitation agreement under Delaware law.

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

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.

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.

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. 

money.jpgFormer employees seeking to get out of their noncompete agreements often throw up a flurry of defenses. Most of these defenses usually pertain to the scope of the restrictions, whether the covenant is designed to protect legitimate business interests, or the balance of hardships. Occasionally, however, employees are able to successfully argue that the non-compete is not an enforceable contract.

One such defense is to assert that there had been a prior material breach of the underlying contract by the former employer. If the employer materially breached the employment agreement, the employee may be excused from compliance with the covenant not to compete.

It is not all that uncommon for companies to withhold wages or bonuses from departing employees who go to work for a competitor or solicit their customers. But employers should think twice before doing this, especially if there is no legal basis for withholding the compensation.
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scales.jpgThe Court of Chancery is often hesitant to enforce a covenant that would preclude an individual from earning a living. Where a restriction on the ability to be gainfully employed is involved, the customary sensitivity of the Court to the particular interest affected by its remedies is heightened. As a result, parties seeking to enforce covenants not to compete must use caution so as not to request relief that would essentially render the defendant unable to work.

In balancing the equities, the Chancery Court will analyze whether the consequences of enforcement to the employee are grave and/or whether the interests of the employer are “slight or ephemeral.” Disproportionate hardship is often a reason for refusing equitable remedies. If the equities balance in the employee’s favor, even a well-drafted covenant may not be enforced.

When determining the balance of hardships, only actual harm is relevant to this determination. Actual harm normally requires there to be specific economic harm. A technical violation of a noncompete that causes no cognizable injury may leave the plaintiff without equitable relief.

The amount of actual harm is also considered. The pilfering of one or two customers may not be enough while evidence of wide spread solicitation will normally prompt action from the Court. The Court may examine whether there is evidence that the former employee is using the employer’s customer lists or other proprietary information before granting injunctive relief.

Other considerations include the level and sophistication of the former employee. The Court of Chancery has noted that the more skilled, the higher positioned the former employee, the greater the harm that would inure to the employer if the covenant were not enforced.
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Releases are a common element of any settlement agreement between parties, including employers and employees. In the case of general releases, however, care must be exercised that the parties do not inadvertently relinquish unintended rights. A recent case from the Court of Chancery illustrates this point when a company apparently unintentionally waived its rights to enforce a noncompete agreement.

Christopher Schaffer was a major stockholder and Executive Vice President of a company acquired by CorVel Enterprise Comp, Inc. On the same day that the stock purchase agreement was signed, Schaffer, for additional consideration, also executed a noncompetition agreement which prohibited him from competing with CorVel for a five year period.

A dispute subsequently arose between Schaffer and CorVel regarding an earn out payment under the stock purchase agreement. That dispute was resolved in February 2009 through a settlement agreement providing Schaffer with a payment of $800,000. Significantly, both parties executed general releases of all claims as part of the settlement.
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In many cases the consideration element of a noncompetition agreement is mere formality and often taken for granted. But in many states this element, which is an essential part of any contract, can be a critical questions when it comes to enforcement.

Most states, including Delaware, follow the general rule that the initial offer of employment is sufficient consideration to support a non-compete agreement. More problematic is when the employer asks an existing employee to enter into a noncompete. In these cases, choice of law becomes critical, since a significant number of states require additional consideration above and beyond the continued employment relationship.

In Delaware, the Court of Chancery has consistently ruled that continued employment is alone sufficient consideration to support a noncompetition agreement. Still, it is advisable to consider offering additional consideration as an incentive both for morale purposes and to weaken the employee’s ability to raise hardship issues when the time for enforcement arrives.

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