Recently in Non-compete and Non-solicit agreements Category

August 6, 2014

Drafting Enforceable Non-solicitation Agreements

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.

Be Clear About What You Are Trying to Protect

The most widely recognized protectable interest is the goodwill a business has cultivated with its customers. Delaware courts recognize that a company has an interest in protecting its client relationships against misappropriation by departing employees. This is particularly true where the employee had significant personal contact with the clients.

But employers often overlook a second interest that merits protection. Courts have recognized that companies have a right to protect their confidential information by prohibiting former employees from soliciting clients. In these instances, courts may restrict a former employee from soliciting business from customers even if that employee had no direct contact, so long as the employee gained significant knowledge or understanding of those customers during his or her employment.

An important consideration for this rule is that the information must be of such confidential nature it would give the former employee (and his new employer) and unfair competitive advantage. As a general rule, confidential information would not include general knowledge or skills the employee acquired during his employment or information that is available to the public through other sources.

Set a Reasonable Time Period

In order to be enforced, non-solicitation agreements must have a reasonable time limit. This is often interpreted to be a period no longer than that which is needed for the company to rebuild its customer relationships. The determination of whether a time period is reasonable is fact specific and must be examined on a case-by-case basis.

In some instances, it may be that a period of several months is reasonable for a company to put a new employee on the job and demonstrate his/her effectiveness to the customers. If the selling or servicing of the relationship is relatively complex, a longer period may be justified.

Courts in Delaware have in general presumed that restrictions of two years or less are reasonable, unless circumstances demonstrate otherwise. Longer periods may be necessary to protect the business, particularly if the former employee had access to confidential information which could provide a competitor with an unfair competitive advantage for many years following the employee’s departure.

Avoid the "I Didn't Solicit Them; They Called Me" Defense

A common defense invoked by former employees accused of violating a non-solicitation agreement is that they did not “solicit” the customer. In many cases, an agreement will prohibit employees from "soliciting" customers without defining the term "solicit." In such instances, courts typically defer to the common meaning of the term "solicit" as defined in dictionaries, and will take into account public policy considerations.

Employers can avoid the potential for uncertainty by defining the term "solicit" or by specifying in the agreement that a former employee may not accept business from the employer's customers. Many jurisdictions, but not all, will enforce non-solicitation agreements that prohibit the former employee from “accepting business” from certain clients.

Consider a Liquidated Damages Provision

Finally, institutions should consider including a remedy of liquidated damages against former employees who improperly solicit customers. It is usually easier to sue a former employee for money than obtain injunctive relief from a court, and the potential for a significant award of damages may make the employee think twice about poaching clients. A liquidated damages provision also can make it easier to calculate monetary losses, which are often difficult to quantify at trial.

In order for a liquidated damages provision to be enforceable, it must set forth a reasonable estimate of the monetary loss likely to be suffered, yet relate to an injury incapable of accurate estimate. Reasonable estimates of damages might include the fees or payments made by the solicited customer to the former employer during a certain time frame.

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 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

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.

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.

March 28, 2011

Court of Chancery Indicates It May Strike - Not Reform—Overly Broad Non-Compete Clause

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.chancerylogo60

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

February 11, 2011

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

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)

June 30, 2010

Withholding Wages From Departing Employees May Render Non-Competes Unenforceable

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.

Continue reading "Withholding Wages From Departing Employees May Render Non-Competes Unenforceable" »

June 14, 2010

Contract Language Key to Obtaining Jurisdiction Over Non-Residents

Any party wishing to litigate a dispute in Delaware involving a non-resident defendant must establish that the court has personal jurisdiction. If jurisdiction is challenged, the court will apply a two part analysis in determining whether there is basis for personal jurisdiction. First, the Court considers whether there is a basis for jurisdiction under Delaware's long-arm statute, 10 Del. C. § 3104. Next, the court must determine whether there are minimum contacts sufficient to satisfy the Due Process Clause of the Fourteenth Amendment.

For enforcement actions against non-residents with non-compete agreements, the personal jurisdiction requirement is usually met when the agreement contains a provision consenting to the jurisdiction of the Delaware courts. It is important to ensure that the language of the agreement unambiguously confers exclusive jurisdiction to the courts of Delaware in order to avoid a battle over venue. A case from the Court of Chancery illustrates why.

In Mobile Diagnostic Group Holdings, LLC v. Suer, 972 A.2d 799 (Del. Ch. 2009), the Court of Chancery dismissed an action to enforce a noncompete agreement after finding it had no personal jurisdiction over the defendant, a resident of California. In that case, the plaintiffs had negotiated a non-competition provision with one of its sales executives as part of a purchase agreement.

Continue reading "Contract Language Key to Obtaining Jurisdiction Over Non-Residents" »

June 11, 2010

Noncompetition Agreements with Independent Contractors

1099 form.jpgMost non-compete agreements are between an employer and employee. But what about independent contractors? Can a company restrict an independent contractor's ability to compete once the contract has ended?

The relationship between a company and its independent contractors is inherently different than that of its employees. For instance, independent contractors by definition maintain a greater degree of control over how they accomplish tasks and traditionally work with a lesser degree of supervision.

Independent contractors also are not subject to certain employee protections, such as workers compensation benefits and wage laws, and are responsible for paying their own income taxes. Perhaps most importantly, independent contractors generally do not receive the investment of knowledge, resources and contacts that employees obtain from companies which necessitate protections from future unfair competition.

The Delaware Court of Chancery has ruled that noncompetition agreements can be enforced against independent contractors, but with certain limitations. In a written opinion from Chancellor Chandler, the Court noted that the legitimate economic interests of a company in restricting "substantially similar" activities of an independent contractor will be more limited than they would be with respect to an employee. EDIX Media Group, Inc. v. Mahani, C.A. No. 2186-N (Del. Ch., Dec. 12, 2006).

According to the Court, preventing an independent contractor from engaging in any activities that are "substantially similar" to the company's activities raises the risk that a contractor in an independent business may be forced entirely from employment in a given industry. This runs afoul of the traditional concern of the Court for the preservation of competition, and suggests strongly that enforcement of substantially similar provisions in non-competition clauses will be both inequitable to the contractor and against public policy.

The Court indicated, however, that noncompetition agreements that prohibit independent contractors from directly competing in the same line of business may be enforceable. The bottom line appears to be that noncompete agreements can be used for independent contractors in Delaware, but that special attention must be given to the scope of restrictions.

June 8, 2010

Balance of Equity Considerations for Non-Compete Agreements

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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June 8, 2010

Chancery Court Utilizes Two-Step Analysis for Enforcement of Non-Competes

The Delaware Court of Chancery generally employs a two-step analysis to determine the enforceability of a covenant not to compete in the employment context. The first step of the analysis is a question of basic contract law. The Court looks to whether there was mutual assent between the parties, whether adequate consideration was exchanged, and whether a material breach of the other party excuses performance.

Assuming that the covenant is valid under ordinary contract principles, the Court then determines whether four additional, covenant-specific conditions are satisfied. First, the temporal restrictions of the covenant must be reasonable in scope and duration. Second, the geographical limitations (if any) must be reasonable. Third, the covenant must advance a legitimate economic interest of the employer at the time enforcement is requested.

Fourth, the covenant must survive a balance of the equities test. Here, the Court looks to the harm likely to be caused to each party should their position be unsuccessful. The Court then balances the harms to ensure that no one party will suffer unfairly. This fourth condition is grounded in the equitable nature of the injunctive remedy being sought. As a result, a covenant not to compete may be valid but may not be specifically enforceable in the circumstances presented at the time of the application for enforcement.

May 28, 2010

So What Makes a Non-Compete a Valid Contract?

Delaware's well-known respect for private contracts requires that the covenant not to compete be enforced according to its plain terms where possible. Therefore, the first step in the analysis is to determine whether the covenant is, in fact, a valid private contract.

Like any contract, the covenant requires mutual assent to be enforceable. Usually this means the covenant has been signed by the employee, manifesting his or her assent. So long as there is no valid claim of duress or coercion, mutual assent will likely be found. A defense of ignorance of the terms normally will not suffice. In addition, the doctrine of laches may bar an employee from claiming lack of mutual assent when the issue is raised only after his employment ends.

Next, there must be consideration sufficient to support a valid contract. This requirement is easily met under Delaware law. Generally, mutual promises between an employer and employee constitute lawful consideration for an employment contract. More specifically, the offer of new employment, of a new position, or even of continued employment will all satisfy the consideration requirement. Continued employment may not satisfy the consideration requirement, however, if the employee already had an employment contract with a predetermined date for expiration.