Recently in Enforceability Category

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 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.

September 27, 2011

Court Denies Preliminary Injunction Based on Insufficient Record

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

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

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

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

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

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

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.

Continue reading "Balance of Equity Considerations for Non-Compete Agreements" »

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.

May 27, 2010

Drafting an Enforceable Covenant Not to Compete

Many employers use restrictive covenants (also called noncompetition agreements or non-competes) to protect against unfair competition from ex-employees. In Delaware, noncompetition agreements are enforced in the Court of Chancery, our world-renowned court of equity. The Court of Chancery has the power to issue injunctions, or orders, to stop employees from doing things like soliciting your clients or employees and, in some cases, working for a competitor.

But not all restrictive covenants are valid. Careful employers should begin to scrutinize their restrictive covenants to make certain they meet the following requirements:

First, make sure you're protecting a legitimate business interest, not simply trying to exercise economic control over your employees or competitors. To determine if your business interest qualifies, focus on the nature of your business, your customers, and competitors and what information the employee will have access to that could be used unfairly against you by a competitor.

Second, make certain your restrictive covenant is reasonable in its scope and duration. Don't count on a court to "reform" a poorly drafted restrictive covenant that's overly broad or vague. Review the scope and duration of your non-compete, keeping in mind that their reasonableness is tied directly to the interests the covenant is designed to protect, the type of job the employee has, and the nature of the industry you're in. Most important, remember that the mere fact that a restriction prohibiting competition within, say, 100 miles for two years is reasonable in one case doesn't mean it's reasonable in all cases.

May 25, 2010

General Release thwarts attempt to enforce Non-compete

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.

Continue reading "General Release thwarts attempt to enforce Non-compete" »

May 25, 2010

Consideration Issues can be Key for Covenants Not to Compete

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.