Recently in Protectable Interests 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.

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 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

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.