When a key employee resigns, the question always asked is “what are your plans?” If the employee is subject to a non-compete agreement, the answer may not always be truthful, particularly if the employee plans to work for a competitor in violation of a non-compete restriction. This is why many employers wisely include a provision in their non-compete agreements which requires employees to disclose the fact that they are going (or intend to go) to work for a competitor.  But even with such a provision many departing employees do not disclose their intentions. noncompete-150x150

In fact, it is common for a former employer not to learn that the employee is violating a non-compete for weeks – or even months – after the employee has been working for the competition.   If the employer does not learn about the violation until months later, the question then becomes, for enforcement purposes, when does the restricted period begin to run?  In other words, does it begin from when the employer found out about the violation or does it begin to run as soon as the employee went to work for the competition?  The answer depends largely upon the agreement itself.

If the non-compete agreement includes a properly drafted tolling provision the answer, at least in Delaware, seems clear – the restricted period will not include any time during which the former employee violated the restriction – assuming that the restricted period itself is held to be reasonable.  In such case, the employer gets the benefit of what it bargained for, i.e., a full restrictive period free from a former employee’s breach.

Business agreements often contain a provision that provides the parties agree that a breach constitutes irreparable harm entitling the non-breaching party to injunctive relief to enforce the agreement.  These provisions are designed to protect the terms of the agreement and make it easier for the non-breaching party to secure an injunction while a claim is pending.  In Martin Marietta Materials v. Vulcan Materialsthe Delaware Supreme Court held that contractual provisions as to irreparable harm suffice to establish that element for the purpose of issuing injunctive relief.

In the area of noncompete agreements, employers often use these provisions as a means to “stipulate” that a violation would cause irreparable harm and thus entitle the company to an injunction preventing the employee from working competitively.   Whether a court applying Delaware law will honor such a provision contained in an employment noncompete — and issue a preliminary injunction in the case of a breach — is another matter.  While no Delaware court has formally ruled on this issue, here are a few key points to keep in mind.

First, it is clear that not all contractual provisions stipulating to irreparable injury will be automatically enforced.  While generally Delaware courts give the parties broad leeway to determine the terms of an agreement, they will not enforce stipulated harm provisions where there is a danger that they could have the effect of “confer[ring] equitable jurisdiction” when there is none, or if there is clearly an available remedy of law. Gildor v. Optical Solutions, Inc., C.A. No. 1416-N (Del. Ch. June 5, 2006) (“Delaware courts do not lightly trump the freedom to contract and, in the absence of some countervailing public policy interest, courts should respect the parties’ bargain. … [A]s long as the parties did not include the irreparable harm stipulation as a sham, i.e., when an adequate remedy at law clearly exists, or simply as a means to confer jurisdiction on this court, then the stipulation will be upheld”).

noncompete-150x150The proliferation of the use of non-compete agreements was highlighted in a recent article in the New York Times (see, “How Noncompete Clauses Keep Workers Locked In”, May 13, 2017).  The article referenced a survey which concluded that about 20 percent of the American workforce was subject to some form of non-compete clause, and how these agreements are hurting employee mobility.  This explains why a number of states, including California and Utah, have banned or limited the use of such agreements, and why other states are considering such legislation.

In Delaware, non-compete agreements are considered restraints on trade, so courts such as the Delaware Court of Chancery will enforce them only if they are “reasonable”.  The reasonableness of the restrictions depends upon factors such as the employer’s interest in protecting its business; the scope of the restrictions; the employee’s right to work and earn a living; and the public’s interest in free trade and competition.  Below are a number of considerations for businesses to consider when drafting and enforcing non-competes subject to Delaware law.

Ask Yourself – What are You Trying to Protect?

When litigation involving the same dispute and parties has been commenced in two different venues, many courts adhere to the “first-filed rule” which provides that the litigation should be confined to the forum in which it is first commenced. This often results in a race to the courthouse by litigants seeking to have the dispute heard in their preferred choice of venue.

Delaware courts, as a general matter, have followed this common law rule and allow judges broad discretion to grant a stay when there is a prior action pending in another state and involving the same parties and issues. There is, however, one important exception to this rule.

In cases where contracting parties have expressly agreed to a legally enforceable forum selection clause, the Delaware Supreme Court has held that courts must honor the parties’ contract and enforce the clause, even if, absent any forum selection clause, the first-filed rule might otherwise require a different result.  As a result, a party’s effort to avoid a Delaware forum selection clause by commencing suit in a different state can be defeated if the proper steps are taken. A recent proceeding in case pending in the Delaware Court of Chancery provides guidance.

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

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

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

Covenants not to compete, or noncompete agreemenoncompetents, can play a key role in helping a business entity protect its confidential information,  prevent unfair competition and the raiding of its workforce.  A poorly drafted agreement, however, can leave the business exposed to claims that the covenants are not enforceable, which in turn can lead to unnecessary litigation. Below are a number of common components that make up a well-drafted non-competition agreement.

Define the Parties

The parties should always be identified as one of the first terms in the agreement. The drafting attorney should make sure that all corporate entities which have an interest in the protections afforded by the agreement are included. This is especially important where there are parent, subsidiary or affiliated companies.

All businesses have customers. Many maintain an electronic database of their customers that includes such things as contact information, pricing and purchasing information, and other data that has been collected through time and expense. This database can be an important asset to the business and provide it with a competitive advantage in the marketplace. As such, a majority view this information as “confidential” and believe it constitutes a “trade secret” and thus is protected from unauthorized disclosure under the law.

Not all customer information, however, may qualify as a trade secret under Delaware law. In addition, many businesses fail to take steps to protect confidential information such as requiring employees to enter into non-disclosure agreements. Unfortunately, businesses frequently learn this when it is too late to do anything about it. The time to address these issues is before such information is removed by a departing employee or other third party.

All employers should require employees who have access to confidential information and trade secrets to sign confidentiality or non-disclosure agreements. In Delaware, a company may legally require employees who have access to such information to sign such an agreement in order to keep their job. If drafted properly, the agreement can provide the business with contractual remedies against the former employee, including emergency injunctive relief from a court and a potential award of damages. 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.

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.

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.”

A recent survey conducted by several of my colleagues demonstrates the speed in which litigants can obtain preliminary relief from the Court of Chancery. The survey included a sampling and analysis of approximately 200 cases between 2009 and 2011, in which the court ruled upon a motion for temporary restraining order or a motion for preliminary injunction. The results reflect the frequency and speed at which the court has granted injunctive relief in recent years:

  • For cases in which the court ruled on a motion for temporary restraining order, the court granted the motion 58 percent of the time. On average, the court granted the motion 7 days after its filing.
  • For cases in which the court ruled on a motion for preliminary injunction, the court granted the motion 30 percent of the time. On average, the court granted the motion 26 days after its filing.
  • The survey also looked at cases from the sample that involved trade secret claims and in which the court ruled on a motion for temporary restraining order or preliminary injunction. In those cases, the court granted the motion for temporary restraining order 88 percent of the time and granted the motion for preliminary injunction 75 percent of the time.

Based on these statistics, there seems to be little doubt that the court will order injunctive relief on an expedited basis in cases where circumstances require expedition, including those involving noncompete agreements and misappropriation of trade secret.

A copy of the full article drafted by my colleagues and published by BNA can be obtained on the Young Conaway Stargatt & Taylor website.

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