Parties alleging state law trade secret misappropriation often feel compelled to identify a specific state statute as the basis for their claim, but that identification is unnecessary in the Delaware courts. The Delaware Court of Chancery has recently made clear that a claimant asserting a state law trade secret misappropriation claim need not identify the specific state law or statute that was allegedly violated.
When determining the enforceability of a covenant not to compete, Delaware courts typically spend most of their time analyzing whether the scope of the restrictions are reasonable and necessary to protect a legitimate business interest, and also whether the balance of harm favors enforcement. It is important to remember, however, that covenants not to compete are contracts and thus are subject to fundamental principles of contract law. A recent Delaware Court of Chancery decision highlights the importance of fulfilling your contractual obligations before seeking to enforce a non-compete agreement.
In Physiotherapy Corporation v. Moncure, C.A. No. 2017-03960-TMR (Del. Ch. Mar. 12, 2018), the Court of Chancery refused to enforce a non-compete provision against a former employee because the former employer had unilaterally discontinued a bonus plan. Physiotherapy employed Moncure to manage its physical therapy clinics in southern Delaware. Moncure was subject to an employment agreement with Physiotherapy which included a non-compete provision prohibiting him from conducting certain competitive activities. Moncure subsequently resigned and commenced employment with a competitor resulting in Physiotherapy filing suit against Moncure to enforce the non-compete.
Among the various defenses raised by Moncure was that Physiotherapy was barred from enforcing his non-compete due to a prior breach of his employment agreement. Specifically, Moncure claimed that Physiotherapy had cancelled the bonus plan which he was entitled to under the terms of his employment agreement. Physiotherapy argued that under his employment agreement it had a right to “amend” the bonus plan at any time and that it had in fact simply replaced his old bonus plan with a new one. The Court questioned whether discarding one bonus plan and substituting another constituted an “amendment”, but nevertheless found that Physiotherapy failed to show that it adopted a new plan under which Moncure was eligible for a bonus. The Court thus found that Physiotherapy’s prior material breach of the employment agreement through its cancellation of the bonus plan excused Moncure’s performance of the non-compete.
Young Conaway Stargatt & Taylor, LLP recently unveiled the formation of its Trade Secret and Employee Mobility practice. Our practice is comprised of a team of intellectual property, employment, corporate, and business litigation specialists who have a wide range of experience with internal investigations, employee mobility counseling, and prosecuting and defending expedited cases in various courts in and around the Mid-Atlantic region, including the Delaware Court of Chancery, Delaware Superior Court and District Court for the District of Delaware.
The primary areas of the practice will include:
Prevention of Loss of Trade Secrets and Goodwill
Enforcement of noncompete agreements is typically governed by state law, so knowing which state’s law applies is an important question both for drafting and enforcement purposes. Knowing what law will apply is particularly relevant if any of the parties are located in states which disfavor or even refuse to enforce noncompete agreements (think California). A recent decision from the Delaware Superior Court may add clarification whether businesses can utilize choice-of-law provisions to increase the enforceability of their noncompete agreements.
A Delaware choice-of-law provision provides that, if litigation arises over the terms of a contract, that the law to be applied to the contract will be Delaware contract law (as opposed to the law of the state where the employer or employee is located). Delaware follows the Restatement (Second) of Conflicts § 187 which provides that if the contracting parties designate a certain state’s laws to apply:
(2) The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless either:
The use of employee covenants not to compete – once restricted to salespeople and high-level management – has continued to expand into the ranks of ordinary employees. A recent survey suggests that as many as one in five employees have some form of agreement placing restrictions on their post-employment activities.
The growing prevalence of such agreements – and their potential restraint on job mobility and economic growth – has led many states to enact laws or propose legislation that would limit or restrict their use. No such laws currently exist in Delaware, but its courts have developed a “reasonableness” test to determine whether covenants not to compete will be enforced. This test includes whether the restrictions are narrowly tailored to protect some legitimate economic interest, the scope of the restrictions, the former employee’s need to earn a living, and the public’s interest in having open competition in the marketplace.
The broader use of covenants not to compete has also led to more lawsuits. Frequently, these lawsuits are brought not only against the former employee, but against the new employer as well. Such claims typically allege that the new employer hired the employee despite its knowledge of the noncompete and/or allowed or encouraged the employee to disclose and use the former employer’s trade secrets.
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.
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 Materials, the 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”).
The 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 Vigliante, the 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.