Articles Posted in Court of Chancery

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

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:

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.youngconaway

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.”

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.

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.

The Delaware Court of Chancery is nationally respected for its consistent and conscientious decisions in cases involving complex business issues. As a result, many legal practitioners recommend that contracting parties include a forum selection clause requiring that any disputes arising from a given contract be heard by a court of competent jurisdiction in the State of Delaware, including the Court of Chancery. A recent case in the Delaware Court of Chancery provides insight into the effective enforcement of a forum-selection clause.youngconaway

In the daintily-named case of ASDC Holdings, LLC v. The Richard J. Malouf 2008 All Smiles Grantor Retained Annuity Trust, two parties entered into an agreement regarding the sale of equity in a Texas business. The agreement contained both an arbitration and a Delaware forum-selection clause which provided that any actions “with respect to any claim or cause of action arising under or relating to this Agreement” must be brought in a Delaware state or federal court with jurisdiction.

After the deal was executed, both parties became unhappy and sought legal relief: Plaintiff initiated an arbitration proceeding, and Defendant brought suit in a Texas court. Plaintiff thereafter filed papers in the Delaware Court of Chancery, seeking a preliminary injunction to prohibit the Texas action from moving forward in violation of the forum-selection clause.

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.

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.

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.

While we are all familiar with the use of preliminary injunctions in aid of litigation, they also have a place in alternative dispute resolution. In Chartis Warranty Guard, Inc. v. National Electronics Warranty, LLC, the Delaware Court of Chancery issued a preliminary injunction pending the outcome of contractually mandated arbitration. The inclusion of a clause allowing issuance of a preliminary injunction prior to binding arbitration is a wise move if a contract includes non-competition or confidentiality provisions, the violation of which would lead to irreparable harm.

In Chartis Warranty, the plaintiff was a joint venture formed between the defendant, National Electronics Warranty, LLC (“NEW”) and Chartis Insurance. The purpose of the joint venture was to provide retailers with consumer warranty programs. Pursuant to the contracts governing the parties’ responsibilities, NEW received a designated fee for administering the retailer warrant programs, and Chartis received all profits earned above the fee owed to NEW.

In the course of its administration, NEW gathered a variety of data relating to the consumer warranty programs. Some of this information was publicly available, and some was sensitive. Among the move sensitive information was loss ratios, profitability, and earnings curves, which would be valuable to Chartis’s competitors. In the process of reorganizing certain programs, NEW provided this sensitive information to some of plaintiff’s competitors, leading to a dispute about whether the data was subject to various confidentiality provisions contained in the contracts governing the parties’ relationship. NEW maintained that it owned the data, and was permitted to disclose it-Chartis disagreed, asserting that it maintained exclusive ownership over the relevant information.

Vice Chancellor Chandler recently stayed, sua sponte, an action commenced in Delaware’s Court of Chancery by a company seeking a declaratory judgment against a former employee.  The decision reiterates the importance of bargaining for consent to the jurisdiction of Delaware’s Court of Chancery in any contract. 

Online Resources Corp. sought a declaration regarding the meaning of a severance agreement with a former employee.  The employee, however, commenced an action against Online Resources Corp. in a Virginia trial court, alleging that the company breached the agreement and wrongfully terminated him.  Online Resources Corp. sought to have the Virginia action dismissed because of the pending Delaware Court of Chancery Action, and because the claims raised by the employee in his Virginia action arose from the same facts and circumstances as those set forth in the company’s Delaware Court of Chancery action.

The subject of Vice Chancellor Chandler’s opinion was whether the employee’s motion to dismiss the company’s Delaware action should be granted.  After fully briefing the issue for the Virginia court, that court rejected Online Resources Corp. arguments and sua sponte stayed the case indefinitely in favor of allowing the case to proceed in Virginia. 

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