Articles Posted in Enforceability

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. ยง 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.
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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.

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.
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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.

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.

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.

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.
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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.

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