Protectable Interests

May 18, 2017

USING NONCOMPETITION AGREEMENTS EFFECTIVELY: KNOW YOUR LIMITS IN DELAWARE

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?

March 8, 2016

Court Applies Delaware Law to Noncompete Agreement and Refuses to Enforce Under “Employee Choice” Doctrine

by Scott Holt

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.

February 9, 2016

What Should Be in Your Noncompete Agreement?

by Scott Holt

Covenants not to compete, or noncompete agreements, 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.

August 6, 2014

Drafting Enforceable Non-solicitation Agreements

by Scott Holt

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.

February 4, 2014

Noncompetition Agreements in Business Transactions

by Scott Holt

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.”

February 11, 2011

Court Doesn’t Buy Sellers’ Effort To Get Out Of Noncompete Agreement

by Scott Holt

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.

June 14, 2010

Contract Language Key to Obtaining Jurisdiction Over Non-Residents

by Scott Holt

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.
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June 11, 2010

Noncompetition Agreements with Independent Contractors

by Scott Holt

1099 form.jpg Most 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.

June 8, 2010

Chancery Court Utilizes Two-Step Analysis for Enforcement of Non-Competes

by Scott Holt

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.