Articles Posted in Non-compete and Non-solicit agreements

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.

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.

Hiring an employee who is subject to a non-competition agreement can be a risky venture.  In many instances, the new employer can find itself on the receiving end of an expedited lawsuit along with the new hire.  But there are a few simple measures new employers can take to reduce the chances of being named as a co-defendant in a lawsuit. 

First, make certain your new hire has “clean hands” before commencing employment.  This means that all documents, computers, PDAs, flash drives, and any other property arguably belonging to the former employer has been returned intact.  The employee needs to be aware that erasing hard drives and databases before returning equipment (even if inadvertent) can often result in a negative ruling from the court or even a spoliation finding.  Once completed, the employee should confirm in writing that all property in his possession has been returned to his former employer. 

Next, make sure the potential new hire does not engage in competition while still at his old job.  In Delaware, it is generally permissible to make preparations to compete while still employed, which would include discussions with other companies about possible employment opportunities.  But employees often cross the line when these discussions develop into actual competition, and if there’s evidence the new employer encouraged these acts, it may open the door for a civil conspiracy claim. 

I n today’s technology driven workplace, departing employees often leave with more than a few notepads and office supplies. Most companies have a wealth of information available by electronic means that proves to be too tempting for some who have designs to unfairly compete

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The latest trend among noncompete law practitioners has been the assertion of various computer theft statutes to reign in this activity. On the federal level, the Computer Fraud and Abuse Act, 18 U.S.C. § 1030 et seq. (CFAA), is being brought with more frequency in noncompetition enforcement and trade secret cases. The statute requires a showing of intentional access to a protected computer without authorization or beyond authorization that results in damages. It also provides for attorneys’ fees if the plaintiff is successful in proving its case.

money.jpgFormer employees seeking to get out of their noncompete agreements often throw up a flurry of defenses. Most of these defenses usually pertain to the scope of the restrictions, whether the covenant is designed to protect legitimate business interests, or the balance of hardships. Occasionally, however, employees are able to successfully argue that the non-compete is not an enforceable contract.

One such defense is to assert that there had been a prior material breach of the underlying contract by the former employer. If the employer materially breached the employment agreement, the employee may be excused from compliance with the covenant not to compete.

It is not all that uncommon for companies to withhold wages or bonuses from departing employees who go to work for a competitor or solicit their customers. But employers should think twice before doing this, especially if there is no legal basis for withholding the compensation.
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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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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.

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