Articles Posted in Non-compete and Non-solicit agreements

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.

Thumbnail image for business.JPGA well drafted noncompetition agreement should contain an assignment clause allowing a company to assign its rights to a successor. But what happens if this provision is left out and the company is sold? In most states, the successor is out of luck.

The majority of states follow the rule that a restrictive covenant not to compete is not assignable to a purchasing business entity in the absence of a specific assignability provision. The courts in these states rely on the theory that such covenants are personal in nature and, as a result, cannot be assigned without the employee’s permission.

Delaware, however, appears to follow the minority rule. The Delaware Court of Chancery recently ruled that even without an specific provision noncompete agreements are generally assignable from one employer to another as long as both employers are engaged in the same industry. The court acknowledged that while personal service contracts usually may not be assigned, noncompete agreements and other restrictive covenants exist for the benefit of the business — not the individual parties. The court explained that the business, whether as assignee or assignor, should enjoy that benefit by having the power to enforce such restrictive covenants.

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