When determining the enforceability of a covenant not to compete, Delaware courts typically spend most of their time analyzing whether the scope of the restrictions are reasonable and necessary to protect a legitimate business interest, and also whether the balance of harm favors enforcement. It is important to remember, however, that covenants not to compete are contracts and thus are subject to fundamental principles of contract law. A recent Delaware Court of Chancery decision highlights the importance of fulfilling your contractual obligations before seeking to enforce a non-compete agreement.
In Physiotherapy Corporation v. Moncure, C.A. No. 2017-03960-TMR (Del. Ch. Mar. 12, 2018), the Court of Chancery refused to enforce a non-compete provision against a former employee because the former employer had unilaterally discontinued a bonus plan. Physiotherapy employed Moncure to manage its physical therapy clinics in southern Delaware. Moncure was subject to an employment agreement with Physiotherapy which included a non-compete provision prohibiting him from conducting certain competitive activities. Moncure subsequently resigned and commenced employment with a competitor resulting in Physiotherapy filing suit against Moncure to enforce the non-compete.
Among the various defenses raised by Moncure was that Physiotherapy was barred from enforcing his non-compete due to a prior breach of his employment agreement. Specifically, Moncure claimed that Physiotherapy had cancelled the bonus plan which he was entitled to under the terms of his employment agreement. Physiotherapy argued that under his employment agreement it had a right to “amend” the bonus plan at any time and that it had in fact simply replaced his old bonus plan with a new one. The Court questioned whether discarding one bonus plan and substituting another constituted an “amendment”, but nevertheless found that Physiotherapy failed to show that it adopted a new plan under which Moncure was eligible for a bonus. The Court thus found that Physiotherapy’s prior material breach of the employment agreement through its cancellation of the bonus plan excused Moncure’s performance of the non-compete.
This case is a reminder that businesses seeking to enforce non-competes need to be mindful of the general contract rule that a party guilty of a material breach of contract may not complain when the other party subsequently refuses to perform. It is worth noting, however, that not just any breach will excuse performance: the breach must involve a material part of the agreement. In this case, the Court found Moncure’s bonus was a material part of his employment agreement.
Finally, many businesses have covenants not to compete contained in “at-will” employment agreements – that is, agreements where the underlying consideration for the non-compete is that the employee is offered (or gets to keep) employment. While this is sufficient contractual consideration under Delaware law for a non-compete, employers should be aware that Delaware courts have recognized that an employer’s breach of the employee’s at-will contract can render a covenant not to compete unenforceable. See, e.g., Research & Trading Corp. v. Pfuhl (Del. Ch. 1992)(“Plainly the circumstances in which an at-will employee is terminated may have a vital bearing upon the question whether a covenant against future competition will be specifically enforced.”). This might include a breach of the implied covenant of good faith and fair dealing (implicit in every at-will contract), or even failure to pay all wages (including bonuses).