• The Delaware Chancery Court has issued yet another decision invalidating restrictive covenants, continuing a trend of recent decisions in which the court has refused to “blue-pencil,” or modify, covenants. In Sunder Energy, LLC v. Jackson, the court again declined to engage in blue-penciling which would have readily produced covenants whose terms still would have been violated by the defendant’s alleged conduct.
• Moreover, the court in Sunder Energy went one step further, endorsing a general principle that courts should refuse to enforce overbroad covenants rather than blue-penciling them, at least when the covenants are between parties of unequal bargaining power.
• The court found multiple forms of overbreadth in the covenants, which were in an LLC agreement. For example, the court faulted the covenants for being potentially “indefinite” because they were tied to a minority member’s continued ownership of Incentive Units, the transferability of which was controlled by the managing members.
• In addition, the court in Sunder Energy expressed frustration with the large number of restrictive covenant cases brought in Delaware Chancery Court involving businesses, like Sunder Energy, which operate exclusively outside of the state.
• To stand a chance of enforcement, restrictive covenants under Delaware law or litigated in Delaware must be very narrowly tailored to a company’s clearly identifiable business interests in imposing the covenants, and no broader. The covenants must be reasonable if interpreted literally, including in unlikely scenarios.

In this OnPoint, we discuss the key aspects of the Sunder Energy decision. We also offer some important practice pointers for companies drafting, or considering enforcement of, restrictive covenants that are or could be governed by Delaware law or litigated in Delaware.

Case Background

Sunder Energy, LLC (Sunder Energy) is a solar energy systems dealer organized under the laws of Delaware and headquartered in Utah. Sunder Energy sought to enjoin Tyler Jackson, its co-founder and former head of sales and resident of Texas, from allegedly breaching certain restrictive covenants contained in Sunder Energy’s LLC Agreement.

Under the LLC Agreement, members holding Incentive Units—including members of management like Jackson—were bound by four restrictive covenants (the “Covenants”), prohibiting: (1) competitive activity (the “Competition Restriction”), (2) solicitation of Sunder Energy’s employees and independent contractors (the “Personnel Restriction”), (3) solicitation or acceptance of business from Sunder Energy’s customers (the “Customer Restriction”), and (4) inducement of Sunder Energy stakeholders into terminating their relationships with Sunder Energy (the “Stakeholder Restriction”). The Competition Restriction prevented work in “the business of engaging in the marketing and selling of services and products, including those related to pest control, alarms, solar, satellite, TV and wireless internet, directly to third parties in their homes.” Each Covenant applied for as long as a member held Incentive Units and for a period of two years thereafter, and applied equally to that member’s “Affiliates,” defined to include the member’s spouse, parents, siblings, and descendants.

Jackson left Sunder Energy to join a direct competitor headquartered in Nevada as part of a mass exodus of Sunder Energy personnel. Sunder Energy sued Jackson, alleging that he had violated the Competition Restriction and Personnel Restriction in the LLC Agreement when he joined the competitor and successfully solicited a large group of Sunder Energy employees to follow him.

The Court’s Decision

At the outset of his decision,¹ Vice Chancellor Laster lamented the large number of restrictive covenant suits filed in the Delaware Chancery Court by businesses not operating in Delaware. The court reasoned that this forum choice stems from the widespread practice of businesses around the country forming entities and drafting “internal governance documents” under Delaware law, inserting restrictive covenants into those documents, and ultimately selecting the Delaware Chancery Court for litigation to enforce them. The Vice Chancellor opined that such businesses seek to “invoke Delaware’s contractarian regime” and “override how other jurisdictions regulate restrictive covenants.”²

The court commented, however, that the jurisdictions outside Delaware where the businesses operate have a “significant interest” in these disputes and that the Delaware Chancery Court lacks the resources to handle the large number of resource-intensive restrictive covenant cases on its docket. “In an ideal world,” the court noted ruefully, “this case would have been filed in Utah, Nevada, or Texas.” The court urged policymakers to provide a solution to this “unsustainable” problem that “diverts the court’s attention from its core mission.”³

In the meantime, the court proceeded to scrutinize the covenants in Sunder Energy in great detail and find them unenforceable, for two independent reasons.

First, the court found that Sunder Energy’s amended LLC Agreement was not validly adopted by the minority members of the company and resulted from a breach of fiduciary duty by the managing members. The court concluded that in issuing an amended LLC agreement, the managing members had wrongfully failed to alert the minority members that they were in an arms-length negotiation involving extensive material changes to their rights, including the inclusion of the Covenants.⁴

Second, the court found that the Competition Restriction and Personnel Restriction were unreasonably overbroad.

The court found that the Competition Restriction was overbroad because it:

1. barred door-to-door sales of all products of any type, regardless of whether the products being sold were similar to products sold or marketed by Sunder Energy;
2. bound not only Jackson, but also his spouse and children;
3. covered almost the entire country, thus not providing a fair opportunity for Jackson to pursue his livelihood; and
4. lasted indefinitely, because it was tied to a member’s ownership of Incentive Units, which were transferable only if Sunder Energy chose, in its complete discretion, to repurchase them.⁵

In addition, the court found the Competition Restriction unreasonable because it was coupled with the Customer Restriction, which the plaintiff was not attempting to enforce but which the court examined anyway and found to be overbroad. The court faulted the Customer Restriction for prohibiting Jackson from engaging in any business of any type with any homeowner in the states where Sunder Energy did business prior to Jackson’s departure. The court noted that “[a] restriction on soliciting employees might be reasonable standing alone, but might become unreasonable when combined with other restrictions in the agreement.”⁶

Similarly, the court found the Personnel Restriction to be unreasonable because it (1) applied to not only Jackson, but also his affiliates, (2) could potentially last indefinitely, and (3) applied to all current and past employees and independent contractors, regardless of the duration of their affiliation with Sunder Energy or the reason for any cessation of the affiliation.

Although the LLC agreement expressly stated that any covenant found to be overbroad should be narrowed by the court so as to be enforceable, the court declined to modify, or “blue-pencil,” any of the Covenants. In so doing, it observed that if overbroad covenants can be blue-penciled, employers would have no incentive to draft properly narrowed covenants: “[T]he law should not create a ‘no-lose’ scenario in which employers receive these benefits [of overbroad covenants] and, on those occasions when enforceability is challenged, gain the benefit of a lawful restriction through blue-penciling.”⁷

Other Recent Delaware Case Law on Restrictive Covenants

The Sunder Energy case is the latest in a recent string of Delaware Chancery Court memorandum opinions declining to modify restrictive covenants and instead finding them unenforceable, including:

• Kodiak Building Partners LLC v. Adams (October 2022): The Chancery Court declined to enforce a non-compete and non-solicit executed in the sale of a business, finding the covenants overbroad because they covered activities of the acquiror’s legacy business which went beyond the acquired company’s business. The court refused to modify the covenants to render them enforceable. The court also declined to enforce an express waiver in the contract of the right to challenge the covenant’s reasonableness.⁸
• Ainslie v. Cantor Fitzgerald L.P. (January 2023): The court determined that a forfeiture-for-competition provision in a partnership agreement was unenforceable—even though forfeiture provisions are typically reviewed more leniently than are standard non-competition covenants which raise the specter of injunctive relief — because the geographic scope and scope of prohibited activities were overbroad. Citing Kodiak, the court commented that “Delaware courts do not mechanically enforce non-compete or non-solicit agreements.”⁹
• HighTower Holding, LLC v. Gibson (February 2023): The court addressed the enforcement of restrictive covenants in a sale transaction in which an Alabama business was formed as a Delaware LLC and inserted restrictive covenants into its Delaware LLC agreement. Vice Chancellor Will declined to honor the parties’ choice of law, instead applying Alabama law on the basis of its more significant relationship to the dispute. The court went on to rule that “[t]he non-compete provisions are likely void under Alabama law,” citing Alabama statutory provisions including a prohibition on non-competes with “professionals.” The court then found the covenants to be fatally overbroad and did not consider blue-penciling in its opinion.¹⁰
• Intertek Testing Systems v. Eastman (March 2023): The court found that a non-competition provision executed in the context of a sale of a business was unenforceable, as it purported to cover activity anywhere in the world and thus did not serve a legitimate business interest. The Chancery Court again refused to blue-pencil the covenant, finding that to “save [the company] – a sophisticated party – from its overreach would be inequitable.”¹¹

In Sunder Energy, the court took a more forceful stance against blue-penciling than it had in the four cases discussed above. Whereas the Vice Chancellors in the prior cases had, at most, noted a general hesitancy to blue-pencil and then refused to do so on the particular facts of those cases, the court in Sunder Energy went a step further, announcing a general rule that unreasonable covenants with individual employees must be invalidated rather than modified in light of the imbalance in bargaining power between the parties.

Practice Pointers

Employers must be mindful of the Delaware Chancery Court’s recent decisions considering the enforceability of restrictive covenants generally, as well as in the context of business sales and with regard to restrictive covenants contained in partnership and LLC agreements. While non-competes and other restrictive covenants remain enforceable under Delaware law, the Delaware Court of Chancery is applying an increasingly high level of scrutiny to covenants in all contexts. Further, it appears that the court will no longer blue-pencil covenants in employment contracts, and is also increasingly hesitant to blue-pencil covenants executed as part of business sales or other transactions.

Accordingly, when drafting covenants, it is essential to tailor them very narrowly to protect the legitimate business interests particular to the covenantee and to understand the risks of choosing Delaware in choice of law provisions or Delaware courts in forum selection clauses. Similarly, when considering or confronting litigation of a restrictive covenant, the risks of a court – and especially the Delaware Court of Chancery – refusing to blue-pencil or enforce must be taken into account.

By way of examples, we offer also these more specific practice pointers:

• Avoid covenants of potentially indefinite duration, such as covenants that are tied to ownership of equity interests that are not freely transferable.
• Limit the restricted party to the employee or business seller and their successors in interest, rather than broadly including also the person’s spouse, children, or others.
• Narrowly tailor covenants in sale/business transaction documents to the activity scope, geographic scope and duration no greater than necessary for the legitimate business interests of the acquired business. Avoid defining the scope based on the preexisting business and goodwill of the buyer in other industry segments.
• Ensure that covenants are reasonable if interpreted literally, including in unlikely scenarios.
• Narrowly tailor covenants in employment contracts to the activity scope, geographic scope and duration no greater than necessary for the legitimate business interests of the employer. For example, consider narrowing non-solicitation clauses to customers and employees who have recently interacted with the employee.
• Consider whether non-solicitation covenants alone (without non-competes) would sufficiently protect the employer’s interests.
• Consider whether to include or enforce Delaware choice of law and Delaware forum selection clauses, including consideration of alternative choices such as the state where the employer is headquartered and/or the employee is located.
• Consider the enforceability and effect of covenants not only standing alone, but also when combined with any other covenants between the parties.
• Draft covenants on the assumption that an enforcing court will not blue-pencil them. Resist the temptation to overreach.

* The authors would like to thank Sierra Sanchez for her contributions to this OnPoint.

1. Sunder Energy, LLC v. Jackson, et al., 2023 WL 8166517 (Del. Ch. Nov. 22, 2023).
2. Id. at *1-2.
3. Id. at *3.
4. Id. at **19-21.
5. Id. at **23-28.
6. Id. at *23.
7. Id. at *24, n68.
8. Kodiak Bldg. P’rs, LLC v. Adams, 2022 WL 5240507 (Del Ch. Oct. 6, 2022).
9. Ainslie, et al. v. Cantor Fitzgerald, L.P., 2023 WL 106924 (Del Ch. Jan. 4, 2023).
10. HighTower Hldg., LLC v. Gibson, 2023 WL 1856651 (Del Ch. Feb. 9, 2023).
11. Intertek Testing Svcs. NA, Inc. v. Eastman, 2023 WL 2544236 (Del. Ch. Mar. 16, 2023).