A non-compete clause is often part of an employment agreement. In the employment context, these restrictive covenants can prevent an employee or independent contractor (together, “Worker” or “Workers”) from working for a business that competes with their employer or prevents a Worker from starting their own business that competes with their employer. Over the last few years, many states have passed laws that either ban or restrict the parameters of non-compete clauses and non-compete agreements (collectively “Non-Competes”), as well as courts showing their disfavor towards Non-Competes. Non-competes are also often part of the sale of a business to protect the acquirer’s business interests in the target company.
Common public policy arguments against Non-Competes are that they unreasonably restrain trade (especially in industries with only a few dominant players), the Worker is at an unfair advantage because they lack bargaining power, and the Worker has an impaired ability to earn a living in their chosen field. Workers are often forced to sign such agreements as a condition of being hired or as a condition of their continued employment. This is in contrast to Non-Competes executed as part of the sale of a business, where a Non-Compete is part of an arms-length negotiation between sophisticated parties of comparable bargaining power in a transaction.
Recently the Delaware Court of Chancery found that a non-compete restrictive covenant was unreasonable and unenforceable. In October 2022, Kodiak Bldg. Partners, LLC v. Adams, 2022 Del. Ch. LEXIS 288, the Court of Chancery denied plaintiff’s motion for a preliminary injunction to enforce a Non-Compete against a former employer (in part) because the restrictive covenant was overbroad with respect to plaintiff’s legitimate business interests and consequently unreasonable.
Plaintiff was in the business of acquiring smaller construction and lumber-related companies. Plaintiff sought to enforce the Non-Compete (as well as other restrictive covenants) against the defendant, a former employee and stockholder of a roof truss company acquired by the plaintiff. (Defendant Adams worked for the target company as their general manager for almost 17 years). The transaction also included the business’s goodwill and Adams’ 8.33% interest in the target company. After only a few months post-acquisition, plaintiff left and began working for a nearby roof truss and lumber business, resulting in Plaintiff filing suit.
Despite the fact that the Non-Compete contained a provision where the target company’s stockholders waived the right to contest or raise the issue of the reasonableness of the restrictive covenants, the Court explained that no precedent was found upholding a contractual waiver to contest reasonableness and proceeded to analyze the reasonableness of the non-compete provisions. Delaware courts do not mechanically enforce non-competes. They review “non-compete and non-solicit provisions to ensure that they (1) [are] reasonable in geographic scope and temporal duration, (2) advance a legitimate economic interest of the party seeking its enforcement, and (3) survive a balancing of the equities.” Kodiak, at 7-8. The Court of Chancery also noted that Delaware law imposes less scrutiny in the context of a business transaction than in an employment context and that Delaware courts are hesitant to blue pencil restrictive covenants to make them reasonable.
Although Delaware courts are known to respect freedom of contract, under certain limited circumstances, such as when a contract violates public policy, Delaware courts will not enforce contractual obligations, no matter how clear or sincerely intended when executed. Kodiak, at 12. Public policy requires that the restrictions in Non-Competes are reasonable. In this case, Plaintiff had defined the competitive landscape as all of its businesses (all of the businesses that Plaintiff had acquired – not just the target company) and failed to limit the definition of competitive businesses to only those lines of business that were directly related to the target company’s goodwill and competitive space. The Court declined to blue pencil the agreement to limit the scope of the competitive business and held that the Non-Compete was unenforceable.
In Delaware, the use of Non-Competes remains legal and enforceable under certain conditions. In Kodiak, the Court declined to blue pencil a Non-Compete by reducing the scope of the business restrictions and instead found the Non-Compete unenforceable due to its unreasonable, overbroad scope. The Court also declined to enforce a waiver to contest the reasonableness of the Non-Compete. As the legal landscape continues to evolve and courts become more restrictive in their enforcement of these agreements, employers may need to reconsider the scope and language of their non-competition agreements and not rely on the possibility that blue penciling by a Delaware court will save an otherwise unenforceable Non-Compete. Employers should draft narrowly tailored agreements and be aware of the evolving legal landscape surrounding Non-Competes and other restrictive covenants under Delaware law.
[View source.]
