Enforceability of Noncompete Agreements Post-Merger
Posted on October 9, 2012 by Young Conaway Staff
The enforceability of a noncompete agreement can vary greatly by State. When drafting a noncompete agreement or restrictive covenant, a critical decision will be which State's law should apply in an enforcement dispute. Delaware employers have very favorable law on their side, as noncompete agreements are enforced here to a much greater extent than many others. Here's an example.
In May, the Ohio Supreme Court considered the enforceability of a non-compete agreement by a successor of the original contracting employer. In other words, can a non-compete agreement be enforced after the original employer is acquired in a sale or merger. In Acordia of Ohio v. Fishel, four employees signed non-compete agreements with their employer. The agreements provided that the employees would not compete with the employer for two years following termination. The agreements did not contain language that would extend the prohibitions to the employer's successors or assigns.
In 2001, the employer merged with Acordia of Ohio, LLC. Following the merger, only Acordia survived. The four employees continued to work for the new entity until August 2005, when, you guessed it, they went to work for a competitor. Within six months of their resignations, they'd managed to recruit 19 customers worth about $1 million to the competitor.
Acordia sued the former employees and their new employer, seeking to enforce the terms of the noncompete. The court denied the motion and dismissed the case. Acordia appeal but the decision was affirmed. Relying on the State's merger statute, the Ohio Supreme Court found that, following the 2001 merger, the new employer could enforce the terms of the agreements–but only under the agreement's original terms.
Technically, the merger had terminated the employees' employment with the original employer because the employer ceased to exist. Thus, their obligations under the noncompete agreement had ended in 2003–two years after the merger. By the time they went to work for the competitor in late 2005, their noncompete period had expired and they were free to compete.
There is an important lesson to be learned from this case for any counsel charged with drafting a non-competition agreement or other restrictive covenant: non-compete agreements that will be construed under Ohio law must expressly provide for the possibility of a merger or acquisition in order to be enforced by a successor employer. That is not the case in every State, though. In Florida, for example, the issue remains unsettled, although a decision from an appellate court in August found that a covenant not to compete could be assigned in DePuy Orthopaedics, Inc. v. Waxman (Fla. 1st DCA Aug. 3, 2012). In Delaware, though, the issue has been decided.
In January 2010, the Delaware Court of Chancery determined that restrictive covenants contained in an employment agreement lacking an assignability clause are enforceable by a successor company that has purchased substantially all of the original employer's assets. In Great American Opportunities, Inc. v. Cherrydale Fundraising, LLC, No. 3718-VCP (Del. Ch. Jan. 29, 2010), Vice Chancellor Parsons explained that noncompete agreements and other restrictive covenants "exist for the benefit of the business and not the individual parties.
Thus, the business, whether as assignee or assignor, should enjoy that benefit by having the power to enforce such restrictive covenants." The court went on to hold that absent specific language prohibiting assignment, noncompete covenants "remain enforceable by an assignee when transferred to the assignee as part of a sale or transfer of business assets regardless of whether the employment contract contains a clause expressly authorizing such assignability, so long as the assignee engages in the same business as the assignor."
Thus, whereas in Ohio, a noncompete agreement does not transfer to a successor entity unless there is specific language that provides for such transfer, in Delaware, the successor entity gets all of the rights of the original employer unless there is specific language in the agreement that prohibits it. Yet another reason to consider drafting noncompete agreements and restrictive covenants to apply Delaware law.
See also Delaware Noncompete Law Blog
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