Delaware noncompete law trending

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Despite ever-increasing hostility toward noncompetes, Delaware had always seemed like a safe option for enforcing choice of law and forum selection clauses in those cases.

Indeed, the Delaware Chancery Court was the first to interpret California Labor Code 925 (prohibiting an employer from “requir[ing] an employee who primarily resides and works in California, as a condition of employment, to agree to” a non-California choice of law or choice of forum provision absent being advised by counsel) as weakening California’s public policy against noncompetes, and thereby making it easier to avoid application of California law in a noncompete dispute.

However, back in March of this year, John Marsh highlighted a possible trend in the Delaware Chancery Court refusing to enforce noncompetes that were previously likely to be enforced. See Are Three Decisions a Trend? The Delaware Chancery Court’s Turn Against Noncompetes.

The trilogy of cases John discussed were the following:

  • Kodiak Building Partners, LLC v. Adams, 2022 WL 5240507 (Del. Ch. Oct. 6, 2022), in which the court (Judge Zurn) refused to revise or enforce an overly broad noncompete arising in the context of a sale of a business, despite Delaware law permitting courts to reform overly broad noncompetes and especially when they arise in the context of the sale of a business.
  • Ainslie v. Cantor Fitzgerald, L.P., 2023 WL 106924 (Del. Ch. Jan. 4, 2023), in which the court (same judge) invalidated and refused to reform a noncompete and, more forebodingly, a forfeiture-for-competition provision in a partnership agreement.
  • Intertek Testing Services NA, Inc., v. Eastman, 2023 WL 2544236 (Del. Ch. March 16, 2023), in which the court (Judge Will) refused to revise or enforce a worldwide noncompete against the founder of the business because the court found the territory to be unreasonable.

As John pointed out, while “[n]oncompetes are frequently criticized because of the [assumed] unequal bargaining power of the parties[,] . . . noncompetes involving parties with significant leverage – the owner of a business or a senior employee investing in a limited partnership – would presumably be more likely to be enforced because they are the product of negotiation. But these apex noncompetes are increasingly being rejected by the preeminent business court in the United States.”

The trend continues…

It seems that John’s observations are continuing to bear out. (That should not come as a surprise; John is an extremely knowledgeable and talented trade secret/restrictive covenant lawyer.)

Since John’s post, the Chancery Court has continued to issue decisions reinforcing John’s observation that the earlier decisions reflect a trend, including the following:

  • Frontline Technologies Parent LLC et al. v. Murphy (Del. Ch. Aug. 23, 2023), in which the court (the same judge as in Intertek Testing) refused to find a violation of a noncompete in a context where, though written incorrectly, the noncompete was obviously intended was to cover the defendants’ conduct. The rationale is summarized quite well in the first paragraph of the decision:

This case presents a textbook example of why parties should ensure their contracts say what they mean and mean what they say. A holding company entered into equity agreements with two (former) employees, including non-compete provisions barring the employees from working for a competitor of the holding company. What it intended, though, was to prevent the employees from working for a competitor of its operating subsidiary. The equity agreements say nothing of the sort.

  • Centurion Service Group, LLC v. Wilensky, 2023 WL 5624156 (Del. Ch. Aug. 31, 2023), in which the court (the same judge as in Kodiak Building Partners and Ainslie) refused to apply Delaware law despite a Delaware choice of law provision and summarily refused to reform and enforce an overly broad agreement with a stockholder/former manager of an acquired company. This analysis is reminiscent of yet another recent case this year, HighTower Holding, LLC v. Gibson, 2023 WL 1856651 (Del. Ch. Feb. 9, 2023) (Judge Will), rejecting Delaware choice of law in favor of Alabama’s law, though not with an “apex” employee.

What are the takeaways?

There are at least three.

First, as John also noted, it is just two of the six Chancery Court judges responsible for these decisions. So it remains to be seen if the other judges will fall in line.

Second, regardless, Delaware may no longer be the safe haven it once was for companies hoping to have their covenants enforced without too much scrutiny.

Third, with the increasing hostility toward noncompetes generally, companies should be thinking hard about what steps they need to take to protect their legitimate business interests. For some thoughts about more conventional alternatives, this article identifies some steps you may wish to consider. In addition, we created the following resources (available for free):

In addition to those resources, there may be other options to consider. For example, ERISA “Top Hat Plans” with forfeiture-for-competition provisions may provide some protection – at least for as long as the federal government does not eliminate that option.

 

* Thanks to Leslie Pappas for identifying the Frontline case and to Steven Pearlman, Daryl Leon, and E. Sydney Cone for identifying the Centurion case.

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