In a blog earlier this year, we discussed the Delaware Chancery Court’s refusal to impose a non-competitive business sale on Kodiak Building Partners, LLC x Adams. We then ask ourselves if codes represented a one-off decision or boded a trend that might make business buyers hesitate. The Delaware courts appear to have answered the question. In what constitutes a notable trend for business buyers, Delaware courts twice more refused to enforce non-compete in the sale of a business analysis.
In The decision issued by the Delaware Court of Chancery in January of this year, the Delaware court declined to enforce certain restrictive clauses in the context of a partnership agreement. sSeveral of Defendant’s former partners have signed partnership agreements that restrict them from engaging in a competing business for a period of one year after their departure from the partnership. The Defendant alleged that the limited partners’ non-compliance with the covenants exempted it from its obligation to pay the limited partners certain sums owed to them under the terms of the partnership agreement. The “competing forfeiture provision” “serves(d) as a financial disincentive, rather than a barrier per se to obtaining employment with a competitor,” and the Delaware court chose to apply the more lenient sale of a standard of business to your applicability analysis.
Even applying the lenient standard, the Delaware court found the non-compete to be unenforceable, arguing that the worldwide geographic scope was too broad. Furthermore, the court found that the scope of the prohibited activities was excessively broad, in part because it included activities competitive not only with the Defendant entity, but also with any of its affiliates. The court noted that the extent of the restriction could result in a partner unwittingly engaging in competitive activity. This latter analysis is consistent with some FTC rulings we discussed earlier. here. The Delaware court refused to dismiss the non-compete, finding it wholly unenforceable.
So in Intertek Test Systems v. Eastman, 2023 WL 2544236 (Del. Ch. March 16, 2023), the Delaware court found unenforceable a non-compete provision contained in a stock purchase agreement. The agreement contained several restrictive clauses restricting the Defendant from competing with the acquired business. The court found the geographic scope restricting the Defendant’s employment to “anywhere in the world” to be too broad because the acquired business operated only nationally. “The incongruity between the geographic scope of the agreement and that of the (acquired) business” led the court to conclude that non-competition was unreasonable. How not two issues already discussedthe Delaware courthouse in Intertek test he refused to write the alliance in blue pencil. The court opined that reviewing the noncompete to save the buyer – a sophisticated part in the court’s eyes – “would be unfair”.
This trio of cases represents a shift in how Delaware courts, typically non-competitive, view restrictive clauses, even those in the context of selling a business. As we routinely advise, buyers must ensure that non-competitors, even in the context of selling a business, are strictly tailored to protect the legitimate business interests acquired in the transaction. Buyers cannot rely on courts to save overly broad covenants, redraft or otherwise modify them to make them enforceable.