Delaware Supreme Court refuses to enforce non-compete against company founder who joined competitor
As reported previously (here and there), some Delaware courts recently declined to “blue-pencil,” i.e. modify and narrow restrictive covenants that were too broad. Instead, they have stricken covenants that are deemed to be overbroad in their entirety and declined to enforce. In Sunder Energy, LLC, v. Tyler Jackson, and others, the Delaware Supreme Court held that Delaware courts can refuse to enforce overbroad restrictive agreements, even if a defendant’s behavior would violate a more tightly circumscribed covenant.
In Sunder Energy the plaintiff, a solar dealer, sought to enforce an noncompete against Tyler Jackson after he left to join Solar Pros, another competitor. The noncompete prohibited Jackson and his “affiliates”, as holders of incentive units, from engaging in door-to-door business in markets where Sunder operated, or reasonably anticipated operating. The Delaware Court of Chancery ruled that the noncompete was too broad because it “requires Jackson to prevent his [a]ffiliates” from engaging in sales of products in consumers’ homes. Jackson’s daughter is not allowed to go door-to-door selling Girl Scout Cookies as written. The court also opined that the noncompete was potentially indefinite, since it lasted two years after Jackson stopped owning incentive units which he could not freely transfer. Jackson was bound to the noncompete until Sunder decided that the restriction would be triggered. As a minority member, Jackson did not have the rights of an owner, such as voting and information rights and, per the court, was effectively an employee, not a partner.
Sunder argued that the court should “blue pencil” the noncompete because Jackson’s actions would have constituted a breach of even the most narrowly circumscribed restrictive covenant. The Court of Chancery declined to do so, and denied Sunder’s motion for a preliminary injunction.
On appeal, the Delaware Supreme Court affirmed, reasoning that Sunder’s argument “turns the analysis on its head and creates perverse incentives for employers drafting restrictive covenants,” who would “be less incentivized to craft reasonable restrictions from the outset.” The Court explained, whether a restriction should be blue-penciled “cannot turn on the egregiousness of the employee’s conduct,” but rather “should be based on the covenants themselves and the circumstances surrounding their adoption.” The Court noted that Delaware courts have exercised their discretion to blue-pencil restrictive covenants under circumstances that indicate an equality of bargaining power between the parties, such as where the language of the covenants was specifically negotiated, valuable consideration was exchanged for the restriction, or in the context of the sale of a business. In this case, the Court found:
- Jackson was not involved in any negotiations or discussions concerning the restrictive covenants or their scope. Jackson was not invited or present at the meeting where Sunder’s lawyers explained the terms of the agreements to the majority members. The majority members testified that they would have not been able to comprehend the agreement without the assistance of counsel.
- Jackson was paid “minimal to no separate compensation” for agreeing to be bound by Covenants. Instead, he received incentive units that were not transferable and later repurchased for $0 by Sunder because he had left Sunder with “no good reason.” “Bad leaver status.”
- The Court explained the relief Sunder requested was not simply a restriction on the restrictive covenants’ temporal or geographical scope, but would have required the Court to “craft an entire new covenant to which neither party agreed.” This was the opposite of the freedom-of-contract principles that are cherished by Delaware’s legal systems.
The Sunder case confirms a trend: Courts in Delaware are increasingly refusing modification of overreaching and too broad restrictive covenants This decision reminds employers to tailor restrictive covenants and non-competition clauses to protect their legitimate business interests and resist the temptation to go beyond this construct. Employers must ensure that the restricted party has adequate consideration, is given enough time to review the agreement, understands its restrictions, and can obtain legal advice. The case also raises questions about the use of forfeiture provisions for bad leavers.
