Delaware, where more than half of U.S. public companies are incorporated, has done much to drive the development of corporate governance. As a result, “Delaware’s courts have led the way, which is not surprising given the crucial role the state’s judiciary plays under what Chief Justice Leo Strine has described as the ‘Delaware Model’ of corporation law.” Look no further than the Delaware Court of Chancery’s own website which says it is “widely recognized as the nation’s preeminent forum for the determination of disputes involving the internal affairs of the thousands upon thousands of Delaware corporations and other business entities through which a vast amount of the world’s commercial affairs is conducted.” Consequently, rulings by the Delaware Chancery Court are highly influential and may impact the reasoning of other state and federal courts. Three recent noncompete decisions by the Chancery Court potentially signal a significant shift against noncompetes involving sophisticated commercial parties.
Let’s start with the first Chancery Court decision about which I reported last November, rejecting a noncompete accompanying the sale of a business. This decision was an eye-opener because lawyers frequently assume that noncompetes accompanying an asset sale or stock purchase are fully enforceable since they are negotiated by sophisticated commercial parties. However, in Kodiak Building Partners, LLC v. Adams, Vice Chancellor Morgan Zurn declined to enforce the noncompete before her on the grounds that the noncompete was unreasonable and not narrowly tailored to protect a legitimate business interest of the acquiring party. Vice Chancellor Zurn also declined to blue-pencil or rewrite the overly broad noncompete, reasoning that as a matter of public policy, it would only encourage employers to draft similarly overly broad provisions in the future because they would be in a “no lose” position. For those looking for deeper dives on the decision, I would recommend Arent Fox’s Linda Jackson’s fine article in The National Law Review; Paul Pryzant and Matthew Simmons’ post on the decision for Seyfarth’s Trading Secrets Blog; and Matt Albaugh and his Taft colleagues’ comprehensive article.
Two months later, on January 4, 2023, the Chancery Court declined to enforce restrictive covenant and forfeiture provisions in a limited partnership agreement. In Ainslie v. Cantor Fitzgerald, L.P., No. 9436-VCZ, 2023 WL 106924 (Del. Ch. Jan. 4, 2023), Vice Chancellor Zurn (the author of the Kodiak opinion above) found the covenants to be “facially overbroad” and declined to “blue pencil” those provisions; she also applied Delaware’s reasonableness test to invalidate a forfeiture provision requiring a return of capital and deferred compensation if the employee violated his restrictive covenants. For more on the decision, see Paul Hastings’ Jenifer Baldocchi, Kenneth Gage, Christopher Sheaffer and Samuel Domjen’s post.
And last week, on March 16, 2023, the Chancery Court issued a third decision, dismissing a complaint based on a noncompete accompanying the sale of a business. In Intertek Testing Services NA, Inc., v. Eastman, Vice Chancellor Lori Will ruled that a 5-year noncompete against a company’s founder, Jeff Eastman, was unenforceable because its geographic scope–“anywhere in the world”–extended to territories that were untouched by the previous employer and therefore unreasonable. Although Vice Chancellor Will’s opinion did not rely on it, I suspect the fact that (1) Eastman had already complied with the noncompete for 3 years and (2) there was no evidence that he had solicited any customers or taken any trade secrets had some impact on the court’s noncompete analysis.
So what does it all mean? Noncompetes are frequently criticized because of the unequal bargaining power of the parties: employers have the power to impose the terms on new employees, sometimes unexpectedly at the start of employment, after the employee has quit their previous job and has no meaningful ability to reject or negotiate those terms. In contrast, 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.
Now two of the three opinions were written by Vice Chancellor Zurn, so some will argue this is not part of a larger trend. But perhaps it shows the subtle pressure that political forces (like the FTC’s proposed rule banning noncompetes, 4 federal bills banning some or all noncompetes and state legislation (at last count, 65 bills in 24 states)) are exerting on courts. And of course, it may also mean the days of employers attempting to overreach with their noncompetes are coming to an end in Delaware.