Buyer Beware: Delaware Declines to Enforce Sale of Business Non-Compete

Courts and state legislatures go on to get aim at post-work non-competes. In a companion blog, we not long ago comprehensive the Federal Trade Commission’s proposed rule banning put up-work non-competes. However, for yrs (and even less than the FTC’s overreaching proposed rule), non-competes in the sale of business context have generally obtained fewer scrutiny.

The Delaware Chancery Court docket threw the offer planet a curveball when it recently declined to enforce a sale of business enterprise non-contend. In Kodiak Making Associates, LLC v Adams, the Delaware Chancery Courtroom dominated that a non-compete contained in the parties’ sale of enterprise arrangement was overbroad. Rather than blue-penciling or normally modifying the covenant to modify or strike the overbroad restriction, the court docket struck the non-compete as unenforceable in its entirety.

As background, Kodiak operated 4 company lines in 81 spots and 16 states: (i) lumber and making products which, based on the area, could incorporate roof trusses (ii) gypsum, including drywall and related supplies (iii) construction supplies, principally metal, rebar and structural steel, and (iv) kitchen area interiors, these kinds of as kitchen appliances, flooring, cabinets and countertops. 

Kodiak entered into a stock buy settlement to obtain Northwest and Mandere Development, Inc., an Idaho company selling, manufacturing and offering roof trusses. In link with the acquisition, Kodiak entered into a restrictive covenant settlement with selected of Northwest’s stockholders, including Philip Adams.

The restrictive covenant settlement with Adams was detailed and provided constraints on geography and time. It prohibited him for a period of time of 30 (30) months post-closing, from proudly owning, taking care of, operating, controlling, or participating in the ownership, administration, operation or command, in any endeavor or action or “Business” which was equivalent to or in competition with the “Business” or any part of it, everywhere in Idaho or Washington and in a 100 mile radius of any locale exterior of Idaho and Washington exactly where Kodiak experienced marketed products or furnished products and services within the 12-months prior to closing. Business was described as “manufacturing, advertising and marketing, marketing, distributing, setting up and/or delivering of trusses roof, ground and stair elements framing siding and other constructing elements and materials, and giving companies with respect thereto, including design, engineering, switch-crucial options, challenge administration and trade coordination providers.”

Adams joined a competing truss business inside of three months of closing. Kodiak then submitted a lawsuit in opposition to Adams in search of to implement the non-compete. The Delaware Chancery Court ruled the non-compete unenforceable. As is customary underneath Delaware’s quasi “rule of reason” assessment, the Courtroom very first observed that restrictive covenants have to progress a reputable company fascination of Kodiak, the get together seeking enforcement. The Court docket further acknowledged that in the context of a sale of a business enterprise, Kodiak experienced a legitimate company curiosity to defend the property and goodwill it obtained in the sale. However, the Courtroom opined that the prohibition against Adams went beyond making an attempt to shield the roof truss small business Kodiak obtained from Northwest. In its place, the restriction on Adams extended to all 4 of Kodiak’s company lines, which exceeded the scope of the transaction. 

Particularly, Vice Chancellor Zurn uncovered the non-compete overbroad since it restricted Adams from competing in 100 miles of all of Kodiak’s places alternatively than the one particular Northwest area Kodiak obtained and mainly because the expansive definition of “Business” encompassed all of Kodiak’s four small business strains alternatively than just the truss company in which Adams labored. The Court docket famous “the buyer’s valid issues about monetizing its obtain do not assist limiting the seller from competing in other industries in which the customer also transpired to spend in prior to the acquisition.” This language indicates the Court docket would have placed less scrutiny on limitations tied entirely to (i) Northwest’s geographic spot and (ii) Northwest’s truss company.

Just as noteworthy, the Courtroom refused to blue-pencil or normally modify the covenant and strike the overbroad provision. Rather, the Court docket considered the complete non-compete unenforceable mainly because of the overbroad provision, and opined that in blue penciling overbroad restrictive covenants, courts produce a “no-lose” incentive.

It stays to be observed whether or not other Delaware courts adopt the Kodiak rationale and keeping, but potential buyers would be clever to make certain non-competes, even in the sale of organization context, are personalized to guard the genuine business interests acquired in the transaction.