Restrictive covenants include agreements by an employee not to compete, not to disclose confidential information, and not to solicit an employer’s clients. Based on a recent decision from Delaware’s Court of Chancery, these agreements are more valuable than ever. Deciding a novel issue in Delaware, the Court held that, absent a provision to the contrary, restrictive are assignable from one employer to another, so long as both employers are engaged in the same business. This means that when businesses merge, employees who are already subject to restrictive covenants with the acquired business do not have to execute new agreements with the acquiring business. In addition, the Court reminds us that contracts defining the employer-employee relationship, are the only way to prevent a competitor from poaching employees in an at-will employment state, like Delaware.
The background in Great American Opportunities, Inc. v. Cherrydale Fundraising, LLC, is one that will be familiar to many employers. Three businesses were competing in the surprisingly cut-throat world of third-party fundraising (selling fundraising materials to non-profit organizations such as schools and churches, who then sell the materials to their communities to raise money). Two of the businesses, Great American Opportunities, Inc. (GAO) and Kathryn Beich, Inc. (KB) merged, leaving GAO as the surviving business. At the same time, the third business, Cherrydale Fundraising, saw an opportunity to expand its market presence by hiring away several of KB’s sales representatives. GAO discovered what was going on shortly after the merger.
To KB’s credit, it had been a careful employer and almost all of its employees were subject to the trifecta of restrictive covenants: non-competition, non-disclosure, and non-solicitation contracts. However, GAO was not a party to any of these contracts. Faced with a complicated situation, GAO filed a lawsuit alleging that Cherrydale tortiously interfered with the contractual relationship between GAO and its employees, leaving the Court to sort out the details.
Before it could address Cherrydale’s activities in poaching KB’s employees, the Court had to decide if there was any formal relationship between GAO and KB’s employees as a result of their merger. Cherrydale argued that Delaware’s doctrine of at-will employment prohibits a claim of tortious interference with a contractual relationship. But KB’s employees were subject to a contract, as they had signed non-competition, non-disclosure, and non-solicitation contracts. Thus, Cherrydale’s first argument was unsuccessful.
The Court next had to determine whether KB could lawfully assign its rights under the employees’ restrictive covenants to GAO, in conjunction with the sale of a business. Surprisingly, this was an issue that had not been thoroughly analyzed under Delaware law. Adapting the general rule that contract rights may be assigned absent a provision prohibiting assignment, the Court held that an employer’s rights under a restrictive covenant may be assigned, in conjunction with the sale of a business, so long as the former employer and the current employer engage in the same type business.Bottom Line For employers who have workers with specialized skills, restrictive covenants, including non-competition, non-disclosure, and non-solicitation contracts, are as important as ever. In Delaware and other at-will states, such contracts are the only thing preventing your competitors from poaching your employees and their valuable know-how. But restrictive covenants are now more valuable because they can be assigned from one employer to another in a merger or asset sale. So if your employees are not subject to restrictive covenants, now is a better time than ever to consider whether they may be right for your business’s circumstances. Great American Opportunities, Inc. v. Cherrydale Fundraising, LLC, C.A. No. 3718-VCP (Del. Ch. Ct. Jan. 29, 2010)