Employment Law Alert – Restrictive Covenant in the Sale of a Business Subject to Unprecedented Scrutiny
November 10, 2022
In Kodiak Building Partners, LLC v. Adams (“Kodiak”), C.A. No. 2022-0311-MTZ, the Delaware Court of Chancery recently found the restrictive covenants imposed on a stockholder in a business acquisition were overbroad and therefore unenforceable. Historically, Delaware (and most) courts routinely uphold even aggressive non-compete agreements in connection with the sale of a business. However, this decision – an unprecedented departure from this practice – is consistent with the near-national trend to strictly scrutinize restrictive covenants, enforcing only those narrowly tailored to protect the confidential information and related business interests of the employer or, as it appears now – the business/business assets sold.
Here, the Buyer (Kodiak) entered into a stock purchase agreement to acquire a roof truss company. Defendant (Adams) was both an employee and stockholder of the roof truss company acquired. As part of the acquisition, Kodiak entered into a restrictive covenant agreement with Adams that included non-competition, non-solicitation and confidentiality provisions. After the sale, Adams left the acquired company and went to work for another, nearby roof truss company. Predictably, Kodiak sued Adams for breach of the restrictive covenant agreement and sought a preliminary injunction.
The Court’s Ruling
First, the Court found that the restrictive covenant agreement’s waiver provision did not preclude it from reviewing the restrictive covenant for reasonableness. Then, the Court found the non-compete overbroad and unenforceable because it not only restricted Adams from competing with the acquired business but with all businesses under Kodiak’s broader corporate organization including other unrelated construction businesses. The court noted: “[r]restrictive covenants in connection with the sale of a business legitimately protect only the purchased asset’s goodwill and competitive space that its employees developed or maintained.”
Notably, the Court also declined to “blue-pencil” the restrictions, choosing not to revise this overly broad non-compete restriction to make it enforceable which, in itself, was another important departure from what Delaware courts have been willing to do in the past.
Key Takeaway = Buyer Beware!
The Kodiak decision is consistent with many courts’ view that restrictive covenants exist only to safeguard an entity’s protectable interests from an individual’s unauthorized use of confidential information and trade secrets or other unfair competition. While restrictive covenants entered into in connection with the sale of a business are generally subject to less judicial scrutiny than those solely in employment relationships, this decision demonstrates that restrictive covenants given in consideration for the sale of a business may be held unenforceable in their entirety if their scope is deemed overbroad, and not narrowly tailored/limited to the acquired business and only its confidential information and related protectable interests.
The Kodiak decision highlights the expanding attack on restrictive covenants, and in particular, non-competes, nationwide – both as related to employment and now expanding into M&A transactions. As a result, it is even more critical for employers and business purchasers to review and consult with legal counsel when drafting restrictions agreements, or reviewing and interpreting these restrictions, whether to ensure that they are both narrowly and appropriately tailored to protect business’ interests or, alternatively, to determine if any such existing restrictions could be challenged as overbroad and unenforceable.
The contents of this Alert are for informational purposes only and do not constitute legal advice. If you have any questions about this Alert, please contact the Shulman Rogers attorney with whom you regularly work or a member of the Shulman Rogers Employment and Labor Law Group.
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