No Solicits Join Noncompetes in Coming Under Scrutiny

Delaware courts are applying increasing scrutiny to restrictive covenants. Recent decisions make clear that no solicitation provisions are no exception, even in a business sale.

In a recent Court of Chancery decision involving a sale-of-business transaction, the court dismissed the no-solicitation claims, finding that language prohibiting “encouraging” or “disrupting” relationships restricted “noncompetitive” speech and was overbroad.

This decision follows two prior decisions in which no-solicitation clauses were voided. These cases signal that Delaware courts are scrutinizing no-solicitation clauses, even in sale-of-business contexts where courts have historically been more liberal.

In the most recent case, the court considered restrictive covenants entered into in connection with the sale of a business. The case arose after a former director allegedly formed and led a competing enterprise following a $14 million transaction that included noncompete, employee, and customer no-solicit provisions. The former business sought to enforce both sets of covenants.

The court allowed a noncompete tied to a substantial purchase price to proceed but dismissed the no-solicit claims.

The court concluded that the no-solicit provision was facially overbroad because it prohibited “encouraging” or “inducing” employees and customers and “disrupting” third-party relationships. The court declined to rewrite or narrow the provision.

In a prior case, the dispute arose from an acquisition in which the defendant entered into a restrictive covenant agreement executed in connection with the transaction. The no-solicit provision prohibited the executive, for 12 months following the termination of his employment, from soliciting or encouraging any employee of a defined group company to leave employment. The agreement defined the target group as any person who was employed by any Group Company within the ninety (90) days preceding the date on which Executive’s employment terminated and whose employment the Executive had actual knowledge of.

The company argued that the no-solicitation provision should receive the more deferential review applied to sale-of-business agreements. The court rejected that framing because the defendant agreed to the restrictions in exchange for continued employment, not as a selling equity holder. The court held that even if the less-restrictive-sale-of-business standard applied, the no-solicitation provision would still fail.

The court found the clause overbroad in two ways.

• The restriction applied to the entire corporate family, including affiliates for which the executive had never worked, thereby severing the covenant from the goodwill actually at issue.

  
  

• The prohibition on encouraging employees to leave was facially overbroad because it captured noncompetitive conduct, like advising a colleague to retire or pursue a different career path for personal reasons. The court held that was facially overbroad and unenforceable as a matter of law.

The court declined to blue-pencil the provision. The court emphasized that the company, as a sophisticated party, must live with the consequences of drafting overbroad restrictions.

In the first of these three cases, the no-solicitation provision was embedded in an LLC agreement governing incentive holders rather than in a sale-of-business transaction. It barred the member and his affiliates from soliciting, recruiting, hiring, inducing, or encouraging any employee or independent contractor, including anyone employed or hired by the Company, to leave. The agreement defined this to include initiating communications with a Company employee or independent contractor regarding actual or possible employment or an independent contractor relationship with an entity other than the Company. It applied during the period when the holder owned the incentive units and for two years afterward.

The court found that the restriction was overbroad for several reasons. It applied to former employees and independent contractors regardless of whether the defendant had worked with them or for how long ago they worked for the company, extended to a category of affiliates, and prohibited not only solicitation but also inducing or encouraging employees to leave or initiating communications relating to other actual or possible employment.

The court observed that the no solicit would have been reasonable had it (i) only restricted Jackson, (ii) only lasted for a reasonable time, (iii) only applied to current company personnel, and (iv) only restricted recruiting existing personnel for another business.

On appeal, the Delaware Supreme Court affirmed the discretion to decline to blue-pencil overbroad restrictive covenants.

Tips:

• Companies should not assume that, just because non-solicits are inherently less restrictive than noncompetes, a court will treat them with greater deference.

  
  

• No solicitations should be drafted to support the legitimate business interests behind those restrictions, including the jurisdictions and related corporate entities covered.

• Do not assume a court’s blue-pencil authority will save a no solicit that a court may deem overbroad.

• Review your employee and customer no solicits to ensure they are narrowly tailored to protect your company’s legitimate interests. This should include reviewing (a) the scope of employees or customers covered and (b) whether the language is the type courts might find non-competitive activities like talking to employees about non-competitive jobs or retirement.

• Exercise caution in extending no solicits to a broad or undefined group of affiliates.