It may sound odd for a noncompete attorney to say this, but when it comes to enforcing a non-compete restriction, the applicable law is often less important than the context in which the noncompete restriction arises.
To better understand this point, consider that noncompete restrictions, sometimes referred to as covenants not to compete, often arise in three broad situations:
- A noncompete restriction between an employee and the employee’s employer;
- A noncompete restriction between a seller and the buyer in connection with the sale of a business; and
- A noncompete restriction given by a member in a limited liability company or corporation, who may also be an employee of that LLC.
Certainly all three of these categories of noncompete agreements will share commonality when it comes to the enforceability of a particular noncompete restriction. But each category will not likely receive the same level of scrutiny from a court responsible for determining whether a particular noncompete restriction is enforceable. Accordingly, it is important to understand these differences in order to draft a noncompete restriction that will likely be enforced
Common Principles Applicable to Noncompete Agreements
As to the commonality, the enforceability of any non-compete restriction under any of the above circumstances will generally depend on whether the restriction protects the reasonable competitive business interest of the party seeking to enforce the restriction, which will in turn generally depend upon the duration, geography, and scope of the covenant.
As with most legal issues, the devil is in the details, and the details of your particular noncompete restriction will need to be reviewed by an experienced noncompete attorney. And because noncompete law is state specific, that noncompete attorney should be licensed in the state whose law applies to the enforceability of the noncompete agreement. But here are few general principles likely to apply to each situation.
Noncompete Restriction Employee / Employer
Generally, the reasonableness of non-compete clauses in the context of employee restraints is scrutinized more rigorously than the reasonableness of a covenant not to compete for a sale of business or in connection with acquiring an ownership interest in a company.
While there are many issues that can threaten the enforceability of an employee noncompete agreement, one hotly contested issue is whether the employer’s noncompete agreement impermissibly prevents all competition, which is not a legitimate business interest. Instead, the noncompete agreement must prevent the employee from gaining an unfair advantage in competition with the employer.
Noncompete Restrictions in the Sale of a Business
One the one hand, the reasonableness of a covenant not to compete in the sale of a business is determined under the same rule applicable to an employer-employee non-compete clause. But on the other hand, courts addressing noncompete restrictions arising in the context of a sale of a business recognize the equal bargaining power of freely contracting parties for a covenant not to compete for a sale of business. For this reason, courts almost always focus only on the reasonableness of the application of the restraint to the specific facts of the transaction under discussion.
Noncompete Restrictions and Acquiring Membership in a Closely Held LLC
Michigan case law analyzing non-compete restrictions between members in a closely held LLC or for that matter, even among shareholders in a closely held corporation is limited. However, the limited case law suggests that broader restrictions are likely to be enforceable in such situations.
For example, this blog previously discussed the case of Landscape Forms, Inc v William Quinlan (2012), which involved a dispute between William Quinlan, a former employee of a Landscape Forms, Inc., a closely held corporation, challenged a non-compete agreement with Landscape. During his employment, Quinlan received stock pursuant to his employee compensation plan. The stock purchase agreements in which Quinlan received stock all contained noncompetition provisions “forbidding LFI shareholders from competing with LFI for five years after ceasing to be a shareholder.”
The trial court had evaluated the non-compete clause in the context of an employment agreement between Quinlan and Landscape. Under that evaluation, the court elected to reform the agreement to shave off two years of the post-employment restriction, i.e., restriction reduced from five years to three years.
The Court of Appeals disagreed, noting that the noncompetition agreement arose out of the stock purchase agreements made between the company and Quinlan rather than the employment agreement. While the Court of Appeals agreed that the trial court may reform the agreement, the Court of Appeals sent the case back to the trial court “to make modifications to the scope and duration of [the] non-competition provision as necessary to render it reasonable.” In other words, the Court of Appeals signaled that because the noncompete restriction did not arise in the context of an employee and employer, shortening the duration of the noncompete agreement may have been improper.
The above points show that when it comes to noncompete agreements, courts have a certain degree of discretion when it comes to determining whether they are enforceable, i.e., is the scope and duration of the non-compete clause reasonable. That discretion, however, will depend upon the context in which the noncompete agreement arises with noncompete agreements in employment relationships being the most scrutinized and noncompete agreements in the sale of a business or in closely held companies being the least scrutinized.
For more information on Michigan noncompete law, enforcing or challenging the enforceability of a noncompete agreement, and best practices in drafting an enforceable noncompete agreement, contact Jason Shinn.