Court said that Arkansas applies stricter scrutiny to noncompete agreements in employment contracts than those connected with a sale of a business.
M&A Stories
June 1, 2022
Introduction:
In a recent court case, a noncompetition covenant given by a seller to a buyer was deemed likely unenforceable. The court’s decision was based on the connection of the covenant to the seller’s employment with the buyer, rather than solely to the sale of the business. This case highlights the importance of carefully considering the enforceability of noncompete agreements in employment contracts.
The Deal:
The case involved a business sale in 2013 where a video equipment provider for school districts was sold for $1.9 million. As part of the deal, the seller’s owner agreed to work for the buyer after the acquisition under an employment agreement. This agreement included a five-year noncompetition covenant, a five-year customer nonsolicitation covenant, and a two-year employee nonsolicitation covenant.
The Lawsuit:
After working for the buyer for 6 ½ years, the seller’s owner was terminated by the buyer. Subsequently, the buyer accused the seller’s owner of competing against them, thereby violating the noncompetition and nonsolicitation covenants. The buyer sought a preliminary injunction to prevent the seller’s owner from competing during the lawsuit. However, the court declined to issue the injunction, stating that the buyer had a limited chance of success in enforcing the noncompete agreement.
Stricter Scrutiny for Noncompete Agreements:
The court highlighted that Arkansas applies stricter scrutiny to noncompete agreements in employment contracts compared to those associated with a business sale. The noncompete agreement must be reasonably necessary to protect the buyer’s interests. In this case, the court found that the restrictions were likely excessive and went beyond the buyer’s valid interests.
Reasoning for Likely Unenforceability: The court found issues with both the length and definition of the competition restriction. The five-year duration was likely too long, and the restriction defined protected business activity too broadly, even including activities the buyer had abandoned long before the seller’s owner’s termination.
Similarly, the customer-solicitation restriction was deemed excessive as it prohibited the seller’s owner from contacting potential customers with whom he had no prior contact. The court stated that the buyer’s valid interests could be protected without such broad restrictions.
This case is referred to as Progressive Technologies, Inc. v. Chaffin Holdings, Inc., No. 20-1474, United States Court of Appeals, Eighth Circuit, (Submitted: January 14, 2021. Filed: May 2, 2022.)
Conclusion:
This case serves as a reminder for buyers to carefully consider the enforceability of noncompete covenants when acquiring a business and having the seller, its owners, or key employees continue working after the sale. Consulting with a lawyer to ensure the terms are reasonably designed to protect the buyer’s interests is crucial. Furthermore, buyers should be aware of varying state laws regarding the enforceability of noncompete agreements, as in some states, like California, noncompetes are generally unenforceable against employees.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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