Non-compete given by business seller’s owner to business buyer in employment agreement held by court to be unenforceable

Seller’s owner is a computer programmer who operated Seller, a Portland, Maine based business that provided data and consulting services for the tire and automotive industry.

In November 2010, Buyer contacted Seller’s owner about purchasing Seller. Buyer is based in Duluth Minnesota and offers similar services and had common customers with Seller. Buyer was primarily interested in buying Seller, so Buyer could expand Buyer’s business with a particular client, who worked with both businesses but did more business with Seller.

Negotiations ensued, and Seller’s owner ultimately agreed to sell Seller to Buyer. The parties memorialized that agreement in two separate contracts: the asset purchase agreement and the employment agreement.

In the asset purchase agreement, Buyer agreed to pay Seller a $100,000 down payment, following by sixty monthly payments of about $6,600, and an annual earn-out payment equivalent to 35% of Seller’s gross receipts.

In the employment agreement, Buyer agreed to pay Seller’s owner $150,000 per year until December 31, 2020. The employment agreement also contained a covenant not to compete.

Seller’s owner began working for Buyer in January 2011. The relationship between Buyer and Seller’s owner eventually deteriorated, and in 2013, Buyer terminated Seller’s owner.

Buyer did not document any particular problems with Seller’s owner’s employment; Buyer simply felt that Seller’s owner did not “fit within the culture very well” and believed that “it was time for a change.” Buyer gave Seller’s owner $2,500 in severance and stopped all payments under the asset purchase agreement and employment agreement. Following his termination, Seller’s owner allegedly began communicating with Buyer’s clients.

Seller and Seller’s owner sued Buyer. Buyer counterclaimed against Seller and Seller’s owner.

Buyer, in part claimed that Seller’s owner by soliciting Buyer’s clients, breached a covenant not to compete provision in the employment agreement and violated Minnesota trade secret law by using Buyer’s customer list.

The court noted that the covenant not to compete applied to “prospective” clients of Buyer. Buyer, the court said, had no legitimate interest in prohibiting Seller’s owner from soliciting Buyer’s prospective clients. Moreover, compliance with this non-compete is essentially impossible—Seller’s owner had no way to know who Buyer considered a prospective client.

Finally, the non-compete was overbroad because it did not restrict competition to customers who are related to Seller’s owner’s employment with Buyer, which is significant because Buyer’s business involves services in other industries.

The noncompetition covenant was not only overbroad, it was unreasonable because of the 5-year term. The court said that Minnesota law would not approve of a non-compete term that long unless Buyer provided Seller’s owner special training. And there was no evidence that special training was provided. Therefore, the court held that the non-compete provision was unreasonable and unenforceable.

Finally, even if it the non-compete was otherwise enforceable, the court would not enforce the non-compete provision against Seller’s owner because Buyer did not substantially perform Buyer’s employment agreement obligations. Here, the employment agreement provided for a $25,000 severance if Seller’s owner was terminated without cause. Buyer only gave Seller’s owner $2,500.

The court also found no violation of the trade secret law. The only possible violation would be Seller’s owner’s use of Buyer’s customer list. However, the court said that Buyer made no effort to keep its customer list secret and so the customer list was not a trade secret.

This case is referred to as Riddle v. Geckobyte. Com, Inc.,  Civ. No. 17-623 (PAM/LIB), United States District Court, D. Minnesota (June 22, 2018).

Comment. Some states like California won’t enforce a non-compete against a former employee. However, California like most states will enforce a reasonable non-compete against the seller of a business (or the owner of the business). However, a covenant not to compete is unenforceable if the territory is unreasonably large, the term is unreasonably long, or the prohibited customer group is too broad.

By John McCauley: I help people start, grow, buy and sell their businesses.



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Posted in covenant not to compete, customer list, trade secret misappropriation

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