TOP TIP: Non-Competes in the Context of the Sale of a Business
Many employers require certain of their employees to execute non-competition agreements as a condition of employment at the time of hire. Similarly, in many business acquisitions, there is an agreement by the seller of a company not to compete with the purchasing business for a period of time. While courts closely scrutinize non-competition agreements in the context of employment, they offer much greater latitude in the context of the sale of a business. Which standard applies is not always clear, however.
Background of the Case. In the recent case of Progressive Technologies v. Chaffin Holdings, Inc., the U.S. Court of Appeals for the Eighth Circuit analyzed whether to apply the employment standard or the sale of business standard to a non-competition agreement. The case involved an asset purchase agreement, an employment agreement, and a non-competition agreement.
In the asset purchase agreement, the plaintiff, Progressive, agreed to pay almost $2 million over three years to purchase the individual defendant, Chaffin’s, business. The court did not elaborate as to whether the asset purchase agreement contained any restrictive covenants. The employment agreement, which provided for employment for one year followed by at-will employment for an indefinite period, required Chaffin to assist with new sales and to transition relationships to Progressive. Following the one-year term, Chaffin remained employed for five and a half years at which time Progressive terminated his employment.
The non-competition agreement prohibited Chaffin from being involved in the “Video Security Business” throughout Arkansas for five years, the restrictive period beginning on the later of the date of the execution of the non-competition agreement or the termination of Chaffin’s employment.
Following the termination of his employment, Chaffin allegedly breached the non-competition agreement and Progressive sued him for, among other things, breach of contract. The U.S. District Court granted a broad preliminary injunction, but the Eighth Circuit reversed.
The Eighth Circuit’s Ruling. In its analysis, applying Arkansas law, the Eighth Circuit reiterated the general principle that courts apply “stricter scrutiny to noncompete agreements in employment contracts…than those connected with a sale of a business.” (internal quotations omitted). In determining that the non-competition restriction should be analyzed in the context of employment rather than sale of business, the Eighth Circuit focused on the following factors: (1) The termination of Chaffin’s employment triggered the non-competition obligations; (2) Progressive characterized the obligations as “post-employment” and “post-termination” restrictions; and (3) The lack of close temporal proximity between the sale of the business and the enforcement action (six and a half years and more than three years after Progressive finished paying for the business).
In applying the stricter employment standard, the Eighth Circuit deemed the restriction overbroad both because the temporal scope of five years extended longer than necessary to protect Progressive’s legitimate business interests and because the scope of the activity restricted, which included any activity engaged in by Chaffin from the time of the sale to the time of his termination, was similarly overbroad.
In its discussion, the majority opinion noted the absence of binding case law in Arkansas to provide guidance on this analysis. Our state of Maryland similarly lacks binding case law on this point, but at least one Maryland court, in Allegis Group, Inc. v. Jordan, has analyzed a hybrid non-competition agreement in the same manner, citing as persuasive authority the Virginia case of Capital One Financial Corp. v. Kanas.
Lessons for Employers. It is not unusual to see the seller of a business hired as an employee subject to restrictive covenants. Purchasers should be mindful to structure their agreements with the understanding that restrictions connected to the post-sale employment are likely to be more closely scrutinized than those that are related solely to the sale of the business and such restrictions will run from the date of the transaction rather than the termination of employment.