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Recent case shows Court of Chancery has its limits when it comes to noncompete agreements

On Behalf of | Sep 23, 2022 | Corporate Litigation

Recent estimates find 68% of Fortune 500 companies have registered in Delaware. In 2020, over 250,000 new businesses registered in the state. With these numbers, it is no surprise that business leaders refer to Delaware as a corporate paradise. The state’s corporate friendly tax policies and laws have played a key role in the pro-business reputation.

One of the key benefits business leaders point to when discussing incorporation within Delaware is the presence of the Court of Chancery. This court specializes in corporate law issues. This means that those who move forward with a business dispute in Delaware have significant precedent and established law to help guide the dispute towards a resolution.

Court of Chancery and non-competes: General history

One of the hot topics in the business world in recent years is the use of non-compete agreements. President Joe Biden’s administration has stated that they want to reduce the power of these documents, that they caused too many restrictions and limit innovation.

The Court of Chancery has taken a different approach. When reviewing whether to enforce a noncompete agreement Delaware courts look to the covenants of the agreement to make sure they satisfy three elements:

  • Reasonableness. The court will review the language of the contract for its limitations in geographic scope and duration. The court will generally not support an agreement that has too broad of a geographic restriction or lasts for too long.
  • Advance a legitimate economic interest. The employer may need to establish the agreement is not generic but one designed to specifically protect their interests.
  • Survive a balance of equities. The court will also use a balance test to weigh the interest of the employer to that of the employee. The court will not enforce an agreement that results in an “undue hardship” to the former employee.

A noncompete could survive a challenge in the Court of Chancery even if the agreement does not meet these provisions. The Court of Chancery is known for “blue-penciling” or changing the language of a noncompete agreement as needed to produce an enforceable arrangement. A common example is a change to language that results in too broad of a restriction and would otherwise result in an unenforceable agreement. The Court may take this approach in situations when the facts of the case support such a change.

A recent note of caution: Well-drafted noncompete agreements are important

Although business-friendly, the Court of Chancery does have its limits. This was recently highlighted in a case that involved an emergency care center that operated in Tennessee. It attempted to enforce its noncompete agreement against a former employee who opened a competing practice in Alabama.

The Court noted the agreement was overbroad as it barred the employees from owning, managing, or working in an urgent care facility anywhere in the United States. The language within the noncompete agreement noted the employer had business throughout the country but failed to define the business. It is relevant to note that the employer had not yet opened nor had any intention to open a clinic in Alabama, likely due to strict regulatory requirements.

Although the Court did not enforce this agreement in part due to its overbroad language, it is important to note that this is not always the case. The Court has stated in past cases that it could be persuaded to enforce a broad limitation if the employer can establish that the language is necessary to protect a strong economic interest.

This example showcases the importance of a well-drafted non-compete agreement. Business leaders are wise not to become complacent and expect the Court of Chancery to rule in their favor. Take the time to draft the document wisely or prepare a strong defense if challenged.