March 22, 2023

Delaware Dings Another Sale of Business Non-Compete

Last week, in Intertek Testing Systems v. Eastman, (Del. Ch.; 3/23), the Chancery Court struck down yet another sale of business non-compete covenant, and the recent performance of those clauses with the Delaware judiciary suggests that parties negotiating them should take the lyrics of Warren Zevon’s “Bad Luck Streak in Dancing School” to heart:

Bad luck streak in dancing schoolDown on my knees in painI’ve been breaking all the rulesSwear to God I’ll change. . .

I think the last couple of lines of that verse are pretty on-point, because if Delaware’s recent case law has a theme, it’s that buyers can’t assume that the Delaware courts will bail them out when it comes to restrictive covenants that they knew likely “broke the rules” when they negotiated them.

Many buyers have opted to push the envelope on non-competes because they assume that, if challenged, the Delaware courts will “blue pencil” their covenant into something that’s enforceable. In fact, Delaware courts are reluctant to do that in the face of unreasonable non-compete terms. The Intertek decision is the latest example of this. The case involved a non-compete that prohibited the defendant from competing with the buyer “anywhere in the world.”  Although Vice Chancellor Will acknowledged that Delaware has enforced relatively broad restrictive covenants in connection with the sale of a business, she said that those covenants still “must be tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests.”

She concluded that the non-compete at issue here failed that test, and also rejected the plaintiff’s call for her to blue pencil the agreement.  This excerpt explains her reasoning for striking the non-compete instead of revising its terms:

Intertek urges me to “blue pencil” the non-compete provision if I conclude that it is unreasonable in breadth. Although the Court of Chancery has, at times, blue penciled expansive non-competes to supply judicious limitations, it “has also exercised its discretion in equity not to allow an employer [or covenantee] to ‘back away from an overly broad covenant by proposing to enforce it to a lesser extent than written.’”

In my view, revising the non-compete to save Intertek—a sophisticated party—from its overreach would be inequitable. “[A] court should not save a facially invalid provision by rewriting it and enforcing only what the court deems reasonable.”

The Delaware Chancery Court’s response to recent efforts to persuade it to revise unreasonable non-competes suggest that dealmakers who operate under the assumption that the best way to proceed is to take aggressive positions when negotiating restrictive covenants would be wise to take Warren Zevon’s advice and swear to God they’ll change.

John Jenkins