In Sunder Energy v. Jackson, No. 455, 2023 (Del. Supr., December 10, 2024), the Delaware Supreme Court upheld the Delaware Court of Chancery’s decision not to enjoin a former employer and member of a Delaware LLC from competing with plaintiff. The decision turned on two different versions of what outcome best reflected Delaware’s public policy favoring freedom of contract. The plaintiff contended that the court should “blue pencil” a contractual noncompete to give the plaintiff the benefit of his bargain, even if the contract was overly broad. The defendant contended that when a party did not negotiate in any way the terms of the covenant not to compete and received minimal consideration in exchange, and the covenants themselves were overly broad, the Court of Chancery has discretion to decline to enforce the covenants entirely. As described below, the Supreme Court held that the circumstances in which Delaware courts have blue penciled contracts differed from those present here and upheld the Court of Chancery’s denial of the requested injunction.
Background Facts
The defendant, a top sales performer, left the company when management changed the compensation system and structure of its business. The defendant then left to join a customer as its CEO. Hundreds of other salespersons followed. The defendant was not aware of the restrictions on competition that would have precluded him from working for a competitor until his new employer asked for his agreements with plaintiff at a time when the new employer was attempting an amicable negotiation with plaintiff. The defendant only left when it appeared those negotiations were on the verge of success. But they did not ultimately succeed and the plaintiff, a Delaware limited liability company based in Utah, sued to enjoin defendant from competing.
Supreme Court Finds Court of Chancery Did Not Abuse its Discretion in Declining to Enforce the Covenants Not to Compete
Applying an abuse of discretion standard of review, the Delaware Supreme Court reviewed the Delaware cases where the lower court had blue penciled a contract to enforce a non-competition covenant and found this case did not present a factual predicate that would have justified that approach. The court noted that the competition restriction was contained in an LLC agreement procured by management and presented for signature to defendant and the other founders on the last day of the year with direction that company counsel thought it important to have the document signed by year end. The two managers who had alone met with company counsel to draft the agreement did not explain the key terms, including how the managers would have greater power and fewer restrictions than defendant and the other founders. A later amendment was similarly procured without explanation and accompanied by a separate signature page which would have allowed the founders to sign without reviewing the substance. Moreover, the defendant received no material compensation for the newly imposed restrictions on competition. And the covenants themselves were overly broad as to duration and scope.
On appeal the plaintiff did not challenge the Court of Chancery's factual findings but instead argued that it erred in not blue-penciling the LLC agreement to make the restrictions more reasonable. While the Delaware Supreme Court recognized that precedent allowed for blue-penciling, it also noted that that occurred when parties negotiated the original agreement with equal bargaining power, where the restricted party received reasonable compensation for the restraints, or where the restrictions arose from the sale of the business. The Supreme Court agreed with the lower court that blue-penciling without those circumstances would create perverse incentives for a company to overreach in reliance upon a court blue-penciling unreasonable restraints and re-writing the parties' bargain. The court noted this would not validate the freedom of contract principle otherwise argued by plaintiff.
Lessons Learned
Sunder teaches that Delaware courts will enforce covenants not to compete but will not blue pencil an overly broad restriction on competition unless the proponent can present an appropriate factual predicate. Factors favoring this outcome include equal bargaining power at the time the restrictions were agreed to and the receipt of fair compensation for the restraint on freedom to compete.
The plaintiff contended that the court should “blue pencil” a contractual noncompete to give the plaintiff the benefit of his bargain, even if the contract was overly broad. The defendant contended that when a party did not negotiate in any way the terms of the covenant not to compete and received minimal consideration in exchange, and the covenants themselves were overly broad, the Court of Chancery has discretion to decline to enforce the covenants entirely.
