On the pro-enforcement side is the "sale-of-business" covenant, under which the restrictions normally are examined only for their reasonableness as to time, territory and scope. On the anti-enforcement side is the traditional employment-based covenant, which usually requires an enforcing party to show not only that the covenant is reasonable, but also tied to a legitimate business interest. The burdens on an employee's ability to earn a living, and the public interest are usually considered as well under an exacting "reasonableness" analysis.
The history of covenants not to compete is quite interesting (to me), and many would argue that the old justifications and presumptions that courts used long ago do not apply in a more modern economy. Sale-of-business covenants were the first types of covenants to be enforced by courts, and for the most part, they pose few enforcement problems. Employment covenants are a different story.
In the past on this blog, I have been critical of the sale-of-business nomenclature, because it is underinclusive and suggests to courts, lawyers, and (most importantly) clients that the test only applies to a covenant signed in connection with a business sale. Sounds logical.
But it's not right.
In point of fact, courts analyze a wide range of covenants under this more relaxed standard. Among these are covenants in franchise agreements and shareholder agreements. Last week, a Virginia court - in a matter of first impression - added another type of agreement to this list: settlement agreements.
This makes sense. Many settlement agreements are the product of arms-length negotiations and pose few problems in terms of being adhesive. That is not always the case, though. For many terminated employees, a severance agreement may not be negotiable at all and may be presented as a take-it-or-leave-it offer. A lot depends on the employee's position within the company, and pre-existing contracts he or she has which may impact the terms of any release.
In McClain & Co., Inc. v. Carucci, the employer and employee reached a post-employment settlement agreement after Carucci apparently embezzled nearly $300,000. The agreement called for him to pay the employer $250,000, grant it a 30-month non-compete, and exchange releases. The court examined the few other cases on point and concluded that the "sale-of-business" test applied to the settlement agreement, at least in Carucci's case.
The court did not lay down a per se rule on this, nor should it have. A court when confronting a non-compete in a release agreement likely will examine a number of factors, including the degree to which it was negotiated, the benefits the employee received (such as garden-leave), the circumstances of the employee's termination, and other unique circumstances.
Court: United States District Court for the Western District of Virginia
Opinion Date: 5/4/11
Cite: McClain & Co., Inc. v. Carucci, 2011 U.S. Dist. LEXIS 48404 (W.D. Va. May 4, 2011)