Employee Noncompetition Agreements - Will They Survive When the Employer Is Acquired?
 
October 13, 2003
 
Hank E. Jackson- West Palm Beach

Corporations have routinely required employees to sign noncompetition agreements to protect the corporation’s confidential information as well as customer relationships.  When 100 percent of the corporation’s stock is purchased, trial courts are increasingly being asked to decide whether the corporation, in the absence of express consent of assignment by the employees, can enforce the noncompetition agreements.  As exemplified in three recent appellate decisions in Florida, corporate law principles and employment law principles not only analyze the issue from different perspectives, but also can come to opposite results. 

Earlier this year, the Florida Supreme Court in Corporate Express Office Products, Inc. v. Phillips, 847 So. 2d 406 (Fla. 2003) ultimately and decisively adopted the corporate law view and held that noncompetition agreements in such circumstances are enforceable.  However, such a firm and strict pronouncement of the law on this issue is not uniform across the 50 state jurisdictions.  As a result, when it comes to the effect of a 100-percent stock purchase on a corporation’s employee competition agreements, the warning of “buyer beware” is appropriate.  

Determined by State Law

Under early common law principles, employee noncompetition agreements were generally considered restraints against trade and void as against public policy.  Through a succession of case opinions and statutory enactments, the various state jurisdictions have modified this prohibition against noncompetition agreements.  Even though state law differs substantially among the 50 states, the test that has evolved regarding the general enforceability of noncompetition agreements is whether the restrictions are reasonably necessary to protect a legitimate business interest of the company desiring to enforce the noncompetition agreement.  Commonly recognized legitimate business interests include the protection of a company’s trade secrets, confidential information and customer relationships.

With the prevalent use of 100 percent stock purchases to acquire corporations, courts have been asked to consider the effect of such a transaction on the enforceability of employee noncompetition agreements.  The courts are turning to both corporate law and employment law principles for guidance. 

The Corporate Law View

Under a corporate law view, the form of the purchase is definitive in determining its effect.  If a corporation’s stock is purchased, including a purchase of 100 percent of the stock, there is no impact on the corporation’s rights and obligations.  This principle is fundamental and a bedrock of corporate law and commercial transactions.  Courts can and do easily find both statutory and common law authority supporting and re-enforcing this fundamental corporate law principle. 

Understandably, this straightforward and business-minded approach was followed by an intermediate Florida appellate court in Sears Termite and Pest Control, Inc. v. Arnold, 745 So. 2d 485  (Fla. 1st DCA 1999).  In that case, Sears purchased 100 percent of the stock of an extermination company and changed the company’s name to Sears Termite and Pest Control, Inc.   Employees of the extermination company, who had signed noncompetition agreements with the company prior to the purchase of the stock by Sears, left the company and began competing.  Sears sued the employees for violating their noncompetition agreements.  The employees’ primary defense was that the noncompetition agreements were not enforceable because they had not been assigned to Sears.  The court disagreed.  Relying on corporate law principles, the court held that assignments were not required because the change in ownership of corporate stock does not effect the corporation’s existence or its contractual rights. 

However, this corporate law view as expressed in Sears Termite was adamantly rejected two years later by another intermediate Florida appellate court.   In Phillips v. Corporate Express Office Products, 800 So. 2d 618 (Fla. 5th DCA 2001), which is discussed below, the intermediate appellate court adopted the master/servant or employment law view.  It held under a similar fact pattern that noncompetition agreements were not enforceable.

The Employment Law View

The common law of employment relationships, which traditionally has been referred to as master/servant, holds that personal service contracts cannot be assigned absent the consent of the employee.  The concept is derived from the realization that employees (servants) have agreed to act under the direction and control of their employers (masters) and that such a relationship is often inherently more personal than other contracts.  As a result, employees would not generally enter into such relationships with total strangers, and therefore, their agreements regarding such relationships should not be assigned to total strangers without their consent.   Similarly, employees should not be bound by noncompetition agreements that have been assigned without their consent.  

As mentioned previously, this view was applied to an employee’s noncompetition agreement in Phillips v. Corporate Express Office Products, Inc. 800 So. 2d 618 (Fla. 5th DCA 2001).  In Phillips, the Florida intermediate appellate court was confronted with whether employees of a corporation that sold 100 percent of its stock, merged into its parent company and then changed its name, could be required to adhere to noncompetition agreements that they had entered into prior to the 100-percent-stock sale.  The court, relying on employment law principles, ruled that noncompetition agreements are personal service contracts and are not assignable without the parties’ consent.   The court acknowledged the contrary corporate law view as expressed in Sears Termite. However, it held that the form of the purchase, whether by asset sale, stock sale or merger, was irrelevant to the enforceability of the employee noncompetition agreements.  Instead, the court focused on the realities of the employment relationship, including the differences in the culture and mode of operation of the company before and after the acquisition.  Referring to the law of master/servant, the court explained that  employees enter into noncompetition agreements based on the character and personality of the master.  Servants do not intend to suffer such a restraint for the benefit of a stranger to the original undertaking.

The Florida Supreme Court

The Florida Supreme Court accepted review of the Phillips decision on the grounds that there existed a clear conflict between two of  Florida’s intermediate courts.  In Corporate Express Office Products, Inc. v. Phillips,  847 So. 2d 406 (Fla. 2003), the Florida Supreme Court acknowledged the corporate law and employment law views.  However, it decisively and unequivocally chose the corporate law view and rejected the employment law view.  As expressed in its opinion, the court relied upon the fundamental principle of corporate law that ownership of corporate stock does not alter a corporation’s existence, identity or rights.  The Court appears to have not even considered any fact-specific arguments that supported the employment law view.  Instead, it explained its rejection of the employment law view by stating that the consideration of changes in corporate culture and mode of operation would interject unnecessary uncertainty into corporate transactions.

Other Jurisdictions 

Although Florida’s appellate courts have now decisively ruled on the issue and chosen the corporate law view of enforcing employee non-competition agreements in the context of 100-percent-stock purchase transactions, the law in other jurisdictions is not so clear.  Most opinions in other states are at the trial court level and not as definitive.  As exemplified in the three Florida appellate cases, until a jurisdiction’s highest court makes a decisive ruling to accept the corporate law view and reject the employment law view, there will remain uncertainty as to enforceability.

A noteworthy example of this uncertainty is found in Securitas Security Services USA, Inc. v. Jones, 16 Mass. L. Rptr. No. 19, 486 (August 18, 2003), a recent ruling in Massachusetts by that state’s specialized business litigation court.  In Securitas, a security services corporation acquired another security services corporation.  The court accepted the fact that the acquisition did not dissolve or terminate the acquired corporation, but that it remained an existing corporate entity.   A high level employee who had executed a noncompetition agreement with the acquired security company resigned shortly before the acquisition.  The court refused to enforce the noncompetition agreement based on employment law principles.  It held that the employee had not consented to an assignment of the contract; and therefore, the employee had not shown a willingness to suffer the restraint of the non-competition agreement with a stranger.   

The common law as well as the statutory law governing noncompetition agreements varies substantially from state to state.  Moreover, it continues to develop and change.   Confronted with competing public policy arguments, different state courts are not likely to rule uniformly on whether and to what extent the corporate law or the employment view should prevail. As a result, assessing the enforceability of an employee noncompetition agreement will continue to require a specific analysis under the law of the state that governs its enforceability.    

Drafting Around the Issue

To minimize uncertainty, corporations that request their employees to execute noncompetition agreements should include in those agreements a provision that the employee explicitly agrees that it is assignable.  This can substantially bolster the acquiring corporation’s ability to enforce the noncompetition agreement irrespective of the legal form of the purchase.  Some state noncompetition statutes, such as Florida Statute § 542.335 (1)(f), explicitly provide that courts shall not refuse to enforce noncompetition agreements on the ground that the person seeking enforcement is an assignee or successor to the agreement if the agreement expressly authorized enforcement by a party’s assignee or successor. 

Conclusion   

Corporate law strongly supports that a 100-percent purchase of a corporation’s stock will have no effect on whether a particular employee noncompetition agreement is enforceable.  However, courts that continue to view the issue through the lens of employment law principles have and may continue to reach an opposite conclusion depending on the specific facts of the case.  

For more information, e-mail Hank Jackson at hank.jackson@hklaw.com, or call toll free, 1-888-688-8500.