November 20, 2014

Problems with noncompetition agreements

Posted in Corporate Litigation, Employment Law by Gene Killian |

We have a case in the office right now involving a dispute between two business entities over which of them (if either) has a perfected security interest in certain collateral. Let’s just say that we believe corporate formalities were not followed by the other side, and, among other things, “value” was never given to perfect their claimed security interest. The principal of the business entity on the other side claims that he gave value on behalf of his company to perfect the interest, but there’s no loan documentation to prove his point. While it’s true that he personally dealt repeatedly with the owner of the collateral, we don’t believe that his personal business dealings can be magically transformed into dealings on behalf of his company. The result, unfortunately for all, has been an expensive litigation.

How do these things happen? Many times, they happen when experienced businesspeople and transactional lawyers fail to follow proper procedures.  That may have been the problem in a recent Superior Court decision from Judge Robert Wilson (an excellent judge) here in New Jersey, APR, LLC v. Lomans.

Lomans, APR (Lomans’ company) and Dr. Reddy’s were parties to a joint development and supply agreement, and had worked for years together to develop a hormone replacement drug known as Premarin (derived from the urine of pregnant mares - ugh).  Eventually, Dr. Reddy’s bought the assets and intellectual property of APR. The deal included a provision under which Dr. Reddy’s would pay royalties to APR for Premarin sales.  As part of the agreement, Lomans signed a three-year consulting agreement, that included a noncompete. The contract provided that certain of its provisions would survive any termination or expiration of the agreement – but the survival provisions did not refer to the noncompete.

Supposedly, during the term of the noncompete, Lomans began independently developing a competing product for another pharmaceutical company, a turn of events that did not thrill Dr. Reddy’s. But Lomans claimed that Dr. Reddy’s had breached its agreement with him (in a way that’s unspecified in the decision), and that he was free to do whatever he wanted.  Unpersuaded, Dr. Reddy’s sued and moved for summary judgment on the question of whether the noncompete had been violated.  The Court dealt Dr. Reddy’s a bad result, writing:  “The motion cannot be sustained when there is a genuine dispute as to whether or not a material breach of the contract was committed. Any such breach would relieve Defendant Lomans of performance under the Consulting Agreement, including the restrictive covenants, unless the law provides otherwise.” 

That wasn’t great news for anyone trying to enforce a noncompete.  Breach the main contract in any way, and you lose your protection.

Dr. Reddy’s also argued that the restrictive covenants were independent from its obligations under the consulting agreement, so that it didn’t matter whether Dr. Reddy’s had breached certain provisions in the agreement. The Court rejected that argument as well, writing:  “There is specific consideration cited in [the contract] for the restrictive covenants at issue. Lomans’ contention that this cannot be valid consideration at all on the basis that it did not flow directly to him, but rather to other entities, is insufficient as a matter of law. However, to state that consideration does not need to flow directly to the parties to be bound for it to be valid is not to state that the consideration was valid in this manner. Furthermore, the Court does not state that the consideration was independently offered for the particular promises in the restrictive covenants, but holds that this is a matter of intent, and therefore a question of fact. The parties clearly dispute this material fact, and as such, summary judgment is inappropriate.”

Hindsight is always 20/20, but if a noncompete or nondisclosure agreement is an important aspect of a deal, it’s important to make it a standalone agreement.  It’s also important to state in the agreement the specific consideration paid or exchanged for the noncompete or NDA, and not simply to assume that consideration paid in connection with the overall deal will suffice.

Litigation over noncompetes and NDAs tends to be quite expensive up front, because it often involves an order to show cause and a “mini-trial” to get restraints.  After everyone spends a ton of money on lawyers, the parties often settle. If you’d like to avoid that unhappy scenario, make sure that the documents are clean and understandable from the get-go, and that proper procedures are always followed. Contracts are good only if they’re understood. 

-        Gene Killian