In this Chancery Court opinion, Concord sought a permanent injunction and money damages for breach of a restrictive covenant. A preliminary injunction was granted in April 2008. After a three-day trial, post-trial briefing and oral argument, the Court granted a permanent injunction barring the defendants from breaching the covenant-not-to-compete until September 2011 and found liability for more than $500,000 in damages as well as “reasonable attorneys’ fees and expenses.”
This opinion provides a 44-page description of the Delaware law on covenants-not-to-compete, sometimes referred to as restrictive covenants or non-competition agreements. Bottom line: the general rule is that they will be strictly enforced if they comply with the minimal prerequisites applicable, despite what can be extreme hardship–even bankruptcy for the party against whom enforcement is obtained (which can be a business or an individual, or both.)
The Non-Competition Covenant in this matter was contained in an Asset Purchase Agreement (“APA”) between Concord Steel and Wilmington Steel Processing Co. (“WSP”). The Non-Competition Covenant provided that for a period of four (4) years, WSP (and its CEO) would not engage in or have an interest, “anywhere in the world” in any “competitive business” as was defined in the agreement. The litigation focused on the definition of “competitive business” in the agreement.
The complaint in this case was filed in November of 2007, at which time a preliminary injunction was also sought. After oral argument in March 2008, the Court granted a preliminary injunction in April 2008. The trial took place in October 2008 and post-trial oral arguments took place in April 2009. The prior decision on the preliminary injunction is cited as Concord Steel, Inc. v. Wilmington Steel Processing Co., 2008 WL 902406 (Del. Ch. April 3, 2008), and linked above.
Summary of Claims
Concord argued that WSP violated the proscription against engaging in a “competitive business” as defined by the APA by accepting and performing a very specific type of work that was described in detail in the opinion. Defendants deny any breach and argue that the Non-Competition Covenant did not prevent them from performing the work at issue. Also, Defendants urged as a defense to the imposition of a permanent injunction that it would be an “invalid restraint on competition” and that it would not advance any legitimate economic interest of Concord. They also object to the request for lost profits as being based on gross, rather than net, profits.
The Court reviewed the elements of a breach of contract claim which needs to be proven by a preponderance of the evidence. See footnotes 55 and 56. The Chancery Court reiterated the well settled Delaware law on contracts which is a “objective theory of contracts” and that a determination about whether a contract is ambiguous is a question for the Court to resolve as a matter of law. See footnotes 58 through 69.
The Court engaged in an extensive factual and legal analysis of the intent of the parties, including extrinsic evidence in the form of testimony by experts in the steel industry. After a careful deductive process, the Court concluded that the Non-Competition Covenant was breached. The Court also rejected a laches defense, in light of the finding that Concord sued within one month of becoming aware of the claim.
The Court reviewed the prerequisites for obtaining permanent injunctive relief. See footnote 110. For specific performance of a Covenant-Not-To-Compete, the Court also recognized the well established requirements that it must be demonstrated by “clear and convincing evidence that the Non-Competition Covenant is reasonable in geographic scope and temporal duration, and advances Concord’s legitimate economic interest.” (See footnote 111.)
In reviewing the balancing of equities aspect of the elements of injunctive relief, the Court was not persuaded that enforcement of the covenant “would be fatal to WSP.” The Court’s reasoning was based on its finding that WSP would still be able to do some work that was outside of the restricted behavior. Rather, the Court explained that an injunction would merely put the parties in the position that they agreed to be in under the APA. [Sidebar note: The author of this blog post can attest from experience that bankruptcy can result from enforcement of these covenants but that is a risk of the party who enters into these agreements, and one should not expect to be saved via the "balancing of the equities test.".]
Money Damages and Lost Profits
The Court determined that the proper measure of damages would be gross profits of WSP and not the net profits because under Delaware law, “fixed costs generally are not deducted from lost profits.” See footnote 121.
In addition, the Court relied on a provision in the APA that awarded attorneys’ fees to the prevailing party in the event of a breach. In closing, the Court ordered that counsel for plaintiffs submit a stipulated or proposed form of judgment in accordance with the opinion and in accordance with Section 4734 of Title 10 of the Delaware Code. (Ouch.)