A recent Delaware Court of Chancery decision is helpful for anyone seeking to defend or enforce a non-compete agreement that prohibits a former employee from competing with her former employer. In the case of Physiotherapy Corporation v. Moncure, C.A. No. 2017-03960-TMR (Del. Ch. Mar. 12, 2018), the court refused to enforce a non-compete provision against a former employee, based on the prior material breach of the applicable agreement by the former employer.
On a purely contractual level, there is nothing groundbreaking or new about the general principle of contract law that: “If plaintiff is first guilty of a material breach of contract, it may not complain if defendant subsequently refuses to perform.” See footnote 36. It must be emphasized that the prior breach needs to be material, and a “slight prior breach” by one party may not relieve the other party of his duty to perform. This general principle has previously been applied in Delaware in actions to enforce a covenant not to compete. See footnotes 36 to 39.
In the facts of this case, the prior employer, after new owners acquired the company, unilaterally and without justification changed the bonus plan that was part of the employment agreement of the employee involved. The failure to fulfill the bonus plan, and the failure to make payments pursuant to that plan, relieved the employee of his obligation under the non-compete provisions due to the prior breach by the employer of the employment agreement. That prior breach was considered material because the amount of compensation went to the essence of the employment agreement.
One could argue that this same reasoning might apply to a common non-compete provision in connection with the sale of a business where the sellers of the business were the key stockholder-managers who are prevented from competing with the new owners of the business. In the instance of an earn-out provision in the acquisition agreement for such a sale that also includes a non-compete provision for key management on the seller’s side, if there is a material breach of the earn-out provision or other material prior breach of the acquisition agreement, and that breach preceded any violation of the non-compete provisions, the same basic contract principles in this decision should arguably apply.