In-house counsel should be careful not to write overly broad noncompete agreements with the expectation they’ll be fixed later in court if they’re found to be unenforceable, Sheppard Mullin attorneys say in an analysis of a December 10 Delaware Supreme Court decision.

In an appeal to a 2023 Chancery Court ruling dismissing its motion for a preliminary injunction, Utah-based solar sales dealer Sunder Energy said the trial court erred in not blue-penciling, or fixing, its noncompete agreement after it was found likely to be unenforceable. The agreement prevented the company’s incentive equity holders, and their affiliates, from engaging in door-to-door sales in any of the states the company operates in for two years after they leave and sell their shares.

In its appeal to the state’s top court, Sunder said the Chancery Court should have fixed its noncompete agreement rather than rule it’s likely unenforceable and decline its motion to enjoin one of its incentive equity holders who left to compete against it.  

Responding to that appeal, the Supreme Court said Sunder was asking too much of the Chancery Court. Although it’s appropriate for the court to step in with a rewrite of an unenforceable agreement, historically the court has done so to pare back the scope of overly broad restrictions in geography or duration, not to rewrite an agreement from scratch, which would have been required in this case. 

“The relief Appellant sought was a wholesale reformation of the parties’ agreement,” the court said. “It would require the court to craft an entirely new covenant.”

A broader concern is the “perverse incentive” a complete rewrite would have given to companies, the court said. “If employers know that even the most unreasonable covenants will be enforced [after a rewrite] employers will be less incentivized to craft reasonable restrictions from the outset.”

In other words, a company could purposely write an overly broad agreement knowing it will get fixed if it’s challenged in court. 

Lower court findings

The Chancery Court found Sunder’s agreement problematic facially and as a matter of law. 

On the matter of law, the company’s leadership executed the agreement in breach of their fiduciary duties by, among other things, not giving the incentive equity holders a reasonable opportunity to know what’s in it. (As a side matter, the Supreme Court reversed this part of the lower court’s ruling because the preliminary injunction stage doesn’t allow for a full review of the facts, which would be needed for a breach finding.) 

On the facial matter, the agreement was found to be overly broad by not allowing the incentive equity holders to do any kind of door-to-door sales in any of the states the company operates in, and by extending that to their affiliates. Under those restrictions, they, or their affiliates, wouldn’t even be allowed to sell products that don’t compete with Sunder. 

“As written, [an equity holder’s daughter] cannot go door to door selling Girl Scout cookies,” the Chancery Court had said in its 2023 ruling. 

The two-year restriction was also too broad because it was up to the company’s leadership to decide when the clock would start ticking based on when it purchased the equity holder’s shares. If the company chose not to purchase the shares, the clock would never start ticking, effectively turning the two-year term into an open-ended restriction. 

Focus on business interests

For in-house counsel, the ruling is a reminder to narrow noncompete provisions only to what’s needed to protect the company’s legitimate business interests, the Sheppard Mullin attorneys say in their analysis.  

“Resist the temptation to expand beyond that construct,” the attorneys said. 

What’s more, make sure you give people signing the agreements the opportunity to know what they’re signing and, if they agree to give up something, give them something in return, they said. 

“Ensure that the restricted party is provided adequate consideration, has sufficient time to consider the agreement, understands the restrictions, and is given an opportunity to obtain the advice of counsel,” according to the analysis, written by partners Jennifer Redmond and Shawn Fabian and a senior associate, Gal Gressel.