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Company acquisition leads to non-compete confusion

Whether an acquiring company will be able to enforce an employee non-compete agreement entered into by its predecessor will have everything to do with how its acquisition is structured, a pair of recent decisions by a judge in the Massachusetts Business Litigation Session make clear.

In his initial ruling, Superior Court Judge Kenneth W. Salinger denied the acquiring business’s motion for a preliminary injunction, saying that the agreement defined “the Company” to include only the original company’s subsidiaries or affiliates, not its assignees. That created two problems for the acquiring company.

For one, while the employee was technically still bound not to compete with subsidiaries or affiliates of his original employer, the agreement did not speak to whether he could work for a competitor of the acquiring company.

Moreover, once the employee began working for the acquiring company, he ceased to be an employee of the original company, which started the clock ticking on his 12-month non-compete clause. By the time the employee changed jobs this past January, the non-competition provisions of the contract had expired, Salinger found.

However, the acquiring company moved for reconsideration, advancing a new legal theory: that, rather than receiving an assignment of the original employer’s rights, it had actually, through a series of mergers, become the legal successor to the last subsidiary that had been entitled to enforce the agreement against the employee, a contention supported by the governing contracts the company filed with its motion for reconsideration.

While now finding that the acquiring company could enforce the non-compete, the employee still won in the end as a practical matter, as Salinger concluded that the agreement’s restrictions on competition and solicitation went too far geographically.

The 10- and six-page decisions are NetScout Systems, Inc. v. Hohenstein.

 Careful drafting a must

As of March 6, the parties had filed an agreement for dismissal mirroring “significantly, though not entirely” Salinger’s last order, said Peter V. Lawlor, the defendant employee’s Chelmsford counsel.

The agreement allows Lawlor’s client to work, so long as he stays out of the geographic area in which he previously had been working.

Lawlor said attorneys should be wary of the notion that non-compete clauses are “viewed with some hostility.” To the contrary, he said his experience is that such clauses are “fairly rigorously enforced” and need to be read carefully.

He added that there is a shortage of reported appellate opinion, as cases will often be resolved at the Superior Court level, as his client’s was.

Boston attorney Ralph J. Rivkind said Salinger’s first opinion provides an object lesson in the importance of careful drafting of agreements.

“Lawyers are chastised for long documents,” Rivkind said. “However, I view the language of an agreement not to be written so the two parties to the agreement understand the transaction; they already know what they are trying to accomplish. The drafting should be designed to be reviewed by a third party, so that the reviewer — whether a judge, mediator or arbitrator — clearly discerns exactly what the two parties are agreeing to.”

Cambridge attorney David E. Belfort agreed that the case is a cautionary tale to advocates to pay “special attention upfront to the mechanism by which their client alleges a right to enforcement of the restriction.”

But the company may never have been dragged into court at all had it taken one simple step, according to Boston attorney Lee T. Gesmer.

“The way you avoid this is to have the employee execute a new agreement at the time of acquisition,” he said.

However, doing so is “fraught with its own risk,” Boston attorney Russell Beck argued.

“Any time you ask a new employee in this context to sign a non-compete, there is possibility they reject the employment and the accompanying non-compete,” he said. “If that happens, depending on how the offer is made, the prior agreement may or may not be enforceable.”

Either way, Gesmer agreed that the takeaway is the need to be “extraordinarily careful” in crafting non-compete clauses, ensuring to include “assignees” in the definition of “company,” as was not done here.

Especially in light of the dearth of precedent, Beck noted that the judge made “significant statements” on a pair of common non-compete issues, albeit ones that did not affect the outcome.

The first is the “material change doctrine.” Salinger found that even though the employee had been promoted, assumed additional responsibilities, and seen his salary increase by a third, those changes were not significant enough to invalidate the non-compete he had signed years earlier.

Salinger also discussed the fact that other employees had been allowed to leave the company without being held to their non-competes.

While Salinger rejected out of hand the notion that inconsistent enforcement weakens a company’s position, and other courts have agreed, some have taken that fact into account when weighing an attempt to enforce a non-compete, Beck said.

In the bigger picture, Belfort said that the case’s nuanced legal argument “screams for legislative intervention.”

“No typical employee can be expected to reasonably assess, at execution, the scope of a restriction’s applicability when it includes ‘all subsidiaries and affiliates’ into the future,” he said.

Belford added that Salinger’s distinctions between the impact of assignment and merger serve as an excellent roadmap for attorneys, but leave unrepresented employees that are often pressured to sign non-competes “largely in the dark.”

Efforts to obtain comment from the plaintiff employer’s attorney, Erik Weibust of Boston, were unsuccessful.

rivkind-ralph

“The drafting [of an agreement] should be designed to be reviewed by a third party, so that the reviewer — whether a judge, mediator or arbitrator — clearly discerns exactly what the two parties are agreeing to.”

— Ralph J. Rivkind, Boston

Joining the competition

In January 2001, defendant Carl Hohenstein began a 14-plus-year career working with subsidiaries of Danaher Corp. For close to a decade, until April 2014, he was a sales engineer for Fluke Networks, and then for a year held the title of senior systems engineer with the same company. He subsequently took a similar position with a different subsidiary, AirMagnet.

In late 2011, Hohenstein and Danaher entered into an agreement under which Hohenstein was prohibited from using or disclosing any confidential information belonging to “the Company” for any purpose other than performing his duties as a Danaher employee, and from competing with “the Company” by soliciting potential customers or helping to develop competing products while working for “the Company” and for 12 months thereafter.

The agreement defined “the Company” as “Danaher Corporation including its subsidiaries and/or affiliates” but, importantly, failed to include any assigns of Danaher or its subsidiaries or affiliates.

Plaintiff NetScout acquired Danaher’s communications business, which included Fluke Networks and AirMagnet, on July 14, 2015. Hohenstein and NetScout never entered into any non-competition or non-solicitation agreement of their own.

As initially described by the court, the acquisition was an “asset deal,” which led to Hohenstein becoming a NetScout employee, apparently ending his tenure as a Danaher employee.

Under such an interpretation, Hohenstein’s non-compete clause would have expired a year later, on July 14, 2016, and only bound him not to compete with Danaher and its subsidiaries, not NetScout, Salinger initially ruled.

However, in its motion for reconsideration, NetScout proved that its initial assertion that it received an assignment of Danaher’s rights under Hohenstein’s agreement was incorrect. Instead, Hohenstein’s employment had been transferred to a Danaher subsidiary, which was then merged into a wholly-owned subsidiary of NetScout.

The effect of those transactions was to make NetScout “the legal successor to the last Danaher subsidiary that was entitled to enforce the Agreement against Hohenstein,” Salinger wrote.

Hohenstein worked for NetScout as a principal sales engineer for the mid-Atlantic region, making technical presentations to NetScout’s prospective or current customers. Hohenstein had access to confidential financial information about NetScout’s sales and customer accounts, but only within his territory.

This past January, Hohenstein joined Riverbed Technologies as sales engineer director/manager. His territory includes most of the New England states, the northern part of New York and eastern Canada.

Riverbed is enough of a NetScout competitor to have published at least one marketing paper comparing the architecture and performance of its information technology solutions with those sold by NetScout.

Salinger ultimately decided to bar Hohenstein from soliciting NetScout’s customers or attempting to sell products that compete with those of NetScout in the mid-Atlantic states until Jan. 12, 2018.

Too wide a sweep

After concluding that NetScout was entitled to enforce Hohenstein’s obligations under his contract with Danaher, Salinger concluded that the agreement also was “reasonable with respect to the scope of activities it restricts and the length of time … that those provisions remain in effect after Hohenstein stopped working for NetScout.”

But he added that agreement’s restrictions on completion and solicitation were overbroad geographically.

“Although Hohenstein occasionally dealt with customers located outside the mid-Atlantic region, NetScout has not met its burden of proving ‘that its good will’ is likely to suffer irreparable harm [if] Hohenstein supervises sales engineers who engage in or support sales activity ‘outside of the sales territory formerly assigned to him,’” the judge wrote.

NetScout tried to argue that the geographical scope of the agreement’s non-competition and non-solicitation provisions should not be limited due to Hohenstein’s access to technical information about its products.

“But NetScout has not met its burden of proving that this information was in fact confidential, as opposed to something that is routinely shared with customers,” Salinger wrote.

Indeed, Riverbed’s marketing materials comparing the architecture and performance of its products with those sold by NetScout “suggests that competitors and customers are well aware of the kind of technical information that Hohenstein had access to and used while he was part of NetScout’s sales team.”

Salinger added that it was settled law that Hohenstein could make use of publicly available information as well as knowledge he accrued on the job.

“The Court therefore concludes that the non-competition and non-solicitation provisions of the Agreement may only be enforced within the mid-Atlantic region that was the focus of Hohenstein’s sales efforts while employed by NetScout,” Salinger said.

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