Bankruptcy and Non-Compete Agreements: Impacts and Considerations

By: Thomas Zeichman June 2, 2020 7:10 am

By: Jeffrey Lynne, Esq. and Laura Stinson, University of Miami School of Law (2L)
June 2, 2020 7:10 am

Bankruptcy and Non-Compete Agreements: Impacts and Considerations

Unemployment and company bankruptcies have rapidly increased during the last few months. The employee/employer dynamic can become an issue in the bankruptcy context.  Specifically, many employment agreements include non-compete and non-solicitation provisions. Additionally, when a business owner sells a business the agreement may include these provisions as well. Leaving aside whether the provisions are enforceable under ordinary circumstances, what happens if the employee or the employer files for bankruptcy? Are the non-compete provisions enforceable? Discharged? Modified? Courts have approached these issues in a variety of ways through fact intensive analysis. Below are some considerations and Bankruptcy Code provisions which come into play.

What are non-compete and non-solicitation provisions?

Non-compete provisions generally state that the employee or former business owner in the sale context is not permitted to compete for a defined period of time and in a defined geographic location. Non-solicitation provisions generally seek to prohibit a party from contacting clients or employees from a prior company to entice them to do business or join a new company.

Employer Bankruptcy Issues

Recently the number of business Chapter 11 filings has surged.  There are certain key aspects where non-compete provisions may come into play:

  • bankruptcy sales; and
  • the assumption and rejection of executory contracts.

In the sale context, one of the questions is whether the employment contracts are part of the assets being purchased. If not, who is able to enforce these provisions? How are these contracts being addressed if they are not being included in the sale?

Next, one of the powerful tools under the in bankruptcy is the ability to assume or reject leases and executory contracts. Recently this power has been used in the numerous retail bankruptcies to address store leases. If a lease is not assumed or rejected within the 120 days from the petition date, then it is rejected. A rejection constitutes a breach of the agreement. In at least one case, a court found that a company who rejected a commission contract could not later enforce the non-compete and non-solicitation provisions contained therein.

Employee Bankruptcy Issues

Individuals file for bankruptcy for a variety of reasons including as a result of judgments. Occasionally, those judgments occur when a party seeks to enforce a non-compete or non-solicitation provision through litigation. Can an employee or former business owner discharge their obligations under a non-compete or non-solicitation provision? To address this, it is important to understand what is discharged in bankruptcy and the potential remedies sought when enforcing those non-compete and non-solicitation provisions as well as other restrictive covenants.

Unless an exception applies (certain taxes and other debts), bankruptcy discharges “claims.” Under Section 101(5) of the Bankruptcy Code “claims” are defined as

(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or

(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.

In non-compete and non-solicitation cases the party seeking to enforce the provisions generally seeks both financial damages and an injunction to prevent future breaches of non-compete and non-solicitation provisions.

Certain courts have found that the injunctive relief does not constitute a “claim” which may be discharged because they found that a payment of money would be an inadequate remedy. In those cases, the monetary damages portion is discharged. Other courts have found the opposite depending on the governing state law and whether money damages were an available remedy.

Conclusion

As more employers and employee filed for bankruptcy it is likely non-compete and non-solicitation provisions will become a recurring issue. The enforceability of non-compete and non-solicitation provisions post-bankruptcy filing requires a review of the provisions, the applicable state law, and the unique facts of the employer and employee cases.

Questions? BMU+L’s attorneys have experience representing debtors (both businesses and individuals), creditors, purchasers, and sellers through the various bankruptcy chapters.

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