Tag: Non-competition agreements

Limits of Indemnification for Directors in Post-Employment Conduct Suits

David A. Katz is a partner specializing in the areas of mergers and acquisitions, corporate governance and activism, and crisis management at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Katz, William Savitt, and Nicholas Walter. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Recent rulings by the Delaware Court of Chancery have clarified the availability and limits of indemnification and advancement for former directors and officers of Delaware corporations in lawsuits concerning post-employment behavior.

In Lieberman v. Electrolytic Ozone, Inc., C.A. No. 10152-VCN (Aug. 31, 2015) , two former officers of a company sought advancement for defending claims brought against them by the company for breach of a noncompete agreement. Each former officer had signed an indemnification agreement providing that the company would indemnify him against lawsuits brought “by reason of the fact” that he was an officer-the greatest extent of indemnification possible under Delaware law. In addition, the company had agreed to advance the officers’ expenses for any lawsuit against which the officers were indemnified. The Court denied their claim for advancement: “Importantly, [the company’s] contractual claims are not dependent on any alleged on-the-job misconduct.” Therefore, the Court held, the lawsuits were not claims brought “by reason of the fact” that the defendants had been corporate officers, and they were accordingly not entitled to indemnification or advancement.


Non-Compete Provisions in CEO Contracts

The following post comes to us from Michael S. Katzke, a founding partner of Katzke & Morgenbesser LLP, and is based on a Katzke & Morgenbesser publication by Mr. Katzke and Henry I. Morgenbesser.

In negotiating the terms of a CEO employment arrangement, arguably the most important term for the board of directors of the employer is the non-competition (or non-compete) provision. A recent study by three business and law school professors (Bishara, N., Martin, K, and Thomas, R., When Do CEOs Have Covenants Not to Compete in Their Employment Contracts? (October 18, 2012) Ross School of Business) has found that, in spite of concerns by commentators that CEOs often have bargaining leverage over employers, there has been a significant upward trend over time in the use of non-compete provisions in new and restated CEO contracts. The study found usage of non-competes peaked in 2008 (89%) and in 2010 was at approximately 79%, up from 60-65% in the early 1990s.


CEO Employment Contracts and Non-compete Covenants

Randall S. Thomas is a John Beasley II Professor of Law and Business at Vanderbilt Law School.

In our recent working paper, When Do CEOs Have Covenants Not to Compete in Their Employment Contracts?, we undertake the first comprehensive study of contractual restrictions on CEOs’ post-employment competitive activities. The large random sample of nearly 1,000 CEO employment contracts for 500 companies was selected from the S&P 1500 from the 1990s through 2010. We find that about 70% of CEO contracts have post-employment competitive restrictions. We also find more covenants not to compete (CNCs or noncompetes) in longer-term employment contracts and at profitable firms. In addition, our study uses a nuanced state-by-state CNC strength of enforcement index to test the variance of CEO noncompetes across jurisdictions.


Tying Non-Competes to Sale of Business: California Appellate Court Decision

Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn client alert by Jim Alexander, Frederick Brown, Steven J. Johnson, Jason Schwartz and Katherine V.A. Smith.

On August 24, 2012, in the case of Fillpoint, LLC v. Maas, a California appellate court issued an opinion reinforcing both California’s general public policy against covenants not to compete and the important exceptions to that rule. While California Business and Professions Code § 16600 generally declares void any covenant that restrains an individual from engaging in a lawful profession, trade or business, § 16601 provides an exception to this rule for covenants executed in connection with the sale of a business. The Fillpoint case instructs that, to qualify for § 16601’s sale-of-business exception, employers must thoroughly document and tether any non-compete covenant to the sale of a business.


Noncompetition Agreements

(Editor’s Note: This post comes from Mark Garmaise of UCLA Anderson School of Management.)

For most firms, the human capital of their employees is a core asset, but it is one over which they cannot exercise full ownership. Noncompetition agreements (also known as covenants not to compete) are contracts that restrict workers from joining (or forming) a rival company, and they represent one of the most important mechanisms binding employees to a firm. In my forthcoming Journal of Law, Economics and Organizations paper, Ties that Truly Bind: Noncompetition Agreements, Executive Compensation, and Firm Investment, I make use of time-series and cross-sectional variation in noncompetition enforceability across the states of the United States to analyze the effects of these agreements.

I start my analysis by considering two contrasting theoretical models. In the first model (Model A), I study the effects of noncompetition enforceability on a firm that is deciding whether to make a non-contractible partially firm-specific investment in the human capital of its manager. In my second model (Model B), managers also have the option to make a non-contractible investment in their own general human capital. I make use of data on state regulations and the Execucomp database of executive compensation to test the predictions of Models A and B by analyzing the effects of noncompetition enforceability. I first show that noncompetition are quite commonly utilized; I find that 70.2% of firms use them with their top executives. I then perform two types of tests. My time-series tests consider changes in noncompetition enforceability law that took place in Texas, Florida, and Louisiana. These tests employ firm fixed effects to analyze the impact of the legal shifts, controlling for all firm-specific variables. My cross-sectional tests analyze differences in enforceability across all states. I argue that noncompetition law is particularly important to firms with substantial within-state competition since covenants not to compete typically have limited geographic scope and are easiest to enforce in the same legal jurisdiction. I then use the interaction between enforceability and the extent of in-state competition as a measure of the power and relevance of noncompetition law for a given firm. I include state fixed effects in our cross-sectional tests to control for differences between states unrelated to noncompetition enforceability, and I also control for industry effects.