The Interplay Between Mergers and Enforceability of Non-Competition Agreements
Imagine learning that your employee’s non-competition period began to run—and may even have run through its entire term—before that employee even leaves your company. Under a recent Ohio case, there are circumstances in the context of a merger or consolidation that could lead to that very result.
Under Ohio law, covenants not to compete (also called "non-competes" and "non-competition agreements") are generally enforceable provided that the agreement is reasonable and creates obligations on both parties. A non-competition agreement is reasonable if the party seeking to enforce the agreement can demonstrate that the restrictions (1) are no more than necessary to protect the company's interests, (2) do not impose undue hardship on the employee and (3) are not injurious to the public.
In the context of a merger or consolidation, non-competition agreements transfer by operation of law to the successor entity post-merger or consolidation. Ohio Revised Code 1701.82(A)(3) states "[when] a merger or consolidation becomes effective . . . [the] surviving or new entity possesses all assets and property of every description, and every interest in the assets and property . . . and the rights, privileges, immunities, powers, franchises, and authority . . . of each constituent entity." As such, the surviving entity inherits the rights of any valid non-competition agreement. However, the analysis does not end here. While a successor entity inherits the rights under the non-competition agreement, it may not have the right to enforce the agreement during the intended non-compete period -- namely, after the employee's employment is terminated -- unless the agreement is drafted with care.
In Acordia of Ohio, L.L.C. v. Fishel, 2010-Ohio-6235, (1st Dist. Hamilton Co., Dec. 17, 2010), Acordia of Ohio, L.L.C. ("Acordia"), an insurance agency, filed for injunctive relief against a competitor company and four former employees for alleged violation of the employee's non-competition agreement. The court ruled that although non-competition agreements from a predecessor entity are inherited by the successor entity, flaws in drafting ultimately rendered the agreements unenforceable. Acordia was actually a product of six different mergers, acquisitions and name changes over an eight year period. The various employee defendants signed valid non-competition agreements. For example, defendant Michael Fishel ("Fishel") joined the insurance agency Frederick Rauh & Co. in 1993 and signed a non-competition agreement. In 1994, Fredrick Rauh & Co. was acquired by Acordia, Inc. and changed its name to Acordia of Cincinnati, Inc. which in turn later changed its name to Acordia of Ohio, Inc. and, in 2001, eventually merged into what is today, Acordia. Throughout all these mergers and name changes, Fishel never signed a new non-competition agreement.
First, the court determined that non-competition agreements, like other rights and assets, transfer by law in a merger or consolidation. Acordia had inherited all the rights to Fishel's non-competition agreement from Acordia of Ohio, Inc. which had inherited the rights from Acordia of Cincinnati, Inc. and so forth. Next, the court examined whether the non-competition agreement was enforceable against Fishel. Here, the court turned to the language of the agreement. Signed in 1993, Fishel's non-competition agreement reads:
In consideration of my employment and its continuation by Fredrick Rauh & Company (hereinafter, Company) I hereby covenant as follows: (A) For a period of two years following termination of employment with the company [sic] for any reason, I will not directly . . . perform services relating to the insurance business, insurance policies, or related insurance services . . .
The agreement goes on to say, "[the] covenant contained above shall remain in full force and effect regardless of the cause of termination." Since the non-competition agreement explicitly identified Fishel's employer as "Fredrick Rauh & Company" and the covenant would remain for two years "regardless of the cause of termination," the court found that once the entity Fredrick Rauh & Company ceased to exist as a surviving entity, the two year non-competition period had begun to run. By the time Fishel left in 2005, the two year non-competition period had already run out entirely and, therefore, Fishel was no longer subject to its terms. The court rejected Acordia's argument that the non-competition agreement was consistent with public policy because the four employees had remained continuously employed because, by the terms of the agreement, the two year non-competition period began the moment Fishel was no longer employed at Fredrick Rauh & Company. The same was true for the other three employees. In Ohio, post-merger, the non-surviving entity ceases to exist as a separate business entity and therefore Fishel was effectively terminated post-merger even though he continued to be employed by the surviving entity.
Analysis and Recommendations
While the court's conclusion that the employees' non-competition agreements were unenforceable may seem unexpected and harsh, the decision demonstrates the importance of careful contract drafting. The court's conclusion primarily stemmed from the absence of any language confirming that the agreement would be binding on successors. If the non-competition agreement had contained language stating that a merger or consolidation does not constitute a termination, then Acordia could have enforced the non-competition agreement. However, due to the way the agreement was structured, once the entity employing Fishel ceased to exist, Fishel was terminated for all intents and purposes and the non-competition period began to run.
When considering whether to initiate a merger, it is important to distinguish between the right to assign a non-competition agreement and the ability to enforce it. In Acordia, the court agreed that, like all other rights and assets, a non-competition agreement can generally be inherited by the surviving entity. However, depending on the structure of the agreement, if the employer entity is not the surviving entity in a merger or consolidation, the transaction may trigger the unintended running of the non-competition period. In order to ensure the surviving entity’s ability to enforce the non-competition agreement during the intended non-compete period, the agreement should explicitly state that it is binding on the company's successors and that a merger or consolidation does not constitute a termination. Alternatively, the employer may require all new employees to sign a new, valid non-competition agreement with the surviving employer entity.