Louisiana Court Upholds Ruling Allowing for the Reformation of a Noncompetition Agreement
The Louisiana Second Circuit Court of Appeal recently held that a noncompetition provision under La. R.S 23:921 affecting a former member of an accounting limited liability company (LLC) could be reformed when the scope of the defined business and geographic limitation was overly broad. It also held that an LLC may not prohibit its former members from becoming employed by a competing business, though it can prohibit an employee from owning an interest in a competitor.
In Heard, McElroy & Vestal, LLC v. John C. Schmidt, et al., 52,783-CA (September 25, 2019), an accounting firm, Heard, McElroy & Vestal, LLC (HMV), sued its former member John Schmidt, a certified public accountant (CPA), and his limited liability company John Schmidt CPA, LLC (Schmidt LLC) for violations of the noncompetition provision in HMV’s operating agreement.
La. R.S. 23:921(L) allows an LLC and its members to agree to “refrain from carrying on or engaging in a business similar to” the LLC or from soliciting customer of the LLC for a period of up to two years.
In July 2013, Schmidt LLC became a member of HMV and agreed to be bound by the provisions of its operating agreement. Under Article 22 of the agreement, “members of HMV may terminate a member at any time for cause, which includes conduct considered by the other members to be unbecoming to a CPA or detrimental to HMV’s reputation.” In June 2018, two-thirds of HMV’s members “voted to terminate Schmidt LLC for cause.”
Article 25 of the HMV operating agreement contained a noncompetition provision, which provided that once terminated for cause, Schmidt LLC was prohibited from the following conduct:
Engaging in the performance of accounting services within the geographic area designated in the agreement, including serving as a director, manager, officer, agent, or employee
Soliciting clients of HMV within the designated area
Serving as an executor or trustee of any client of HMV within the area
“Serving as a voting member on the board of Directors of a company nonprofit organization that HMV is auditing at the time of the termination date or at any time during the restricted term”
The trial court found that Article 25 was overly broad in how it defined the competing business and its geographic range under La. R.S. 23:921(L), but that the noncompetition provision was nevertheless enforceable after reformation by the court. The trial court held that (1) Schmidt was not allowed to carry on or engage in his own business in competition with HMV and could not solicit HMV’s clients for a period of two years and (2) Schmidt was entitled to seek employment with and be employed by HMV’s competitors. HMV appealed the judgment.
The Court of Appeal’s Interpretation of La. R.S. 23:921(L)
The Louisiana Second Circuit upheld the trial court’s finding that La. R.S. 23:921(L) “does not allow a member of an LLC to contractually agree not to seek employment with a competitor of the former company after termination.” The court noted that the starting point in interpreting any statute is the plain language of the statute itself. Section 921(L) provides the following:
A limited liability company and the individual members of such limited liability company may agree that such members will refrain from carrying on or engaging in a business similar to that of the limited liability company and from soliciting customers of the limited liability company within a specified parish or parishes, municipality or municipalities, or parts thereof, for as long as the limited liability company carries on a similar business therein, not to exceed a period of two years from the date such member ceases to be a member.
HMV argued that La. R.S. 23:921(L) uses the same phrase “carrying on or engaging in” a business similar to the former company that the legislature defined in subsection D. Subsection D states that “[F]or the purposes of subsection (B) and (C) [of the statute], a person who becomes employed by a competing business, regardless of whether or not that person is an owner or equity interest holder of that competing business, may be deemed to be carrying on or engaging in a business similar to that of the party having a contractual right to prevent that person from competing.” La. R.S. 23:921(B)–(C) provide exceptions for noncompete agreements involving employees and the sale of the goodwill of a business. Essentially, subsection D means that a person does not need an ownership stake in the competing business to be barred from competing with his or her former employer. However, the court noted that subsection L was added after subsection D and the legislature could have, but did not, make subsection D applicable to subsection L. It further pointed out that “treating employees and members differently may be based on the contrasting roles of each in the entity, just as is done by HMV, in which members sign the operating agreement and decide how the LLC will be managed while employees do not.” Accordingly, the court held that Schmidt might be barred from owning a competing business but not from being employed by one.
Furthermore, HMV argued that the trial court erred in finding that La. R.S. 23:921(C), which applies to agents or employees, did not apply to Schmidt. HMV argued that Schmidt was an agent of HMV and therefore could agree to refrain from being employed by a competing business pursuant to subsection C. The court held that Schmidt was not an agent for HMV because the agreement expressly referred to him as a member, not as an agent. Accordingly, it held that subsection L, not C, applied to the noncompete provision.
Reformation of a Noncompetition Agreement
The court held that the trial court did not err in concluding that the agreement’s definition of “clients” was overly broad and “made it difficult to determine the limits of solicitation,” as well as that “the geographic range improperly extended to locations where HMV might intend to do business.” Nonetheless, the court determined that it was not necessary to invalidate the agreement, citing the agreement’s broad severability clause, which provided that “to the extent that the covenant hereunder shall be adjudicated to be invalid or unenforceable in any one such jurisdiction, this Agreement shall be deemed amended to reform the portion thus adjudicated to be invalid or unenforceable.” Although the court spoke in terms of severability, it appears that this provision allows for reformation and the court used the reformation, rather than severability, process. The court specifically noted that the “severability clause reflects the parties’ intent that if possible, the court should reform the agreement by excising any offending language.”
In conducting its reformation, the trial court “narrowed the geographic range to locations where HMV conducted business activities, removed sentences from the solicitation provision, deleted part of the definition of client and deleted the provision that prohibited Schmidt from being employed by HMV competitors.” Although the court of appeal acknowledged that the trial court’s revisions to Article 25 were “fairly extensive,” the court held it could not find that the trial court “abused its discretion in deciding to reform Article 25.1 by deleting the overbroad provisions, resulting in an enforceable noncompetition agreement.”
This case reminds us that Louisiana’s noncompete statute is a demanding one. When drafting noncompetition agreements, members of LLCs and counsel advising them may want to consider this decision’s holding that an LLC may not prohibit a former member from being employed by a competitor. LLCs may want to focus the non-compete obligation on one’s status as a member, not as an employee or agent. Louisiana courts have refused to reform overly broad non-compete agreements.