Restrictions against competition are frequently included in employment agreements and agreements for the sale of business assets or stock.  The restriction against competition is designed to secure a time period for the employer or buyer of business assets, as the case may be, during which the employer/buyer is free from competition for a departed employee or seller so as to facilitate the transition and better protect their own business assets and customer relationships.  If properly drafted and implemented, restrictions against competition are enforceable under Pennsylvania law.

The primary method of enforcement in the event of breach is a preliminary injunction in equity.  In order to prevail on a petition for preliminary injunction, a petitioner must demonstrate several factors including (1) the need to prevent irreparable harm which cannot be compensated by money damages, (2) that more harm will result from the denial of the preliminary injunction than from granting same, (3) that the injunction will restore the parties to the status quo, (4) the likelihood of success on the merits, (5) that the injunction is designed to abate the offending activity, and (6) that the injunction will not negatively impact public policy.   In most cases the issues of likelihood of success on the merits and irreparable harm incapable of compensation with money damages represent the contested issues.

In Bucks County, the petition for preliminary injunction must be accompanied by a verified complaint and an order for hearing.  The petition is often, though not always, heard by the initial pre-trial judge assigned to the case at the time of filing.  Court administration reviews all petitions for preliminary injunction and assigns the presiding judge, courtroom and date for evidence to be taken.  The order for hearing is an essential aspect of the petition; without it, no hearing will be scheduled.

The petitioner in any injunction matter bears a heavy burden.  Adequate evidence as to the need for enforcement of the covenant, the potential irreparable harm and right to relief must be presented.  Because the entry of injunctive relief is an extraordinary remedy, the evidence must be clear and persuasive.  In employment and business asset transfer cases, the language of the restriction in the applicable agreements must be constrained to those aspects of competition which are reasonably necessary for the protection of the employer/buyer.  For example, a covenant which is overbroad in terms of geography, time or scope will not be enforced.

Preliminary injunctive relief may be acquired in the Bucks County Court of Common Pleas if supported by the underlying agreement and if properly perfected under the practices and procedures employed in the County.

Just when minority owners of Delaware LLCs thought that the Delaware Limited Liability Company Act (the “Act”) protected them from overreaching managers, along comes the Delaware Supreme Court to say “better get it in writing.” It appears that practitioners longing for certainty will have to wait until the Delaware legislature steps in and revises the statute.

The Delaware Supreme Court recently published an opinion in a case involving a Delaware LLC (Gatz Properties, LLC) that was the manager of another LLC (Peconic Bay, LLC). Gatz Properties is managed and controlled by William Gatz, and the Gatz family and their affiliates owned controlling equity interests in Peconic Bay. They also owned real estate that was leased to Peconic Bay, which in turn subleased the property to a national golf course operator. The golf course proved to be unprofitable because it was poorly managed, and Mr. Katz anticipated that the sublease would be terminated. He decided to acquire the sublease and Peconic Bay’s other assets for himself. Consequently, he foiled the efforts of a third party to buy the sublease rights. He then engaged a valuation expert to appraise the property but did not provide the expert with information about the prior third party offers or tell the expert that the golf course’s unattractive financials were the result of its being mismanaged. Not surprisingly, the resulting appraisal showed that Peconic Bay had no net positive value. Next, Mr. Katz hired an auctioneer with no experience in the golf course industry to sell the golf course business. After lackluster advertising for the auction, Mr. Katz was the sole bidder and acquired the property for $50,000 plus the assumption of debt. Peconic Bay’s minority members brought suit in the Delaware Court of Chancery, alleging that Mr. Katz had breached his fiduciary duties to them. The Court of Chancery held that Gatz had breached both his contractual and statutory duties to the minority members, and Gatz appealed to the Delaware Supreme Court.

The Delaware Supreme Court agreed with the Court of Chancery that the LLC agreement’s clear language prohibited self-dealing without the consent of 2/3 of the minority owners, and Mr. Gatz testified on several occasions that he understood that Gatz Properties owned fiduciary duties to the minority members. The Court also upheld the lower court’s finding that Gatz breached this duty.

Moving on to whether Gatz breached a statutory duty under the Act, the Court noted that it was “improvident and unnecessary” for the Court of Chancery to decide that the Act imposed “default” fiduciary duties on managers where the LLC agreement is silent because, in the case at bar, the issue could be decided by interpreting the text of the LLC agreement. Additionally, no litigant asked that the lower court resolve the issue by interpreting the Act. Another concern for the Court was the lower court’s suggestion that its statutory interpretation should withstand scrutiny because practitioners rely on its rulings. The Court remarked that, as the highest court in Delaware, it was not bound to follow the lower court’s decisions. The Court rebuked the lower court for using the case at hand as a “platform to propagate [its] world views on issues not presented.” The Court concluded its reprimand by stating that because the issue of whether the Act imposes default fiduciary duties is one on which reasonable minds can differ, the matter should be left to the legislature to clarify.

Following the decision in Gatz Properties, equity holders in Delaware manager-managed LLCs would be prudent to clearly identify in the LLC agreement which fiduciary duties are intended to apply to their managers. Given the Court’s position that the issue is a matter for the legislature (not the courts) to decide, practitioners will be monitoring the activities of the legislature to see if it takes up the gauntlet.

It is not uncommon for a minority shareholder to cry foul when the corporation is sold and the shareholder believes he received less than fair value for his shares. Such claims often result in shareholder oppression suits, with the majority shareholder accused of having breached a fiduciary duty to the minority owner. Now it seems that controlling shareholders of even privately held corporations have another potential adversary: the Securities Exchange Commission. The SEC recently sued Stiefel Laboratories and its then-controlling shareholder and CEO Charles Stiefel, alleging that they defrauded current and former employee shareholders out of more than $110 million by buying back shares in the company at undervalued prices prior to the sale of the company to GlaxoSmithKline PLC.

The complaint alleges that the defendants misled the employee shareholders, who had acquired the shares as part of a stock bonus plan, by concealing material information about the potential acquisition of the company by GlaxoSmithKline. Information regarding several offers from private equity firms to acquire stock in the company at a higher price than the valuation provided to employees was also allegedly withheld from employees. The complaint further asserts that the valuation that the company provided to employees was prepared by an unqualified accountant who used flawed methodology. Adding insult to injury, a 35% discount incorporated into the valuation was not disclosed to the employees.

The complaint cites, among other things, the company's repurchase of 800 shares from employees at a price equal to $16,469 per share in the months leading up to the sale to GlaxoSmithKline, which acquired the company for $68,000 per share. As a result of the reduced number of outstanding shares, the remaining shareholders (consisting mostly of Stiefel family members) received a windfall.

The SEC warns that privately held companies and their officers should be aware that federal securities laws are intended to protect all shareholders, regardless of whether they acquire their shares in a private transaction such as a stock bonus plan or on a public market. Corporate officers in corporations with stock bonus plans should take care to obtain appropriate valuations to support stock repurchases from accredited professionals using commonly accepted valuation methodologies. Stock option plans and corresponding summary plan descriptions should be carefully reviewed, with a particular focus on their stock repurchase provisions. All material facts must be fully disclosed to plan participants in a timely manner.

To avoid post-transaction cries of foul play from former shareholders, we often include “tail” provisions that allow the former shareholders to enjoy the same economic benefit of a major company transaction such as a sale or merger that follows the sale of their shares. Such provisions are usually of limited duration (e.g., twelve months). This protects the company and senior management from claims like those raised by Stiefel Laboratories employees after the expiration of the tail period.