Enforcement of Noncompete Undermined By Choice of Remedy

To the uninitiated, a standard non-disclosure, non-competition and non-solicitation agreement may seem like pages of meaningless legal “boilerplate” punctuated by a few interesting sentences containing the guts of the document: the restrictions themselves. A recent Massachusetts court decision illustrates that this approach to noncompetition agreements can be perilous. The case underscores the need for employers that utilize non-competition and non-solicitation agreements to give careful attention not just to the specific restrictions being imposed, but also to other aspects of the agreement they may believe to be standard boilerplate.

In Palladium Group, Inc. v. MacGillivray, a company failed in its effort to enforce restrictive covenants not because of any problem with the restrictions themselves, but because of language elsewhere in the agreement limiting the remedies that were available to the employer when an employee breached. The plaintiff in the case, Palladium Group, filed a lawsuit against three former employees and their new employer, Cervello, Inc., to enforce non-competition and non-solicitation provisions in their employment agreements. As is common in cases where the employer believes that competition by ex-employees poses an imminent threat, Palladium immediately asked the court for a preliminary injunction ordering the individuals to stop working for a competitor. The backdrop to this story is that the employment agreements at issue were entered into by the individual defendants as they were selling to Palladium a company they had founded. In exchange for agreeing to several post-closing restrictive covenants, the individuals received various forms of compensation and equity, including deferred compensation, promissory notes and shares in Palladium.

The agreements contained very standard language acknowledging that in the event the employees breached any of the restrictive covenants, the damage to Palladium would be “irreparable.” Such language is included in non-competition and non-solicitation agreements to buttress a potential argument that monetary damages are not sufficient to remedy any harm caused by a breach and, therefore, that immediate injunctive relief – an order from a judge prohibiting certain conduct – is appropriate. So far, so good.

The problem for Palladium, however, was language elsewhere in the agreements stating that if the individuals breached the restrictive covenants, they would forfeit their rights to compensation and equity that they were promised as part of the transaction, and that this forfeiture would be “the sole and exclusive remedy” for any breach.

Palladium attempted to get around this exclusivity language by pointing to the language about irreparable harm and asserting that this was indicative of the parties’ intent that Palladium could seek an injunction if the employees breached the restrictions. Superior Court Judge Diane Kottmyer concluded that the inconsistency in the language rendered the document ambiguous and considered external evidence of the parties’ intent. Palladium, however, offered no evidence to rebut evidence from the individuals that the documents were revised after negotiation to eliminate injunctive relief as a remedy. Thus, Judge Kottmyer denied Palladium’s injunction request, leaving the employees free to compete and solicit customers and employees.

As the agreements were interpreted by the court, the exclusive remedy provision essentially converted the non-competition provision into what is sometimes referred to as a “forfeiture for competition” provision.  The agreements did not, in fact, prohibit competition and solicitation.  Instead, they simply extracted a monetary penalty in the event that the employees chose to compete or solicit.  In this particular case, the employees made precisely that choice.

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