The Massachusetts Supreme Judicial Court (SJC), the Commonwealth’s highest court, recently clarified the standards applicable to analyzing nonsolicitation and anti-raid restrictive covenants following the sale of a business—an area of law where state appellate court jurisprudence had been lacking.
The SJC’s recent decision in Automile Holdings, LLC v. McGovern, SJC-12740 (January 14, 2020), highlights the differences between nonsolicitation agreements formulated in the context of employment relationships and those arising out of the sale of a business. The decision also describes what may constitute a legitimate and protectable anti-raiding business interest in the sale of a business, and helps to establish a clearer standard for when a trial court may (and may not) exercise its equitable powers by extending the duration of a nonsolicitation covenant.
Factual Background
In 2015, disagreements arose between the defendant, Matthew McGovern and his coshareholders of the Prime Motor Group, which led to the termination of McGovern’s employment. During the year after his termination, Prime applied pressure on McGovern to sell his minority interest in the company. Following negotiations, Prime agreed not to discount McGovern’s ownership interest, despite the fact that Prime was a closely held corporation. In exchange, McGovern agreed not to hire, solicit, or encourage any Prime employees to leave Prime for a period of 18 months. Despite this, during the restricted period, McGovern put to use his specific knowledge of Prime’s employees (including their compensation structures), soliciting and hiring several Prime employees to work at his new venture, McGovern Motors. Prime sued and sought injunctive relief, including an extension of the duration of the nonsolicitation covenant.
The Lower Court’s Decision
The lower court issued a preliminary injunction and set trial for June of 2018, two months prior to the expiration of the nonsolicitation covenant. Following trial, the judge found that the nonsolicitation covenant was enforceable. He also awarded equitable relief, extending the life of the covenant by one year, until August of 2019. McGovern appealed.
The SJC’s Decision
Recognizing that this dispute presented previously unanswered questions about the enforceability of anti-raiding/nonsolicitation covenants, as well as the extent of lower courts’ equitable discretion to extend the duration of restrictive covenants such as McGovern’s, the SJC took on McGovern’s appeal in October of 2019 (despite the fact that the lower court’s extension of the nonsolicitation agreement had since expired).
The SJC affirmed the enforceability of the nonsolicitation covenant. The SJC noted that while some nonsolicitation agreements may at times raise concerns regarding an individual’s ability to compete and arguably may be the “product of unequal bargaining power,” those concerns recede in the context of the sale of a business (though in dicta, the court confirmed the limitations on the enforceability of restrictive covenants in the context of employment/non-sale relationships, noting that employers’ legitimate, protectable business interests in that context “consist of trade secrets, confidential information, and good will”).
Finding that the agreement at issue was semi-hybrid in that it contained elements of the employment agreement context (because it was related to McGovern’s prior employment with Prime), the court nonetheless held that it was more closely related to the sale of McGovern’s business interest. Accordingly, Prime’s potential protectable interests extended beyond trade secrets, confidential information, and goodwill. Specifically, the court found that Prime had a legitimate anti-raiding business interest in light of (1) McGovern’s prior high position within Prime and the insider knowledge about employees’ strengths and compensation structures he had thereby attained; (2) his present position as a direct competitor well-equipped to poach Prime employees; and (3) the additional consideration that McGovern had received (full value for his minority interest in Prime) in exchange for agreeing to the nonsolicitation covenant.
The SJC reversed the lower court’s decision to equitably extend the duration of the nonsolicitation covenant by one year, finding that the judge had abused his discretion where the parties’ agreement did not contain a tolling provision, and absent a finding that monetary damages would provide inadequate relief.
The SJC also clarified the circumstances under which a court’s award of equitable relief extending the scope of a restrictive covenant beyond its plain terms might be proper: when a plaintiff has demonstrated “why monetary damages cannot be reasonably estimated, or calculate[d] the monetary damages incurred and demonstrat[ed] why damages would nonetheless be insufficient such that extraordinary relief is warranted.”
Key Takeaways
- Covenants restricting the solicitation and hiring of a company’s employees are generally enforceable in the context of a sale of a business in Massachusetts.
- The analysis required to determine the enforceability of a restrictive covenant in the context of a sale of a business versus in the employment context is different. However, so-called hybrid covenants that contain elements of both contexts present an added wrinkle. The SJC’s opinion in this case suggests that courts may carefully review the facts surrounding the formation of an agreement to determine which context is more relevant in order to apply the appropriate legal standard.
- Tolling provisions—i.e., contractual provisions that provide for the extension of an agreement’s expiration date in the event of a breach—potentially are enforceable. In the absence of such a provision, a party seeking “equitable relief that extends the scope of [a] restrictive covenant beyond it plain terms” will likely need to show that “monetary damages would provide inadequate relief.”
