While non-competition arrangements are subject to strict scrutiny in the context of employment agreements, enforceability is governed by a more flexible standard when the agreement arises in the context of the sale of a business.
In Capital One Financial Corporation v. Kanas and Bohlsen, the Honorable Liam O’Grady of the U.S. District Court for the Eastern District of Virginia was presented with the rare opportunity to delineate the characteristics that distinguish between the two arrangements and to test the reasonableness of a five-year restriction with nationwide limits on competition.
Over many years, Kanas and Bohlsen (‘the partners”) develop a very successful banking business in the New York metropolitan area; so successful that in 2006, Capital One acquired North Fork Bank from the partners for $13.2 billion. The terms of the sale included post-sale employment for the partners with Capital One and a restrictive share agreement providing that the partners would not engage in “competitive business” for five years after ending their employment with Capital One. While most of the post-employment restrictions were national in scope, the range of each restriction was carefully tailored to the lines of business that were considered competitive.
The partners left Capital One in July 2007. In May 2009, they formed BankUnited in Florida, where Capital One had no branches. However in 2011, within the restricted period, BankUnited acquired mortgage loan portfolios within the restricted area and then acquired a Maryland bank that made equipment loans nationwide. Conscious of the non-compete, BankUnited and the partners implemented a “ring-fencing structure” in an effort to isolate the partners so that they were “not providing services” within the meaning of the non-compete. Capital One did not find the ring-fencing to be adequate and brought suit to enforce the non-competition agreements. The partners responded by filing a motion for summary judgment, asking the court to void the non-competition agreement. In reviewing the partners’ motion for summary judgment, Judge O’Grady pointed out that Virginia courts have developed two frameworks for analyzing non-competition agreements, depending on whether the covenant is ancillary to the sale of a business or arises from an employment relationship. When analyzing non-competes between a seller and a buyer of a business, greater latitude is allowed in determining the reasonableness of the restraint. Since the Capital One dispute contained elements of both types of arrangement, Judge O’Grady’s first step was to determine which analytical template applied.
According to Judge O’Grady, the two key features of the sale of business framework are that the owner of a business conveys its “full value on its sale by contracting not to destroy the goodwill of that business through immediate competition” and that the transaction is the result of “an arms-length negotiation between sophisticated parties of comparable bargaining power.”
In the case of the partners’ separation from Capital One, the body of the separation agreement is consistent with “the metes and bounds of the parties’ employer/employee relationship” and there is no reference to the sale of North Fork’s goodwill or the other assets of the business. Judge O’Grady also found other characteristics particular to the employment relationship: that confidential information received “during their employment” was provided to the partners during the term of their employment; that the non-compete ran from the termination of employment and not the date of the sale; and that the covenant not to compete was not a condition of the sale of North Fork. The judge concluded that while “it is true that… policy considerations favor proceeding under the sale-of-business framework…. [n]onetheless, policy considerations alone cannot dictate the applicable framework.” The determination that the far stricter employment standard of analysis applied, was a preliminary victory for the partners.
Judge O’Grady then evaluated the enforceability of the non-competition agreement under the well-established test of reasonableness of duration, geography and function in light of the employers legitimate business interests. Particularly in light of the five-year duration and the national scope of the functional prohibition, the restriction appeared vulnerable under the employment test.
However, the court also found it to be indisputable that Kanas and Bohlsen had, during the course of their employment, access to confidential information and personal contact that allowed them to developed strong professional relationships with Capital One’s customers. Moreover, Capital One had legitimate reason to fear “the Defendants’ ability to grow a bank into a formidable competitor. After all, they had done it before.” In light of the partners’ unusual ability to compete successfully, the court found that the provision was reasonable in both geographical scope and duration. Because it was “no broader than reasonably necessary,” the provision was enforceable.
By sustaining a non-competition agreement with a five-year duration and national restrictions on competition, Judge O’Grady upheld a provision outside the generally accepted boundaries of reasonableness under the employee-employer framework. But, the judge also reminds us that in Virginia, non-competes must always be analyzed on a case-by-case basis – what is unreasonable in one context might be acceptable in another. In this case, the value of the consideration to the partners, their business sophistication, and their admitted ability to make a living without violating the non-compete all argued that, even under the strict employer-employee standard, the five-year non-compete was no broader than necessary to protect Capital One’s legitimate interests, and that is the ultimate measure of enforceability.