Court Opinion

ID: 2774269
Source: CourtListenerOpinion
Date Created: 2015-01-28 21:02:43.050697+00
Date Added: 2024-06-11T11:27:53.503047
License: Public Domain

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

ASCENSION INSURANCE               )
HOLDINGS, LLC, a Delaware limited )
liability company,                )
                                  )
                  Plaintiff,      )
                                  )
                                  )
      v.                          ) C.A. No. 9897-VCG
                                  )
ROBERTS F. UNDERWOOD, an          )
individual, and ALLIANT INSURANCE )
SERVICES, INC., a Delaware        )
corporation,                      )
                                  )
                  Defendants.     )

                       MEMORANDUM OPINION

                     Date Submitted: January 27, 2015
                      Date Decided: January 28, 2015

Barry M. Willoughby, Rolin Bissell, and Margaret M. DiBianca, of YOUNG
CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; OF
COUNSEL: Kaye E. Steinsapir, of BRYAN CAVE LLP, Santa Monica,
California, Attorneys for Plaintiff Ascension Insurance Holdings, LLC.

Kathleen Furey McDonough, John A. Sensing, and Andrew H. Sauder, of
POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; OF
COUNSEL: Debra L. Fischer, of MORGAN LEWIS & BOCKIUS LLP, Los
Angeles, California; Seth M. Gerber, of MORGAN LEWIS & BOCKIUS LLP,
Santa Monica, California, Attorneys for Defendants Roberts F. Underwood and
Alliant Insurance Services, Inc.

GLASSCOCK, Vice Chancellor
       This Memorandum Opinion addresses the Plaintiff’s request for preliminary

injunctive relief enjoining the Defendant Roberts F. Underwood and his current

employer, Defendant Alliant Insurance Services, Inc., from breaching a covenant

not to compete entered by Mr. Underwood in 2008 as part of an employee

investment agreement (the “EIA”). There is no question that the covenant, if

enforceable, would support the injunctive relief sought here. The Defendants

argue strenuously, however, that the covenant is unenforceable as against the

public policy of California, the state where the contract was entered.1

                                     I. BACKGROUND

       I heard oral argument on the Plaintiff’s Motion for a Preliminary Injunction

on October 15, 2014. In a bench decision, I denied the Motion without prejudice

and allowed the parties to engage in supplemental briefing addressing (1) whether

the EIA was part of an asset sale, and (2) whether a 2011 employment agreement

superseded the EIA. I heard oral argument on that supplemental briefing on

January 21, 2015, after which the parties filed additional memoranda on the

remedies sought. The background that follows is based on the facts gleaned from

the limited record developed as described above.

       Underwood participated in a sale of the assets of Paula Financial to the

Plaintiff, Ascension Insurance Holdings, LLC (the “Parent” or the “Plaintiff”) in

1
  The Plaintiff previously agreed that the grounds for its preliminary injunction rise and fall with
the enforceability of the EIA.
                                                 1
2008. That transaction was governed by an asset purchase agreement (the “APA”).

In connection with the APA, Underwood entered into an accompanying

employment agreement (the “Employment Agreement”), and pursuant to both

contracts he agreed to refrain from engaging in the business of the Parent or its

subsidiaries, including Underwood’s former employer, Ascension Insurance

Services, Inc., (the “Subsidiary”), for a period of five years. Those contractual

arrangements were entered into in January and February of 2008, and the

covenants by which Underwood agreed not to compete for five years after the

transaction closed—provisions that were contained in the APA and the

Employment Agreement—have lapsed. However, as part of the asset sale, the

parties to that sale contemplated that a subsequent arrangement would be reached

between Underwood and the Parent permitting Underwood to purchase an interest

in the Parent. That agreement, the EIA, was entered into in July 2008, some five

or six months after the Employment Agreement and APA, respectively, were

entered into and became effective. As part of the EIA, Underwood agreed not to

compete with the Parent or Subsidiary for a period of two years after leaving

employment with the Subsidiary. It is that provision which the Plaintiff seeks to

specifically enforce here.

                                       2
                              II. STANDARD OF REVIEW

       Under the well-known standard for a preliminary injunction, a plaintiff must

demonstrate: (1) a reasonable probability of success on the merits; (2) that absent

preliminary injunctive relief, it faces imminent and irreparable injury; and (3) that

such harm outweighs the harm that may result from the injunction, should it prove

to have been improvidently granted.2

                                       III. ANALYSIS

       Unlike Delaware, California public policy disallows contractual agreements

not to compete.3 In other words, in California, a contracting party’s right to freely

be employed (and to compete thereby with the parties with whom he has

contracted) trumps his freedom to contract. This is not a common-law prohibition;

it is enshrined in statute.4 There is, however, a narrow exception to that statutory

prohibition against covenants not to compete; where a covenant not to compete is a

part of a sale of equity (or assets) that includes goodwill, the parties may restrict

2
  See C & J Energy Servs., Inc. v. City of Miami Gen. Employees, 2014 WL 7243153, at *13
(Del. Dec. 19, 2014).
3
  See, e.g., Metro Traffic Control, Inc. v. Shadow Traffic Network, 27 Cal. Rptr. 2d 573, 577
(Cal. Ct. App. 1994) (“California courts have consistently declared [Section 16600] an
expression of public policy to ensure that every citizen shall retain the right to pursue any lawful
employment and enterprise of their choice.”); Hill Med. Corp. v. Wycoff, 103 Cal. Rptr. 2d 779,
784 (Cal. Ct. App. 2001) (“California has settled public policy in favor of open competition.”).
4
  See Cal. Bus. & Prof. Code § 16600 (“Except as provided in this chapter, every contract by
which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is
to that extent void.”).
                                                 3
the seller from competing against the purchaser of the interest, to protect the value

of the goodwill that the purchaser is acquiring.5

       In the EIA, the parties agreed to both Delaware venue and Delaware choice

of law. Delaware law respects the parties’ right to freedom of contract, including

with respect to reasonable covenants not to compete.6 Delaware also follows the

Restatement (Second) of Conflict of Laws (the “Restatement”), under which the

parties’ choice of law will generally control an agreement.7 The Restatement

recognizes an exception to that general principal, however: where the parties enter

a contract which, absent a choice-of-law provision, would be governed by the law

of a particular state (which I will call the “default state”), and the default state has a

public policy under which a contractual provision would be limited or void, the

Restatement recognizes that allowing the parties to contract around that public
5
  See id. § 16601 (“Any person who sells the goodwill of a business, or any owner of a business
entity selling or otherwise disposing of all of his or her ownership interest in the business entity,
or any owner of a business entity that sells (a) all or substantially all of its operating assets
together with the goodwill of the business entity, (b) all or substantially all of the operating
assets of a division or a subsidiary of the business entity together with the goodwill of that
division or subsidiary, or (c) all of the ownership interest of any subsidiary, may agree with the
buyer to refrain from carrying on a similar business within a specified geographic area in which
the business so sold, or that of the business entity, division, or subsidiary has been carried on, so
long as the buyer, or any person deriving title to the goodwill or ownership interest from the
buyer, carries on a like business therein.”).
6
  Under Delaware law, “[t]o be enforceable, a covenant not to compete must (1) meet general
contract law requirements, (2) be reasonable in scope and duration, both geographically and
temporally, (3) advance a legitimate economic interest of the party enforcing the covenant, and
(4) survive a balance of the equities.” All Pro Maids, Inc. v. Layton, 2004 WL 1878784 (Del.
Ch. Aug. 9, 2004) aff'd, 880 A.2d 1047 (Del. 2005).
7
  See, e.g., Total Holdings USA, Inc. v. Curran Composites, Inc., 999 A.2d 873, 881–82 (Del.
Ch. 2009); Weil v. Morgan Stanley DW Inc., 877 A.2d 1024, 1032 & n.16 (Del. Ch. 2005) aff'd,
894 A.2d 407 (Del. 2005); Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032,
1047 (Del. Ch. 2006).
                                                 4
policy would be an unwholesome exercise of freedom of contract.8 In other words,

the Restatement is generally supportive of choice-of-law provisions, but recognizes

that allowing parties to circumvent state policy-based contractual prohibitions

through the promiscuous use of such provisions would eliminate the right of the

default state to have control over enforceability of contracts concerning its citizens.

       Here, the contract at issue—the EIA—was entered between a California

resident and a Delaware limited liability company that has its principal place of

business in California. The EIA was negotiated in California9 and involved an

agreement not to compete that was limited almost completely to areas within

California, by virtue of the geographic scope of the Plaintiff’s business.10

California is the state with the strongest contacts to the contract, and there is no

question that, absent the contractual agreement of the parties to import Delaware

law, California law would apply here.11 In such a case, the Restatement provides

8
  Section 187 of the Restatement provides that the chosen law will apply unless
        application of the law of the chosen state would be contrary to a fundamental
        policy of a state which has a materially greater interest than the chosen state in the
        determination of the particular issue and which, under the rule of § 188, would be
        the state of the applicable law in the absence of an effective choice of law by the
        parties.
Restatement (Second) of Conflict of Laws § 187 (1971).
9
  The Defendants assert that “the alleged claims arise out of acts which occurred exclusively in
California,” which presumably includes the negotiation, formation, and execution of the contract.
See Defs.’ Answering Supplemental Br. Opposing Pl.’s Mot. for a Preliminary Injunction at 7.
The Plaintiff has not disputed this assertion. I assume, for purposes of this preliminary
injunctive relief analysis, that the contract was negotiated and entered in California.
10
   The Plaintiff seeks to enforce the covenant predominantly in California, but also in one county
in each of Arizona and Nevada, as indicated in its proposed orders.
11
   See Restatement (Second) of Conflict of Laws § 188(2), which provides:
                                                5
that I must determine whether enforcement of the covenant would conflict with a

“fundamental policy” of California. If so, I must determine whether California has

a materially greater interest in the issue—enforcement (or not) of the contract at

hand—than Delaware. If both these questions are answered in the affirmative,

California law will apply notwithstanding the choice-of-law provision in the EIA.

      A. The Covenant Not to Compete Would Be Void Under California Policy as

        Expressed by Statute

      The Plaintiff argues that the exception to California’s public policy

prohibiting covenants not to compete—an exception restricted to covenants not to

compete in association with the purchase of assets and goodwill—applies here. It

points out that Underwood sold his interest in Paula Financial, including a sale of

goodwill, to the Plaintiff, and that at the time of that asset sale the parties

contemplated that Underwood would be able to purchase an interest in the Plaintiff

itself. The Plaintiff’s factual assertion is bolstered by a side letter agreement,

contemporaneous with the APA, indicating that the parties contemplated that they

      In the absence of an effective choice of law by the parties (see § 187), the contacts
      to be taken into account in applying the principles of § 6 to determine the law
      applicable to an issue include:
              (a) the place of contracting,
              (b) the place of negotiation of the contract,
              (c) the place of performance,
              (d) the location of the subject matter of the contract, and
              (e) the domicil, residence, nationality, place of incorporation and place of
              business of the parties.
      These contacts are to be evaluated according to their relative importance with
      respect to the particular issue.
                                               6
would reach an agreement whereby Underwood would purchase a $250,000

interest in the Plaintiff.12       Accordingly, the Plaintiff argues, the EIA, which

embodied this contemplated agreement, should be deemed a part of the purchase of

assets by the Plaintiff, and its non-compete covenant preserved consistent with

Section 16601.

       The problem with the Plaintiff’s argument is that even though Underwood’s

purchase of an interest in the Plaintiff, as provided for in the EIA, was

contemplated at the time the parties entered into the APA, there was no discussion

between the parties that a restriction on competition would be a part of that

contemplated agreement. In fact, there was a covenant not to compete associated

with the APA, both in the APA itself and restated in the 2008 Employment

Agreement.13 Those agreements prohibited Underwood from competing for a

period of five years after the consummation of the APA and are precisely the type

12
   See Joint Appendix to Supplemental Opening Briefs (“Joint Appendix”) at JA1179–80.
13
   See id. at JA1130–31 (APA § 7.5) (“The sale of the Purchased Assets represents a sale of
substantially all of the assets of the Companies, along with all goodwill associated with the
Business and the Companies, from Sellers to Buyer. In furtherance of the sale of the Purchased
Assets to Buyer hereunder, and more effectively to protect the value and goodwill of the
Purchased Assets and the Business, the Sellers covenant and agree that, for a period of five years
from the Closing Date . . . neither the Sellers nor any of their respective Affiliates . . . shall,
directly or indirectly . . . own, control, manage, operate, conduct, engage in, participate in,
consult with, perform services for or otherwise carry on . . . a business competitive with the
Business anywhere in any county in which the Business has been conducted by the
Companies . . . .”). The APA also included a non-solicitation provision in that section. See id. at
JA1131. The 2008 Employment Agreement, noting that its execution is a condition to closing
the asset sale, binds Mr. Underwood for a “a period of five years following the Closing Date”
from competing with “the Business” in California, or any other place where the sellers conducted
business. See id. at JA1168 (2008 Employment Agreement § 8).
                                                7
of agreement that is contemplated by the statutory exception of Section 16601. To

the extent the EIA attempted to add additional restrictions on Underwood’s right to

compete, those clearly cannot have been relied on as part of the asset purchase

because there was no contemporaneous agreement under which those restrictions

could have been enforced. The non-compete portions of the EIA and its Delaware

choice-of-law provision arose in a contract draft created by the Parent and first

given to Mr. Underwood months after the APA and the Employment Agreement

had been implemented. The evidence does not support a finding that the covenant

not to compete found in the EIA was a negotiated part of the asset purchase; thus,

it could not have been relied upon by the parties as security against competitive

impairment by the seller of the goodwill and assets purchased, which is the sole

ground upon which California relaxes its public policy prohibition against

covenants not to compete.

      On this point, both parties rely on Fillpoint v. Maas to support their

arguments. In that case, the California Court of Appeals was presented with two

agreements, both relating to the same sale of assets, and each containing a different

covenant—one provided for a post-acquisition period for its non-compete, while

the other provided for a post-employment period. The Plaintiff relies on this case

to argue that “the fact that the APA and the EIA were not executed simultaneously

                                         8
has no bearing on the enforceability of the Covenants here,”14 because the

California court ultimately held that the two agreements—though not executed

simultaneously—must be read together. The Defendants, however, rely on this

case for its holding that, even when read together, the post-employment covenant

was void, while the post-acquisition covenant was valid under the Section 16601

exception. As the court noted, “To conclude that the purchase agreement and the

employment agreement should be read together begins, not ends, the analysis

whether the covenant not to compete in the employment agreement is

enforceable.”15 Ultimately, the court concluded that, considering the terms of the

different covenants,

       by their very nature, the restrictions in the covenants not to compete in
       the purchase agreement and the employment agreement are different.
       The purchase agreement’s covenant was focused on protecting the
       acquired goodwill for a limited period of time. The employment
       agreement's covenant targeted an employee's fundamental right to
       pursue his or her profession.16
The former employee in that case had satisfied the post-acquisition covenant, and

the court held that the post-employment covenant did not fall within Section

16601. Consequently, the court upheld the dismissal of the action for breach of

that contract.     Accordingly, Fillpoint provides no support for the Plaintiff’s

position here.

14
   Pl.’s Answering Br. as Supplemental Supp. of Mot. for Preliminary Injunction at 2.
15
   Fillpoint, LLC v. Maas, 146 Cal. Rptr. 3d 194, 203 (Cal. Ct. App. 2012).
16
   Id. at 204.
                                               9
          I find that, but for the choice-of-law provision, California law would apply

to the EIA, and that the non-compete provisions of that agreement would violate a

fundamental public policy of California. The sole remaining question, therefore,

involves whether California’s interest in vindicating its public policy is greater

than Delaware’s interest in enforcing the agreement.

          B. Balancing of the Interests

          The Plaintiff points out that Delaware is strongly contractarian in its law.

This jurisdiction respects the right of parties to freely contract and to be able to rely

on the enforceability of their agreements; where Delaware’s law applies, with very

limited exceptions, our courts will enforce the contractual scheme that the parties

have arrived at through their own self-ordering, both in recognition of a right to

self-order and to promote certainty of obligations and benefits.               Upholding

freedom of contract is a fundamental policy of this State.17 The Plaintiff argues

that Delaware’s interest in this public policy—in favor of the sanctity of contracts

freely entered into—is at least as great as California’s interest in ensuring that its

citizens are not burdened by covenants not to compete. In this regard, the Plaintiff

cites as controlling a bench decision of this Court, DGWL Investment Corp. v.

Giannini.18 After careful consideration of that case, I find it is not controlling

precedent here.         DGWL admittedly involved a similar scenario, involving a

17
     See NACCO Indus., Inc. v. Applica Inc., 997 A.2d 1, 35 (Del. Ch. 2009).
18
     C.A. No. 8647-VCP (Del. Ch. Sept. 19, 2013) (TRANSCRIPT).
                                                10
defendant resident in California against whom the plaintiff sought to enforce a

non-compete agreement that specified Delaware law as governing, but with an

important difference from the facts here: the Court in DGWL found that, in

connection with the sale of his controlling interest in an LLC, the defendant had

received $10 million both for that interest and for his agreement not to compete.

Therefore, the DGWL Court found that the defendant was squarely within the

Section 16601 exception to the prohibition against non-compete agreements, under

California law. In other words, unlike this case, the Defendant in DGWL entered a

covenant not to compete in connection with the sale of goodwill to the Plaintiff,

which is not against the public policy of California.19

          The Court went on to say, in an alternative holding, that even if the

contractual provision at issue was contrary to California law, this jurisdiction’s

interest in freedom of contract was not materially outweighed by the interest of

California in restricting such a non-competition agreement.          That holding,

obviously, was made in light of the facts of that case, which involved a sale of

goodwill, a purchase price which represented not only the transfer of equity but the

promise not to compete, and the re-domicile of the entity sold, from California to

Delaware, as part of the asset purchase agreement. In that context, even assuming

the covenant not to compete did not come within California’s statutory exception

19
     See id. at 9–10.
                                         11
to the prohibition against such covenants, it would be so closely related to that

exception, and so equitably compelling, that California’s interest in promoting its

public policy would be small, and insufficient to outweigh that of Delaware in

enforcing the parties’ contractual choices.

       I cannot agree with the Plaintiff, however, that the teaching of DGWL is that

Delaware’s broad interest in freedom of contract will always, or even routinely,

trump the default state’s public policy. Here, where I find that California law

would clearly prohibit the non-compete provision at issue on fundamental policy

grounds, I find, too, that California’s specific interest is materially greater than

Delaware’s general interest in the sanctity of a contract that has no relationship to

this state. This case involves a contract between a corporation doing business in

California and an employee residing in California, entered into in California and to

be performed predominantly in California—not in Delaware.20 The performance

of the covenant not to compete in that agreement is against a clear public policy of

California stated unequivocally by statute. Against this is a general interest of

Delaware in freedom of contract. Without minimizing that significant interest, it

seems to me that, where it is clear that the policy of the default state is that the

contract at issue is abhorrent and void, and where, as here, the formation and

20
  The non-solicitation provisions of the EIA are, of course, geographically limited to where the
Parent or Subsidiary conduct business. See Joint Appendix at JA1365–66 (EIA § 9(b)). One of
the Plaintiff’s proposed orders includes one county in each of Arizona and Nevada, as well as 14
counties in California.
                                              12
enforcement of the contract relate overwhelmingly to the default state, a general

interest in freedom of contract is unlikely to be the equal of that public policy

under the Restatement analysis. The entire purpose of the Restatement analysis is

to prevent parties from contracting around the law of the default state by importing

the law of a more contractarian state, unless that second state also has a compelling

interest in enforcement. In other words, in every instance where the parties seek to

circumvent application of the law of the default state, the state whose law was

chosen and is asked to enforce the contract will have the interest of protecting

freedom to contract. It would be a tautology to suggest that such an interest alone,

arising in every case, can trump the public interest of the default state, which, by

definition, has the greatest contacts with the contract at issue; otherwise, the

Restatement test would be meaningless, and the default state would lose its ability

to constrain pernicious enforcement of contract rights.

      As discussed above, I find that California law would otherwise apply to the

EIA, that enforcement of the non-competition provisions of the EIA would violate

a fundamental policy of California, and that California’s interest in preventing the

enforcement of a covenant not to compete against a California resident employed

and seeking to compete largely in California—and not in Delaware—is greater

than Delaware’s general, though profound, interest in vindicating freedom of

contract.

                                         13
                                 IV. CONCLUSION

      The ability to self-order is the sine qua non of free markets; without the

ability to hold and dispose of property, and to agree to be bound contractually, no

functional market could exist. Nonetheless, most if not all jurisdictions have

determined as a matter of public policy that some contractual obligations are so

pernicious that they must be removed from the self-ordering realm. To protect

those policy interests, and for reasons of comity, states embracing the Restatement

approach recognize that necessary to the right of a jurisdiction to limit contractual

ordering for its citizens is a limitation on the ability of contracting parties to choose

the law of a foreign jurisdiction which does not impose that limitation, and which

itself has little or no interest in the enforcement of the contract at hand.

      For the reasons set out above, I find that this is such a case; therefore, the

Plaintiff has not demonstrated a reasonable likelihood that it would prevail upon

the merits. Because such a showing is a prerequisite to the imposition of the

extraordinary remedy of preliminary injunctive relief, I need not progress to the

other two showings also necessary before the grant of such relief: irreparable harm

and a favorable balance of equities. Similarly, I need not reach the Defendants’

contention that a 2011 employment agreement between Underwood and the

Subsidiary superseded the EIA, making the latter unenforceable. The Plaintiff’s

request for a preliminary injunction is, accordingly, denied. An appropriate order

                                           14
is attached. The parties should inform me what further proceedings are appropriate

in this matter.

                                       15
   IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

ASCENSION INSURANCE                   )
HOLDINGS, LLC, a Delaware limited     )
liability company,                    )
                                      )
                Plaintiff,            )
                                      )
                                      )
     v.                               ) C.A. No. 9897-VCG
                                      )
ROBERTS F. UNDERWOOD, an              )
individual and ALLIANT INSURANCE      )
SERVICES, INC., a Delaware            )
corporation,                          )
                                      )
                Defendants.           )

                                ORDER

     AND NOW, this 28th day of January, 2015,

     The Court having considered the Plaintiff’s Motion for a Preliminary

Injunction based on a purported breach of the 2008 Employee Investment

Agreement, and for the reasons set forth in the Memorandum Opinion dated

January 28, 2015, IT IS HEREBY ORDERED that the Plaintiff’s Motion is

DENIED.

SO ORDERED:

                                       /s/ Sam Glasscock III

                                       Vice Chancellor