Merger does not invalidate noncompete, nonsolicitation covenants

EMPLOYMENT CONTRACTS

November 2016
Ryan B. Frazier
Utah Employment Law Letter

When corporate mergers and acquisitions take place, the parties frequently ask, “What is the effect on the acquired company’s contracts?” That was the issue in a case involving noncompetition and nonsolicitation covenants in employment contracts. In the case, a title company purchased the stock of another company to form a parent-subsidiary relationship. The two companies subsequently merged into a single entity. After the merger, employees who had signed noncompetition and nonsolicitation covenants with the acquired entity left and formed a new title company in competition with their former employer. The former employees who started the new company convinced other employees to defect to the new title company.

When their former employer sued them for violating their noncompetition and nonsolicitation covenants, the employees took the position that the covenants were no longer valid and couldn’t be enforced by the entity that purchased the stock of their original employer and became the “surviving” company after the merger. Read on to find out if the federal court in Utah determined that the restrictive covenants survived the stock purchases and the merger.

Noncompetition and nonsolicitation covenants

First American Title Insurance Company and First American Title Company, LLC, sued Northwest Title Insurance Agency, LLC, Michael Smith, Jeff Williams, and Kristi Carrell for breach of contract. Specifically, First American sought to enforce the noncompetition and nonsolicitation covenants Smith, Williams, and Car­rell signed when they worked for Equity Title Insurance Agency.

Smith, an attorney, signed an employment agree­ment with Equity on August 15, 2004. Likewise, Wil­liams signed an employment agreement on May 16, 2006. Both employment agreements contained a non­competition covenant and a nonsolicitation covenant that were effective during Smith’s and Williams’ em­ployment and for one year after their employment came to an end. The employment agreements also contained a provision stating that their terms, conditions, and ob­ligations inured to the benefit of and were binding on successors and assigns.

Carrell signed a letter agreement with Equity setting forth the terms of her employment. Her letter agreement contained a noncompetition covenant that precluded her from competing within a 40-mile radius for one year after her employment with Equity came to an end.

First American merges with Equity

In September 2003, First American acquired a 25% interest in Equity. It acquired another 25% ownership in Equity in March 2005. First American purchased another 45% ownership in October 2008, making it the majority owner. The stock purchase agreement (SPA) that effectu­ated the acquisition, which was dated October 15, 2008, specifically stated that all material contracts remained in full force and effect. The SPA also defined the employ­ment contracts with Smith and Williams as “material” contracts. After the acquisition, Equity continued to exist.

In February 2009, First American acquired the re­maining 5% ownership interest in Equity, becoming the sole owner. Smith, Williams, and Carrell continued to be employed by Equity. Then, in 2012, First American Title Company, LLC, and Equity merged into a single entity. The name of the surviving entity was First American Title Company, LLC. Smith, Williams, and Carrell con­tinued their employment, in some capacity, with First American after the merger.

Northwest hires First American employees

On March 9, 2015, Smith’s employment with First American came to an end. Northwest opened the same day. Smith is an owner and principal of Northwest and manages the operations of the business. It provides in­surance, escrow, and closing services in competition with First American.

Williams and Carrell both resigned from First Amer­ican on March 10, 2015, and went to work for Northwest. Williams is employed as executive vice president of es­crow operations and is also an owner of the company. Carrell is employed as a vice president, an escrow offi­cer, and a branch manager of Northwest’s Sugar House office.

The parties do not dispute that Smith, Williams, and Carrell have been working in competition with First American. Moreover, between March 10, 2015, and March 24, 2015, Northwest hired 28 employees from First American. Most of them essentially work in the same positions and locations as they did at First American.

First American filed a lawsuit against Northwest, Smith, Williams, and Carrell alleging that they breached their agreements with Equity by competing with First American. It argued that the right to enforce the employ­ment agreements transferred to it from Equity under the law; Smith, Williams, and Carrell violated the noncom­petition provisions of the employment agreements; and Smith and Williams violated the nonsolicitation provi­sions in their employment agreements.

Employment agreements transferred to First American

The court explained that to prove the contracts transferred to it, First American had to prove that (1) Smith, Williams, and Carrell’s employment contracts remained in force after it purchased Equity through the SPA and (2) the employment contracts remained in force after the merger.

The court concluded that the employment contracts remained in effect after the stock purchase. The court recognized that a corporation whose stock is acquired continues to exist. The corporation’s interests and legal obligations also continue when stock is purchased. In other words, any contractual obligations survive the purchase of stock. Because the employment contracts at issue (which contained the noncompetition and nonso­licitation covenants) were valid on October 15, 2008, the date that First American purchased a majority interest of Equity’s stock through the SPA, the employment agree­ments survived the stock purchase.

Northwest argued that on October 16, 2008—the day following the stock purchase—Smith, Williams, and Carrell were “terminated” from their employment with Equity and became employees of First American. Under this theory, the one-year term of the noncompeti­tion and nonsolicitation would have elapsed in 2009, and the applicable statutes of limitations would have run.

The court determined that accepting Northwest’s argument would produce an absurd result: First American’s hiring of Smith, Williams, and Carrell would have triggered the noncompetition and nonsolicitation covenants, but the only party that could have filed suit would have been Equity—and it would have had to file the lawsuit against its sole shareholder, First American. Thus, the court rejected Northwest’s “termination” theory.

Instead, the court concluded that after the stock purchase, Equity and its employees, including Smith, Williams, and Carrell, essentially became a division of First American. First American could “hire” Smith, Wil­liams, and Carrell without destroying Equity’s contracts. Therefore, the contracts continued to be valid after the stock purchase.

The court also concluded that the employment contracts remained in effect after the merger with First American. Under Utah law, all assets, including contrac­tual obligations owed to corporations, transfer and vest automatically in the surviving corporation by virtue of a merger. Moreover, Smith’s and Williams’ employment contracts explicitly provided that their terms, conditions, and obligations inured to the benefit of any successors. Thus, their obligations to Equity transferred to First American as the surviving company in the merger.

Violation of the agreements

The court concluded that Williams and Carrell violated the noncompetition covenants. They both admitted that they had provided insurance, escrow, and closing services within the geographical scope of their agreements. However, the court concluded that Smith didn’t violate his noncompetition covenant because its express terms stated that it applied only if his termination was involuntary. Because he resigned, the noncompetition covenant wasn’t triggered.

The court also concluded that Smith and Williams violated their nonsolicitation covenants. They hired sev­eral employees of First American in violation of the cove­nants. Carrell didn’t agree to a nonsolicitation provision. First American Title Insurance Company v. Northwest Title Insurance Agency, LLC, et al., 2016 WL 6091540 (D. Utah).

Lessons learned

The clear lesson from this dispute is that a stock purchase or a merger doesn’t invalidate contractual ob­ligations between employees and their former employer, including noncompetition or nonsolicitation covenants. Former employees’ contractual obligations will survive the merger—particularly when the contracts indicate that the obligations and benefits of the contracts flow to any successors and assigns.

Employment agreements should include provisions that make it clear that they survive when new owners come into the picture. Nevertheless, as long as a merger or stock purchase is done properly, there shouldn’t be any concern that it invalidates otherwise enforceable employment agreements.

You can contact the author at rfrazier@kmclaw.com or 801-323-5933. 

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