A recent decision from the Bankruptcy Court in Denver examines (and struggles with) some of the many issues that arise when a person subject to a noncompete files for bankruptcy.
In In re Hruby, 2014 WL 2071997, Debtor had been employed by Midwest Motors, but quit and apparently took another job with a competitor and made sales to customers that he serviced when he was employed with Midwest. There was evidence that the debtor had accessed Midwest’s computer files containing confidential customer information and that debtor had utilized Midwest’s confidential customer information to solicit Midwest’s customers. The debtor had signed a noncompete agreement when he was employed by Midwest. The noncompete included a noncompete provision (two years from the time any violation ceased) and a non-solicit provision that barred solicitation or service of any customers contacted, serviced or supervised by the employee. The noncompete agreement called for the application of Ohio law and stated that any enforcement action “must” be filed in Ohio.
Once the debtor filed for bankruptcy in Colorado, Midwest sought relief from the automatic stay for the sole purpose of obtaining injunctive relief to enforce the noncompete. Judge Tallman first was asked to decide whether the company’s claim, including the claim for injunctive relief to enforce the noncompete, was a dischargeable debt. That is, Tallman had to decide whether the debtor had been relieved of his noncompete obligations by filing for bankruptcy. In keeping with decisions from other jurisdictions, Tallman decided that the clain for injunctive relief did not constitute a dishargeable debt.
To move forward with his noncompete analysis, Judge Tallman then had to decide which state’s laws should be applied to determine the enforceability of the noncompete. This analysis was the key to the decision according to Tallman because the application of Ohio law would mean that the noncompete was enforceable. Leave would then be given to enforce the noncompete. On the other hand, application of Colorado law would mean that the noncompete was not enforceable and leave would not be granted.
Tallman found that, despite the parties’ choice of Ohio law, the Ohio state court would find that Colorado law should apply. The Ohio state court, according to Tallman, would apply Colorado law because Colorado law would apply if the parties had not chosen Ohio law and because the law of Ohio was contrary to to a fundamental policy of Colorado. Tallman’s decision to apply Colorado law is questionable because the general rule is that courts will apply the law chosen by the parties. Ohio had a connection to the contract because that’s where Midwest was located. Nonetheless, it’s not surprising that Tallman chose to apply Colorado law. The debtor’s sales territory was in Colorado and Wyoming. Debtor was domiciled in Colorado. These factors make it seem “unfair” to apply Ohio law. Applying Colorado law, Tallman concluded that the noncompete provision in the agreement was not enforceable. Tallman implicitly found that none of the exceptions under Colorado’s noncompete statute were applicable.
Tallman went on to hold that, even under Colorado law, the nonsolicitation provision in the noncompete was enforceable. Tallman reasoned that Midwest’s offer of proof sufficiently connected the “Debtor’s use of trade secrets with the solicitation of [Midwest’s] customers in violation of the No Solicitation or Service provision”. Based on this finding, Tallman granted leave to Midwest to enforce the nonsolicit provision in Ohio state courts.
There are a number of take-aways from this decision. First, the obvious ones. Employees sometimes file for bankruptcy, and the bankruptcy may discharge any claim for damages against the employee. Companies seeking to enforce noncompetes need to carefully consider the risk that any judgment for damages may not be recoverable. Another take-away is that employees subject to a noncompete shouldn’t assume that bankruptcy will discharge the noncompete. Their former employer may still be able to pursue a claim for injunctive relief.
Yet another take-away is that companies can’t always assume that their choice of law clause in an employment agreement will be enforced. Tallman struggled to avoid applying Ohio law and ultimately applied Colorado law.
A final take away from the decision is that a bankruptcy judge like Tallman may distinguish between the a noncompete clause and a nonsolicit clause. Equitable considerations may lead a court to enforce a nonsolicit clause because it is less onerous.