Kodiak Two Years Later: Is Delaware’s Blue Pencil Turning Red for Non-Competes?

October 6, 2024 marks the two-year anniversary of Kodiak Building Partners, LLC v. Adams—the case in which the Delaware Chancery Court refused to enforce a sale-of-business non-compete against an executive who received $1 million for selling his stake in a construction company. Kodiak was soon followed by Intertek and Cantor Fitzgerald, two similar decisions that indicated Kodiak was not a one-off. In the two years since Kodiak, the increased non-compete scrutiny that decision seemed to signal shows little sign of stopping in the First State.

Perhaps nowhere is this scrutiny more notable than the Delaware courts’ increasing refusal to blue pencil non-competes they find overbroad. As surveyed further below, Delaware courts, both state and federal, have continued not only to find non-competes unenforceable for overbreadth, but have also declined to reform them. Since the Delaware Chancery Court refused to blue pencil in Kodiak, courts in Delaware have refused to blue pencil non-competes in at least five additional cases (in addition to Intertek), each of which involved senior executives or regional managers. And each time, the courts have cited Kodiak in doing so.

So far, the Delaware Supreme Court has generally not disturbed these decisions. Earlier this year, the Delaware Supreme Court did uphold a forfeiture-for-competition provision in a limited partnership agreement, reversing the Delaware Chancery Court’s decision in Cantor Fitzgerald to not enforce it. But, as discussed below, this was a narrow ruling with helpful guidance for forfeiture-for-competition provisions, and one that nonetheless highlights the scrutiny with which non-competes are viewed in Delaware.

While the cases surveyed below generally arose in the employment and not sale-of-business context (as Kodiak and Intertek did), they continue to underscore the importance of carefully drafted non-competes, even in historically “friendly” and “blue-pencil” jurisdictions such as Delaware.

The Centurion, Sunder, Hub, and Fortiline Cases—Delaware Chancery Court

On August 31, 2023, the Delaware Chancery, in Centurion Serv. Grp., LLC v. Wilensky, 2023 WL 5624156 (Del. Ch. Aug. 31, 2023), declined to enforce or blue pencil an employment non-compete it deemed overbroad.

• Facts: Centurion involved a non-compete dispute between an employer (Centurion) and its former employee (Wilensky). The non-competition clause prohibited Wilensky, a former senior executive at Centurion, from participating in any business that was directly or indirectly engaging in (i) the buying and selling of medical equipment via auctions and private sales, (ii) providing medical surplus management for healthcare facilities including certified appraisals, trade-in value verification, asset and facility inventories, relocations and closures for such facilities, and (iii) any other business activities in which Centurion, at any time during Wilensky’s employment, was engaged or in which it was actively planning to engage. The provision extended to any area within the United States or other country where Centurion was actively engaged in its actual or planned business endeavors and lasted for a period of two years following termination. Wilensky filed a motion to dismiss Centurion’s claim, asserting that the non-competition provision was unenforceable. The court agreed.
• Geography and Duration Overbroad: In assessing the enforceability of the non-competition provision, the court found that the geographic scope operated effectively as a nationwide ban for two years following termination, as Centurion is engaged in business throughout most states. The non-compete further restricted Wilensky’s ability to engage in any area where Centurion intended to conduct or solicit activity. The court found that the “geographic and temporal scope” were not reasonable, and that the terms of the covenant cast “a limitless net over Wilensky in both scope of geography and scope of conduct.” Wilensky, the court found, was “prohibited from working not just in “areas” where Centurion conducts its core business of medical equipment sales and surplus management, but also “areas” that “Centurion might have thought about entering, and where Centurion does or thought about doing any other activity.” The court found that Centurion failed to identify a strong economic interest justifying a nationwide scope and even suggested that a nationwide scope would be appropriate only in a sale-of-business non-compete.
• Refusing to Blue Pencil: Citing Kodiak, the court refused to blue pencil the non-compete and did not provide a reason for its unwillingness to do so.

Shortly thereafter, the Delaware Chancery in Sunder Energy, LLC v. Jackson, 305 A.3d 723 (Del. Ch. 2023), denied the defendant’s preliminary injunction motion on the ground that the covenants in the disputed agreement were facially unreasonable. Yet again, the court declined to blue pencil the agreement.

• Facts: Jackson, Sunder’s former head of sales, signed an agreement containing a non-compete in consideration of receiving incentive units in Sunder. Under the terms of the non-compete, Jackson was prohibited from engaging or conducting the “business of engaging in the marketing and selling of services and products, including those related to pest control, alarms, solar, satellite, TV and wireless internet, directly to third parties in their homes, and taking other actions similar or related thereto.” The non-compete was limited to around 20 states that the agreement specified by name and “such other states in which, at any given time, the Company conducts, or reasonably anticipates conducting its business (including the Business).” Contending Jackson breached the non-compete, Sunder filed suit and sought a preliminary injunction. The court denied the motion, finding that the covenants were “facially unreasonable.”
• Overbroad and Unreasonable Non-Compete: In reaching its decision, the court specifically found that the non-compete was “astonishingly broad” on several grounds, namely: (1) the restricted activity extended to “the entire door-to-door sales industry, without regard to whether Sunder markets or sells similar products”; (2) it broadly captured Jackson’s affiliates; (3) the geographic scope covered all states, at any given time, in which Sunder conducts “or reasonably anticipates” conducting business; and (4) the nature of the duration—that the two-year clock did not run from termination of employment but from when Jackson no longer held the incentive units—meant it could continue indefinitely.[1] The court found the non-compete to be even “more egregious” given the scope of the accompanying customer non-solicit, the combination of which essentially barred Jackson from participating in any business that sold anything to a homeowner in the states in which Sunder conducted business before Jackson’s departure.

• Refusing to Blue Pencil: The court declined to blue pencil the non-compete, finding that doing so would create a “no-lose situation” for employers:
  
  To blue-pencil the provision creates a no-lose situation for employers, because the business can draft the covenant as broadly as possible, confident that the scope of the restriction will chill some individuals from departing. If someone does challenge the provision, then the worst case is that the court will blue-pencil its scope so that it is acceptable. It also enables employers to extract benefits at the expense of employees by including unenforceable restrictions in their agreements. The logical result of such a system is sprawling restrictive covenant[s].

A few months later, the Delaware Chancery Court, in Hub Grp., Inc. v. Knoll, No. 2024-0471-SG, 2024 WL 3453863 (Del. Ch. July 18, 2024) (Glasscock, J.), denied a defendant’s motion for a preliminary injunction to enforce the terms of a one-year non-compete in an employment context.

• Facts: The non-competition provision at issue was between (a) Knoll, a former senior vice president of Hub Group, and (b) Hub Group and 25 affiliates and other entities under its control, all of which the agreement defined collectively as “Hub.” It prohibited Knoll from directly or indirectly—for one year following the termination of his employment—engaging in a “Competing Business” in one of the following three capacities: (1) in a capacity relating to the management, development, manufacture, sales, marketing, or operation of any Competing Services[2]; (2) in a position with similar responsibilities to those Knoll held at Hub at any time during the three years preceding termination; and (3) in any capacity in which Knoll could disclose confidential information. The agreement defined “Competing Business” as business conducted by Hub on the date the employee’s employment ends or any business Hub is actively considering or was considering at any time during the one-year period preceding the date of the end of employee’s employment with Hub. The agreement in turn defined “Restricted Territory” as “any geographic area in which Hub conducts business or provides products or services, including the contiguous United States.”
• Overbroad and Unenforceable Non-Compete: Holding the non-compete to be overbroad and unenforceable, the court construed the non-compete as prohibiting Knoll from “working for an entity that competes with any of Hub’s 25 entities, located in at least four countries and in 42,000 zip codes within the United States, if Knoll (a) does anything ‘substantially the same as’ what he did while employed at Hub or if he possesses any information related to any Hub entity; (b) is in a position related to sales, customer management, setting strategic goals for sales employees, supervision of a team, or researching sales tools; or (c) could disclose any nonpublic information related to any business conducted by a Hub entity.” This was “compounded,” the court found, by the “Agreement’s purported (and frankly baffling) binding effect upon Knoll and Knoll’s “successors, heirs, executors, and representatives.”[3]
  
  The non-compete’s multiple, interconnected definitions and qualifications were seemingly designed to clarify and narrow its scope but ended up doing the opposite. The court found them to be a “pile of words” that were so “confusing” that not even the employer could, “with clarity,” “explain its scope.”
  
  While the court acknowledged that Delaware is a contractarian jurisdiction, it made it clear that this policy must be balanced against other considerations, such as “the encouragement of competition and discouragement of restraints on trade, the recognition of an individual's right to choose her employment, and the desire to avoid oppressive or unclear obligations arising from contracts of adhesion.”

• Refusing to Blue Pencil: The court declined to blue pencil the agreement because “[t]hat would encourage the use of overbroad non-competes; with some fraction of employees cowed into accepting unenforceably-broad restrictions.”[4]

Just last month, the Delaware Chancery Court, in Fortiline, Inc. v. McCall, No. 2024-0211-MTZ, 2024 WL 4088629, at *1 (Del. Ch. Sept. 5, 2024), again found an employment non-compete to be unenforceable on overbreadth grounds and declined to blue pencil it.

• Facts: Fortiline involved a dispute between Fortiline and eight of its former employees, all branch or regional managers, who had been granted options in Fortiline’s parent company, PSH, in exchange for agreeing to, among other things, a one-year non-compete that ran from the termination of their employment. The non-compete prohibited the employees from engaging in the “Business” anywhere in the United States, or assisting or investing in anyone who competes with the Business. “Business” was defined as “the business of [PSH] and its Subsidiaries as currently conducted on the date hereof, as conducted within the five (5) years prior to the date hereof, or which the Board has authorized the Company to develop or pursue (by acquisition or otherwise).” “Subsidiary” was in turn defined as any entity in which PSH owns directly or indirectly more than 50 percent of the equity or voting power.

• Overbroad Based on “Affiliates”: The court found that the non-compete was unenforceable and overbroad, largely because the plaintiff could not justify the scope of the non-compete extending to the parent company’s many affiliates. The court remarked that “Including affiliates in a restrictive covenant greatly expands the covenant’s breadth, and therefore requires a broader legitimate economic interest.” And the court held that “A covenant including the employer’s affiliates is ‘not tailored to [the employee’s] role while employed,’ and the inclusion of affiliates in different sectors and different countries is ‘not essential to the protection of [the employer’s] legitimate business functions’.” Plaintiff argued that the scope was justified because “PSH’s Affiliates run an ‘integrated business that share[s] common leadership, training, governance, and some commercial products” and there was “customer overlap.” But that was insufficient. Per the court:
  
  The fact that PSH’s other sectors are under the same corporate umbrella does not, without more, show that PSH has a legitimate business interest in protecting those other sectors from Defendants’ work. Plaintiffs have offered nothing else that makes that showing. Defendants worked only for Fortiline, in the geographic region of the Fortiline branch office where they worked, and only in Fortiline’s waterworks industry, not in the industry or area of any other PSH Affiliate. Defendants did not obtain confidential information about any other PSH Affiliate. Even assuming, as Plaintiffs argue, that Defendants Peterson and Roberts were involved in Fortiline projects that involved PSH plumbing affiliates, that alone does not demonstrate those Defendants could cause those affiliates harm by competing with them; and it falls far short of demonstrating a legitimate interest to protect for all PSH Affiliates.

• Refusing to Blue Pencil: Citing Kodiak and Sunder Energy, the court declined to blue pencil the non-compete.

The Gordian Case: The U.S. District Court for the District of Delaware

Relying heavily on Kodiak, the U.S. District Court for the District of Delaware found an employment non-compete to be unenforceable and declined to blue pencil it in Gordian Med., Inc. v. Vaughn, No. CV 22-319 (MN), 2024 WL 1344481 (D. Del. Mar. 30, 2024).

• Facts: In Gordian, an employer (AMT and its holding company) sued a former employee (Vaughn) and the employee’s new employer (Curitec), alleging that Vaughn breached her agreements with AMT and Curitec by tortiously interfering with the agreements. Gordian asserted numerous allegations, including that Vaughn breached the non-compete contained in her equity and employment agreements. Both non-competes generally prohibited Vaughn, a former senior vice president, from seeking employment in the wound-care field, anywhere in the United States or another country where AMT and its holding company operated during her employment, for two years after leaving her employment with AMT.
• Overbroad and Unenforceable Non-Compete: The court found the non-competition provisions overbroad as “Vaughn could not even work as a school nurse or as a paramedic for a county EMS Department, because she would be ‘engaged in the business of providing ... related wound care evaluation [and] treatment,’ which would fall within the proscriptions of the Agreement.” Plaintiffs also implied at trial, according to the court, that Vaughn “could not even work in an area such as flower arranging, i.e., an area wholly unrelated to her work with wound care at AMT.”
• Refusing to Blue Pencil: Citing Kodiak, the court declined to blue pencil the agreements, including because AMT failed to suggest how it should go about doing so.

The Cantor Fitzgerald Case:

On January 29, 2024, the Delaware Supreme Court reversed the Delaware Chancery Court’s decision in Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024). That decision (Ainslie v. Cantor Fitzgerald, L.P., 2023 WL 106924 (Del. Ch. Jan. 4, 2023), deemed a forfeiture-for-competition clause in a limited partnership agreement unenforceable under the less-searching sale-of-business standard. On appeal, the Delaware Supreme Court reversed, holding that, absent unconscionability, bad faith, or other extraordinary circumstances, Delaware courts should uphold forfeiture-for-competition provisions between sophisticated parties in limited partnership agreements. In reaching this decision, the Delaware Supreme Court relied on the “emphatic policy statement” under Delaware law to “give maximum effect to the principle of freedom of contract[s] and to the enforceability of partnership agreements.” The court further contrasted forfeiture-for-competition provisions with employment non-competes, where an employee is “effectively deprived of his livelihood.” Its analysis is instructive:

The distinction between a restrictive non-competition covenant that precludes a former employee from earning a living in his chosen field and an agreement that allows a former partner to compete but at the cost of relinquishing a contingent benefit is, in our observation, significant. In the restrictive-covenant context, the former employee is effectively deprived of his livelihood and, correspondingly, exposed to the risk of serious financial hardship. This gives rise to the strong policy interest that justifies the review of unambiguous contract provisions for reasonableness and a balancing of the equities, two exercises typically foreign to judicial review in contract actions. By contrast, however, forfeiture-for-competition provisions, which, unlike restrictive covenants, are not enforceable through injunctive relief, do not prohibit employees from competing and remaining in their chosen profession, and do not deprive the public of the employee’s services, present no such concern. The policy interest that preponderates in the former case is diminished—if it does not vanish—in the latter. To put it another way, the interest to be vindicated when evaluating a covenant that prohibits competition and that might even preclude gainful employment is significantly weakened when competition—often (as in this case) highly remunerative—is permitted. That diminished interest is insufficient to override the Delaware Revised Uniform Limited Partnership Act’s directive to “give maximum effect to the principle of freedom of contract and the enforceability of partnership agreements.”

The decision, then, may be easy for some to distinguish as being limited to the limited partnership context in which it arose. But based on the language quoted above, the court’s favorable view of forfeiture-for-competition provisions is not expressly cabined to limited partnership agreements. While such provisions would certainly face less scrutiny in the limited partnership context, the court’s broad language suggests they are entitled to greater leniency than non-competes, regardless of whether they are in an agreement between an employer and employee or between limited partners.

Practical Takeaways

It may be that the FTC’s non-compete ban never takes effect, but that does not mean employers that rely on non-competes can rest easy. State legislatures and courts across the country continue to make decisions that complicate how non-competes are drafted and interpreted. The latest cases in Delaware prove it is no exception.

As we stated back in 2023, Delaware’s blue pencil is not necessarily a “fail-safe.” That seems to have never been more true than today, two years on from Kodiak. While Delaware’s blue pencil is not yet red, Kodiak and its progeny have given Delaware courts much more cover to refuse to enforce employment and sale-of-business non-competes on overbreadth grounds. Delaware is no longer the relatively “safe bet” for restrictive covenants that many have long supposed it to be.

In light of these developments, there are few takeaways to keep in mind:

• Non-competes should be drafted in a manner that can support the legitimate business interests for those restrictions, including the jurisdictions and related corporate entities that are covered.
• Do not rely on Delaware’s blue-pencil authority to save a non-compete that a court may consider overbroad.
• Review your non-competes to ensure they are narrowly tailored to protect your company’s legitimate interests. Even nationwide non-competes for senior executives face increasing scrutiny and could jeopardize enforceability.
• Be mindful of the “janitor rule,” i.e., the notion that a non-compete should not be so broad as to prohibit the employee from providing non-competitive services to a competitor, such as arranging flowers or working as a janitor.
• Avoid extending non-competes to a broad or undefined group of affiliates.
• Consider relying on a forfeiture-for-competition provision in lieu of, or in addition to, a non-compete.
• Consult with counsel to determine whether there is another jurisdiction or forum with a sufficient connection to the contracting parties that may be more favorable for enforcement than Delaware.

[1] Jackson held vested and unvested incentive units. According to the Court, “a holder does not automatically forfeit vested units, and although Sunder has the right to repurchase vested units for zero dollars, Sunder decides when to exercise that right.”

[2] The agreement defined “Competing Services” as “products, processes, or services of any person or organization other than Hub, in existence or under development, that are substantially the same as, may be substituted for, or applied to substantially the same end use as, the products, processes, or services with which Employee worked at any time during the last three (3) years of Employees’ employment with Hub or about which Employee possessed Confidential Information through Employee’s work with Hub.”

[3] Literally construed, this could prohibit Knoll’s children from working for a Hub competitor if they possessed confidential information, the court found.

[4] Following this decision, Hub asked the court to certify an interlocutory appeal on several grounds, including that there has been a “recent trend in Court of Chancery decisions striking down restrictive covenants for overbreadth while prior decisions enforced non-competes and narrowed their restrictions.” Hub Grp., Inc. v. Knoll, No. 337, 2024 WL 4343006, 2024 BL 343533 (Del. Sept. 30, 2024), Court Opinion. The court denied Hub’s application for certification, and the Delaware Supreme Court affirmed that denial on September 30, 2024. Id.