The Ability of Successor Employers to Enforce Covenants Not to Compete

• Author: Brian A. Riddell
• Position: Associate, Keating, Muething & Klekamp, P.L.L., Cincinnati, Ohio
• Pages: 500-524

Page 500

I Introduction

An employee signs an employment contract with Company A to be a window washer, earning $15.00 per hour. The employment contract states that the employee will not compete with Company A for one year after her termination within a 100 mile radius of Company A's principal place of business. Subsequently, all of Company A's assets are purchased by Company B, and shortly thereafter, Company B announces that it will cut the employee's wages to $10.00 per hour. Having no desire to work for Company B for only $10.00 per hour, the employee quits to go work for a competitor who pays $15.00 per hour. Immediately, Company B seeks to prevent this by attempting to enforce the covenant not to compete entered into between the employee and Company A.

This hypothetical presents the issue of whether a successor employer can enforce a covenant not to compete between an employee and a predecessor employer. On this issue, courts are split three ways nationally and two ways in Ohio.¹

One group of courts, focusing on contract law, holds that successor employers can enforce covenants not to compete only where employees consent to the assignment of the covenant from the predecessor employer to the successor employer.² Some Ohio courts have adopted this approach.³ Thus, where employee consent is required, the successor employer in the above hypothetical can only enforce the covenant not to compete if the employee consents to the assignment of the covenant.⁴

A second group of courts, also focusing on contract law, holds that a successor employer can enforce a covenant not to compete between an employee and a predecessor employer because the successor employer is a third-party beneficiary of the covenant not to compete.⁵ Ohio courts have not adopted this approach.⁶ Under this view, the successor employer in the above hypothetical is entitled to enforce the covenant not to compete between the employee and the predecessor employer.⁷

A third group of courts ignores the traditional concepts of contract law altogether. This group focuses on property law, holding that successorPage 501 employers are entitled to enforce covenants not to compete because such covenants are company assets, which are generally transferable where one business is being transferred to another.⁸ Some Ohio courts have adopted this approach.⁹ Under this approach, the successor employer in the above hypothetical acquired the covenant not to compete in the transfer of assets from the predecessor company and, therefore, can enforce the covenant not to compete.¹⁰

This Article argues that Ohio courts should chart a new course and only permit a successor employer to enforce a covenant not to compete under three circumstances. First, the employee must give express consent not to compete against the successor employer. Second, the contract of sale or merger between the predecessor employer and the successor employer must specify that any covenants entered into between the predecessor employer and its employees are transferable assets of the predecessor employer that are being assigned to the successor employer. Third, the successor employer must have an interest to protect by enforcing the covenant. Enforcing non-compete covenants only under these circumstances will ensure that an employee is not bound by the terms of a covenant to which she or he has not consented.

Part II of this Article discusses the general enforceability of covenants not to compete under Ohio law. Part III provides a detailed overview of the "Employee Must Consent," the "Third-Party Beneficiary," and the "Covenant is a Transferable Asset" approaches that courts, nationally, have used to resolve the issue of whether successor employers can enforce covenants not to compete. Part IV analyzes the strengths and weaknesses of each approach. Part V sets forth a comprehensive proposal that Ohio courts should consider in determining whether a successor employer can enforce a covenant not to compete. Further, Part V examines the effect that this proposal will have on employees, predecessor employers, and successor employers. Part VI concludes that the proposed approach: (1) incorporates the strengths of the "Employee Must Consent" approaches, the "Third-Party Beneficiary" approach, and the "Covenant is a Transferable Asset" approach; (2) will ameliorate the ambiguity in Ohio law; (3) will give guidance as to how predecessor employers, successor employers, and employees should act; and (4) will protect the rights and interests of employees, predecessor employers, and successor employers.

Page 502

II The Enforceability of Covenants not to Compete

Early Ohio courts held covenants not to compete void as restraints on trade.¹¹ Because workers entered skilled trades only by serving in apprenticeships, mobility was minimal.¹² Accordingly, covenants not to compete were viewed as either destroying a worker's means of livelihood or binding workers to their masters for life.¹³ Nonetheless, as the character of the work world became more flexible, Ohio courts began looking for ways to eliminate this blanket prohibition on employment restrictions.¹⁴

Today, Ohio courts will only uphold covenants not to compete where the covenant is reasonable.¹⁵ In the 1975 case of Raimonde v. Van Vlerah, the Ohio Supreme Court held that a covenant restricting an employee from competing with his former employer is reasonable if (1) the restraint is no greater than is required for the protection of the employer; (2) the restraint does not impose undue hardship on the employee; and (3) the restraint is not injurious to the public.¹⁶ In determining whether non-compete covenants are reasonable, Ohio courts analyze each of the above requirements by considering the following factors: (1) whether the agreement contains time and space limitations; (2) whether the employee is the sole contact with the customer; (3) whether the employee has obtained confidential information or trade secrets in the course of employment; (4) whether the agreement seeks to limit only unfair competition or is designed more broadly to eliminate ordinary competition; (5) whether the agreement seeks to stifle the employee's inherent skill and experience; (6) whether the benefit to the employer is disproportional to the detriment to the employee; (7) whether the agreement bars the employee's sole means of support; (8) whether the skills that the agreement seeks to restrain were actually developed during the employment; and (9) whether the employment forbidden by the agreement is merely incidental to the main employment.¹⁷

A No Greater than Necessary

Ohio courts will only enforce covenants not to compete where the restraint is no greater than what is required to protect the employer.¹⁸ ThePage 503 case Proctor & Gamble Co. v. Stoneham¹⁹ from the Hamilton County Court of Appeals, First District, presents an example.²⁰ In Proctor & Gamble Co., Paul Stoneham worked in the haircare division for Proctor & Gamble Company ("P&G") and focused on hair-conditioning products.²¹ He was an expert in foreign markets, and he obtained knowledge of the needs of foreign consumers and the products that sold best in foreign markets by analyzing raw market research data obtained from a market research firm hired by P&G.²² Thus, as part of his job, Stoneham knew "which products were closest to market, when and where they would be launched, the target consumers, the type of advertising to be used . . . the strengths and weaknesses of the company's scientific backup for its claims about the products, the price for the new products, and the targeted profits."²³ Stoneham also produced "a confidential ten-year [marketing] plan for one of P&G's hair-conditioning products, participated in the development of new products, and helped [fashion] a ten-year marketing plan for P&G's best selling-brand, Pantene."²⁴

Stoneham signed a covenant not to compete in return for receiving P&G stock options.²⁵ The covenant barred Stoneham from competing with P&G for three years after the termination of his employment.²⁶ After thirteen years of employment,²⁷ however, Stoneham left P&G to take a job with Alberto-Culver, a company whose haircare products competed with P&G products.²⁸ Shortly thereafter, P&G filed suit against Stoneham for damages and injunctive relief, alleging that he had breached the covenant not to compete.²⁹ However, the trial court dismissed P&G's claim, holding that P&G had shown no right to relief.³⁰

On appeal, P&G argued that the trial court applied the wrong test to determine whether the non-compete agreement was legally valid.³¹ The appellate court agreed, holding that the trial court erred when it did not cite or refer to the factors enunciated in Raimonde.³² Applying six of thesePage 504 factors, the appellate court held that the covenant not to compete was reasonable.³³ First, the covenant did not impose an undue hardship on Stoneham because enforcement of the covenant not to compete "would not stifle Stoneham's inherent skills in marketing or destroy Stoneham's sole means of support[.]"³⁴ Second, the covenant was reasonable because it permitted Stoneham to work at another company such as Alberto-Culver in a department unrelated to haircare until the non-compete agreement expired.³⁵

Third, the covenant not to compete...