March 2023 in Brief: Business Litigation & Dispute Resolution

Business Litigation

Delaware Court of Chancery Finds Stock Purchase Agreement’s Prohibition of Sellers from Competing “Anywhere in the World” Is Unenforceable

By Jonathan M. Stemerman, Armstrong Teasdale LLP

In recent months, the Delaware Court of Chancery has increasingly viewed restrictive non-competition covenants negatively. Nevertheless, the Court has continued to enforce such non-competition clauses where the provision is related to the sale of a business and not an employment contract. In Intertek Testing Services, NA, Inc. v. Eastman, however, the Court found the purchase agreement’s restriction on a seller’s ability to compete “anywhere in the world” too broad, and the buyer’s complaint to enforce the restriction was dismissed.

Intertek Testing Services purchased a business—Alchemy Investment Holdings, Inc.—cofounded by Jeff Eastman. Eastman was Alchemy’s cofounder and CEO and was also a major stockholder. The Stock Purchase Agreement (“SPA”) prohibited each “Restricted Seller,” such as Eastman, from competing with Alchemy “anywhere in the world” for a period of five years.

After continuing to work at Alchemy for five months following the sale, Eastman voluntarily resigned as CEO. Approximately two and a half years after the sale, Eastman’s son—a former Alchemy employee—incorporated an allegedly competing company in which Eastman was an investor and member of the board of directors. Intertek subsequently filed suit, arguing that Eastman breached the SPA’s restrictive covenants, and Eastman moved to dismiss.

In dismissing the action, the Court of Chancery concluded that the non-competition provision was facially overbroad and therefore unenforceable. While noting that “relatively broad restrictive covenants have been enforced in the sale of a business context, such covenants must be tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests.” Here, however, the Court found that the provision’s restriction of competition “anywhere in the world” was too broad because Alchemy only provided services in the United States. The Court declined to limit the provision to just the United States, stating that it would be inequitable to save a sophisticated party’s overreach in drafting a facially invalid provision.

Breach of Fiduciary Duty Action against the Sponsor and Directors of a Delaware SPAC Allowed to Move Forward

By Sean M. Brennecke, Partner, Lewis Brisbois

Vice Chancellor Lori W. Will’s recent decision in Laidlaw v. GigAcquisitions2, LLC (2023 Del. Ch. LEXIS 52, 2023 WL 2292488 (Del. Ch. Mar. 1, 2023)), provides another example of Delaware courts protecting purchasers of stock in a Delaware special purpose acquisition company (“SPAC”) from wrongful conduct perpetrated by its directors and sponsor. In Laidlaw, Vice Chancellor Will denied a motion to dismiss a complaint against GigAcquisitions2, LLC (which served as the sponsor of a Delaware SPAC known as GigCapital2, Inc. (“Gig2”)), its founder, and the members of its board of directors, alleging that the defendants breached their fiduciary duties and were unjustly enriched when they caused Gig2 to enter into a merger that ensured the value of their interests would skyrocket at the expense of the public stockholders, and impaired the exercise of public stockholders’ redemption rights by failing to include material information in the proxy statement issued in connection with the merger. The Vice Chancellor’s opinion can be found here.

Supreme Court Deals Delaware’s Unclaimed Property Regime A Loss on MoneyGram’s “Checks,” But Leaves Open Treatment of Other Intangibles

By Rafael X. Zahralddin-Aravena, Lewis Brisbois

Unclaimed property, also known as escheat, is Delaware’s third largest revenue source, and 10% of the state’s incoming dollars. Personal property that is abandoned by its owner over time is held by a state’s unclaimed property administrators. The U.S. Supreme Court issued a ruling that unclaimed property, without a record of the owner, reverts to the record holding company’s state of incorporation. Pennsylvania v. New York, 407 U.S. 206 (1972). Many businesses are incorporated in Delaware, so Delaware has become a default state to hold unclaimed property, which if not claimed, reverts to the general coffers of the State of Delaware. Congress has carved out some exceptions to this process, notably in 1973, when it passed the “Disposition of Abandoned Money Orders and Traveler’s Checks Act” (12 U.S.C. §§ 2501-03) (“Federal Disposition Act”). The Federal Disposition Act directed that “money order, traveler’s check, or other similar written instrument (other than a third-party bank check) on which a banking or financial organization or a business association is directly liable” that has been abandoned is held by the state in which the instrument was purchased. 12 U.S.C. § 2503(1).

The Supreme Court reviewed the applicability of the Federal Disposition Act to MoneyGram’s remission of funds related to “Official Checks” sold outside of Delaware to Delaware. See, Delaware v. Pennsylvania and Wisconsin, U.S. Supreme Court Case No. 220145; Arkansas, et al. v. Delaware, U.S. Supreme Court Case No. 220146 (consolidated). The Commonwealth of Pennsylvania and the State of Wisconsin both sent demand letters to Delaware inquiring about the funds remitted from the sale of MoneyGram checks in their states. When Delaware refused to take a position on the issue, both states filed actions in respective Federal District Courts in their jurisdictions. Delaware petitioned the U.S. Supreme Court to file a complaint against both Pennsylvania and Wisconsin under the Court’s Original Jurisdiction. Arkansas then led an effort to file a complaint in the United States Supreme Court and was joined by twenty-nine other states, which the Supreme Court approved for review on appeal and consolidated with the other action.

Justice Ketanji Brown Jackson wrote the opinion for the Court in unanimous en banc decision, which held that Delaware collected about $250 million in fees related to the MoneyGram checks from 2002 to 2017 and that Delaware must return the money to the states where they were purchased. The case was decided on narrow grounds. The MoneyGram instruments are “similar” to money orders and subject to the federal statute, and the Court was unpersuaded that it mattered whether they were actually money orders. MoneyGram checks were similar to money orders in function and operation to money orders. The Court also reasoned that they have similar characteristics to the types of instruments Congress addressed in the Federal Disposition Act. MoneyGram did not collect the addresses of the creditors, and if the common law priority rules were to apply, “then the abandoned proceeds would escheat inequitably solely to the State of incorporation, just like the money orders expressly referenced in the statute.” The Court found that Congress did not intend sellers of this type of intangible property to keep extensive records and that the Federal Disposition Act was passed to prevent a windfall to the state of incorporation for the escheatment of these types of instruments. The Court left open issues as to whether cashier’s checks, certified checks, or teller’s checks are “money orders” subject to the Federal Disposition Act.

Dispute Resolution

Ninth Circuit Strikes Down Law Imposing Criminal Liability Against Employers Requiring Arbitration Agreements

By Leslie Ann Berkoff, Partner and Chair of Dispute Resolution Department, Moritt Hock & Hamroff LLP

In Chamber of Com. of the United States v. Bonta, No. 20-15291, 2023 WL 2013326 at *12 (9th Cir. Feb. 15, 2023) (“Chamber”), the Ninth Circuit, in a 2 to 1 decision, found Assembly Bill 51 (“AB 51”) to be preempted by the Federal Arbitration Act (“FAA”). AB 51 had prohibited employers under the California Fair Employment and Housing Act, and/or the Labor Code, from requiring employees to sign an arbitration agreement as a condition of employment, continued employment, or the receipt of employment-related benefits, and attempted to impose criminal liability against employers who imposed such requirements. The Chamber Court found that employers could require employees to sign arbitration agreements as a condition of employment and that employers were able to include waiver provisions of class and representative actions in employment agreements. This decision comes on the heels of the Supreme Court decision in Viking River Cruises v. Moriana, 142 S.Ct. 1906 (2022), which held that a California law precluding, under the Private Attorney General’s Act (PAGA), the division of actions into individual and non-individual claims through an agreement to arbitrate was also preempted by the FAA. 

In Chamber, the lower court noted that AB 51 was an attempt by the California legislature to “workaround” the FAA by focusing on pre-agreement behavior as a means to impose penalties. Over the years, the Supreme Court has consistently found that the FAA is clearly intended to promote arbitration and has relied upon the FAA as a basis to strike down laws that create an imbalance with the FAA’s policy favoring arbitration. As such, the current decision is not surprising.

The State of California may still seek en banc review of this decision before the full Ninth Circuit, or seek certiorari review by the U.S. Supreme Court. In the interim, employers may require California employees to sign non-negotiable arbitration agreements to obtain or maintain employment. Of course, these agreements are still governed by the FAA, and there are other grounds to challenge these agreements, such as, for example, that the agreements are unconscionable, or lack mutual, voluntary consent on execution.

While employers may now consider imposing mandatory arbitration as a condition of employment, they should still carefully consider how to craft the underlying agreement. Employers will still need to carve out sexual harassment and sexual assault claims, be mindful of how to address PAGA claims, and understand that courts may invalidate arbitration agreements based on other applicable contract defenses such as fraud or unconscionability. However, for now, AB 51 is no longer an impediment and does not provide a risk of criminal penalties.