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Company's Position Taken in Bankruptcy Voids Noncompete Obligations

September 7, 2016
Thomas E. Hanson Jr.
Delaware Business Court Insider

The Delaware Court of Chancery's decision in Hipcricket v. mGage, C.A. No. 11135-CB, (Del. Ch. July 15, 2016), highlights the importance of coordinating the positions taken in different legal proceedings. The plaintiff in Hipcricket appeared to have a binding and enforceable noncompete agreement prohibiting its former vice president of sales (the defendant) from engaging in any post-employment solicitation of the plaintiff's customers and employees. That defendant breached the agreement shortly after leaving his employment with the plaintiff seemed clear. The plaintiff proved at trial that the defendant joined one of the plaintiff's competitors and "immediately" began soliciting the plaintiff's largest clients, including certain of his former accounts. Despite this showing, the plaintiff did not prevail on its breach of contract claim. Instead, the court found that the plaintiff had materially breached the agreement by rejecting, in its Chapter 11 bankruptcy proceeding, the defendant's claim for unpaid commissions and other amounts plainly due under the agreement. The court ruled that the plaintiff could not "'have its cake and eat it too'" by enforcing an agreement it had materially breached through the position it took in bankruptcy court.


The plaintiff was a mobile marketing company that provided mobile advertising solutions, primarily through text and multimedia messages. The defendant had been employed by the plaintiff from October 2008 to March 13, 2015, and was a party to annual commission agreements. Those agreements included noncompete provisions prohibiting the solicitation of the plaintiff's customers and employees following his separation from the company. The agreement also prohibited the misuse of the plaintiff's confidential information.

On Jan. 20, 2015, the plaintiff commenced a voluntary Chapter 11 case in the District of Delaware. After filing, the plaintiff continued to operate its business as a debtor-in-possession and engaged in a bankruptcy court-approved auction and sale process, which ultimately resulted in the plaintiff becoming a wholly owned subsidiary of ESW Capital upon emerging from bankruptcy. The same day the defendant learned of the plaintiff's bankruptcy, he transferred certain sales reports from the plaintiff's sales tracking and activity database to his personal Hightail account. After communicating with representatives of one of the plaintiff's competitors, mGage, the defendant accepted employment with mGage on March 5, 2015. After giving the plaintiff notice on March 6, 2015, the defendant joined mGage on March 16.

Immediately after joining mGage, the defendant began contacting the plaintiff's customers. Initially, he sent all of his contacts a form email announcing his change in employment and requesting their availability to meet to discuss mGage, which he described as "a 15-year leader in the mobile marketing space and a trusted provider for over 1,000 brands across the globe." Next, the defendant contacted a number of the plaintiff's major clients, including some that he previously served for the plaintiff. For instance, the defendant reached out to his largest account, FordDirect—a company formed by Ford Motor Co. to manage technology for its dealer groups—and participated in preparing mGage's response to a request for proposal. The defendant's assistance with the proposal included the provision of the plaintiff's internal documents, some of which were stamped "confidential and proprietary." Although, at the time of trial, the plaintiff had not lost any of the accounts the defendant solicited, the plaintiff's president testified that, as a result of the defendant's conduct, he was required to renegotiate with, and provide significant concessions to, the plaintiff's largest customer. In addition to his customer solicitations, the defendant was accused of soliciting certain of the plaintiff's employees on behalf of mGage. The court found, however, that, in each case, the relevant employee initiated contact with the defendant, and he merely referred them to mGage's human resources department.

At trial,the defendant argued that the plaintiff could not enforce the noncompete restrictions because it rejected the agreement at issue in its bankruptcy. The court carefully analyzed the plaintiff's rejection of the agreement and agreed with the defendant. Beginning with the relevant provisions of the Bankruptcy Code, the court found that the plaintiff, as a debtor-in-possession, was entitled to "'assume or reject any executory contract.'" It was undisputed that the defendant's commission agreement was an executory contract and that the plaintiff had rejected it. In particular, although the plaintiff initially included it as a contract to be assumed under its reorganization plan, the plaintiff later amended its schedules to omit the agreement. All executory contracts that the plaintiff did not assume were treated as rejected under the final reorganization plan approved by the bankruptcy court.

The court next addressed the legal consequences of the plaintiff's rejection of the agreement and found that it constituted a material breach of the agreement that relieved Defendant of his obligation to abide by the non-compete provisions. The court found that, under the Bankruptcy Code, the rejection of an executory contract constitutes a breach of such contract immediately before the date of the filing of the bankruptcy petition. Under Washington state law, which governed the contract, and was similar to Delaware law, an employer's material breach of an employment agreement excuses performance of the employee's noncompete obligations. The court also found that the commissions and other compensation due under the defendant's commission agreement were material to him and that the plaintiff's rejection of the payment obligation constituted a material breach of the agreement. As a result, the defendant was excused from any further obligations under the commission agreement, including the noncompete provisions, as of the plaintiff's bankruptcy petition date. As all of the allegedly improper customer solicitations occurred after the plaintiff's petition date, the court ruled in the defendant's favor on all of the plaintiff's claims based on the noncompete provisions of the commission agreement. Notwithstanding the bankruptcy filing, the court found that the defendant, by transferring certain of the plaintiff's confidential information, had violated the Washington Uniform Trade Secrets Act and entered an injunction precluding any further use of the confidential information by the defendant or mGage. 

Delaware Business Court Insider | September 7, 2016