Non-Compete Agreements: Dischargeable in Bankruptcy, or Albatross Around Debtor’s Neck?

06 Jul Non-Compete Agreements: Dischargeable in Bankruptcy, or Albatross Around Debtor’s Neck?

An employeecan sometimes be asked to sign a non-compete agreement (also called a covenant not to compete) as a condition of being hired, or as a condition of being given a raise or promotion to a new position. A non-compete agreement is usually sought by an employer whose employee will have access to sensitive client lists, or who may develop relationships with the employer’s clients which could enable the employee to take these clients away from the employer, should the employee quit his or her employment and go to work for a competing business.

The terms of anon-compete agreement typically will prevent the employee from working for a competitor of the employer, or sharing with a new employer confidential information,for a short period of time such as one year, within a specific geographic area. Because such an agreement has the effect of preventing the employee from earning a living inthe employee’s chosen field of work, courts generally will not enforce a non-compete agreement unless it is limited in both duration and geographic area.

If the employee breaks the non-compete agreement, the agreement’s terms usually provide for both money damages and a courtinjunction forbidding the new employment.

But what if the employee files a bankruptcy case prior to the expiration of the non-compete agreement, hoping this will free him or her from the duty not to compete or share information? The employee may hope that the bankruptcy discharge will eliminate the duties imposed by the agreement, leaving the employee free to find new employment.

However, the answer to the question whether bankruptcy eliminates obligations under a non-compete agreement is far from clear, and courts are split on this question. An employee intending to file bankruptcy for this purpose should be aware that such a manuever might fail completely. The answer might also depend on the law of thestate, orthe federal appeals court circuit, in which the bankruptcy is filed.

In states that have lawsgoverningnon-compete agreements, the employee has more hope of discharging the agreement when such laws provide that money damages are adequate to compensate an employer for such a breach by an employee. In states whose laws provide that only a court injunction can adequately address such a breach by an employee, the employee has less chance of discharging a non-compete agreement’s duties.

Filing chapter 13 instead of chapter 7 might also provide a better chance for the employee to discharge such a debt. This is because the employee has the opportunity to propose a chapter 13 plan in which the non-compete agreement is characterized as an executory contract to be rejected by the debtor, and that any resulting claims by the employer are to paid in part by the chapter 13 plan,and then discharged. Because such chapter 13 plan provisions are normally viewed by courts as being binding on all creditors, the non-compete agreement would then be considered a claim to be discharged at the conclusion of the chapter 13 plan.

An employee seeking to address a non-compete agreement in a bankruptcy filing should be aware that although doing so might not be easy, with careful attention the chances of success can be maximized.

(Photo courtesy of Dave Nicoll’s Photostream onFlickr.)

 

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Craig W. Andresen is a consumer bankruptcy lawyer in Bloomington, Minnesota, with 22 years’ experience in consumer and small business bankruptcy cases. He is the Minnesota chair of the National Association of Consumer Bankruptcy Attorneys, and is a member of the Minnesota State Bar Association’s Bankruptcy Section. Mr. Andresen lectures often on the topic of consumer bankruptcy at local and national legal seminars.
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