Nevada’s Supreme Court recently confirmed in Excellence Community Management LLC v. Gilmore et al., 131 Nev. Adv. Op. 38 (2015), that non-compete provisions—contract terms that limit an employee or contractor’s ability to work for a competitor after the relationship ends—are not terminated just because a company’s ownership changes hands. The Supreme Court also reminded businesses and their lawyers that non-compete agreements should be assignable, in case the employee or contractor moves to a new entity as part of an asset sale. Finally, the Supreme Court gave some indirect advice for how to make these agreements more likely to support an injunction, allowing a district court to issue an order halting a departing employee’s work.
History of the Dispute: Familiar Facts for Relationship-Based Businesses.
Excellence Community Management (“Excellence”) provides management services to homeowners associations in the Las Vegas area, and employed Ms. Gilmore from 2005 to 2012. In April of 2011, Excellence required Ms. Gilmore to sign a contract that prohibited her from working for a competitor, or soliciting Excellence’s clients, for a period of 18 months following the end of her employment with Excellence. It did not, however, have a clause making it assignable to a different company or entity.
Shortly thereafter, in May of 2011, Excellence’s two owners sold 90% of their combined membership interest in the company to a new owner. Within the following year, they had sold the remaining 10% to the same purchaser. Excellence then had completely new ownership, but was in all other respects the same company it had always been.
In June of 2012, Gilmore resigned from Excellence and went to work for Mesa Management LLC (“Mesa”)—also a defendant in the lawsuit, and a respondent in the appeal. Like Excellence, Mesa also provides management services to Las Vegas-area homeowners associations. Upon the beginning of Ms. Gilmore’s employment with Mesa, the company notified numerous homeowners associations that it had acquired Ms. Gilmore as an employee.
Seeking to enforce the 18-month non-compete and non-solicitation clauses Ms. Gilmore signed, Excellence filed a lawsuit against her and Mesa. Excellence requested a preliminary injunction to keep Ms. Gilmore from violating her contract by working for Mesa. The Clark County District Court denied Excellence’s motion for two reasons: Excellence’s change in ownership rendered the non-compete agreement unenforceable—which the Supreme Court reversed—and that Excellence had not shown the “irreparable harm” necessary to issue an injunction, with which the Supreme Court agreed.
Procedurally, this case was before the Supreme Court because the Clark County District Court denied Excellence’s motion for a preliminary injunction. Had Excellence’s motion succeeded, it would have stopped Ms. Gilmore from working for Mesa for the duration of the litigation. Whichever way the District Court decided the motion, though, the losing side would have had a right for immediate appeal to the Nevada Supreme Court under Nevada Rule of Appellate Procedure 3A(b)(3).
A 100% Change of LLC Ownership Does Not Create a New Entity.
One of the central issues before the Supreme Court was whether the 100% sale of a limited-liability company’s membership interest is analogous to an asset sale or stock sale. The non-compete provisions’ enforceability turned on this question: because the contract was not assignable, Excellence would not be able to enforce it if its change in ownership was considered an asset sale. In an asset sale, a purchaser acquires the some or all of a corporation and absorbs it, turning it into a new entity and new employer. In contrast, a stock sale simply controls the ownership of the entity without changing or affecting its existence.
Limited-liability companies, however, use membership interest rather than stock to assign ownership, which presented a new question for the Supreme Court to decide. While corporate stock and the membership interest in limited-liability companies serve similar purposes, they governed by different chapters of the Nevada Revised Statutes and pose different challenges. Because corporations and limited-liability companies both have a perpetual existence distinct from their owners, the Supreme Court determined that the sale of 100% of a limited-liability company’s membership interest is the same as a 100% sale of a corporation’s stock. As such, no new entity was created, and Excellence could enforce its 2011 agreement with Ms. Gilmore even under its new ownership.
The subtext to this branch of the Supreme Court’s decision is the importance of change-of-ownership provisions. In small businesses, and particularly in the professional services arena, economic health can be closely tied to the owners. While provisions that allow for termination of an agreement for ownership changes frequently appear in commercial leases, financing instruments, and certain regulatory agreements, they are less common in generic non-competition agreements. Such terms may be helpful in luring top producers to a firm, and for talent who want to work primarily with an organization’s ownership. However, like any term that limits the applicability of a non-compete or non-solicitation provision, this consideration would benefit employees and contractors over the organization retaining them.
Assignability of Agreements with Non-Compete Provisions Still Important.
While the Supreme Court’s decision clarified that a 100% change of ownership in a limited-liability company does not create a new entity to which a non-compete agreement must be assigned, it also reaffirmed that asset purchases do have this requirement. A contract must be assigned to a new entity in order for it to enforce the agreement. Many contracts have language allowing one or both of the parties to assign its benefits or obligations to another person or company. Where the contract does not allow for assignment, though, a new entity will have serious trouble enforcing the agreement, if it can at all.
Asset purchases are different from wholesale acquisitions of a company’s stock or membership interest. Individual stores or franchises can be purchased from a large enough company, and be absorbed by the buyer. Similarly, chunks of a business’ operations can be sold or spun off to outside entities that are not part of the original company. This is common in larger firms where certain functions face challenges that impede the rest of the business. (The mortgage servicing industry, with a rise of small companies servicing the loans of large banks, is a recent example of this phenomenon.)
There are good reasons to ensure that non-compete provisions are assignable, and thus enforceable, by these new entities. For example, a parent company whose employees sign non-compete agreements may wholly own a subsidiary that acquired a risky part of the main business for tax or other strategic reasons. Still, as a new entity that acquired part of the parent’s business, the subsidiary company would need to have the patent company’s non-compete agreements assigned to it. If the non-compete agreements were not assignable, the subsidiary could not enforce them, depriving both it and the parent company of the agreements’ significant benefits.
The Importance of Defining An Employee or Contractor’s Unique Skills.
Despite correcting the District Court’s ruling on the company ownership issue, the Nevada Supreme Court agreed that an injunction was improper because Excellence did not show it would suffer “irreparable harm” from Ms. Gilmore’s conduct. Irreparable harm arises where money damages are inadequate to cure the harm at risk of occurring, whether through the loss of customers or key relationships. The Nevada Supreme Court does not go on to precisely state where it arises, though, further contributing to Nevada’s frequently unpredictable legal landscape.
Obtaining an injunction to stop an employee or contractor from breaching a non-compete provision is more difficult than merely showing he or she is poaching the prior employer’s customers. The Supreme Court indicated that a finding of irreparable harm will ultimately depend on the facts of the case. Where there is evidence that an employee or contractor breaching a non-compete provision has stolen clients or shared trade secrets, there may be a presumption of irreparable harm—but only where the employee or contractor provided “unique” services. In Excellence Community Management, the Nevada Supreme Court found that Ms. Gilmore’s services were not unique enough to be irreplaceable, and did not warrant such a presumption.
This holding is consistent with the broader trend disfavoring any presumption of injunctive relief. As intellectual property litigators can attest, presumptions of irreparable harm have been steadily eroding since the United States Supreme Court’s 2006 ruling in eBay Inc. v. MercExchange LLC. The eBay case that held there was no presumption of irreparable harm simply upon showing infringement occurred—a principle that has crept, arguably oversimplified, into the trademark and copyright arenas. The United States Supreme Court’s tough stance on presuming irreparable harm does not seem to have gone unnoticed.
One way businesses can prevent being affected by a similar ruling is to document the unique skills and abilities of employees or contractors that are covered by non-compete provisions. This requires customization of each agreement, and should be tailored to the contractors and employees most valuable to the business’ operations. It may also lead to the realization that not every employee or contractor requires a non-compete agreement. By taking this step, it may be possible to overcome the objection that an employee’s services are insufficiently specialized to warrant an injunction.
If non-compete provisions cannot be enforced, then they are of little use. With some additional measures, agreements containing non-compete agreements can be enhanced to withstand the challenges identified in Excellence. In the wake of this decision, it is worthwhile for businesses to review their contracts and update their non-compete and non-solicitation terms as needed.