Oklahoma Bar Journal
Noncompetes in Oklahoma Mergers and Aquisitions
By Brandon Kemp
Imagine you get a call one afternoon from an old college friend. She is a small-business owner and her business has had a great few years. Earlier in the week, a competitor offered to sell his business to her. Your friend has run the numbers and the proposed transaction looks like a great deal. But, she is concerned that her competitor will sell out only to start a new competing business. Your friend’s company is an Oklahoma limited liability company headquartered in Tulsa. Her competitor’s company is a Delaware limited liability company also headquartered in Tulsa. The competitor owns 95 percent of the membership interests in the company, and the remaining 5 percent is held by passive investors. Both companies do business regionally, with customers in Oklahoma, Arkansas and Missouri. Your friend asks you, “If I buy this business, what can I do to make sure no one unfairly competes with me? What does the law say?” You would probably reply, “Well, in Oklahoma, it’s a little complicated … but I have a few ideas.” What follows is an introduction to Oklahoma noncompete law in the context of business acquisitions.
Covenants in restraint of trade have been disfavored by the common law since the 15th century.1They have been prohibited by statute in Oklahoma since 1890, when Oklahoma Territory adopted the Dakota Territory statute regarding covenants in restraint of trade.2 Today, though recodified and slightly modified, the Oklahoma statute prohibiting covenants in restraint of trade is substantively the same as the 1890 version. The statute, 15 O.S. §217, now provides, “Every contract by which any one is restrained from exercising a lawful profession, trade or business of any kind, otherwise than as provided by [statute] is to that extent void.”3
As 15 O.S. §217 allows, the broad prohibition of covenants in restraint of trade is subject to four statutory exceptions:
- In a “sale of goodwill,” the seller may agree “to refrain from carrying on a similar business within a specified county and any county or counties contiguous thereto, or a specified city or town or any part thereof, so long as the buyer, or any person deriving title to the goodwill from him carries on a like business therein;”4
- In a dissolution of a partnership, the partners may agree that “none of them will carry on a similar business within a specified county and any county or counties contiguous thereto, or a specified city or town or any part thereof;”5
- An employee may agree not to “directly solicit the sale of goods, services or a combination of goods and services from the established customers of the former em-ployer” following the employee’s termination;6 and
- An employee or an independent contractor may agree with a person or business not to “solicit, directly or indirectly, actively or inactively, the employees or independent contractors of that person or business to become employees or independent contractors of another person or business …”7
The first two exceptions — the sale of goodwill exception and the dissolution of a partnership exception — were also adopted from the Code of Dakota Territory,8 and they are a codification of a long-recognized common-law exception to the general prohibition of covenants in restraint of trade.9 Both exceptions contain a territorial limitation, and both contain a savings provision that authorizes a court to reform a territorially overbroad but otherwise lawful covenant to “the county comprising the primary place of the conduct of the subject business and within any counties contiguous thereto.”10
The third statutory exception, adopted in 2001, allows employees to agree they will not solicit a former employer’s “established customers.” This provision codifies an Oklahoma common-law exception to 15 O.S. §217 that developed in the 1970s.11
The final statutory exception, which the legislature added in 2013, allows an employee or independent contractor to agree not to poach a business’s employees or independent contractors. Therefore, in the context of a sale of a business, statutory exceptions one, three and four could be written into the transaction and its ancillary documents. The first exception (i.e., the goodwill exception) would apply to the owners of the target business. The third and fourth exceptions (i.e., the nonsolicitation exceptions) would apply to employees of the target business.
SALE OF GOODWILL EXCEPTION
As set out above, the goodwill exception provides, “One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business within a specified county and any county or counties contiguous thereto, or a specified city or town or any part thereof, so long as the buyer, or any person deriving title to the goodwill from him carries on a like business therein.”12Therefore, for the goodwill exception to apply to a transaction, the transaction must involve a “sale” and “goodwill.” Any covenant must also be appropriately limited in time and territory.
The Supreme Court of Oklahoma has held that “sale,” in the context of the goodwill exception, encompasses an array of transactions. Specifically, in Farren v. Autoviable Services, Inc., the court held that the term “sale” does not require an “actual cash sale.”13 The court explained,
We do not believe that an actual cash sale of goodwill was the paramount reason for inclusion of this statute in the law of this State. We believe that the purpose of this statute is to allow the parties to the transfer of a going business to mutually agree, as a part of the value of the business transferred, that the transferee will be protected from his transferor who might use his previously acquired experience, contacts and expertise to promote his own interests in the same field of business in competition with his transferee.14
On this reasoning, the court held that where the goodwill of a target corporation was “included in the corporate entity that merged with … the surviving corporation, and thus transferred to [the surviving corporation]” there was “a ‘sale’ of the good will within the meaning of [15 O.S. §218].”15Therefore, a “sale” of goodwill encompasses not only cash sales, but also corporate mergers and likely other transfers of goodwill.
Determining whether a transaction involves a sale of “goodwill” is not as straightforward. The Oklahoma Statutes define a business’s goodwill as “the expectation of continued public patronage …”16 The Supreme Court of Oklahoma has similarly defined “goodwill” as “the custom or patronage of any established trade or business; the benefit or advantage of having established a business and secured its patronage by the public.”17 The Supreme Court of Oklahoma has also explained that while “good will is in its nature intangible, it is uniformly recognized that it is a species of property and constitutes a valuable asset of the business of which it is a part.”18 Additionally, where a contract for the sale of a business does not explicitly address the transfer of goodwill, a court will examine the contract to determine if the parties intended a transfer of goodwill.19
While determining whether a transaction includes a transfer of goodwill is easy in a sale of sole proprietorship or 100 percent of the equity in a business entity, it is not so simple in a transfer of a small percentage of stock or limited liability company units. In the first reported Oklahoma case to address this situation, Key v. Perkins, the Supreme Court of Oklahoma held that the sale of a 20 percent interest in a corporation by an “active business manager” was a sale of goodwill within a predecessor statute to 15 O.S. §218.20 The court explained,
As we view it, the weight of authority and sound reasoning and logic support the contention that the owner of an appreciable interest in the stock and property and assets of a corporation has a proportionate interest in the goodwill of the business; and that on a sale thereof such owner is bound by a contemporaneous agreement, supported by an adequate consideration, not to engage in a similar business within the territorial and time limits provided by [15 OS §218].21
Later decisions have latched on to Key’s “appreciable interest” requirement. For example, in Bayly, Martin & Fay, Inc. v. Pickard, the court stated that a .8 percent interest in a corporation held by a salesman was a “miniscule amount of stock” and was “insufficient to support an argument that the goodwill exception to [15 O.S.] §217 [was] applicable.”22 Though this statement was obiter dictum, it has been relied upon by the Oklahoma Court of Civil Appeals to reverse and remand a district court decision for further fact-finding to determine whether an interest in a business was “appreciable,” and thus sufficient to support a transfer of goodwill, or “miniscule,” and thus insufficient.23 Therefore, in transactions where the seller will transfer an equity interest of less than 20 percent of the business, the sale of goodwill exception may not apply. Certainly, the exception will not apply to a transfer of a .8 percent or smaller interest.
Assuming that the sale of goodwill exception applies to a particular transaction, under Oklahoma law, a covenant not to compete may cover “a specified county and any county or counties contiguous thereto, or a specified city or town or any part thereof, so long as the buyer, or any person deriving title to the goodwill from him carries on a like business therein.”24 By statute, the duration of the covenant not to compete may be perpetual, as long as the buyer or his assigns continue the purchased business within the territory. Unfortunately, though, the territorial limitation of a county and its contiguous counties limits the usefulness of the 15 O.S. §218 goodwill exception. Perhaps a county and its contiguous counties seemed like a vast territorial range in 1890, but it is meager in modern terms.
That said, many states will enforce a noncompete with a much larger territory. Thus, if the parties choose the law of another jurisdiction to govern their transaction, an Oklahoma court might enforce a noncompetition covenant in a sale of goodwill to the extent of the chosen jurisdiction’s law. In Oklahoma, a contract will be governed in accordance with Oklahoma’s choice-of-law principles “unless otherwise agreed and unless contrary to the law or public policy of the state where enforcement of the contract is sought.”25In other words, an Oklahoma court will enforce a choice-of-law clause that complies with Section 187 of the Restatement (Second) of Conflict of Laws.26 Therefore, if the parties to a transaction choose a governing law with a substantial relationship to the transaction — e.g., the state of incorporation of the target company or the buyer — and the terms of the noncompetition covenant do not violate Oklahoma’s public policy, an Oklahoma court should enforce a noncompetition covenant that is in compliance with the law of the chosen jurisdiction.27
Though the Supreme Court of Oklahoma has not addressed this issue, at the time of the publication of this article, there is a case pending in the court that may.28 Additionally, at least one published decision supports that Oklahoma would enforce a covenant not to compete beyond the territorial restrictions of 15 O.S. §218 in a transaction that included a sale of goodwill and was governed by the law of another jurisdiction. In Eakle v. Grinnell Corp., the United States District Court for the Eastern District of Oklahoma held that a five-year noncompetition covenant that covered the entire states of Oklahoma and Arkansas and was governed by Delaware law was enforceable in Oklahoma.29 The noncompete was entered into as part of a sale of 100 percent of the stock of a corporation operating in Oklahoma (i.e., a sale of goodwill),30and the buyer was a Delaware corporation.31 Two years after concluding the sale of the corporation, the buyer-employer terminated the seller-employee.32 Thereafter, the seller-employee sought a declaratory judgment that the “noncompete agreement” entered into as part of the sale of the corporation was void because it violated Oklahoma public policy by being territorially overbroad.33
The Eastern District disagreed with the seller-employee. First, the Eastern District recognized that Delaware will enforce a covenant not to compete “if reasonably limited as to time, area, and purpose and if such promise does not constitute an unreasonable restraint of trade or otherwise contravene public policy,”34 and concluded that the noncompete covenant complied with Delaware law.35 Next, the Eastern District acknowledged that, under Oklahoma law, a noncompete covenant made in connection with a sale of goodwill may only encompass the city or county (and contiguous counties) where the sold enterprise is operated.36 Nevertheless, the Eastern District noted that the public policy of Oklahoma authorized noncompete agreements entered into in connection with a sale of goodwill to some degree and determined that Oklahoma would enforce the noncompete agreement.37 Specifically, the Eastern District explained,
A mere difference in the law is not sufficient to warrant the application of the public policy exception argued for by [seller-employee] … To hold otherwise would be to allow the exception to swallow the rule. If the court were to follow [seller-employee’s] line of reasoning then the forum’s law would always apply when a difference in respective states’ laws could be shown. The mere fact a chosen law differs from the forum’s law does not make the application of the chosen law a violation of the forum’s public policy. Rather, a broader concept of public policy is required. Here, the public policy of Oklahoma authorizes noncompete agreements in the context of the sale of goodwill. While it is true that certain limitations have been enacted under section 218 to govern these situations, the fact re-mains that Oklahoma nonetheless approves of the concept of noncompete agreements when the sale of goodwill is involved, albeit with certain geographic restrictions. The court concludes such restrictions do not act as an impediment to its application of Delaware law in connection with the [noncompete agreement].38
The Eastern District also found that the covenant’s five-year duration and prohibition of certain activities complied with Oklahoma law.39 Though Eakle is a federal district court opinion, it provides support that Oklahoma would enforce a noncompete covenant, entered into in connection with a sale of goodwill, that complied with the law of another state chosen to govern a transaction. Therefore, it may be possible to extend the territorial limits of 15 O.S. §218 in an Oklahoma transaction, provided there is a reasonable basis for choosing the law of another jurisdiction.
Even if an Oklahoma court declined to enforce a noncompete covenant because it exceeded the territorial limits of 15 O.S. §218, the statute mitigates the risk of trying. Section 218 specifically provides that a noncompete covenant that is “otherwise lawful but which exceeds the territorial limitations specified by this section may be deemed valid, but only within the county comprising the primary place of the conduct of the subject business and within any counties contiguous thereto.” In the past, Oklahoma appellate courts have reformed and enforced noncompetes that were territorially overbroad but otherwise complied with 15 O.S. §218.40 Likewise, in an unpublished decision involving the goodwill exception, the United States District Court for the Northern District of Oklahoma declined to follow the holding in Eakle, but enforced an “overbroad” noncompete to the territorial limits of 15 O.S. §218.41
In addition to noncompete covenants with the owner of a target business, the buyer of a target business also has options to protect the target business from unfair competition by the target’s business managers or other employees. Unfortunately, though, while the seller of a business may outright agree to not carry on a similar business, an Oklahoma court will not uphold the same covenant made by a mere employee.42 For employees, the exceptions to Oklahoma’s broad prohibition of covenants in restraint of trade are limited to nonsolicitation of established customers and nonsolicitation of employees and independent contractors.43
Since 1970, Oklahoma courts have upheld covenants made by employees not to solicit established customers.44 In 2001, the Oklahoma Legislature codified this exception to 15 O.S. §217 as 15 O.S. §219A, which permits employee covenants not to “directly solicit the sale of goods, services or a combination of goods and services from the established customers of the former employer.” Unfortunately, the statute does not define “established customers,” and no Oklahoma appellate court has interpreted that term.
Additionally, at least one Oklahoma appellate court decision interpreting 15 O.S. §219A has held that covenants not to solicit established customers that do not comply with “rule of reason” will be rejected.45 An Oklahoma court will modify an unreasonable nonsolicitation covenant “if the contractual defect can be cured by imposition of reasonable limitations concerning the activities embraced, time, or geographical limitations.”46 But, a covenant “cannot be judicially modified if essential elements of a contract must be supplied.”47
Though the Supreme Court of Oklahoma has not considered whether the “rule of reason” applies to nonsolicitation covenants following the adoption of 15 O.S. §219A, it would still be prudent to draft any nonsolicitation covenant to conform to nonsolicitation covenants that have been upheld under the “rule of reason” before the adoption of 15 O.S. §219A. To that end, Oklahoma courts have upheld covenants not to solicit established customers with durations as long as two years.48 Any nonsolicitation covenant with a longer duration or that extends beyond “established customers” risks being determined unenforceable and perhaps not reformable.49
Finally, in 2013, the Oklahoma Legislature adopted 15 O.S. §219B, which provides that an employee or an independent contractor may agree with a person or business not to “solicit, directly or indirectly, actively or inactively, the employees or independent contractors of that person or business to become employees or independent contractors of another person or business …”50 The statute does not define any of its material terms, such as “soliciting,” “actively,” “inactively,” “directly” or “indirectly.”51 And, there is no Oklahoma precedent evaluating the enforceability of a covenant not to solicit employees or independent contractors, either before or after the statute was adopted.52 Nevertheless, as in the case of covenants not to solicit established customers, it is possible that a reviewing court would subject a covenant by an employee not to solicit a company’s employees or independent contractors to “rule of reason” analysis. A practitioner should consider limiting the duration and territorial scope of a covenant not to solicit employees or independent contractors to survive “rule of reason” analysis.
So, back to your ideas for that old college friend. First, you would probably tell her that if she buys 20 percent or more of the business, through an asset sale or an equity sale, the deal may require an agreement by the seller not to carry on a similar business in Tulsa County and its contiguous counties for as long as she operates the purchased business. You might also tell her that because the target company is a Delaware limited liability company, choosing Delaware law to govern the agreement may enable her to extend the territory of the noncompete, say, to include Oklahoma, Arkansas and Missouri. Certainly, you would let her know that she unfortunately cannot similarly restrict the target company’s business managers or other employees but can require them to agree not to solicit the target company’s established customers, employees or independent contractors. Of course, you would have to conclude, “This could all change tomorrow. Law and legislation are moving targets.”
Brandon Kemp is an associate attorney with Conner & Winters LLP. Mr. Kemp primarily practices with the firm’s corporate and securities and litigation practice groups. Among other things, his practice includes securities registration and SEC reporting, securities and asset-sale transactions and commercial litigation in a variety of industries. He is a 2013 graduate of the OU College of Law, where he was an editor of the Oklahoma Law Review.
2. Compare Terr. Okla. Stat. Ch. 17, art. IV, §8 (1890) with Terr. Dak. Code §959 (1883). See also 1 Revised Statutes of Oklahoma 1910, vii, 262 (Clinton O. Bunn ed., 1912) (“The great body of the [Oklahoma] statutes … came from Dakota …”).
3. Despite its seemingly absolute terms, 15 O.S. §217 only prohibits “unreasonable” restraints of trade. Key Temp. Pers., Inc. v. Cox, 1994 OK CIV APP 123, ¶8, 884 P.2d 1213, 1215. The common-law exceptions that developed under the “rule of reason” are now encompassed by the statutory exceptions that are discussed in this article.
4. 15 O.S. §218.
5. 15 O.S. §219.
6. 15 O.S. §219A(A).
7. 15 O.S. §219B.
8. Compare Terr. Okla. Stat. Ch. 17, art. IV, §8 (1890) with Terr. Dak. Code §960 (1883). Compare Terr. Okla. Stat. Ch. 17, art. IV, §9 (1890) with Terr. Dak. Code §961 (1883). See also 1 Revised Statutes of Oklahoma 1910, vii, 262-63 (Clinton O. Bunn ed., 1912).
9. See note 1, supra.
10. 15 O.S. §§218-219.
11. See Bayly, Martin & Fay, Inc. v. Pickard, 1989 OK 122, ¶¶11-12, 780 P.2d 1168, 1171-72 (detailing the emergence of the “rule of reason” in Oklahoma).
12. 15 O.S. §218.
13. 1973 OK 4, ¶5, 508 P.2d 646, 648.
15. Id. at ¶6, 508 P.2d 646, 648.
16. 60 O.S. §315. The definition also clarifies that “goodwill … does not include a right to use the name of any person from whom it was acquired.”
17. Freeling v. Wood, 1961 OK 113, ¶12, 361 P.2d 1061, 1063.
18. Id. at ¶13, 361 P.2d 1061, 1063 (quotation omitted).
19. Griffin v. Hunt, 1954 OK 87, ¶8, 268 P.2d 874, 876 (upholding a covenant not to compete under the goodwill exception where the contract did not refer to goodwill but the transfer of goodwill was “the plain purpose and effect” of the agreement).
20. 1935 OK 142, ¶¶3, 14, 46 P.2d 530, 531-32.
21. Id. at ¶14, 46 P.2d 530, 532 (emphasis added).
22. 1989 OK 122, ¶9, 780 P.2d 1168, 1170.
23. Oliver v. Omnicare, Inc., 2004 OK CIV APP 93, ¶13, 103 P.3d 626, 630. After remand, the parties stipulated to dismissal with prejudice; therefore, it was never determined whether the transfer at issue supported the goodwill exception. See Stipulation of Dismissal with Prejudice, Oliver v. Omnicare, CJ-2003-1070 (D. Ct. Okla. Cnty. Jan. 6, 2005). See also Cardoni v. Prosperity Bank, 805 F.3d 573, 588 (5th Cir. 2015) (invoking the “appreciable”/“miniscule” dichotomy to reject an argument that a .39 percent equity interest would support the goodwill exception under Oklahoma law).
24. 15 O.S. §218.
25. Oliver, 2004 OK CIV APP 93, ¶4, 103 P.3d 626, 628.
26. Dean Witter Reynolds, Inc. v. Shear, 1990 OK 67, ¶6, 796 P.2d 296, 298-99 (noting that a litigant “could have, but did not, call for a judicial analysis of any of the facts supportive of a choice-of-law challenge under the Restatement (Second) Conflict of Laws §187”).
27. See Restatement (Second) of Conflict of Laws §187. The statement in Oliver, note 25, supra, somewhat oversimplifies the Restatement’s analysis. To invalidate a choice-of-law provision, the analysis requires not only that the enforcing court determine that the provision is contrary to its state’s fundamental public policy, but also that the state has the most significant relationship to the transaction and the parties. See Dean, 1990 OK 67, ¶7, 796 P.2d 296, 299. Nevertheless, the enforcing court is likely to determine that its state has the most significant relationship.
28. Berry and Berry Acquisitions, LLC v. BFN Properties LLC, No. DF-114,442 (Okla. Sup. Ct. appellants’ brief filed Aug. 16, 2016).
29. 272 F. Supp. 2d 1304, 1312 (E.D. Okla. 2003).
30. Id. at 1306.
31. Id., syllabus, at 1304.
32. Id. at 1307.
34. Id. at 1308 (quoting Turek v. Tull, 139 A.2d 368, 372 (Del. Ch. 1958), aff’d, 147 A.2d 658 (Del. 1958)).
36. Id. at 1312.
38. Id. (internal citations omitted).
39. Id. at 1311-12.
40. See, e.g., Hartman v. Everett, 1932 OK 460, ¶6, 12 P.2d 543, 544.
41. Sw. Stainless, L.P. v. Sappington, No. 07-CV-0334-CVE-PJC, 2008 WL 918706, at *6 (N.D. Okla. Apr. 1, 2008). The Northern District declined to follow Eakle on the basis of the Oklahoma Court of Civil Appeals’ choice-of-law analysis in Oliver, which was adopted by the 10th Circuit. Id. Again, though, Oliver oversimplifies the Restatement (Second) of Conflict of Laws analysis, which appears to have been adopted by the Supreme Court of Oklahoma. See notes 25-27, supra. To invalidate a contractual provision, the Restatement requires not merely that the provision violate the law of the enforcing state, but that the provision be “contrary to a fundamental policy of the state with the materially greater interest …” Dean Witter Reynolds, Inc. v. Shear, 1990 OK 67, ¶7, 796 P.2d 296, 299 (internal quotation omitted).
42. See, e.g., Cardiovascular Surgical Specialists, Corp. v. Mammana, 2002 OK 27, ¶20, 61 P.3d 210, 215 (striking noncompete provisions from an employee’s employment contract).
43. 15 O.S. §§19A, 19B. Though not the subject of this article, an Oklahoma employer can combat unfair employee competition through other means, such as through the protection and defense of its trade secrets in accordance with the Oklahoma Uniform Trade Secrets Act. See 78 O.S. §§85–94.
44. Bayly, Martin & Fay, Inc. v. Pickard, 1989 OK 122, ¶¶11-12, 780 P.2d 1168, 1171-72.
45. Inergy Propane, LLC v. Lundy, 2009 OK CIV APP 8, ¶28, 219 P.3d 547, 557. “The determination of whether a restraint is reasonable depends on all the facts and circumstances. A restraint is deemed reasonable only if it 1) is no greater than is required for the employer’s protection from unfair competition; 2) does not impose undue hardship on the employee; and, 3) is not injurious to the public.” Loewen Grp. Acquisition Corp. v. Matthews, 2000 OK CIV APP 109, ¶15, 12 P.3d 977, 980 (citingTatum v. Colonial Life & Acc. Ins. Co. of Am., 1970 OK 27, ¶8, 465 P.2d 448, 451-52).
46. Bayly, 1989 OK 122, ¶14, 780 P.2d 1168, 1173.
47. Key Temp. Pers., Inc. v. Cox, 1994 OK CIV APP 123, ¶8, 884 P.2d 1213, 1215.
48. See, e.g., Tatum v. Colonial Life & Acc. Ins. Co. of Am., 1970 OK 27, ¶12, 465 P.2d 448, 452; Thayne A. Hedges Reg’l Speech & Hearing Ctr., Inc. v. Baughman, 1998 OK CIV APP 122, ¶3, 996 P.2d 939, 941.
49. See Bayly, 1989 OK 122, ¶18, 780 P.2d 1168, 1175 (striking down a nonsolicitation provision that extended beyond established customers).
50. 15 O.S. §219B.
51. See id.
52. In Howard v. Nitrolift Technologies, LLC, which was decided before 15 O.S. §219B was adopted, the Supreme Court of Oklahoma held that employee covenants regarding the nonsolicitation of employees were unenforceable under Oklahoma law. 2011 OK 98, ¶23, 273 P.3d 20, 29, cert. granted, judgment vacated, 133 S. Ct. 500 (2012). The opinion was vacated by the Supreme Court of the United States on other grounds, and the Oklahoma legislature adopted 15 O.S. §219B to abrogate the holding in Howard. See Teresa L. Green, The Shifting Landscape of Restrictive Covenants in Oklahoma, 40 Okla. City U. L. Rev. 449, 463 (2015).
Originally published in the Oklahoma Bar Journal -- OBJ 88 pg. 128 (Jan. 21, 2017)