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Restrictive Covenants Need to Limit their Scope in Order to Be Effective, Kodiak Case Suggests

Updated: Jan 9, 2023

A 2022 decision involving Kodiak Building Partners and an ex-employee from a company that Kodiak acquired serves as a reminder that courts are viewing non-compete covenants ever more critically, several law firms say.

The news also is pertinent because the Federal Trade Commission on Jan. 5 issued a proposed rule that would ban non-compete agreements.

Kodiak Building Partners LLC. v. Adams dealt with a restrictive covenant agreement (RCA) with Phillip Adams, a general manager and part owner of Northwest Building Components. When Kodiak purchased Northwest in June 2020, Adams signed an RCA that included provisions barring him for 30 months from competing with Kodiak and soliciting customers.

Adams remained at Northwest until October 2021, and then about two months later went to work for Builders FirstSource, the Reed Smith law firm reported. By March 22, Kodiak determined it was losing business to BFS. Kodiak then sued Adams, and the case went to Chancery Court in Delaware, where Kodiak is incorporated.

"The court confirmed that a purchaser has a legitimate interest in protecting goodwill purchased from a business’ seller," the Davis + Gilbert law firm reported in its commentary. "The covenants in Adams’ RCA, however, purported to restrict him from competing with all of Kodiak’s other businesses, and from soliciting all of those businesses’ customers, not just Northwest’s or even those of Kodiak’s other lumber and building materials companies. As the court explained, 'Kodiak’s legitimate economic interest supporting a restrictive covenant binding a Northwest employee and stockholder does not extend to goodwill and competitive space acquired in other transactions with other Company Group members in other industry segments.' The court would not enforce covenants seeking to restrict Adams in that other competitive space."

In its commentary, the Debevoise & Plimpton law firm said in effect that Kodiak lost because its RCA was too tight. "The dynamic faced by Kodiak Partners—the buyer in this case—is a common one," it wrote. "... Even where the buyer acknowledges some uncertainty regarding its ability to enforce restrictions that go beyond the scope of the business being acquired, it often considers the risk well worth taking."

"Ironically, it appears that the selling stockholder’s conduct would have breached even a narrow restriction, limited to the pre-closing business of the target, and that the broader covenant was in this instance unnecessary," Debevoise & Plimpton wrote. "Nonetheless, for want of a narrower scope, the entire covenant was lost."

Davis + Gilbert said the Kodiak case "suggests that, at least under Delaware law, courts will limit the enforceability of covenants even in the sale of business context, enforcing them only to the extent to protect specific, legitimate business interests of the buyer."

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