The difficult economic circumstances of the last few years have affected employer/employee relationships in a number of different ways. One of these effects has been that fewer employees changed jobs. During a period of high unemployment, many employees rationally decided not to risk the uncertainty associated with pursuing new opportunities.
Now that the economy is showing signs of recovery, many employees have decided that now is the time to make a move. Employers are rightly concerned with this development, because an employee departure may mean the former employee will soon be competing against the employer. As a result, the use of non-compete agreements, and corresponding litigation seeking to enforce non-compete agreements, has increased significantly. This litigation is not limited to high-level executives. In fact, it has become common practice for employers to require mid-level employees to execute non-compete agreements in recognition of the fact that many mid-level employees have access to valuable trade secrets and practices.
Employers who sue former employees for covenants not to compete can expect a certain number of the former employees to respond with the threat of a bankruptcy filing. Employers should be aware of the potential effects of a former employee filing bankruptcy. Simply put, an employer seeking to enforce important and valuable non-compete obligations should not throw in the towel as soon as the former employee brings up the prospect of bankruptcy. The fact is that a meaningful number of courts allow for the enforcement of these obligations, even after a bankruptcy filing.
In practice, when the former employee files bankruptcy, he or she will likely seek to characterize the non-compete agreement as an “executory contract” subject to rejection. Generally speaking, rejecting an executory contract frees a debtor of its obligations under the contract, leaving the other party with no more than an unsecured claim. Many bankruptcy courts have held that a former employee’s covenant not to compete against the former employer is not the type of contractual obligation subject to rejection. In addition, even if portions of an employment contract are subject to rejection, a bankruptcy court may allow for the covenant not to compete to be carved out of a contract and enforced post-rejection.
Some courts, however, have gone the other way and have allowed former employee debtors to free themselves of non-compete obligations through bankruptcy. The take away point for an employer is that, depending on the jurisdiction, a bankruptcy filing may not prevent the employer from enforcing a non-compete agreement in order to protect the company in the current volatile employment market.