You Dissented From a Merger. Are You Bound by Your Non-Compete?
March 26, 2018
New York’s business-entity statutes, like those across the nation, provide minority owners with the right to dissent from a merger and to be paid the fair value of the dissenter’s ownership interest. Now assume the dissenter also has an employment agreement with the pre-merger entity containing a non-compete provision. Can the post-merger surviving entity enforce the non-compete against an owner who exercises the statutory right to dissent? Does the answer depend solely on the terms of the employment agreement, or does the statutory protection of minority rights embedded in the merger statutes require a different analysis?
Those questions are especially important to certain professional organizations such as medical and accounting practices which traditionally bind their shareholders — or members, in the case of professional LLCs — to employment agreements containing non-compete and/or non-solicitation provisions, and which, due to accelerating market forces, experience significant merger activity.
In a recent first-impression decision by an intermediate appellate court in Colorado, the court denied enforcement of non-compete and liquidated damages provisions in an anesthesiologist’s shareholder employment agreement following his dissent from a merger. While the decision explicitly refused to construe the agreement’s enforceability without consideration of the dissenter’s statutory rights, implicitly it left undecided whether a firm can contract around those rights to enforce restrictive covenants against a dissenter who exits the practice and competes post-merger.
The Crocker Case
In Crocker v Greater Colorado Anesthesia, P.C., 2018 COA 33 [Ct App Div. IV Mar. 8, 2018], Dr. Michael Crocker dissented from the 2015 merger of his Denver-based anesthesiology practice, organized as a professional corporation, into a larger anesthesiology practice. Dr. Crocker had been a shareholder of the practice and its predecessor firm (“Old GCA”) since 2001, and at the time of the merger was party to a shareholder employment agreement that contained a non-compete provision imposing formula-based liquidated damages upon a shareholder/employee who engages in a competing practice for two years after termination of the agreement anywhere within a 15-mile radius of a hospital serviced by Old GCA.
Two months after the merger, Dr. Crocker commenced employment with another anesthesiology practice within the defined non-compete area. The subsequent litigation featured Dr. Crocker’s claim for the fair value of his 1.1% stock interest in Old GCA, which he valued over $1 million and for which the post-merger entity (“New GCA”) had offered $100 based on Dr. Crocker’s nominal capital contribution to Old GCA. It also featured New GCA’s liquidated damages claim against Dr. Crocker for over $200,000 for his alleged violation of the non-compete.
The trial court concluded both that it was unreasonable to enforce the non-compete against a dissenting shareholder “forced out” of employment by the merger, and that the claimed liquidated damages were not reasonably related to New GCA’s actual injury. The trial court also determined the fair value of Dr. Crocker’s 1.1% share of Old GCA to be approximately $55,000 which was the figure proffered by New GCA’s appraisal expert.
The appellate court affirmed across the board. Its analysis of the statutory and contractual interplay began with the general rule relied upon by New GCA’s argument, that the rights and obligations of the merging entities vest in, and are enforceable by, the surviving entity. But the general rule did not prevail in Crocker, the court went on to hold, because under Dr. Crocker’s agreements with Old GCA his shareholder and employee rights were inextricably interwoven. Here’s what the court wrote:
[W]e do not agree that the district court erred by considering Crocker’s exercise of his dissenter’s rights when determining that Crocker was no longer bound by the Agreement upon the merger. GCA urges a pure contract law analysis, arguing that Crocker’s statutory rights as a dissenter apply only to Crocker’s shareholder rights and not to his rights as an employee. But under the terms of his agreements with old GCA, Crocker’s shareholder rights are wed to his rights as an employee. Indeed, the Agreement, which incorporates by reference the Corporate Stock Sale Agreement, does not permit Crocker to be an employee and not a shareholder. And the Corporate Stock Sale Agreement, which incorporates by reference the Agreement, does not permit Crocker to be a shareholder and not an employee. Accordingly, when he exercised his dissenter’s rights, Crocker was forced to cease his employment with GCA. Thus, we cannot construe the enforceability of the Agreement without consideration of Crocker’s rights as a dissenter. [Italics added; footnotes omitted.]
The court acknowledged that it was writing on a blank slate, noting that neither the parties nor the court itself found “any authority evaluating the enforceability of a noncompete provision under similar circumstances . . . in this or any other jurisdiction.”
To help fill in the blank, the court fell back on the general principle that non-compete covenants are enforceable only if they are “reasonable,” defined under Colorado law as not imposing “hardship on the promisor.” Because Dr. Crocker lived within the non-compete area, and because it was undisputed that an anesthesiologist “must reside within 30 minutes of where he or she works,” the court found that “enforcement of the noncompete provision would require Crocker either to move or to pay GCA damages to practice his profession.” Enforcing the non-compete, the court wrote, would “further penalize Crocker’s exercise of his right to dissent, rather than protect him from the conduct of the majority” in pursuing a merger.
“Under these circumstances,” the court concluded, “the noncompete provision of the Agreement is unreasonable and imposes a hardship on Crocker, and it is thus not enforceable against him as of the date the merger was finalized.”
At least under Colorado law, the Crocker decision does not necessarily support a categorical rule against the enforcement of a shareholder’s contractual, post-termination non-compete upon the shareholder’s exercise of dissenting shareholder rights. The decision seems to hinge in large part on the contractual mechanism whereby Dr. Crocker’s employment status automatically ceased upon the termination of his shareholder status triggered by his dissent. And while such provisions are not unusual in professional practice shareholder agreements, arguably it leaves the door open to non-competes that expressly address post-merger enforcement, perhaps by way of an express, prospective waiver of dissenter’s rights in determining the non-compete’s reasonableness.
Practices considering a merger, and which have existing shareholder employment agreements like the one in Crocker, also can weigh the pros and cons of providing for continued employment as a non-shareholder to those who dissent. Of course, in either event, the non-compete and any liquidated damages provision also must survive judicial scrutiny as to reasonableness under general principles of employment law.
Would Crocker make it in New York? I’ll take the Colorado court’s word for it, that there’s no case law in any other jurisdiction including New York addressing similar circumstances. So the answer is, I don’t know.
Crocker does bring to mind, however tangential, the MGM Court Reporting case from the late 1980’s, when the New York Appellate Division, Second Department, held that an “oppressed” minority shareholder who sued for judicial dissolution, and whose shares the majority then elected to purchase for fair value, was not subject to a seller’s implied restrictive covenant against soliciting former customers of the business because the sale was “under compulsion.” Crocker involves a contractual rather than an implied covenant, so I’m hesitant to say MGM points in a different direction even assuming a shareholder’s dissent from a merger likewise is deemed a compulsory sale, not to mention that when the Court of Appeals affirmed the ruling in MGM, it did so on other grounds and expressly refrained from deciding whether the statutory buy-out in that case was a sale “under compulsion.”