Rescinding Non-compete Agreements after the Employer's Breach

Unlock Non-Compete Agreements: Keys to Escape

posted by Neil Klingshirn  |  Nov 4, 2010 1:47 PM [EST]  |  applies to Ohio

Some states will not enforce a non-compete clause if the party seeking enforcement previously breached a material provision of the contract containing the covenant not to compete. The breach must be material, going to the essence of the bargain, and factors sounding in equity must justify rescission.

Rescission has the legal effect of voiding the contract from the outset. Consequently, a party cannot both rescind an agreement and pursue damages for its breach. However, the injured party could pursue an equitable remedy of unjust enrichment. 

Since rescission voids an agreement, a party also cannot rescind a portion of it. Trebilcock v. Elinksy, 2007 U.S. Dist. LEXIS 6167, 15-20 (N.D. Ohio Jan. 26, 2007)  See also, Am. Jur. Contracts § 533 (Partial Rescission); Ryley v. Langenbach, 3 Ohio Law Abs. 475 (Ohio Ct. App. 1925) (partial rescission only available for divisible or separable contracts).

Finally, a breach of a material term in one contract does not allow the injured party to rescind another contract, even if between the same parties. Thus, an employer’s breach of an agreement to pay a performance bonus would not allow an employee to rescind a separate non-competition agreement.

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State specific approaches to Rescission


Ohio

Ohio law allows rescission of a non-compete agreement in response to a material breach by the company. MyVitaNet.com v. Kowalski, 2008 U.S. Dist. LEXIS 8951 (S.D. Ohio Jan. 22, 2008) (citing Ehrhardt v. Hamilton Fan & Blower Co., 1986 Ohio App. LEXIS 5985 (Ohio Ct. App., Hamilton County Mar. 19, 1986). In Ehrhardt, a manufacturer agreed to sell fans to a “private brand” distributor at prices lower than those sold through the manufacturer’s independent representative network. In exchange, the distributor, Albert Ehrhard, agreed not to compete against the manufacturer and not to buy products from any other manufacturer. 

After the first eight months, the manufacturer charged Ehrhardt higher prices, which were not authorized by the agreement. Ehrhardt protested and demanded price list information. The manufacturer refused. Ehrhardt began buying supplies from a competitor and, after exchanging legal correspondence with the manufacturer, filed suit seeking rescission of the non-compete agreement. On appeal, the court allowed Ehrhardt to rescind the agreement as a remedy for the manufacturer’s breach of its material promise to charge lower prices, which promise the court found was “the consideration supporting the non-compete provisions.” Ehrhardt v. Hamilton Fan & Blower Co., 1986 Ohio App. LEXIS 5985 (Ohio Ct. App., Hamilton County Mar. 19, 1986).

Ohio courts do not allow rescission for just any breach. Rescission is tantamount to the “unmaking” of a contract. Owens v. Heilmann, 1996 Ohio App. LEXIS 427, 1996 WL 56086 at *2 (Oh. Ct. App. Feb. 12, 1996)(quoting Blacks Law Dictionary (5 Ed.Rev. 1979)). A court cannot permit an injured party to rescind a contract except for the other party’s material breach, and should take into account the following factors before it does so:
  1. the extent to which the breach deprived the injured party of the reasonably expected benefit;

  2. the extent to which the breaching party can compensate the injured party for the benefit that the breach deprived;

  3. the extent to which the breaching party will suffer forfeiture;

  4. the likelihood that the breaching party will cure the breach, taking account of all the circumstances including any reasonable assurances;

  5. the extent to which the breaching party’s behavior comports with standards of good faith and fair dealing.
Trebilcock v. Elinksy, 2007 U.S. Dist. LEXIS 6167, 15-20 (N.D. Ohio Jan. 26, 2007)(not a non-compete case; citing  England v. O'Flynn, 2002 Ohio 103, 2002 WL 27314 at *6 (Oh. Ct. App. Jan. 11, 2002); see also Kersh v. Montgomery Developmental Center, Ohio Dep't of Mental Retardation, 35 Ohio App. 3d 61, 519 N.E.2d 665 (Oh. Ct. App. 1987). The employee’s receipt of some benefit from the breached contract is not necessarily fatal to the request for rescission. In Lingo v. NVR, Inc., 2008 U.S. Dist. LEXIS 13237 (E.D. Pa. Feb. 21, 2008), for example, the court allowed the employee to rescind stock option agreement containing a non-compete provision, even though Mr. Lingo “did exercise some of his stock options, to his financial benefit.”

Kentucky
 
Kentucky recognizes the right to rescind a contract as a remedy for the other party’s material breach.  However, Kentucky courts do not “look lightly at rescission, and rescission will not be permitted for a slight or inconsequential breach.” Fay E. Sams Money Purchase Pension Plan v. Jansen, et al., 3 S.W.3d 753, 757 (Ky. Ct. App. 1999); see also S. Wabash Communs., Ltd. v. Union County Broad. Co., 69 Fed. Appx. 285, 289 (6th Cir. Ky. 2003) (In Kentucky, “it is elementary that a contract may not be rescinded unless the non-performance, misrepresentation, or breach is substantial or material.”); Evergreen Land Co. v. Gatti, Ky. App, 554 S.W.2d 862, 865 (1977) (a contract may not be rescinded unless the non-performance, misrepresentation or breach is substantial or material. The court does not look lightly at rescission, and rescission will not be permitted for a slight or inconsequential breach).

Michigan

A federal court applying Michigan law rejected an attempt to rescind a non-competition agreement based on the employer’s alleged material breaches of contract. The court held that rescission is “an action of an equitable nature in which a party seeks to be relieved of his obligations under a contract on the grounds of mutual mistake, fraud, impossibility, etc.” Since the party seeking rescission had “not alleged any legal duty, other than that created by the contract,” the court refused to rescind the agreement.  Fiddler Assocs. v. Hodder, 1997 U.S. Dist. LEXIS 6019 ( E.D. Mich. Apr. 21, 1997). See also Geno Enterpriese, v. Newstar Energy USA, Inc, 2003 Mich. App. LEXIS 1341, 14-15 (Mich. Ct. App. June 5, 2003), citing West's Michigan Digest Contracts 95K261(2) (Omnicom of Michigan v. Giannetti Inv. Co., 561 N.W.2d 138, 221 Mich. App. 341, 1997).

posted by Neil Klingshirn  |  Nov 4, 2010 1:47 PM [EST]  |  applies to Ohio

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