Once disfavored, non-compete agreements — contractual provisions prohibiting employees from competing with their former employers upon the relationship’s termination — have acquired new legitimacy in recent decades. Today, these covenants will be enforced in all but a handful of jurisdictions via damages or an injunction as long as they are reasonable in scope and protect legitimate business interests.[1] Faced with this new reality, in § 101(5)(B) of the Bankruptcy Code, which defines a “claim” as “[any] right to an equitable remedy for breach of performance if such breach gives rise to a right to payment,”[2] employees have found a means of extrication. If an employer can seek damages for a breach of a non-compete agreement under the relevant state’s statutory or common law, these debtors assert that any potential breach will yield a cognizable right to payment. These employers necessarily hold Code “claims,” and a discharge automatically invalidates these covenants.[3] Numerous bankruptcy courts have agreed.[4]
Despite its apparent appeal, as this technical reading fails to undertake the kind of holistic analysis — one attuned to context, practice and precedent — that modern precedent compels,[5] the reading merits rejection, not perpetration. These sources point to a markedly different construction of § 101(5)(B). If claiming damages cannot serve as a viable alternate remedy for the actual injury that was caused by the non-compete’s breach, a debtor’s wrong can create no attendant financial entitlement.[6] In most states, only if a right to injunctive relief cannot address the debtor’s transgression — and it loses its status as a right[7] — will any pecuniary prerogative arise, so a focus on technical availability obscures a decisive fact: the frequent impossibility of these remedies’ parallel invocation as a matter of applied law. In such cases, apparent only upon a dissection of the relevant facts, no money will ever be exactable and no “claim” is possible.
Consensus of Sorts
If (1) money damages may serve as an “alternate” remedy under the relevant state’s statutory or common law,[8] or (2) compliance with the injunction will require a penny’s expenditure,[9] courts will define a debtor’s obligation under an enforceable non-compete agreement as a § 101(5)(B) “claim.”[10] Within this apparent majority,[11] in assessing the remedies’ equivalence, a number of courts have turned to the applicable nonbankruptcy statutory or common law[12] and examined whether it allows for the possibility of damages for any past, ongoing or prospective breach of a non-compete.[13] Unless “the only remedy allowed by law is non-monetary,” the debtor’s obligation is reckoned to be a “claim” in full.[14] Even those courts that are opposed opt for a rote recitation of an injunction’s special role as a remedy for a non-compete’s breach — thorny details that are rarely explored.[15]
Flaws Obscured
Due in part to the deceptively ambiguous term “right to payment” in § 101(5)(B) — a “right” might be primary or secondary, conditional or absolute — logical gaps undermine these formalistic readings’ cogency. Most strikingly, the drafting history of § 101(5)(B) reveals their rigidity to be unwarranted. Undeniably, the House of Representatives sought to ensure “that all legal obligations of the debtor, no matter how remote or contingent ... [would] ... be dealt with in the bankruptcy case.” Therefore, proposing the “broadest possible definition” of “claim,” encompassing even “equitable right[s] to performance that did not give rise to a right to payment.”[16] Eventually, instead of the words “may” or “might” being added to § 101(5)(B), emendations that would have swept into § 101(5)(B) all contractual breaches theoretically remediable by damages, this expansive denotation was extirpated.[17] As a result, only the brief remarks of the Bankruptcy Code’s principal legislative sponsors, originating the often-cited “alternative right” maxim, even hint at an intended standard: An “equitable remedy” constitutes a “claim” if the debtor’s obligation is subject to “liquidation or estimation,” and money might rectify the breach “in the event performance is refused.”[18]
Two inferences follow. First, although still repeated in opinions construing § 101(5)(B),[19] the suggestive phrase “broadest possible definition” was intended to illuminate the contours of a “claim” as it was first proposed, not as it was encoded. Second, if the import of the Senate’s incision is to be respected, as it must,[20] and if the only two related expressions of legislative intent are fairly considered, as may be done, § 101(5)(B) should be read to require a causal link between the breach entitling a creditor to equitable relief and a debtor’s potential monetary burden. Consequently, if the purported breach that an injunction is intended to foreclose cannot be adequately rectified by any dollar amount, the debtor’s obligation cannot be monetized, and the breach will never engender a financial entitlement “a right to payment.” Thus, it matters greatly that in nearly every state in which both damages and an injunction are potential remedies, the latter will only be awarded upon an employer’s demonstration of the damages’ inadequacy.[21]
A prior breach may entitle a creditor to damages for the injuries sustained thereafter, but as a matter of equally well-settled law, an injunction is “an intangible command incapable of precise monetary estimation,”[22] justified only upon proof of the damages’ inherent insufficiency and an order prohibiting an ongoing or future breach, not compensation for harms committed;[23] the breach that an injunction is intended to remedy is a forthcoming one, a wrong unconvertible into fiscal sums. Although § 101(5)(B) does not incorporate notions of adequacy, the phrase “right to an equitable remedy” does, for implicit within any decision to issue an injunction is a concomitant holding: The debtor’s “breach of performance,” the act triggering the creditor’s “right to an equitable remedy,” can be rectified (i.e., prevented) by that remedy alone, a concurrent demand for financial recompense foreclosed upon an injunction’s issuance.[24]
Second, the reasoning in Ohio v. Kovacs supports such nuanced scrutiny, with the U.S. Supreme Court relying on “the circumstances present.”[25] For all nine justices, a right to payment had arisen upon the creditor’s deliberate decision to reduce the debtor’s “cleanup duty ... to a monetary obligation,” even though it had several options upon the debtor’s contravention.[26] Properly construed, Kovacs appears to reject any superficial examination of the technical availability of damages for a non-compete’s breach, for, as its discussion implies, an injunction would have endured, post-petition, such unquantifiable relief compared to nondischargeable orders of criminal contempt.[27] Rather, Kovacs recommends an evaluation of the relevant circumstances surrounding a debtor’s breach so as to discern if an injunction must be issued, a creditor’s entitlement to such relief serving as simultaneous proof that damages are a fanciful remedy — and hence not a right — in actuality.[28]
Finally, this interpretation safeguards the interests of creditors and debtors alike. Axiomatically, the Code should not be read as expanding rights beyond those that are necessary to maximize the estate or provide the honest-yet-unfortunate debtor with financial relief;[29] relatedly, courts should reject “any construction” that “give[s] ... debtor[s] the perverse incentives to enter ... bankruptcy solely to take advantage of ... substantive change[s] in ... rights.”[30] Based on these precepts, to the extent that a creditor seeks only an injunction to prevent future violations, that right should not be branded a “claim,”[31] for its exemption from § 101(5)(B) preserves the creditor’s substantive nonbankruptcy privileges, as well as thwarts a debtor from using the Code to violate another’s rights with impunity.[32]
At the same time, since any right to damages traceable to that breach will be discharged at the case’s end, a debtor will not be deprived of its fresh start, and as the covenant impinges solely upon a debtor’s future opportunities, enforcement will not diminish the unsecured creditors’ return in a chapter 7 proceeding.[33] For these reasons, it is this holistic approach of categorizing a non-compete under § 101(5)(B) that best serves the Bankruptcy Code’s design, securing its broader equitable ends[34] and averting the adoption of the effective construction that Congress impliedly spurned with its expunction: the forced conversion of effectually equitable rights into unequal dollars.[35]
Monetizing a Breach
In light of the foregoing, a two-part inquiry circumscribed by the relevant applicable state’s employment law is required to ascertain whether the debtor’s obligation under a non-compete constitutes a “claim.”[36] First and most obviously, the non-compete must be found to be valid,[37] the “prevailing common law standard of reasonableness” incorporating such factors as whether (1) “the restraint is greater than is needed to protect ... [a] legitimate interest,” (2) the latter’s need is outweighed by the debtor’s hardship, and (3) the public will be injured.[38] Thereafter, the elements without which no injunction may usually be issued necessitate the following scrutiny:[39] (1) a creditor’s likely success on the merits — a prong satisfied by proof of a debtor’s past breach; (2) the possibility of an irreparable loss if a violation continues or re-occurs; (3) the ever-protean public interest; and (4) a summing of the equities in the creditor’s favor, such as the absence of harm to third parties.[40]
Conclusion
In accordance with context and precedent, whether a debtor’s obligation under a non-compete should be classified as a “claim” under § 101(5)(B) should not depend on technical rules but rather on the relevant state’s common practice. If the applicable nonbankruptcy law unambiguously sees an injunction as the only effective remedy, no Bankruptcy Code “claim” can ever arise. In the absence of such a definite declaration a more complex duty arises, and a bankruptcy court must determine the agreement’s validity and the injunction’s necessity — questions of circumstances that are well told.
[1] Cynthia L. Estlund, “Between Rights and Contracts: Arbitration Agreements and Non-Compete Covenants as a Hybrid Form of Employment Law,” 155 U. Pa. L. Rev. 379, 392-97 (2006).
[2] 11 U.S.C. § 101(5)(B).
[3] Id. at §§ 101(12), 727(b), 1141(d)(1), 1228(a) and 1328(a).
[4] See, e.g., Maids Int’l Inc. v. Ward (In re Ward), 194 B.R. 703, 712 (Bankr. D. Mass. 1996); In re Kilpatrick, 160 B.R. 560, 567 (Bankr. E.D. Mich. 1993).
[5] See, e.g., Green v. City of Raleigh, 523 F.3d 293, 306 (4th Cir. 2008); Ltd. Inc. v. Comm’r, 286 F.3d 324, 333-34 (6th Cir. 2002).
[6] In re Ben Franklin Hotel Assocs., 186 F.3d 301, 305 (3d Cir. 1999).
[7] See Mann v. Calumet City, 588 F.3d 949, 955 (7th Cir. 2009) (describing “unrealizable right” as “no right at all”).
[8] United States v. Apex Oil Co., 579 F.3d 734, 735 (7th Cir. 2009); Rederford v. US Airways Inc., 589 F.3d 30, 36 (1st Cir. 2009).
[9] In re Udell, 18 F.3d 403, 407-08 (7th Cir. 1994); see also R.J. Carbone Co. v. Nyren (In re Nyren), 187 B.R. 424, 425 (Bankr. D. Conn. 1995). But see In re Ward, 194 B.R. at 714.
[10] Kennedy v. Medicap Pharms. Inc. (In re Kennedy), 267 F.3d 493, 497 (6th Cir. 2001).
[11] MCS Acquisition Corp. v. Gilpin (In re Gilpin), 2008 Bankr. LEXIS 1977, at *11-12, 2008 WL 2787520, at *5 (B.A.P. 6th Cir. July 17, 2008) (discussing id.).
[12] See, e.g., Butner v. United States, 440 U.S. 48, 52-53 (1979); Ralar Distribs. Inc. v. Rubbermaid Inc. (In re Ralar Distribs. Inc.), 4 F.3d 62, 67-68 (1st Cir. 1993).
[13] See, e.g., Allegra Network LLC v. Ruth (In re Ruth), 2013 Bankr. LEXIS 133, at *21, 2013 WL 139265, at *3 (Bankr. E.D. Tex. Jan. 10, 2013); Blair 11D Condo LLC v. Rabin (In re Rabin), 361 B.R. 28 (Bankr. S.D. Fla. 2007); Nickels Midway Pier LLC v. Wild Waves LLC (In re Nickels Midway Pier LLC), 341 B.R. 486, 499-500 (D.N.J. 2006).
[14] In re Aslan, 65 B.R. 826, 830-31 (Bankr. C.D. Cal. 1986) (emphasis in original); accord Herman v. Egea (In re Egea), 236 B.R. 734, 743 and n.54 (Bankr. D. Kan. 1999).
[15] See In re Future Graphics Inc., 2010 Bankr. LEXIS 1666, at *14-15, 2010 WL 1965893, at *5 (Bankr. E.D.N.C. May 17, 2010).
[16] H.R. Rep. No. 95-595, at 309 (1977) (referring to H.R. 8200, 95th Cong. (1st Sess. 1977)).
[17] 11 U.S.C. § 101(5)(B).
[18] 124 Cong. Rec. 32,393 (1978) (statement of Rep. Edwards); id. at 33,992 (statement of Sen. DeConcini).
[19] Walton v. Clark & Wash. PC, 454 B.R. 537, 541 (Bankr. M.D. Fla. 2011).
[20] United States v. Wells, 519 U.S. 482, 492-93 (1997) (deletions between bill versions significant); United States v. Riverside Bayview Homes, 474 U.S. 121, 136-37 (1985) (same).
[21] In re Kennedy, 267 F.3d at 497; see Envtl. Servs. v. Carter, 9 So. 3d 1258, 1261 (Fla. 5th D.C.A. 2009).
[22] Sheerin v. Davis (In re Davis), 3 F.3d 113, 116-17 (5th Cir. 1993).
[23] Id.; United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1008 (2d Cir. 1991).
[24] See, e.g., In re Printronics Inc., 189 B.R. 995, 1001 (Bankr. N.D. Fla. 1995); Oseen v. Walker (In re Oseen), 133 B.R. 527, 531 (Bankr. D. Idaho 1991); cf. 3A Norman J. Singer, Sutherland Statutory Construction § 20:16 (7th ed. 2013) (“[I]f a statute creates a right and specifies a remedy to be used to enforce it, the use of other sanctions may be impliedly excluded.”).
[25] 469 U.S. 275, 279 (1985).
[26] Id. at 282-83; see also In re Alongi, 272 B.R. 148, 156 (Bankr. D. Md. 2001) (explicating id.).
[27] Kovacs, 469 U.S. at 282; cf. US Sprint Commc’ns Co. v. Buscher, 89 B.R. 154, 156 (D. Kan. 1988).
[28] See Dent Wizards Int’l Corp. v. Brown (In re Brown), 237 B.R. 740, 745 (Bankr. C.D. Cal. 1999).
[29] Thomas E. Plank, “Bankruptcy and Federalism,” 71 Fordham L. Rev. 1063, 1067 (2002).
[30] United States v. Aldrich (In re Rigden), 795 F.2d 727, 736-37 (9th Cir. 1986).
[31] In re Oseen, 133 B.R. at 531; Michael G. Williamson and Stephanie Crane Lieb, “The Outer Limits of Dischargeablity: When is a Claim a Claim in Bankruptcy?,” Flor. Bar. J., January 2009.
[32] In re Reppond, 238 B.R. 442, 443 (Bankr. E.D. Ark. 1999); In re Peltz, 55 B.R. 336, 338 (Bankr. M.D. Fla. 1985); cf. Dominic’s Rest. of Dayton Inc. v. Mantia, 683 F.3d 757, 760-61 (6th Cir. 2012).
[33] May v. Charles Booher & Assoc. Inc. (In re May), 141 B.R. 940, 943-44 (Bankr. S.D. Ohio 1992); In re Thomas, 133 B.R. 92, 95 (Bankr. N.D. Ohio 1991). This argument would be considerably weakened for a chapter 11 or 13 debtor.
[34] In re Cox, 53 B.R. 829, 833 (Bankr. M.D. Fla. 1985).
[35] In re Udell, 18 F.3d at 411(Flaum, J., concurring).
[36] If a state court issues an injunction post-petition, collateral estoppel or Rooker-Feldman may bar revisiting its factual determinations. Compare Gruntz v. County of Los Angeles (In re Gruntz), 202 F.3d 1074, 1079 (9th Cir. 2000), with Tindall v. Gibbons, 156 F. Supp. 2d 1292, 1299 (M.D. Fla. 2001).
[37] Kurt H. Decker, Covenants Not to Compete 45 (2d ed. 1993).
[38] Reliable Fire Equip. Co. v. Arrredondo, 965 N.E.2d 393, 396 (Ill. 2011); Earnings Performance Grp. v. Quigley, 124 Fed. Appx. 350, 353 (6th Cir. 2005).
[39] See, e.g., Ridgely v. Fed. Emergency Mgmt. Agency, 512 F.3d 727, 734 (5th Cir. 2008); Bryan v. Hall Chem. Co., 993 F.2d 831, 835 (11th Cir. 1993).
[40] See, e.g., Smith & Nephew Inc. v. Nw. Ortho Plus Inc., 2012 U.S. Dist. LEXIS 178715, at *35-36, 2012 WL 6607289, at *14 (W.D. Tenn. Dec. 18, 2012); In re Stone Res., 448 B.R. 361, 371 (Bankr. E.D. Pa. 2011); In re Annabel, 263 B.R. 19, 27 (Bankr. N.D.N.Y. 2001).