Most of the cases that we handle – like any other litigation – get settled before trial. One of the incentives to settle is that invariably the departing owner will agree to some sort of restrictive covenant against competing against his former company.
The case that goes to trial, or which is resolved on a substantive motion, leaves this issue wide open. In fact, there is no statutory basis to deter the ousted business owner from setting up a competitor and trying to lure away the business of his former company, and one would suppose with a bankroll secured by the purchase of his or her interest.
Since most business divorce litigation ends with a deal, and restrictive covenants are critical aspects of those transaction, I thought it worthwhile to write about a recent decision of the Appellate Division that gives a stern warning that the restrictive covenant had better be honored.
In that decision, the appeals court affirmed a trial judge’s holding that the seller of a business had breached a covenant not to compete, even if the amount at issue was just a few hundred dollars, and that the purchaser would therefore be relieved from any obligation to pay the balance of the purchase price.
The Court, in Peek v. Johl & Col, Inc., Docket No. A-0499-10T4 (December 11, 2012) (see opinion below) affirmed the trial court hold that by secretly diverting shared insurance premium commissions from another broker, the seller had committed a material breach that was not excused by the small amount at issue.
The plaintiff Peek sold his brokerage to the defendants and received a note in return, along with an agreement to pay a portion of new premiums received by the firm. The buyers also agreed to rent the office in which the business was located from the seller.
Peek had long had an arrangment with another brokerage to write insurance that his own firm did not handle and after the sale continued to refer business to the other broker and receive a share of the commission – which it appears he was entitled to do. Under the terms of the sale, he would have continued to receive his share of the referral payments.
However, Peek had the payments directed to him instead of to the buyer. And when the seller found out, he stopped paying either the note or the office rent. Peek filed suit and the buyer counterclaimed alleging a breach of the restrictive covenant contained in the sale agreement.
The trial judge rejected the agreements and awarded defendants their half of the withheld payments in the amount of $614.30. Te trial court also found that there had been a material breach of the parties’ contract and that further performance by the buyer was excused.
The Court relied on a pair of decisions, Ross Sys. V. Linde Dari-Delite, 35 N.J. 329 (1961) and Nolan v. Lee Ho, 120 N.J. 465 (1990) holding that the material breach of a contract by one party relieves the non-breaching party of further performance.
We appreciate that the amount in commissions that … plaintiffs wrongfully retained was much less than what defendants were obligated to pay under the contract terms. Even so, a breach of a restrictive covenant, which often can be a key bargaining term when a small business is sold to a new owner, was reasonably found here to constitute a material breach that excused defendants from making those additional payments. Because the material breach prevents a claim of substantial performance, the trial court made no legal error in granting defendants relief on their counterclaim.
The appellate court also rejected the argument that excusing further performance of the contract was a windfall to the buyers who, even if there was a breach, should be liable under the theory of unjust enrichment. Rather, the wrongful conduct made the trial cour’ts rejection of the claim “appropriate, even thought that results in defendants reaping the benefits of the transaction for a lesser sum than the amount originally bargained for under the contract.”