Non-Compete Clause in Manufacturing Contract Held to Be Unenforceable

law offices phoenix, kaibab law offices, roger owersNon-Compete Clause in Manufacturing Contract Held to Be Unenforceable

Arizona Society of Civil Engineers Newsletter, March 2015
By Roger Owers, Ph.D., P.E., J.D.

Or-Cal Inc. is an Oregon corporation that produces lime sulfur products for use in agriculture and water treatment applications.  In 2009, Or-Cal entered into a contract with a company called Tessendero Kerley Inc. (“TKI”), a subsidiary of a Delaware corporation headquartered in Phoenix, Arizona.  Under the contract, TKI agreed to “manufacture, formulate, label, package, and ship” certain lime sulfur products to Or-Cal’s customers according to Or-Cal’s specifications.  The products were specifically listed in the contract.

In their contract, Or-Cal and TKI included a covenant not to compete which prohibited TKI from competing with Or-Cal in sales of the products.  This non-compete clause was limited to TKI’s sales in agricultural markets of the United States for a term of two years following the termination of the contract.  The contract also included a confidentiality agreement that protected the companies’ proprietary information.  The contract and these clauses were heavily negotiated by the parties, both of which were represented by legal counsel.

Pursuant to the contract, over the next several years, Or-Cal purchased large amounts of lime sulfur from TKI.  Or-Cal would place an order with TKI and then TKI would ship the products to Or-Cal’s customers in the western U.S.

However, in 2007, through a business acquisition, TKI itself began manufacturing, marketing, and selling lime sulfur products.  In 2013, TKI informed Or-Cal that TKI intended to terminate their contract.  And in 2014, TKI informed Or-Cal that TKI intended to no longer honor the non-compete clause of their contract.  So Or-Cal sued TKI in federal court, seeking, among other things, to force TKI to honor the non-compete clause.

Though this case was filed in federal court, the court looked to Arizona law.  The court observed that Arizona law tends to disfavor non-compete clauses, but will enforce non-complete clauses if they are (1) ancillary to employment contracts or contracts for a sale of a business, and (2) reasonably limited in their time and territory.

In analyzing the first element, the court found that this non-compete clause, which was in a contract between a customer and a supplier, was not ancillary to an employment contract or a sale of a business.  So the court then analyzed the non-compete clause from a business reasonableness perspective—i.e., whether the clause is necessary to protect a legitimate business interest.  The court found that Or-Cal’s business interests are already protected (especially through the confidentiality clause), so the non-compete clause served no legitimate business purpose.

Then, analyzing the second element, the court observed that Or-Cal’s business was not found throughout the United States, but only in four western states (Oregon, Washington, California, and Texas).  The court also found that the two-year term of the non-compete clause was unreasonable because Or-Cal had more than enough time under the contract to obtain regulatory approvals of new products and secure a relationship with a new manufacturer.

Although the clause was heavily negotiated, the court found the non-compete clause to be unenforceable: it did not serve a legitimate business purpose and was unreasonable in time and territory.

The case is Or-Cal Incorporated V. Tessenderlo Kerley Incorporated, No. CV-14-01980-PHX-DGC (D. Ariz. Feb. 23, 2015).

This article is intended for general information only.  It should not be construed as legal advice with respect to any particular situation.  Readers should not act upon information contained in this article without first consulting their lawyer.

Roger S. Owers is a commercial real estate professional with Keyser LLC and is a lawyer with the Kaibab Law Offices of Roger S. Owers LLC.  Roger holds a Ph.D. in civil engineering, is a registered professional civil engineer, holds a real estate license, and is a licensed attorney.  He can be reached via e-mail at rowers@kaibabllc.com or www.kaibabllc.com.  He can also be found on LinkedIn at http://www.linkedin.com/in/rogerowers/.

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