Courts will decline to enforce contractual restrictive covenants in agreements that unreasonably restrain trade or lack adequate consideration.
Summary of the Case
Innovation Ventures (IV), developer of an energy drink, entered into contracts with a bottler and with a production consultant. Both contracts contained non-compete and confidentiality clauses. Shortly after the bottler’s and consultant’s business relationships with IV ended, IV sued them, together with their principals, in a state court in Michigan for breach of contract. The trial court granted summary judgment to the defendants. Recently, that decision was affirmed on appeal on the grounds that the agreement with the bottler unreasonably restrained competition, and the contract with the consultant lacked adequate consideration. Innovation Ventures, L.L.C. v. Liquid Mfg., L.L.C., Case No. 315519 (Mich. Court of Appeals, Oct. 23, 2014) (unpublished).
The Parties and the Contracts
The bottler. In 2007, pursuant to a contract with IV, Liquid Manufacturing commenced bottling IV’s “5 Hour Energy” using the bottler’s own equipment. Three years later, the bottler, by its principal, and IV executed an agreement terminating that contract. The termination agreement permitted Liquid Manufacturing to use the equipment for bottling other producers’ products (a) if IV gave its consent, and (b) provided that the other producers covenanted not to disclose that the equipment had been used for bottling “5 Hour Energy.” Post-termination, Liquid Manufacturing sued the bottler and its principal for breach of contract.
The consultant. In 2008, IV entered into an oral agreement with a consultant company to design, manufacture, and install certain production and packaging equipment for IV. The agreement was memorialized in writing for the first time in 2009. Less than two weeks later, IV exercised its right to end the relationship without cause. IV then sued the consultant and its managing member for violating the restrictive covenants.
The Appellate Tribunal’s Decision
- The appeals court ruled that the bottler’s principal, who executed the termination agreement as an agent of the corporation, could not be sued for breach of contract because he did not sign on his own behalf.
- Although the bottler may have failed to obtain the covenant described above, any such violation was held to have been cured in a timely manner.
- IV’s attempt in the termination agreement to reserve to itself virtually unfettered discretion to decide which products Liquid Manufacturing could bottle constituted an unreasonable restraint on trade. A provision reflecting the bottler’s stipulation that the termination agreement was reasonable was held to be void because courts, not the parties, determine whether contracts are unreasonable.
- The confidentiality clause in the termination agreement was held to be waived by expressly authorizing the bottler to use supposedly confidential information in order to bottle competing products.
- Consideration for the contract between IV and the consultant was the parties’ implied promises to continue their relationship for a reasonable period of time. IV’s cancellation after less than two weeks was held to have nullified the contract.
This decision teaches that restrictive covenants in commercial contracts are not always enforceable. Just as with a comparable provision in an employment agreement, a non-compete clause in a commercial contract must be no more protective of a manufacturer’s good will than is reasonably necessary. In other words, unfair competition may be restrained, but not fair competition. The ruling also shows that purported consideration in a commercial contract must not be illusory. Absent an express contractual provision to the contrary, a court may decline — for want of adequate consideration — to enforce a non-compete covenant in a contract which the non-covenanting party terminates without cause almost immediately after execution.