Debts Incurred for Violating Non-Competition Provision Usually Are Dischargeable (In re: O'Connor)

In most competition cases, a defendant's obligation to satisfy a monetary judgment entered against him or her may be impacted by the decision to file for bankruptcy.

As a general matter, contract debts are dischargeable. So, if an employee is found liable for breach of a non-compete contract and found to owe lost profits or liquidated damages to the ex-employer, he may be able to avail himself of bankruptcy law and avoid the obligation. It is likely in such a factual matrix that the debt would be discharged.

There are a few notable exceptions, however. If a damages judgment is rendered on a breach of fiduciary duty claim (which often is added to a non-compete case, depending on the pre-termination conduct), that would not be dischargeable as long as the trust relationship existed prior to the act creating the debt. Note that in some jurisdictions (e.g., New Hampshire) ordinary employees do not automatically owe a fiduciary duty to their employers. The test is usually whether the employee was in a supervisory or managerial capacity, but these are rare exceptions.

Another provision of the bankruptcy code provides for non-dischargeability in the event of a willful or malicious injury. No matter how much an employee intends to violate a non-compete, however, the question of malice in a contract claim is meaningless. There is nothing inherently wrong with breaching a contract, as long as the non-breaching party is made whole.

There is one interesting other exception to the non-dischargeability rule: a judgment of damages following a finding of contempt will not be dischargeable. Say, for instance, that a defendant breaches a non-compete agreement and is enjoined by order of the court (or, even by agreement) from further violating his or her contract. If that defendant subsequently competes in a way that violates the court order, any damages arising from the contempt proceeding are non-dischargeable under Section 523(a)(6). This rule applies to both temporary and permanent injunctions.

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Court: United States Bankruptcy Court for the Western District of Louisiana
Opinion Date: 9/30/10
Cite: In re O'Connor, 2010 Bankr. LEXIS 3475 (W.D. La. Sept. 30, 2010)
Favors: Employee
Law: Federal