When Bankruptcy Law Collides with Non-Compete Obligations

Non-compete proceedings for most employees are daunting undertakings. For that reason, most non-compete disputes get litigated in the "shadows," outside of reported court decisions.

And as any attorney representing an employee knows, the possibility of bankruptcy looms should litigation go poorly. Many employees are generally aware that a bankruptcy suit stays (or puts a stop to) other litigation. Although this can alleviate pressure in debt-collection suits, a stay is by no means a safe harbor when it comes to non-compete disputes.

That is because a creditor can file a lift-stay motion in bankruptcy court, which would allow it proceed against an employee for enforcement of the restrictive covenant. Like many other areas of non-compete law, this one too is somewhat opaque and not governed by a clear, bright-line rule. Generally, a bankruptcy court must balance the hardship to a creditor (i.e., employer) if it is not allowed to proceed with the lawsuit against the debtor. It also must consider prejudice to the debtor, the debtor's other creditors, and the bankruptcy estate itself.

A seminal case from 1984, In re Curtis, sets out twelve separate factors that bankruptcy judges must consider when ruling on a lift-stay motion. Those factors are:

(1) Whether relief would result in a partial or complete resolution of the issues;

(2) Lack of any connection with or interference with the bankruptcy case;

(3) Whether the other proceeding involves the debtor as a fiduciary;

(4) Whether a specialized tribunal with the necessary expertise has been established to hear the cause;

(5) Whether the debtor's insurer has assumed responsibility for defending the case;

(6) Whether the action involves primarily third-parties;

(7) Whether litigation in another forum would prejudice other creditors;

(8) Whether the judgment in another action is subject to equitable subordination (!?!);

(9) Whether the movant's success in the other proceeding would result in a judicial lien avoidable by the debtor;

(10) Judicial economy;

(11) Whether the parties in the other proceeding are ready for trial; and

(12) The impact of the stay on the parties and the balance of harms.

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It is important to remember that ongoing compliance with a non-compete is not dischargeable in and of itself, even if defending against the injunction would be costly. But still, an employer must show "cause" under Curtis to lift the stay and seek an injunction. The best argument for relief is that a denial of relief will moot any contract rights the employer has, because non-competes only last a short period of time (usually 6 months to 2 years). Conversely, an employee normally contends that the enforcement will hamper his ability to perform under a plan of reorganization (assuming a Chapter 13 case).

These are difficult interests to reconcile, and for that reason, bankruptcy courts will look to determine the likelihood an employer will prevail in a separate proceeding, and whether a non-compete injunction proceeding was well underway before the bankruptcy filing. Employees should not assume that bankruptcy court provides a safe have to avoid an injunction proceeding, as even that question is so fact-specific that it is difficult to predict accurately how a lift-stay motion will be resolved.