MI Supreme Court in Lawsuit Involving 5 Hour Energy: Commercial Non-Competes Must be Evaluated Under the Rule of Reason.

A while back I wrote a post about the  Court of Appeals Decision: The Non-Compete Lawsuit Involving 5 Hour Energy.

To recap, the facts:

Parties:

• Plaintiff, Innovation Ventures, LLC, – the maker of “5 Hour Energy”

• Defendants Liquid Manufacturing, LLC, K & L Development of Michigan, LLC, and Peter Paisley and Andrew Krause, the presidents and owners of Liquid Manufacturing and K & L Development.

i. Innovation Engages Liquid to bottle 5 Hour Energy

• On May 18, 2007, plaintiff entered into a manufacturing contract whereby plaintiff hired defendant Liquid Manufacturing to bottle 5 Hour Energy.

• In June 2010, plaintiff terminated its agreement with defendant Liquid Manufacturing, and the parties entered into an agreement to formalize the termination and to formalize plaintiff’s exercise of its option to purchase the equipment that defendant Liquid Manufacturing used to bottle plaintiff’s product. Id. pg 1.
•  The Termination agreement contained nondisclosure and non-compete provisions, but permitted defendant Liquid Manufacturing to produce a list of 36 “Permitted Products” on the equipment that was formerly used to bottle plaintiff’s product; that permission could be revoked for violation of the Termination Agreement. Plaintiff agreed, though, to give defendant Liquid Manufacturing 30 days to cure any violation of the agreement. Id.

ii. Innovation Engages K&L to Help Market 5 Hour Energy

• In 2008, Plaintiff and Defendant K&L entered an oral agreement with defendants, defendants to act as consultants “to help design, manufacture, and install certain beverage production and packaging equipment for plaintiff.”

• On April 27, 2009, plaintiff and defendants Krause and K & L Development entered into a written agreements, including a confidentiality and non-compete agreement” Id.

• On or about May 10, 2009, less than two weeks after the signing of the Agreements, plaintiff terminated the parties’ business relationship. The Parties entered into a “Termination Agreement”

And The Plot Thickens…

iii. K&L and Liquid Join Forces to Make: Eternal Energy

• On September 10, 2010, defendant Eternal Energy LLC, which produces a liquid energy shot known as “Eternal Energy” was formed by the owners of Liquid Manufacturing and K&L Development to compete with 5 Hour Energy.

• On May 9, 2011, defendant LXR Biotech was formed;  Defendant LXR Biotech markets and distributes Eternal Energy in approximately 2–ounce bottles, which is approximately the size of 5 Hour Energy bottles. Id. pg 2.

• On September 20, 2010, ten days after the formation of defendant Eternal Energy, defendant’s CFO contacted plaintiff’s counsel, and requested that Eternal Energy be added to the list of Permitted Products that defendant Liquid Manufacturing could, pursuant to the Termination Agreement, produce.

• In an e-mail dated September 21, 2010, plaintiff agreed to include it. (This would prove fatal to Plaintiff’s claim for breach of the termination agreement by Liquid Manufacturing producing “Eternal Energy”).

• On January 27, 2012, plaintiff sued Defendants, alleging breach of a confidentiality agreement, non-compete agreements, as well as  tort claims for the disclosure of its confidential information.

Essentially, Plaintiff claimed that Defendant wrongfully obtained Plaintiff’s confidential information, and the Defendants used the information in marketing Eternal Energy, and by representing to Wal-Mart that defendant previously bottled 5 Hour Energy for plaintiff. Id.

After several amended complaints and extensive discovery of documents, (aka “loads of attorney fees”) Defendants filed a motion to dismiss. The Court granted the  motion and dismissed all claims. Plaintiff appealed. The Court of Appeals affirmed – found in favor of Defendants.

The Court of Appeals held the non-competition agreement unenforceable.

Just a few weeks ago the Michigan Supreme Court overturned the Court of Appeals decision. You can check out the full decision here

Why did the Supreme Court overturn the Court of Appeals? (hint – check out the Title of this Post).

Two issues taken up by the MI Supreme Court:

1. Was the Business Contract void because it lacked consideration?

and

2. Did the Court of Appeals apply the correct test when deciding the non-compete was unreasonable?

To  summarize the Supreme Court’s findings:

1. No. The Business Contract wasn’t void for lack of consideration. 

The Court of Appeals held the Non-disclosure agreement was unenforceable because it lacked “consideration” –  The Supreme Court disagreed.

As the Court held: “To have consideration there must be a bargained-for exchange” Citing Gen Motors Corp v Dep’t of Treasury, 466 Mich 231, 238-239 (2002). “Generally, courts do not inquire into the sufficiency of consideration: “[a] cent or a pepper corn, in legal estimation, would constitute a valuable consideration”. Id. 239.

2. The Court of Appeals used the wrong legal standard to evaluate the reasonableness of a non-compete. It should have used “THE RULE OF REASON”

The Court held: a commercial noncompete provision must be evaluated for reasonableness under the rule of reason.

The Court of Appeals evaluated the “reasonableness” of the parties’ noncompete provision under the standard governing noncompetes between employer and employees.

The Supreme Court noted that “[i]n general, federal courts have assessed noncompete agreements between two commercial entities under the rule of reason.” Citing Perceptron, Inc. v Sensor Adaptive Machines, Inc, 221 F3d 913, 919 (CA 6, 2000).

The Rule of Reason:

As cited by the Supreme Court:

“a court must take into account a variety of factors, including specific information about the relevant business, its condition before and after the restrain was imposed, and the restraint’s history, nature and effect.” Citing State Oil Co v Khan, 522 US 3, 10 (1997).

What Now?

The Case goes back to the trial court to determine whether or not the noncompete provisions are reasonable under the rule of reason.