Reed Mill & Lumber Co., Inc. v. Jensen

165 P.3d 733

REED MILL & LUMBER CO., INC., Plaintiff-Appellant and Cross-Appellee, v. Neil JENSEN, Defendant-Appellee and Cross-Appellant, and General Building Materials, Inc., Defendant-Appellee.

No. 05CA0431.

Colorado Court of Appeals, Div. IV.

September 21, 2006.

As Modified on Denial of Rehearing February 15, 2007.^*

Certiorari Denied July 30, 2007.

Jester & Gibson, Jay S. Jester, Nancy Bauer Egelhoff, Denver, Colorado, for Plaintiff-Appellant and Cross-Appellee.

Bucholtz & Bull, P.C., James C. Bull, Greenwood Village, Colorado, for Defendant-Appellee and Cross-Appellant.

Holland & Hart, LLP, Mark B. Wiletsky, Boulder, Colorado, for Defendant-Appellee.

Opinion by Judge CARPARELLI.

Plaintiff, Reed Mill & Lumber Co., Inc., appeals the judgment in favor of defendants, Neil Jensen and General Building Materials, Inc. Jensen cross-appeals the failure to award him attorney fees. We affirm.

I. Background

Jensen worked for Reed Mill, a mill and lumber business, from 1973 until 2002. During his employment, and before the company was sold in 1996, Jensen received a bonus in the form of company stock.

In 1996, Reed Mill sold its name and all or nearly all of its operating assets to Vranian Enterprises, Inc. (buyer). During the parties' negotiations, it was agreed that each of Reed Mill's shareholders would be required to sign a noncompete agreement.

Section 10 of the purchase agreement states that Reed Mill's covenant not to compete was necessary to ensure the continuation of the business with regard to the assets being sold. It states further that, as consideration and necessary inducement for the purchase, Reed Mill agreed that for a period of three years from the closing date, it would not, among other things, own, manage, operate, or participate in the management or control of any enterprise within a 100-mile radius that was engaged in the provision of mill and lumber services and products.

Reed Mill distributed the proceeds of the sale to its shareholders in accordance with the percentage of shares held by each. Jensen received $50,000 for his shares of the company stock. Shortly after the transaction closed, Jensen and the other shareholders signed noncompete agreements. Of the total price the buyer paid to Reed Mill, $115,000 was allocated as compensation for goodwill and the covenant not to compete. Of this amount, Reed Mill paid Jensen a pro rata share in the amount of $9,857.

Jensen's noncompete agreement states that it was made pursuant to the asset purchase agreement. It provides that the three-year prohibition against competition would begin upon termination of Jensen's employment for any reason, and continue for three years thereafter. The agreement also contains a provision entitling the prevailing party to attorney fees and costs in the event of litigation.

For the first few years after the sale, buyer operated the business under the Reed Mill name, and Jensen continued to manage and oversee the new Reed Mill's operations as its general manager, and remained responsible for operations and sales. Thereafter, although he continued to be responsible for sales, his operational responsibilities were assigned to other employees.

Jensen resigned in 2002 and began working for General Building Materials, Inc. (GBM). Reed Mill sued Jensen for breach of the noncompete agreement and sued GBM for tortious interference with contract. After the jury reached a verdict in favor of Reed Mill, Jensen and GBM filed motions for a directed verdict and for judgment not withstanding verdict, contending that the noncompete agreement was invalid.

The trial court concluded that because the parties executed the noncompete in connection with the sale and purchase of a business, the noncompete was permitted under an exception to Colorado's statutory bar on covenants not to compete. It also found that, at the time of his departure, Jensen was not an executive or management employee of the company, and therefore the executive and management personnel exception did not apply.

The court noted that buyer's principal admitted that the three-year noncompete agreement signed by Reed Mill's majority shareholder, who owned nearly ten times more shares than Jensen, was reasonable to protect buyer's purchase of Reed Mill's good will. On that basis, the court concluded that three years was more than sufficient for buyer to establish itself in the industry.

On these premises, the court found no valid reason why Jensen, a mere employee and an owner of only a small percentage of the business, should be prohibited from competing with Reed Mill in 2002, six years after the closing date. The court also found that prohibiting Jensen from employment in the only area in which he had experience would place an undue hardship on him, and that it was not necessary to bar Jensen for six years after the date of sale, much less for nine years after the sale.

Accordingly, the court ordered a directed verdict and entered judgment for defendants, finding that the duration of the noncompete agreement was unreasonable. The court ordered each party to pay its own attorney fees.

Reed Mill appeals the directed verdict, and Jensen cross-appeals the rulings that the parties must pay their own attorney fees and that the noncompete was made in connection with the sale of a business.

II. Reasonableness in Connection with Sale

Reed Mill contends that although the trial court correctly concluded that Jensen's noncompete agreement was made in connection with the purchase agreement, it erred when it concluded that the duration of the agreement was unreasonable. We perceive no error.

A. Covenants Not to Compete

Colorado public policy disfavors covenants not to compete. However, § 8-2-113, C.R.S.2006, permits such covenants in limited circumstances. DBA Enters., Inc. v. Findlay, 923 P.2d 298, 302 (Colo.App.1996). When a covenant not to compete is statutorily permitted, it is enforceable only if it is reasonable in duration and geographic scope. Nat'l Graphics Co. v. Dilley, 681 P.2d 546 (Colo.App.1984); Colo. Accounting Machs., Inc. v. Mergenthaler, 44 Colo.App. 155, 609 P.2d 1125 (1980). To be reasonable, a noncompete agreement must not be broader than necessary to protect the promisee's legitimate interests, and it must not impose hardship on the promisor. See Whittenberg v. Williams, 110 Colo. 418, 135 P.2d 228 (1943). Covenants not to compete "for terms up to five years and within distances of 100 miles" are commonly upheld. Harrison v. Albright, 40 Colo.App. 227, 231, 577 P.2d 302, 305 (1977).

1. Covenants Ancillary to the Purchase of a Business

Section 8-2-113(2)(a), C.R.S.2006, permits covenants not to compete in connection with contracts for the purchase and sale of a business or the assets of a business. When ancillary to the sale of a business, such covenants protect the buyer's right to enjoy the business good will for which it paid. Gibson v. Eberle, 762 P.2d 777, 779 (Colo. App.1988). Good will "is an incident of a continuing business having a particular locality or name," and includes "the expectation of continued and repeated public patronage." Nat'l Propane Corp. v. Miller, 18 P.3d 782, 786 (Colo.App.2000).

Where the evidence provides adequate support, we will not overturn the trial court's finding that a noncompete agreement was made in connection with a sale of business under § 8-2-113(2)(a). Boulder Med. Ctr. v. Moore, 651 P.2d 464, 465 (Colo.App. 1982).

2. Reasonableness and Enforceability

The reasonableness of covenants ancillary to the sale of business depends on whether the restraint on competition provides fair protection to the buyer's purchase of good will, while imposing restrictions no greater than necessary to protect the value of that good will. See Barrows v. McMurtry Mfg. Co., 54 Colo. 432, 131 P. 430 (1913) (an agreement that arbitrarily binds the seller beyond the duration and geographical scope necessary to protect the good will transferred is without consideration); Gibson v. Eberle, supra, 762 P.2d at 779.

Reasonableness turns on the facts of each case. Zeff, Farrington, & Assocs., Inc. v. Farrington, 168 Colo. 48, 50, 449 P.2d 813, 814 (1969). "To the extent that the legal determinations turn on questions of fact — for example whether a restrictive covenant was reasonable in scope — the [appellate] court must accept the district court's findings unless those findings are clearly erroneous." Bus. Records Corp. v. Lueth, 981 F.2d 957, 959 (7th Cir.1992) (citation omitted).

Some courts have held that, depending on the circumstances, a covenant not to compete that is ancillary to the sale of a business may be enforceable even when a covenant of similar breadth incident to employment would not be. See Rent-A-Ctr., Inc. v. Canyon Television & Appliance Rental, Inc., 944 F.2d 597, 600 (9th Cir.1991); Gann v. Morris, 122 Ariz. 517, 518, 596 P.2d 43, 44 (Ct.App.1979); H & R Block, Inc. v. Lovelace, 208 Kan. 538, 544, 493 P.2d 205 210 (1972). Nonetheless, when the duration of a covenant not to compete is greater than is necessary to protect legitimate interests, it is unreasonable and, consequently, unenforceable. See Alexander & Alexander, Inc. v. Danahy, 21 Mass.App.Ct. 488, 488 N.E.2d 22, 29 (1986).

B. Unenforceable Agreement

Reed Mill asserts that it was reasonable to begin the three-year noncompetition period upon termination of Jensen's employment because Jensen possessed good will at the time of the sale and maintained that good will during his employment with the new company. We disagree.

The purchase agreement states that the covenant not to compete was necessary to ensure the continuation of the business. And, indeed, buyer purchased the good will that was incident to old Reed Mill's locality, name, and expectation of continued and repeated patronage by its customers. It purchased the company's good will from its owners. Because Jensen was an owner, Jensen received a pro rata share of the amount buyer...