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Thursday, March 16, 2006

On Paradoxes at the Intersection of Contracts, Employment and Corporate Reorganization

Iowa_flag_1 The Northern District of Iowa began its opinion in Pro-Edge, L.P. v. Gue with great wind up:

One of the important purposes of commemorating an agreement in writing is to avoid potential lawsuits by clearly defining the rights and obligations of the parties. Thus, a delicately crafted contract is priceless in the sense that it has the ability to prevent costly litigation. This recognition, however, has created somewhat of a paradox. In an attempt to account for every conceivable possibility and to encompass and include every contingency, contracts often become increasingly complex and convoluted. The paradox then, is that contracts, originally designed to prevent lawsuits, are increasingly becoming the source of litigation. This paradox is aptly demonstrated by this controversy arising out of an alleged violation of a covenant not to compete contained in an employment agreement executed between the parties. As this court once again attempts to describe and interpret the intricate and complex nuances of this lawsuit . . . the pricelessness of a precisely drafted, yet simplistic, contract becomes rapidly apparent.

Here is the factual context for the "paradox": an employee works as a veterinarian for a company that provides embryo transfer services for cattle producers. The employee (who also happens to be a shareholder in the company) has an employment agreement with the company containing, among other things, a non-compete clause. The agreement also has a clause requiring prior written consent before the agreement may be assigned by either party.

[Click on "continue reading" for the rest of the story . . . .]

The employer goes through a series of two corporate restructuring and spin-off transactions, and the employer thereby transfers its assets to a newly created entity. The detailed documents governing the employer’s asset transfer transaction excludes mention of the employment agreement. The employee eventually leaves employment. The employer (now re-branded as a new corporate entity) seeks to enforce the terms of the non-compete agreement and enjoin the employee from providing embryo transfer services for its customers for a 12-month period.

This scenario raised many interesting questions for the Northern District of Iowa to address on summary judgment.

First, was the employment agreement transferred with the assets of the employer in the corporate reorganization? The court held: yes. It reasoned that, "according to the plain and clear terms of the . . . Employment Agreement, it appears that no degree of formality is required with respect to the assignment itself." Therefore, the agreement could have been transferred informally, without being mentioned in the asset transfer documents.

Second, did the transfer of assets constitute an "assignment" of the employment agreement? The court held: yes. This was an open question under Iowa law. The court noted that there were "two distinct lines of thought" concerning whether a merger or other change in corporate form constitutes an "assignment." There is one line of thought that holds that a surviving corporation of a merger succeeds to certain rights previously owned by the merged corporation, irrespective of the fact that the original agreements contained anti-assignment clauses. This line of thought rests on the belief that the merger occurs by "operation of law" and, therefore, no assignment or transfer within the meaning of an anti-assignment clause has occurred. The second line of thought recognizes that a transfer has occurred when a business entity has changed form, but holds that such a "mere change" in the form should not necessarily mean that an anti-assignment clause should work to prohibit the transfer of the employment agreement. The court recognized that "both lines of thought exude certain appeal," but, on the facts of this case, adopted the first approach. The court reasoned:

[The first line of thought] emphasizes the importance of drafting accurate contracts and places the burden on the drafters to provide an exception in the case of a merger or change of business structure. However, [the other line of thought] recognizes the fluidity of business entities and appear to temper the harsh consequences that potentially can ensue as a result of the formality of shifting the legal form of a business endeavor. For the reasons discussed below, however, this court finds that, on the facts of this case, the [first] approach controls. First, it must be noted that [the employer] drafted the . . . Employment Agreement. [The employer] is an extremely experienced business entity and should have been savvy to the importance of drafting an explicit and accurate contract. [The employee], although highly educated in the field of veterinary medicine, cannot be held to such a high standard as an individual employee. As the . . . Employment Agreement clearly contemplated and provided for its assignment and provided the conditions which must be met prior to such an assignment, [the employer] could have easily gone one step further and defined "assignment" or provided for an exception in the event of a change in corporate structure. [The employer] failed to do so and should not be allowed to seek refuge by asserting the transactions that followed were a simple "transfer" and insufficient to constitute an "assignment" within the meaning of the parties' agreement. While it is true the basic rule in interpreting written contracts is that the intent of the parties controls, this intent is determined by the language of the contract unless it is ambiguous. * * * An ambiguity does not exist simply because the parties disagree on the meaning of a phrase. * * * Rather, in construing a contract, it is a court's duty to give effect to the language of the contract in accordance with its plain and ordinary meaning. * * * In this case, the word "assignment" is not defined by the parties. Accordingly, it should be given its plain and ordinary meaning, which includes any transfer of all or part of one's property, interest or rights to another. See Black's Law Dictionary 119 (6th ed.1990). Accordingly, the transfer of [the employer’s] assets to [the new entity] constitutes an "assignment," within the word's plain and ordinary meaning. Finally, this court notes that when [the employer] essentially became [the new corporate entity], much more than a mere name change was involved, as excruciatingly detailed in the factual background of this opinion. [The employer] went through a fundamental change in its form of ownership. . . . [A] complex series of legal transactions was involved and essentially resulted in the complete transformation of what used to be known as [the new entity]. For these reasons, the court concludes that under the particular facts of this case, an assignment within the meaning of the . . .Employment Agreement did occur when [the employer] revamped its corporate structure.

The court, therefore, had to address whether the employer obtained the prerequisite written consent from the employee to assign the employment agreement. The employee was also a shareholder in the employer and, therefore, as required under Iowa law, had (as a shareholder) signed the Stock Purchase Agreement and Statement of Unanimous Consent. The court held that "no reasonable factfinder could conclude that [the employee’s] consent as a selling shareholder to an extraordinary transaction as required under the Iowa Business Corporation Act can somehow perform ‘double duty’ and also act as his consent to the assignment of his personal employment agreement."

Finally, the question remained whether the employee ratified the assignment because he was aware of the asset transfer and continued his employment with the newly branded entity. The court held: no, for two main reasons. First, the agreement here was not silent concerning the requirements for a valid assignment, and most of the cases providing for ratification do so in the context of a contract that is silent in this respect. Second, the employer cannot use the employee’s shareholder knowledge of the asset transfer to argue that the employee ratified the assignment.

Pro-Edge, L.P. v. Gue (N.D. Iowa Mar. 7 2006).

[Meredith R. Miller]

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