Meadox Medicals, Inc. v. Life Systems, Inc.

3 F. Supp.2d 549 (D. N.J. 1998)
  • Opinion Date: May 11, 1998

DISTRIBUTORSHIPS; NON-COMPETITION—In the relationship between a distributor and its supplier, if the distributor developed the customer base, selling strategy, pricing strategy, and the like, the manufacturer may not have an interest worthy of protection to support enforcement of a post-termination non-competition agreement.

As part of a distribution contract between an exclusive distributor of medical devices and the manufacturer of them, the exclusive distributor, for itself, its affiliates, its principals, and its stockholders agreed that it would not sell any products or provide any services that were competitive with products offered by the manufacturer. The contract also provided that if the distributor was terminated or the agreement otherwise expired, the distributor would cooperate with the manufacturer to extend reasonable assistance to any successor in the territory and in the orderly winding up of the business. At the end of the term of the contract, the manufacturer decided not to further extend the term, but rather to sell its products directly within what became the distributor’s former territory. Just before the expiration of the contract, some officers of the distributor established a new company and prepared to sell a product that was competitive with a product sold by the manufacturer. The District Court was quite confident that the distributor’s executive officers established the new company for the specific purpose of circumventing the covenant not to compete. In fact, it described it as “a transparent sham.” Nonetheless, it felt obligated to analyze whether the covenant was enforceable under New Jersey law. The District Court analyzed the restrictive covenant as an employment contract. In doing so, it rejected the manufacturer’s contention that the covenant’s validity should have been assessed under the more relaxed “sale of business” standard. While New Jersey courts freely enforce restrictive covenants against sellers of businesses because the buyers paid separate consideration for the seller’s goodwill, the manufacturer, in this case, did not purchase any part of its distributor’s business nor did it pay the distributor any consideration for the restrictive covenant. In the Court’s view, the manufacturer-distributor agreement fell neither within the letter nor the rationale of the sale of business standard.

New Jersey courts will only enforce covenants not to compete that are reasonable. A party seeking to enforce such an agreement must establish its reasonableness under the following three-pronged standard: (1) the covenant must be necessary to protect the parties’ legitimate interest; (2) it must cause no undue hardship to the former employee; and (3) it must not injure the public interest.

The manufacturer asserted two legitimate interests that, in its view, justified enforcement of the covenant: (1) its confidential pricing information and strategies; and (2) its customer relationships. On the facts presented, the Court disagreed with the manufacturer that the pricing information, strategies, and customer relationships belonged to the manufacturer. In the Court’s opinion, these interests belonged to the distributor. The distributor was an independently owned company that purchased products from the manufacturer and then resold those products to doctors and hospitals. The distributor developed its own customer contacts and, in fact, the manufacturer conceded that it did not help the distributor solicit customers. Following New Jersey employment law, the District Court determined that the distributor developed its customer relationship solely through its own efforts and expenses and that the fruits of that labor were not proprietary to the manufacturer. Consequently, the Court found the restrictive covenant to be unenforceable because the manufacturer lacked a protectable interest in the information it sought to protect.