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U.S. Lubes, L.L.C. v. Consolidated Motor Oils, Inc.

A-0642-06T1 (N.J. Super. App. Div. 2008) (Unpublished)

NON-COMPETITION — Even though the seller of a business may later violate the non-competition provision of the sales agreement, the seller may still be eligible to collect monies owed to it if the buyer has breached its implied covenant of good faith and fair dealing by failing to act in a way as to generate sales that would have inured to the benefit of the seller by way of an earnout provision in the sales agreement.

A large company sought to purchase a small distributor that sold petroleum products. The distributorship was owned by a married couple. The large company distributed the same products as did the small distributorship, but it did so on behalf of a major oil company and in much larger amounts. The larger company also had a much higher overhead than the small distributor and required a larger profit margin. The two parties entered into an asset purchase agreement under which the larger company was to obtain the small distributor’s customer list and equipment, as well as the rights held by the couple, all in exchange for and initial cash payment. An additional cash payment was to be made, but it was subject to reduction if sales from customers on the list did not reach a certain threshold. The asset agreement also contained a non-competition clause that prevented the couple from soliciting buyers, but the couple was allowed to sell their remaining inventory within a set amount of time. The larger company retained certain rights to purchase the couple’s inventory. The parties also entered into a services agreement under which the couple, as private contractors paid on commission, was to assist the larger company in reaching customers on the list and to assist the larger company in procuring them as regular customers. The services agreement had a non-competition clause, but with a longer duration period than that in the asset purchase agreement. The services agreement also included an automobile allowance and health insurance coverage for the couple.

Within a few months after the sale of the distributorship, the larger company began to stop doing business with some of the couple’s former customers because the profit margin on those sales was not high enough for the larger company. This was because the couple had personally given favorable prices to those customers. The couple continued to sell their remaining inventory to the rejected customers and also began to restock their supply to maintain sales to these customers. The company found out about the sales and terminated the services agreement due to the couple’s breach of the non-competition clause of the services agreement. The company also brought an action against the small distributor and against the couple for losses that the larger company claimed occurred as a result of the couple’s breach. The couple brought counterclaims for unpaid commissions, for the second payment due under the asset purchase agreement, and for what they would have been owed for services had they been permitted to render them to the larger company over the two following years under the contract had it not been terminated.

The lower court found that the couple violated the non-competition provisions of the two agreements by continuing to sell to customers on their list following the allowable time period and that the larger company had justifiably terminated the agreement. It also found that the couple was not entitled to the future earnings they claimed. The lower court, however, found that the larger company abandoned the customers with whom the couple was dealing and could not have proven that it would have done business with those customers since its per unit prices were higher that those offered by the couple. Since the customers in question were abandoned and would not have become customers of the larger company, the lower court refused to award damages for the profits earned by the couple on those sales. It also found that the larger company breached the covenant of good faith and fair dealing by unilaterally rejecting sales from customers on the list that fell below their profit margin and therefore it awarded eighty percent of the second payment to the couple under the asset purchase agreement.

On appeal, the Court ruled that the lower court’s finding that the larger company abandoned the customers in question was supported by substantial credible evidence. The Court noted that the purpose of a damage award is to make an injured party whole and restore it to as good a position as it would have been had the contract been performed. It also noted that such damages were to be based on losses that occurred as a result of a party’s breach and not be based on the profits that were earned by the breaching party. The Court then found that the larger company never proved that it would have profited from sales to the customers that it abandoned.

The larger company’s argument that the lower court erred by finding that it had breached the covenant of good faith and fair dealing was rejected along with its argument that it did not act in an arbitrary, capricious, or unreasonable way, which was necessary to finding such a breach. The Court pointed out that according to precedent, the covenant of good faith and fair dealing is implied in every contract. Under the implied covenant, no party to a contract is permitted to do anything that would prevent or impede another party from receiving the benefit of the contract. The Court found that under such analysis, the larger company was unreasonable and capricious for imposing its own prices as conditions and for having rejected the customers in question. Such actions, according to the Court, would not have occurred had the larger company conducted due diligence and discovered the lower pricing for the customers in question. Had it done so, it could have raised the matter during negotiations over the agreements. All of the lower court’s findings were affirmed.

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