By Naudia O’Steen:
What is the ‘Blue Pencil’ Doctrine?
For transactional and litigation lawyers alike, a severability clause is key to any contract agreement. Typically, a severability clause states that if a term or provision of a contract is invalid, unenforceable, or illegal, only that term is void and the remaining contract is still valid.[1] Being able to strike out a single provision in a contract while still enforcing the remainder of the agreement is critical to honoring the agreements and intentions of the parties. A severability clause is now a standard must-have in all contractual agreements.
In England in 1843, the court took the concept of severability further in Mallan v. May when the court applied a ‘blue pencil’ to an unreasonable contract clause and struck out the term that was unreasonable to make the remainder of the clause enforceable and reasonable.[2] Over time, the practice was adopted by American courts. Now, 35 states have some form of the blue pencil rule that is actively utilized by the court system.[3] The court only applies the blue pencil rule to overly broad non-compete and non-solicitation agreements. When a single provision has a section that is reasonable and another section is offensive and unenforceable, the court may use their blue pencil to strike out just that small part of the provision that is unenforceable so that the remainder of the clause may still be enforced. Unlike the doctrine of severability, where the entire term would be struck out, the blue pencil eliminates only a portion of a term. While the less severe approach of the blue pencil may appear to honor the intention of the parties more than a severability clause does, it may appear to take the need to draft a carefully crafted clause out of an attorney’s hands.
Delaware’s Treatment of the Blue Pencil Rule
While every state has decided whether it will apply the blue pencil doctrine or refuse to edit a vague and ambiguous clause, Delaware is the leading authority on the blue pencil doctrine for corporations and business professionals. Delaware historically has generously applied its blue pencil to merger agreements and non-compete agreements.[4] Delaware courts have a history of enforcing non-compete agreements as long as the agreement can satisfy some key equity considerations. The court reviews the non-compete and non-solicitation agreements to ensure that they are “(1) reasonable in geographic scope and temporal duration, (2) advance a legitimate economic interest of the party seeking its enforcement and (3) survive a balance of the equities.”[5] The idea is to balance the employer’s legitimate business interest in protecting its confidential information, customer relationships, and other interests, versus the employee’s right to work and earn a living. While Delaware sometimes chooses not to apply the blue pencil to overly broad non-competes, more often than not attorneys can rely on the comfort that Delaware will historically enforce most non-compete agreements. However, recently, Delaware decided not to apply its blue pencil to reform an overbroad covenant due to the inequitable nature of such an application.[6]
Delaware’s Recent Shift in Kodiak Building Partners, LLC v. Adams
In June 2020, Kodiak Building Partners, LLC (“Kodiak”), a family-run building materials distributor, announced that it had acquired eighty-one locations in 16 states.[7] This rapid expansion pushed the business into the lumber, drywall, kitchen cabinets and counters, and construction supply industries.[8] One of these acquisitions, Northwest Building Components, Inc. (“Northwest”) dealt mainly in roof trusses.[9] Northwest only had one office that it operated out of when it was acquired and it served customers only in a sixty-mile radius of its Rathdrum, Idaho location.[10] Adams, a primary shareholder, received $900,000 in consideration for stock purchase deal.[11] Additionally, Adams and three other shareholders signed a restrictive covenant agreement that prohibited them from competing for thirty months after “the Closing.”[12] The restrictive covenant contained a waiver of any reasonableness defense.[13]
In October of 2021, Adams left his position at Northwest and accepted a job as a general manager for Builders FirstSource, Inc., thereby violating his agreement with Kodiak.[14] Kodiak acted swiftly. They first sent Adams a cease-and-desist notice and then after Adams did not resign from his new position, Kodiak filed for an injunction.[15]
Delaware Chancery Court held arguments for the motion on September 26, 2022. While Delaware is known for typically enforcing non-competes and non-solicitation agreements, it ruled in favor of Adams. The court reasoned that Kodiak did not show that Adams “more likely than not breached an enforceable restrictive covenant.”[16] The emphasis here was on enforceability. The court noted that, in a sale of a business, a restrictive covenant that infringes on competition is subject to a “less searching inquiry” than if it were contained in an employment agreement.[17] The court spoke twice to the unique characteristic here of a contract for a business sale instead of the restrictive covenant being in an employment agreement.[18] Due to this, if any part of the agreement is unreasonable, the court will likely not apply its blue pencil to make it reasonable.[19] Upon a common law review of reasonableness, the court found that the restrictive covenant agreement signed by Adams was unreasonable as to considerations of public policy, failing to advance a legitimate business interest, and having an overly broad scope; therefore, the court declined to use its blue pencil to alter the agreement.[20]
A Few Drafting and Deal Considerations for Transactional and M&A Attorneys
As the recent Kodiak case demonstrates, the Delaware judiciary is becoming less fond of lazy clauses that are sweepingly broad and vague. So, while the blue pencil rule may be a life preserver for an attorney’s occasional small mistake, a lawyer should never assume that a judge will do their legwork for them. While non-competes and non-solicitation agreements are increasingly becoming a standardized form that can be copied and pasted from client to client, Kodiak shows the importance of carefully tailoring a document to the individual needs of each client.
For new and well-established transactional attorneys alike, this case serves as an excellent reminder that being the best advocate for your client requires the extra step of fine-tuning provisions in every document. The few extra moments taken to narrow language of overly broad provisions could be the difference in a court refusing to apply the blue pencil or using its discretion to help enforce the term. Further, Delaware case law provides some important guidance for the legal counsel of buyers and sellers when it comes to non-compete agreements in M&A transactions. Non-competes can have a significant impact on the value of an M&A transaction. By carefully considering the terms of these agreements and the laws that govern, counsel on both sides can work to mitigate the potential negative impacts and maximize the value of the acquisition.
[1] Severability Clause, Legal Info. Inst., https://www.law.cornell.edu/wex/severability_clause (last visited Feb. 16, 2023).
[2] Mallan v. May, (1843)11 Meeson and Welsby 653.
[3] Blue Pencil Rule: Everything You Need To Know, UpCounsel (Nov. 3, 2020), https://www.upcounsel.com/blue-pencil-rule.
[4] C & J Energy Services, Inc. v. City of Miami General Employees’, 107 A.3d 1049 (Del. 2014).
[5] Kodiak Building Partners, LLC v. Adams, 2022 WL 5240507, at *4.
[6] Paul Pryzant & Matt L. Simmons, A Delaware Surprise—Busting the Limits of Enforceability of Non-Competes in an M&A Transaction under Delaware Law: Yes, it can be done!, Bus. L. Today (Nov. 15, 2022), https://businesslawtoday.org/2022/11/delaware-surprise-busting-limits-enforceability-non-competes-ma-transaction-under-delaware-law/.
[7] Kodiak, at *2.
[8] Id.
[9] Id.
[10] Id.
[11] Id. at *13.
[12] Id. at *2.
[13] Id.
[14] Id. at *3.
[15] Id.
[16] Id. at *4.
[17] Id.
[18] Id. at *13.
[19] Id. at *4.
[20] Id. at *14.
TRANSACTIONS 
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