Antitrust Law Daily Sherman Act defense fails in Lumber Liquidators breach of restrictive covenant case
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Tuesday, November 12, 2019

Sherman Act defense fails in Lumber Liquidators breach of restrictive covenant case

By Nicole D. Prysby, J.D.

Lumber Liquidators’ breach of contract claims against a cabinet seller will go forward. The court declined to decide, prior to development of a factual record, whether the restrictive covenant is unenforceable under the Sherman Act or Virginia law.

A breach of contract action brought by hardwood flooring retailer Lumber Liquidators, Inc. against Cabinets to Go, LLC (CTG)—a kitchen and bath fixture retailer operator owned by the founder and past chief executive of Lumber Liquidators—for entering the market for flooring in contravention of the parties’ agreement was not dismissed based on an antitrust defense. CTG contended that the underlying restrictive covenant was an unenforceable market allocation scheme in violation of the Sherman Act. Without a factual record about the relevant market, potential competition between the parties, and the effect of the restrictive covenant, the strength of the defense could not be determined. Further, it was premature to determine whether the rule or reason or per se standard applied. In addition, dismissal was not appropriate on the ground that the restrictive covenant violated Virginia public policy against restraints of trade (Lumber Liquidators, Inc. v. Cabinets to Go, LLC, November 8, 2019, Lauck, M.).

Thomas Sullivan, the founder of Lumber Liquidators, served as its chairman of the Board of Directors, CEO, and president for a number of years. In 2010, the Board learned that Sullivan owned and operated CTG, which did not sell flooring products. The Board expressed concern that Sullivan might use confidential Lumber Liquidators information to benefit CTG and entered into several agreements with CTG. One agreement gave Lumber Liquidators an option to purchase Sullivan’s interest in CTG, and a Memorandum of Understanding (MOU) required Lumber Liquidators to provide advertising and consultation services to CTG. Given the ties between the management of the two companies, Lumber Liquidators and CTG included reciprocal restrictive covenants in the MOU. Specifically, CTG agreed not the engage in the sale of hardwood flooring or similar products during the term of the MOU or for two years following its termination. Lumber Liquidators alleged that, even though the MOU remained in force, CTG was advertising, marketing, and selling hardwood flooring and similar products. Lumber Liquidators brought a breach of contract claim. CTG moved to dismiss the claims, arguing that the MOU violates federal antitrust and Virginia law and was therefore unenforceable.

CTG contended that the MOU was a naked restraint of trade, seeking to divide markets horizontally, which was illegal per se under Section 1 of the Sherman Act. The court rejected the argument, holding that it was unsupported by the factual allegations in the complaint and premature at this state of the litigation. Lumber Liquidators’ complaint alleged that the MOU enhanced productivity by permitting Sullivan to continue working with the company, while providing CTG with the opportunity to grow its market base and opportunities. Taking these allegations as true, the court cannot conclude that the restrictions in the MOU would always or almost always tend to restrict competition and decrease output. It would also be premature to determine whether the rule or reason or per se standard applies at this point. The court has not been presented with evidence as to market conditions or other relevant facts. Without detailed information about the relevant market, potential competition between the parties, and the effect of the MOU, the court cannot determine the strength of the defense and will not adopt the per se rule at the motion to dismiss stage, before discovery or trial.

Virginia public policy against restraints of trade. CTG also argued that the MOU violated Virginia public policy against restraints of trade. Again, the court rejected that argument. First, CTG cited the wrong standard for evaluating the restrictive covenant. CTG cited the more exacting standard employed by Virginia courts when determining the validity of non-compete clauses in employment contracts (which includes a requirement that the party seeking to enforce the agreement demonstrate that the restraint is no greater than necessary to protect a legitimate business interest). But that standard does not apply to a contract between two businesses. The less exacting standard—that a contract in restraint of trade will be held void as against public policy if it is unreasonable as between the parties or is injurious to the public—applies. Second, Virginia precedent forecloses CTG’s argument. The Virginia Supreme Court has strongly indicated that the reasonableness of a restriction on trade cannot be resolved on the pleadings. The court cannot determine the unreasonableness of the contract or an injury to the public without a factual record about the relevant market and effects on the public. And even if the court could resolve the question at this time, the MOU would survive the motion to dismiss because, based on the factual allegation in the complaint, it protects a legitimate business interest insofar as it ensured that Sullivan and CTG would not use Lumber Liquidators’ confidential information to usurp corporate opportunities for the benefit of CTG.

The case is No. 3:19-cv-00153-MHL.

Attorneys: Michael Edward Lacy (Troutman Sanders LLP) for Lumber Liquidators, Inc. Angela Hope France (Potter & Murdock PC) for Cabinets to Go, LLC.

Companies: Lumber Liquidators, Inc.; Cabinets to Go, LLC

MainStory: TopStory Antitrust VirginiaNews

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