Private Equity

On July 4, 1776, the thirteen American colonies formally severed their ties to the English throne and parliament.  It took a war (which commenced a little over a year earlier) to actually effectuate the severing of those ties.  But with the Treaty of Paris in 1783, England acknowledged that the United States of America was an independent nation. Given the rejection of the English government and the hostilities that entailed, it may seem curious to some that New York and each of the other former colonies, now states, by its constitution or the enactment of a “reception” statute, adopted the common law of England as the law of land, except where the legislature of that state or its constitution overrode the common law.  And every state admitted to the Union since 1776 (excepting only Louisiana), have similarly adopted the common law of England as its governing law.

But by appropriating the English common law as its own, the American colonies were simply asserting their rights to be governed by the same general law as a citizen of England.  After all, not being recognized as having the same rights as other English citizens was one of the main complaints that lead to the desire to throw off the English government in the first place.  And no less an authority on the common law than William Blackstone, writing in 1765, had declared that: “the common law of England, as such, has no allowance or authority [in the American colonies].”^[1]   Oh yeah, said the American colonies, watch this—we just made it so whether you like it or not.

And why does this matter?  Because the common law, as adopted in the American states, governs the making and enforcement of contracts.  And what is the common law?  It is the law that governs in the absence of legislative pronouncement.  It is “the policies and legal theories that underlie the doctrines that judges invoke to justify their decisions.”^[2]  Like it or not, it is “judge-made decisions extending from ‘the present time back into the ancient courts of England,’ [based upon] a ‘system of reasoning from case to case precedent that [has permitted] the common law to grow with and adapt to changing conditions of society.’”^[3]  It is the common law that determines when a contract has been formed.  It is the common law that determines the remedies available for a breach of that contract.  It is the common law that determines how a court goes about interpreting a written agreement.  And it is for that reason that many U.S. courts cite to English precedent from time to time—and not just to cases decided prior to 1776; the English case of Hadley v. Baxendale was decided in 1854 (a case about the proper means of determining the damages payable for a breach of contract) and it has been cited by the United States Supreme Court, as well as the supreme courts of virtually all of the states.^[4]

But in the United States, unlike in England, there is no overriding authority that reconciles conflicting opinions on the nature of the common law in the various states.  And despite the common origins, different states have adopted different interpretations of certain common law principles that were derived from the same ancient doctrines devised by the English courts.^[5]  Hence the importance of choice of law and forum selection provisions in your contacts, provided that you know why you are selecting the law and forum you are selecting.^[6]

In almost all states, as in England, there is a strong common law doctrine supporting the freedom of parties to make any deal they wish (freedom of contract), as well as a strong policy of interpretation that enforces the parties written agreement in accordance with the words the parties choose to use in making that written agreement (sanctity of contract).  But the common law recognized long ago that parties do not always express every agreement that they intend to make by their contract in the written agreement evidencing their contract.  So, in the absence of an express agreement governing certain matters, the common law supplies an implied agreement.  These implied agreements are sometimes referred to as gap fillers.  If you fail to agree on a specific matter expressly as to which the common law provides a gap filler, you have in fact agreed to that gap-filling term.^[7] In most cases, however, the agreements of sophisticated parties represented by sophisticated counsel (well-trained in the common law) expressly address these issues so they would rarely come into play.  But such is not always the case, and the gap-filling terms that are supplied in some states may come as a surprise to the uninformed.  And that brings us to a unique gap-filling term implied in a New York law governed sale of a business—the Mohawk doctrine.

The Mohawk doctrine derives its name from a 1981 New York Court of Appeals decision, Mohawk Maintenance Co. v. Kessler, 419 N.E.2d 324 (N.Y. 1981).  In Mohawk, the court, relying on a common law doctrine know as “derogation of the grant,” held that the seller of a business that includes its “good will” is subject to an implied obligation “to refrain from soliciting his former customers.”  In an earlier New York Court of Appeals decision cited in Mohawk, the court quoted liberally from a nineteenth century English case describing the rationale for this doctrine, Trego v. Hunt, [1896] 1 AC 7:

A man may not derogate from his own grant; the vendor is not at liberty to destroy or depreciate the thing which he has sold; there is an implied covenant, on the sale of good will, that the vendor does not solicit the custom which he has parted with; it would be a fraud on the contract to do so. These, as it seems to me, are only different terms and glimpses of a proposition which I take to be elementary. It is not right to profess and to purport to sell that which you do not mean the purchaser to have; it is not an honest thing to pocket the price and then to recapture the subject of sale; to decoy it away or call it back before the purchaser has had time to attach it to himself and make it his very own.^[8]

To be clear, the Mohawk doctrine does not impose an implied non-compete on the seller of the business (unlike a similar doctrine in Massachusetts),^[9] but only a duty not to directly solicit for any new business of the seller any existing customers of the business sold.  And those existing customers are free to follow the seller to his new business as long as they are not encouraged to do so. But the duty not to solicit is a perpetual duty, not one of limited duration like an express non-compete or non-solicit typically would be.  It is perpetual because the implied duty is part of that which was sold to the buyer with the good will of the business. The extent and parameters of this duty were examined more recently by the New York Court of Appeals, in Bessemer Trust Co., N.A. v. Branin, 949 N.E.2d 462 (N.Y. 2011). 

Recall, however, that the common law does not typically imply obligations except where the terms of the express agreement are silent on the subject.  Thus, if you directly address in your written agreement the seller’s obligations vis a vis solicitation of customers, the Mohawk doctrine should not come into play.  But simply addressing the question of the seller’s obligation not to compete is apparently not enough.  There was, in fact, a five year non-compete clause in the agreement for the sale of the business in Mohawk.  But that was deemed insufficient to eliminate the implied non-solicit.  A specific and limited non-solicit or an express disclaimer of any such duty is what is apparently required, at least in New York.^[10]

How this doctrine would apply in a sale of a portfolio company by a single purpose entity holding company is far from clear; the doctrine was developed when sellers were almost always individuals.  And the application of this doctrine in other states is equally unclear.^[11] But the legacy of the American Revolution’s insistence upon appropriating the English common law, and then allowing that law to separately develop and adapt to the needs of 50 different states, has left us with the need to know what that particularized local common law is in the state we select to govern our agreement and to address any of its peculiarities.