Investment Manager's Non-Compete is Litigated

Non-compete clauses are common in investment adviser employment contracts and partnership agreements. Although they are widely used, the enforceability of these clauses is sometimes challenged.

An interesting twist on the issue has arisen in a case filed recently in the federal district court in Philadelphia involving two well-known institutions. In that case, a trust company has sued to block enforcement of a non-compete clause an investment management firm was using to prevent a portfolio manager, a former partner of the firm, from taking the trust company and its clients with him to his new firm. A state court in Massachusetts had decreed that the five-year non-compete clause in the partnership agreement of the manager's former firm, which was triggered when the manager left to start his own firm, was enforceable. The Massachusetts court issued an injunction effectively preventing the trust company from continuing to use the manager at his new firm. The Massachusetts appeals court denied the trust company's motion to stay the injunction.

In the federal action, the trust company asserted that its ERISA-covered client plans would be harmed if the portfolio manager cannot continue to manage the plans' assets because of the unique nature of the manager's portfolio management style. The net result of enforcing the non-compete clause, according to the trust company, would be to force the plans to liquidate their assets. In support of its arguments against enforceability of the non-compete, the trust company argued that the investment firm's failure to disclose the existence of the non-compete clause to the trust company at the time the trust company hired the firm and the manager to service its clients violated both ERISA and the Investment Advisers Act. The trust company also asserted that the clause operates effectively as a "penalty" generally not permitted in contracts for services to employee benefit plans. The federal judge found these arguments persuasive, and has issued a preliminary injunction that would prevent enforcement of the non-compete, at least as it affects the trust company.