Trade Secrets and Noncompete Blog : Non-Compete Lawyer & Attorney : Epstein Becker Green Law Firm : Trade Secrets & Confidentiality Agreements

Saylavee, LLC v. Hunt demonstrates the willingness of Connecticut courts to enforce restrictive covenants that are reasonable in length of time and geographic scope.

The defendant Rhonda Hunt worked as an exercise instructor for an exercise studio called Bodyfit, with whom she signed an agreement restricting her for two-years from becoming involved as an employee “in any business which engages in the same or similar business of the company or otherwise competes with the business of the company within a ten mile radius of any exercise studio owned and operated by the company.” Hunt acknowledged in the agreement that she was capable of earning a living in a field for which she was qualified without violating the terms of the covenants. The agreement also addresses protected trade secrets and provides for equitable relief without the necessity of proving irreparable harm or the inadequacy of money damages.

Hunt resigned her job at Bodyfit on August 12, 2011, and at first, honored the non-compete by working at exercise studios more than 10 miles from Bodyfit. In July 2012, she began working at the Equinox gym less than two miles from the Bodyfit gym. She taught exercising classes at Equinox similar to those offered at Bodyfit, and Equinox had the same potential clientele.

In its May 7, 2013 decision , the Superior Court of the State of Connecticut found that the non-competition agreement was in “plain speak” and that Hunt had signed it without showing it to her husband, who was a lawyer. With reference to trade secrets and non-competition covenants, the Court found, “that all of these expensive facilities like to have what they call at Equinox, their ‘signature programs’”, which Hunt was teaching to the same potential clientele as she had taught at the Bodyfit location only two miles away from Equinox and with another year remaining on the term of the non-compete agreement, which prohibited her conduct.

Based on these facts and a plain reading of the restrictive covenants, the Court entered a temporary injunction enjoining: (1) Hunt from working at Equinox or any other exercise establishment within 10 miles of Bodyfit; (2) revealing any of Bodyfit’s proprietary business information to anyone; and (3) soliciting any current or former Bodyfit clients for business.
 

Earlier this month, the New Jersey Assembly introduced a new bill (Assembly Bill No. 3970) that proposes to invalidate non-competition, non-solicitation and confidentiality covenants of individuals who qualify for unemployment compensation. The bill does not seek to nullify covenants already in effect, merely those entered into after the date of the bill’s enactment. By permitting individuals subject to restrictive covenants to seek employment, the bill aims to reduce the State’s unemployment benefits expenditures.

Presently, New Jersey courts approve of restrictive covenants in employment contracts if they are reasonable. To be reasonable, they must protect the employer's legitimate interest, must not cause undue hardship for the former employee, and cannot be against the public interest. If passed, the bill would significantly limit employers’ ability to bind their employees to such restrictive covenants and potentially leave them without means to protect valuable confidential information and customer contacts.

With the introduction of the bill, New Jersey follows in the footsteps of Maryland, which proposed legislation on January 9 to bar non-compete covenants of those individuals who receive unemployment insurance benefits. Like the Maryland bill, the New Jersey bill has been referred to committee.
 

It is common practice for a company, through its legal counsel, to send letters to former employees upon the employee’s resignation in an effort to remind the employee about his or her post-employment contractual obligations to the company, whether through a non-competition agreement, or non-solicitation / non-disclosure restrictive covenants. A recent court decision affirms that companies and their counsel are shielded from liability for defamation that may arise from the publication of those letters due to the absolute privilege protection.

In Wendy Murphy v. Living Social, Inc., a former employee, Wendy Murphy, voluntarily resigned from her employment as a marketing consultant to work for a competitor. Upon her departure, the company, through its in-house counsel, sent Ms. Murphy a letter reminding her of the terms of her employment agreement, which included obligations under a non-competition, non-solicitation, and non-disclosure agreement. Two weeks later, the company sent another letter to Ms. Murphy and Ms. Murphy’s new employer demanding that Ms. Murphy cease and desist from all solicitation of the company’s employees, customers, or prospective customers. The company specifically stated that it was considering taking legal action to protect its interests if the conduct did not stop.

Within days of receiving the second letter, Ms. Murphy filed suit alleging, among other things, that the cease and desist letter constituted libel per se and named both the company and its in-house counsel as defendants to the claim. In granting the company’s motion to dismiss the libel per se count, the U.S. District Court for the District of Columbia concluded that the former employee could not state a claim for libel because she could not establish the essential element that a false and defamatory statement was published “without privilege” to a third party. Specifically, the Court agreed that the statements made in the letter were protected by an absolute privilege because they were made in anticipation of litigation. Noting that the judicial proceedings privilege did not just protect statements within the course of litigation, the Court stated that it also extends to statements made prior to the commencement of litigation, such as the cease and desist letter at issue. Because the letter was written by the company’s attorney, advising the employee and her new employer of the employee’s contractual rights, and stated that the company was reserving its rights to take all legal action to protect its business interests, the statements were absolutely protected by the judicial proceedings privilege.

This case serves as a good reminder of the importance of the practical steps companies take to protect their trade secrets and customer confidential information. When an employee departs for a competitor, it is essential that during the exit interview process, company representatives remind the departing employee of his or her obligations under company policies, applicable employment agreements, and/or non-competition agreements. If evidence is obtained that makes it appear that an employee is violating the terms of his or her restrictive covenant obligations, sending a cease and desist letter, as LivingSocial did in this case, is important to further protect business interests. Importantly, so long as the letter accurately states the facts and merely points out the obligations of the employee without otherwise making accusations of false or illegal conduct, companies should feel comfortable to take these necessary steps without fear of a retaliatory lawsuit against them and their legal counsel asserting meritless claims of defamation.

Accordingly, if your company is not already using cease and desist letters in its arsenal of proactive measures to protect trade secrets and confidential information, now is the time to initiate this best practice.
 

Co-authored with Ted A. Gehring.

Except for very limited statutory exceptions (which do not apply to most employer/employee disputes), California courts will not enforce non-compete agreements, or any restrictive covenant by which anyone is restrained from engaging in a lawful profession, trade or business. Cal. Bus. & Prof. Code § 16600. Since § 16600 embodies a strong California public policy, California law is clear that a party cannot circumvent the § 16600 restrictions with a choice of law provision that designates a more non-compete friendly jurisdiction as the applicable law. The Application Group, Inc. v. The Hunter Group, (1998) 61 Cal.App.4th 881, 888-89.

It appears, however, based on rulings by two federal district courts last year that employers might get some traction in this area by including a choice of venue or forum selection provision in their employment contracts and – through that provision – have the case transferred to a jurisdiction that will be more likely to enforce a restrictive covenant.

In M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 15 (1972) (“Bremen”), the United States Supreme Court addressed forum selection clauses and held that a forum selection clause is unenforceable if: (1) it was the product of fraud, undue influence or overwhelming bargaining power; (2) the forum is so gravely difficult and inconvenient that the party challenging the clause will for all practical purposes be deprived of its day in court; or (3) the clause would contravene a strong public policy of the forum in which the suit is brought. Bremen, 407 U.S. at 15. A strong showing must be made to set aside the forum selection clause. Id. The California Supreme Court has set similar standards. Smith, Valentino & Smith, Inc. v. Superior Court, (1976) 17 Cal.3d 491, 496, (“We conclude that the forum selection clauses are valid and may be given effect, in the court’s discretion and in the absence of a showing that enforcement of such a clause would be unreasonable.”).

In both Hartstein v. Rembrandt IP Solutions, LLC, No. 12-2270 (N.D. Cal. July 30, 2012) and Hegwer v. American Hearing Aid Associates, No. C 11-04942 (N. D. Cal. Feb. 24, 2012), the Plaintiffs were former employees who had signed employment agreements containing restrictive covenants and which also contained, in part, forum selection clauses designating Pennsylvania as the appropriate forum. Both cases were filed in state court and removed to federal court. The Defendants filed motions to transfer or dismiss premised on the forum selection clause.

The Plaintiffs in each case argued, in part, that the motions should be denied because the more restrictive covenant friendly Pennsylvania courts would be more likely to enforce the non-compete which would, in turn, contravene a strong California public policy. Bremen, 407 U.S. at 15. Both federal district courts, however, focused on the reasonableness of the forum selection clause itself, rather than the reasonableness of the clauses’ effect. Both found that the possibility that a Pennsylvania court might enforce the non-compete was not a sufficient basis to invalidate the forum selection clause.

As such, employers that are based in jurisdictions more friendly to restrictive covenants (which would likely be any other state in the country), should consider including forum selection clauses designating the state of their corporate headquarters as the appropriate forum. Although these cases will no doubt be decided on a case by case basis depending on the particular factual circumstances, a forum selection clause will, in many instances, provide, at a minimum, more leverage for the employer in actual or threatened restrictive covenant litigation commenced in California.

An employee who joined a corporate employer that was not a competitor with his former employer was still enjoined and restrained by restrictive covenants he signed with his former employer when his new employer merged with his prior employer’s competitor.

In Amphenol Corporation v. Paul, 3:12-cv-543, (D. Conn. Jan. 8, 2013), the United States District Court for the District of Connecticut granted an injunction and temporary restraining order because after the new employer merged with a competitor of the employee’s former employer, the new employer did not take adequate measures to insulate the employee from information and activities that provided the possibility that documents could be used to violate non-competition agreements signed by the employee with his former employer. Also, before his departure for his new position, the employee had emailed to his personal email thousands of work related emails and downloaded business files.

Amphenol is a multi-national corporation that designs, manufactures and markets electronic and fiber optic connectors, cable and interconnect systems. Richard Paul, a former decades-long employee was the business unit director of Amphenol’s high speed interconnect unit, with an expertise in a device that joins electrical circuits together. He had unlimited access to marketing information regarding sales history, markets and customers.

Paul and Amphenol executed various non-competition agreements over the years, which restricted him from engaging in the development, production, sale or distribution of any product, sold, distributed or in development: (i) by the operation of Amphenol during the 12 months preceding Paul’s termination of employment, or (ii) by Amphenol or its subsidiaries about which Paul received Confidential Information. The agreements also restricted Paul’s ability to divert customers or employees from Amphenol for 24 months following his termination.

The Defendant, TE Connectivity, Ltd., designs and manufactures products that connect and protect data and power, serving customers worldwide in some of the same industries as Amphenol. Although TE and Amphenol were not direct competitors, within the past year, TE merged with Deutsch Group, a manufacturer of electrical and fiber optic connectors that is in direct competition with Amphenol. When Amphenol learned of that merger, it created a team to form a strategic response to the merger, and Paul had access to the team’s findings and documents during his employment with Amphenol.

Paul voluntarily terminated his employment with Amphenol to join TE in March 2012, as global vice president for production management and pricing for TE’s aerospace, defense and marine business unit. The business unit that Paul oversees is not in competition with Amphenol; he works from home; and he does not have direct physical contact with any TE or Deutsch employee who deals with connectors. While those facts are strong arguments against enforcement of Paul’s restrictive covenants, the Court found that after joining TE, Paul was copied on various emails related to TE’s merger with Deutsch and the pricing and marketing connectors. Also, a forensic study of Paul’s computer activity at Amphenol before his departure found 2,000 work related emails forwarded to his personal email address, and the computer hard drives that Paul returned to Amphenol revealed that he had removed various files which had business relevance.

The Court found that Paul could continue in his current capacity, subject to certain restrictions. He was restrained from having any involvement or input regarding the merger, acquisition or integration of TE with Deutch. Also, he was restrained from using Amphenol’s confidential information, trade secrets or sales information and restrained from soliciting Amphenol’s employees, customers and suppliers, among others.

In addition, the Court required TE to implement precautions to confirm that Paul did not share Amphenol’s confidential, trade secret or proprietary information. TE had to distribute a memo reminding senior leaders and managers about Paul’s restrictions; search TE’s IT systems for any evidence that Paul uploaded Amphenol’s documents or data; certify that those IT searches were performed; implement a word-based filter including the terms “Amphenol” and “Deutch” on Paul’s email accounts so that Paul remained “fire walled” from competitive activities; and required Paul to work in the TE’s secure and limited access facility when he was not working from his home.

When corporations merge, the employers and employees must be proactive and consider steps to protect against claims that the merger created a violation of restrictive covenants that did not exist before the merger. Also, an employee who sends work emails to his personal email address and who downloads business files is likely to be caught and to create adverse legal consequences for himself and his new employer. Requiring new hires to certify that they have not brought to the new job any of their work product from past employers, and incorporating the same rule in company policies, are proactive steps employers should consider.
 

Forum selection clauses are common in non-compete agreements, particularly when the employer is multi-state or multi-national. One question that often arises, however, is whether a court will actually require an employee to litigate in a distant jurisdiction with which he had minimal contacts. In a recent case from the Eastern District of Missouri, a federal judge enforced just such a forum selection clause.

Specifically, in Emerson Electric Co. v. Peter Ramos Yeo, the defendant, Peter Ramos Yeo (“Yeo”), was a former “key employee” who had signed a stock option agreement containing a non-compete clause and a Missouri forum selection clause. Because Yeo lives in the Philippines and purportedly had a “lack of minimum contacts with Missouri” (the court did not specify just how minimal his contacts with Missouri were), he challenged the enforceability of the Missouri forum selection clause, arguing, in effect, that the expense and burden of having to litigate in Missouri rendered the forum selection clause unfair and/or unreasonable. (Yeo also unsuccessfully challenged the enforceability of the non-compete on other grounds not discussed in this post.)

The Missouri court did not see it Yeo’s way, explaining that “Defendant is an educated person and is presumed to have agreed to the forum selection clause knowingly and intelligently. It is neither unfair, unjust nor unreasonable to hold Defendant to his bargain and require him to defend this matter in this Court.”

The court’s decision was sparse in certain details (e.g., the precise nature of Yeo’s former position, the extent of his contacts with Missouri, and whether there were other facts and circumstances that rendered him or his conduct unsympathetic). Nevertheless, the decision is notable for its strict enforcement of the forum selection clause.
 

On December 21, 2012, the Supreme Court of New Hampshire, in Ellis v. Candia Trailers & Snow Equipment, Inc., found that a non-compete agreement was a fundamental component of a purchase and sale transaction which was memorialized in three separate agreements. The Seller began competing with Buyer shortly after the sale. After the Buyer did not follow through on purchasing all required assets of the Seller, the Supreme Court reversed the trial court’s decision to partially rescind the non-compete agreement, and instead decided that the non-compete was so essential to the transaction that it required complete rescission of the transaction.

While non-compete agreements frequently come up in contexts other than employment agreements, such as the sale of a business, this case is interesting because of the unusual structure of the deal. (For another example of a non-compete arising outside of an employment agreement, see Caesar v. Sindelin (decided May 4, 2012, Massachusetts Lawyers Weekly No. 11-070-12), where a Massachusetts Appeals Court held that a Probate and Family Court Judge had the authority to enjoin a party to a divorce proceeding from operating a competing business.)

In 2006, the Goff family, owners of Precision Truck (collectively referred to as “the Sellers”), sold its business to Candia Trailers and Snow Equipment, Inc., owned by David Ellis (“the Buyer”). The deal was memorialized by three agreements: an Asset Purchase Agreement (“APA”), a Non-Compete Agreement (“NCA”) and an Inventory Purchase Agreement (“IPA”). The APA specified that it was conditioned on the Sellers signing the NCA and the IPA. The Buyer paid $340,000 to the Sellers as consideration for signing the NCA, which represented the bulk of the purchase price. The Buyer signed the APA and paid $20,000 for the assets, which included the good will of Precision Truck. While the NCA had a term of seven years, it would expire much earlier if the Buyer did not purchase the rest of the assets of Precision Truck by June 1, 2007, which was required under the terms of the third agreement, the IPA. If the Buyer breached that agreement, the Sellers would be relieved of the obligation of the NCA.

Shortly after execution of these agreements, the Sellers started to compete with Precision Truck in violation of the NCA. Thereafter, the Buyer failed to purchase all of the assets of Precision Parts by the date specified in the IPA.

The Buyer brought suit to rescind the NCA for breach of contract and the Sellers counter-sued the Buyer for breach of contract for not buying all of the assets of Precision Parts.

Now comes the interesting part. The trial court found that the APA, the NCA and the IPA were each separate agreements making the NCA severable. While the Court found that the Sellers “materially breached” the NCA, it also found that the Buyer breached the IPA by not buying all the assets by the date certain specified in that agreement. As a result, it ruled that the NCA would be rescinded starting on that date, thereby granting only partial rescission and partial restitution to the Sellers.

On appeal, the Supreme Court of New Hampshire reversed the trial court’s decision and held that “if a contract is part of a larger agreement, it may be rescinded only if it is severable from that larger agreement; if it is not the entire agreement must be rescinded.” The Court found that the three agreements, by their terms, were interdependent and were therefore not severable. It therefore found that since the sale was contingent on the NCA, it could not be rescinded without rescinding the other two agreements. The Supreme Court sent the case back to the trial court to determine what remedies were appropriate.

In drafting the three agreements, the parties complicated what would otherwise have been a straightforward purchase and sale transaction. It was only the language of the three agreements which made the entire transaction contingent on the NCA that resulted in the rescission of all the agreements. While drafting was determinative here, this case demonstrates how critical a non-compete agreement can be to the entire transaction.
 

This week, a Wisconsin Court of Appeals issued its decision in Jeffrey L. Engedal v. Menard, Inc. (Appeal No. 2012AP305). Engedal started working at Menards as a part-time sales associate when he was 18. Over the next 25 years, he worked his way up the corporate ladder. After about 6 years, he became a store manager and 15 years later he became Menards’ hardware merchandise manager, which gave him managerial authority over the hardware departments in all of Menards’ 250 stores. During the later 19 years of his employment, Engedal signed an employment agreement each year with Menards. His 2010 agreement contained an arbitration provision which required him to arbitrate any employment-related claims as well as a non-compete clause which prohibited him from: a) working for any of Menards’ direct competitors in the same or similar position for which he was employed by Menards; or b) working with any of Menards’ direct or indirect competitors within a 100 mile radius of the Menards location where he was last employed. After 25 years of employment with the company, Menards terminated Engedal’s employment in August 2010.

Engedal sued, claiming that Menards wrongfully discharged him and failed to pay him a bonus and requesting a declaratory judgment that the arbitration and noncompete provisions in his 2010 agreement were unenforceable. Menards moved to stay the proceedings and compel arbitration. The circuit court held an evidentiary hearing on Menards’ motion, determined that the arbitration provision in Engedal’s 2010 agreement was unconscionable because it included a noncompete provision which would put him out of a job for two years if he refused to sign it, and refused to compel arbitration. Menards appealed.

The Wisconsin Court of Appeals reversed. The appellate court first reviewed and approved the circuit court’s findings concerning Engedal’s background and responsibilities at Menards: that he was now 43 years old; that he had completed high school and 2 years of college; that he was of “above average intelligence;” that he was employed as a store manager for 15 years; that, during that time, he was responsible for all the operations of his store and supervised 125 employees; that he was subsequently promoted to a high-level management position at Menards’ corporate headquarters in which he directly supervised at least 60 employees and exercised authority over the hardware departments in 250 stores; and that he was responsible for maintaining business relationships with 600-700 hardware vendors. Based on those findings, the appellate court concluded that Engedal was an intelligent adult with significant business experience. Next, the appellate court reviewed and approved the circuit court’s findings that, even though there was no evidence that Menards actually explained the terms of the 2010 agreement to Engedal, he had the opportunity to ask questions about it, had time to review it, signed each page indicating he had done so, and was the primary contact to explain the terms and conditions of employment agreements to his staff at Menards. Finally, the appellate court reviewed the circuit court’s decision that the 2010 agreement was nevertheless unconscionable because it included a noncompete clause that would have put him out of a job for 2 years if he refused to sign it. The appellate court determined that the circuit court’s conclusion conflicted with its own findings that: a) Menards would have offered Engedal a different position within the company if he had refused to sign the 2010 agreement, b)Engedal’s managerial, supervisory, and organizational skills were transferrable outside the “home improvement mega store” industry; and c) Engedal was subsequently able to obtain a job as a general manager for a company in another industry. As a result, the appellate court determined that the circuit court erred in concluding that the arbitration provision was unconscionable and in refusing to stay the proceedings and compel arbitration.
 

In a per curiam opinion issued yesterday in Nitro-Lift Technologies, L.L.C. v. Howard, the United States Supreme Court reversed a decision of the Oklahoma Supreme Court that had determined the enforceability of a non-compete agreement arising out of a contract that contained an arbitration provision. Despite the fact that the restraint at issue was found to violate Oklahoma law, the US Supreme Court determined that the Oklahoma Supreme Court overstepped its bounds and that under the Federal Arbitration Act enforceability of the non-compete should have been left to the Arbitrator.

The dispute arose from a contract between Nitro-Lift Technologies, L.L.C., and two of its former employees. Nitro-Lift contracts with operators of oil and gas wells to provide services that enhance production. The employees Eddie Lee Howard and Shane D. Schneider entered a confidentiality and noncompetition agreement with Nitro-Lift that contained the following arbitration clause: " Any dispute, difference or unresolved question between Nitro-Lift and the Employee (collectively the "Disputing Parties") shall be settled by arbitration by a single arbitrator mutually agreeable to the Disputing Parties in an arbitration proceeding conducted in Houston, Texas in accordance with the rules existing at the date hereof of the American Arbitration Association.”

The Supreme Court noted that state courts rather than federal courts are most frequently called upon to apply the Federal Arbitration Act (FAA), 9 U. S. C. §1 et seq., including the Act's national policy favoring arbitration. It is a matter of great importance, therefore, that state supreme courts adhere to a correct interpretation of the legislation. Here, the Oklahoma Supreme Court failed to do so. By declaring the noncompetition agreements in two employment contracts null and void, rather than leaving that determination to the arbitrator in the first instance, the state court ignored a basic tenet of the Act's substantive arbitration law and accordingly, the Supreme Court vacated the decision.

The lesson here is before going to state court to determine enforceability of any non-compete provision, make sure the agreement at issue doesn’t contain a broad arbitration provision. If it does, you may be better off arguing the applicability of the state law to the arbitrator rather than the Court.

In Pactiv Corporation v. Rupert, the U.S. District Court for the Northern District of Illinois recently held that under an employer’s severance pay plan, the employer could not require a former employee to agree to a restrictive covenant in order to receive severance pay.

The severance plan at issue, which was subject to ERISA, provided that in order to receive severance pay and benefits, an eligible employee had to sign a separation agreement “in a form acceptable to the Company.”

After the employee was terminated without cause, he was told that in order to receive severance benefits under the plan, he had to sign a separation agreement which included a non-compete. A non-compete was never a condition of the employee’s employment; the first mention of it was at the time of his termination. When the employee refused to sign, the employer refused to provide the severance benefits, and this lawsuit ensued.

As a threshold matter, the Court explained that “[c]ovenants-not-to-compete are limitations on the ability to work” which “are disfavored under Illinois law and may not be implied in employment contracts but must be clearly stated.”

In this case, the Court found that the plan document did “not authorize or require” that the employee agree to a non-compete in order to receive severance benefits under the plan. To the contrary, the Court explained that “[r]eserving the right to have a separation agreement in a ‘form acceptable to the Company’ is not notice to an ERISA beneficiary that a non-competition covenant could be required as a condition to receive benefits. What is here proposed is not a matter of ‘form;’ it is a substantial limitation.”

Accordingly, the court held that “[u]nder the written terms of the Plan in effect on [the employee’s] last date of employment, he was not required to agree to a non-compete clause in order to be entitled to the severance benefits provided for in the Plan.”

Although this case involved an unusual fact pattern, it nevertheless highlights the scrutiny with which courts approach non-competition agreements, and the need for non-competes to be clearly set out.
 

Earlier this year, we wrote about the Ohio Supreme Court’s decision, Acordia of Ohio, L.L.C. v. Fishel et al., (“Acordia I”), in which the Court held that when a company that was the original party to a noncompete agreement merges in to another company, unless the noncompete agreement contained a “successors and assigns” clause, the merger was a termination of employment which triggered the running of the restrictive period in the noncompete.

Last week, in Acordia II, the Ohio Supreme Court reversed that decision, holding that after a merger, an “absorbed company ceases to exist as a separate business entity,” but that it is not “erased from existence.” Rather, “the absorbed company becomes a part of the resulting company following merger” and therefore the “merged company has the ability to enforce noncompete agreements as if the resulting company had stepped into the shoes of the absorbed company.”

The Court nevertheless explained that “the employees still may challenge the continued validity of the noncompete agreements based on whether the agreements are reasonable and whether the numerous mergers in this case created additional obligations or duties so that the agreements should not be enforced on their original terms.”

Accordingly, notwithstanding the Court’s change of opinion, this case continues to illustrate the attention which should be placed on the enforceability of a noncompete following a corporate transaction and whether a fresh noncompete agreement should be signed.
 

Amidst the hustle and bustle of running a business or earning a living, paperwork formalities sometimes get pushed to the side, and non-competes don’t get signed, or don’t get signed until after the employee has already started work (thereby creating issues of consideration and enforceability). Those who work in the employment law arena can all share stories of belatedly discovered paperwork defects that ultimately proved dispositive.

A recent case out of Texas provides a good lesson about workplace paperwork formalities. In Holloway v. Dekkers and Twin Lakes Golf Course, Inc., a Texas appellate court ruled that a one-year employment agreement that was not signed by the employer fell within the statute of frauds and was therefore unenforceable. In that case, Clay Holloway was hired by Gideon Dekkers to be the head golf professional at Twin Lakes Golf Course. During July 2008, the parties first met in person, and subsequently communicated via phone and email, eventually agreeing that Holloway would be employed for a one-year period. The parties also agreed to negotiate an extension prior to the expiration of the initial one-year period dependent upon Holloway’s performance review. Holloway subsequently began work on August 5, 2008 before he signed an employment agreement.

Less than a week later, Holloway was presented with an agreement (prepared by Dekkers’ daughter-in-law) dated July 23, 2008, which provided for a “[y]early contract that will be up for renewal after annual performance evaluation.” Holloway signed the agreement, but never presented it to anyone from Twin Lakes to sign. Holloway was then terminated on September 30, 2008, and subsequently filed suit against both Dekkers and Twin Lakes for breach of contract and fraud in the inducement. After the trial court entered summary judgment for Twin Lakes, Holloway appealed.

On appeal, the court reviewed the statute of frauds, and stated that “when a promise or agreement, either by its terms or by the nature of the required acts, cannot be completed within one year, it falls within the statute of frauds and is not enforceable unless it is in writing and signed by the person to be charged.” The court noted that the contract was dated July 23, 2008 and Holloway’s performance could not be completed for over a year from the date of the contract. Additionally, Holloway’s deposition testimony demonstrated he understood his employment would last from August 5, 2008 to at least August 5, 2009, or a period of 366 days.

Holloway argued that because it was necessary for his performance review to occur prior to the expiration of the one-year employment term, the agreement could have been completed within one year. However, the court concluded that the one-year term was not contingent upon his performance review. Instead, the performance review was to determine a possible extension. Therefore, the court concluded there was no way the agreement could be performed within one year, and because Twin Lakes (the party to be charged) did not sign an agreement, any agreement between the parties was unenforceable.

Despite the favorable outcome for the employer, this case should serve as a reminder to employers everywhere not to ignore paperwork formalities; sometimes they are case dispositive.
 

Co-authored by Ted A. Gehring.

In the recent California Court of Appeals decision in Fillpoint, LLC v. Michael Maas, __ Cal. Rptr. 3d __, 2012 WL 3631266 (Cal. App. 4 Dist. 2012), the court continued California courts’ strict reading of California Bus. & Prof. Code section 16600, striking down a non-competition agreement in an employment agreement that was originally connected with the earlier sale of the goodwill of a business.

Defendant Michael Maas (“Maas”) was a shareholder in Crave Entertainment Group, Inc. (“Crave”). In 2005, Handleman Company (“Handleman”) acquired Crave. Maas and other Crave stockholders entered into a stock purchase agreement that included a covenant not to compete that prohibited Maas (and other former Crave stockholders) from competing with Handleman in Crave’s line of business for three years after the purchase date.

Approximately a month later, Maas entered into an employment agreement with Crave, agreeing to work for Crave for three years. The employment agreement included a covenant not to compete or solicit, the term of which was for one year after the expiration of the employment agreement or the termination of Maas’ employment. The employment agreement included an integration clause, integrating it with the earlier stock purchase agreement.

Maas resigned from his employment at Crave in 2008, after satisfying the three year term of his employment agreement.

In 2009, Crave was acquired by Fillpoint. Later that year, still during the term of the employment agreement post-termination non-competition clause, Maas became the president and CEO of Solutions 2 Go, a competitor of Crave. Fillpoint sued Maas for breach of the employment agreement and sued Solutions 2 Go for tortious interference. Maas and his co-defendants asserted that the non-competition clause in the employment agreement was not enforceable pursuant to California Bus. & Prof. Code section 16600. California Bus. & Prof. Code section 16600 generally prohibits covenants not to compete subject to two limited exceptions -- one of which, set forth in California Bus. & Prof. Code section 16601, protects covenants not to compete entered into in connection with the sale of the good will of a business. At trial, the court granted the defendant’s motion for nonsuit, finding the employment agreement unenforceable. Fillpoint appealed.

On appeal, Fillpoint argued that the employment agreement’s covenant not to compete must be read together with the stock purchase agreement. The court agreed, but in analyzing the two agreements found that the employment agreement was nonetheless not enforceable.

The court noted that the stock purchase agreement protected Crave’s goodwill for three full years, and was fully performed. The stock purchase agreement limited Maas’ right to set up a competing business during the three year period following Handleman’s acquisition of Crave. In contrast, the court noted that the employment agreement was much broader, and prevented Maas -- for a year following the termination of his employment -- from making sales to Crave customers or even potential customers and from working for or owning an interest in any business that was in the same business or would compete with Crave. In addition, Maas was barred from employing or soliciting for employment Crave’s employees and consultants. The court held that the employment agreement limited Maas’ rights to be employed in the future. Significantly, Fillpoint conceded that the two covenants not to compete were intended to deal with different damage Maas might do as a major shareholder versus as a key employee. Thus, in reading the two agreements together, the court found that while the stock purchase agreement was targeted to protecting Crave’s goodwill, the employment agreement was not.

The court’s ruling indicates that the terms of the employment agreement’s non-competition clause would not have been upheld even had they been included within the terms of the stock purchase agreement. In invalidating the employment agreement’s non-competition agreement, the Fillpoint court held that the “nonsolicitation terms in the employment agreement are too broad and inconsistent with the purposes and terms of [Cal. Bus. & Prof. Code sections 16600 and 16601],” as the employment agreement barred sales to or solicitation of even potential Crave customers. Based on this decision, buyers should consider negotiating longer non-competition terms in the initial purchase agreement instead of relying on a separate employment agreement that contains different non-competition terms.
 

Addressing an argument frequently encountered in restrictive covenant litigation, an Illinois Appellate Court recently reiterated that only a material breach of a contract containing a restrictive covenant will relieve the other party of its contractual obligation to abide by the restrictive covenant.

In the case InsureOne Indep. Ins. Agency v. Hallberg, the plaintiffs purchased assets of several insurance companies owned or controlled by James Hallberg, and subsequently hired Hallberg to become the company’s new president. Hallberg’s employment agreement – as well as the Asset Purchase Agreement (APA) that governed the original sale of assets – contained noncompetition and nonsolicitation clauses. The APA also contained details for computation and payment of the contingent purchase price, which was a portion of the overall purchase price based on renewal business from Hallberg’s former entities.

Hallberg’s tenure with InsureOne was short-lived, and soon after his departure, he established Hallberg Insurance Agency. Hallberg hired twenty-nine former InsureOne employees and directly competed with his former company. InsureOne subsequently filed suit alleging Hallberg breached his restrictive covenants. Hallberg claimed that InsureOne breached the APA by miscalculating the contingent purchase price and underpaying him. The trial court held that Hallberg breached his restrictive covenants and awarded InsureOne approximately $7.7 million in damages. Additionally, the court determined InsureOne had in fact underpaid the contingent purchase price by approximately $130,000 and awarded this amount to Hallberg.

On appeal, Hallberg argued that InsureOne was barred from recovery because it, too, breached the agreements by failing to pay the full amount of the contingent purchase price. However, the Appellate Court rejected the contention that InsureOne was required to demonstrate proof of such literal or strict performance. Instead, the court noted that “a party suing for breach of contract need only allege and prove that he has substantially complied with all the material terms of the agreement.” Therefore, a “partial breach by one party” will not “justify the other party’s subsequent failure to perform.” Rather, “both parties may be guilty of breaches, each having a right to damages.” Accordingly, the court held that only a “material breach of a contract provision will justify nonperformance by the other party.”

The court subsequently determined that the underpayment of a mere $130,000 on a $16 million deal did not rise to the level required for a breach to be deemed material. According to the court, the test of whether a breach is “material” is whether it is so “substantial and fundamental as to defeat the objects of the parties in making the agreement, or whether the failure to perform renders performance of the rest of the contract different in substance from the original agreement.” The court stated this was not the case, and highlighted Hallberg’s unwillingness to rescind the deal as evidence that he could not have believed the entire deal had been compromised by InsureOne’s breach.

This case illustrates that under basic contract law principles, a party wishing to enforce the terms of a noncompetition or nonsolicitation agreement does not have to prove literal or strict performance of every single term in the agreement. Unless an employer’s breach is material in nature, an employee will remain legally bound to the terms of their employment agreement.
 

The Ohio Supreme Court recently held that when a company that was the original party to a noncompete agreement merges in to another company, unless the noncompete agreement contained a “successors and assigns” clause, the merger is a termination of employment which triggers the running of the restrictive period in the noncompete.

In this decision, Acordia of Ohio, L.L.C. v. Fishel et al., employees of companies that later merged into another company signed two-year, post-employment noncompete agreements. These noncompetes did not contain language commonly found in noncompetes providing that the agreements could be assigned and/or would be carried over to a corporate successor. Rather, by their terms, the agreements were “between only the employees and the companies that hired them.” As such, the agreements “appl[ied] only to ‘the Company’ with which the employees agreed to avoid competing, not the company’s successors.”

Because the companies that originally hired the employees no longer existed after the mergers, the mergers constituted a termination of employment which triggered the two-year, post-employment noncompete provision. As a result, the claims in this lawsuit were found to be untimely because the noncompete periods had already run.

In so ruling, the Court noted that the surviving corporation “could have protected its goodwill and proprietary information by requiring that the employees sign a new noncompete as a condition of their continued at-will employment.” The Court’s ruling also implied that if the agreements had included the type of “successors and assigns” language commonly found in noncompetes, the outcome may have been different.

One dissenting justice noted that “other courts construing similar statutes have rejected the conclusion reached by the lead opinion.”

Another dissenting justice wrote that even though in his opinion, the noncompetes transferred by operation of law to the surviving corporation, they may still be unenforceable in light of all of the changes in corporate structure and size since the agreements were first signed.

This case illustrates the importance of including “successors and assigns” verbiage in a noncompete. It also illustrates the attention which should be placed on the enforceability of a noncompete following a corporate transaction, and whether it may be prudent for an acquiring corporation to have employees sign fresh noncompete agreements.
 

We are pleased to announce that “Preparing for Non-Compete Litigation,” a guide published by The Practical Law Company and authored by EpsteinBeckerGreen’s Peter A. Steinmeyer and Zachary C. Jackson, is now available in PDF format. The guide is a valuable discussion of the primary considerations for employers seeking to initiate legal action to enforce a non-compete agreement.

An increasingly common type of provision found in employment agreements, allowing for extension of an employee’s post-employment non-compete restrictions by a period of time that the employee violates the restrictions, was upheld in a recent decision by New York’s Appellate Division, First Department.

According to the complaint in Delta Enterprise Corp. v. Cohen, the plaintiff Delta Enterprise Corp. is in the business of manufacturing and selling juvenile furniture and other products for infants, toddlers and children. Many of Delta’s products are sold under licenses and use well-known cartoon and other names and images such as Barbie, Spongebob Squarepants, and Hot Wheels. Defendant Ralph Cohen worked in various positions over seven plus years at Delta, and was the co-head of the Toddler Furniture Division in 2009 and early 2010. The complaint alleges that Mr. Cohen misappropriated confidential information from Delta, and began operating a business, called Resolute Trade, in competition with Delta while he was still employed with Delta and afterwards, all in violation of a Confidentiality Agreement (which also contained several two-year non-competition and non-solicitation clauses). Mr. Cohen’s employment with Delta ended on March 1, 2010.

Delta sued Mr. Cohen nearly a year later and on March 1, 2011, secured a temporary restraining order directing Mr. Cohen, among other things, to refrain from engaging in business with any factories with which Delta conducted business, and from interfering with or disrupting any relations between Delta and any of its customers, licensors, employees, or vendors with regard to Delta’s products. After a preliminary injunction hearing, the Supreme Court, New York County, issued a preliminary injunction enjoining Mr. Cohen from taking such actions at any time up through and including February 28, 2012 (i.e., for two years after the end of his employment with Delta).

Although the Court awarded Delta the preliminary injunction, Delta appealed, arguing that it was error for the Court to enforce the two year restrictive covenants only through February 28, 2012, and to fail to enforce the Confidentiality Agreement’s provision tolling the expiration of the restrictive covenants during any period in which Mr. Cohen was in violation of the agreement. In a March 1, 2012 decision, the Appellate Division agreed, holding that the tolling provision should have been given effect and modifying the preliminary injunction to extend until March 1, 2013 (i.e., two years from the date of issuance of the temporary restraining order) or resolution at trial, whichever is earlier.

As more and more employers add such tolling provisions when drafting non-competition and non-solicitation agreements, this appellate court decision, which rejected Mr. Cohen’s arguments that the provision is unenforceable as a matter of law or violates public policy, could prove valuable in employers’ efforts to enforce such tolling provisions. It should be noted, however, that restrictive covenant agreements containing tolling provisions remain subject to judicial analysis as to whether they are necessary to protect the employer’s legitimate business interests, and are reasonable temporally and geographically. Also, the appellate decision specifically noted that Delta proffered an “abundance of unrefuted documentary evidence showing that it was likely that defendant had repeatedly breached multiple provisions of the agreement,” and that there was evidence that Mr. Cohen had consulted with counsel before executing the agreement and received $50,000 in consideration thereof.
 

We are pleased to announce that an updated version of our guide, “Non-Compete Laws: Illinois,” is now available in PDF format. The updated guide reflects the recent Hafferkamp v. Llorca decision of the Second District of the Appellate Court of Illinois, which holds that Reliable Fire Equipment Company v. Arredondo, et al. (an Illinois Supreme Court decision which resolved several years of confusion over the appropriate standard for enforcing non-compete agreements in Illinois), should be applied “retroactively and proactively” to both future non-compete cases as well as pending non-compete cases that were filed before the date that Reliable Fire was decided.

The guide is part of a series of guides written and published by our firm, Epstein Becker Green, and the Practical Law Company.
 

On January 23, 2012, the Canadian National Railway Company filed suit against its former Chief Executive Officer, E. Hunter Harrison, for allegedly violating certain non-compete and non-disclosure obligations. Peter A. Steinmeyer was interviewed about the lawsuit on the Business News Network’s show, “Headline with Howard Green.” To see the interview, click on this link: http://watch.bnn.ca/headline/january-2012/headline-january-24-2012/#clip606360.

Co-authored by Viktoria Lovei.

A federal judge in Chicago recently refused to issue an injunction based upon either the “inevitable disclosure” of trade secrets doctrine or a geographically broad, 24-month non-compete that did not have a narrowly drawn activity restriction. Triumph Packaging Group v. Ward, et al., No. 11-cv-7927 (N.D. Ill. Dec. 2, 2011).

The case was brought by Triumph, a manufacturer of packaging for consumer goods suppliers. It sought, among other things, to enjoin Ward, its former Chief Operating Officer, from assuming a position with AGI, a manufacturer of packaging primarily for the media and entertainment industries.

Triumph argued, among other things, that Ward’s employment with AGI would require him to inevitably use or disclose Triumph’s trade secrets. In evaluating Triumph's claim under the Illinois Trade Secrets Act (“ITSA”), the Court found that Triumph was reasonably likely to succeed in proving the existence of certain trade secrets. However, the Court concluded that Triumph was unlikely to succeed in establishing that the disclosure of such trade secrets by Ward was inevitable because the evidence demonstrated that Ward's role at AGI presented no reasonable danger of him using or disclosing Triumph's trade secrets. Specifically, the Court relied on its findings that: (1) Triumph and AGI were neither “fierce” nor “even direct” competitors because they focused on the manufacture of different types of packaging for mostly different industries and do not currently share any customers; (2) Ward's position at AGI was dissimilar from his position at Triumph in “a variety of ways”; (3) “there is no evidence in the record that Mr. Ward’s new position will require him to use or disclose Triumph’s trade secrets, and he testified credibly that he will not do so”; and (4) Triumph’s trade secrets were not applicable to AGI’s business.

With respect to Ward’s post-employment non-compete, the Court held that it was “extremely overbroad and likely unenforceable.” First, the Court held that it was “extremely broad in geographical scope” because it prohibited Ward “from working with any competitor ‘within any geographical area’ of where Triumph or its subsidiaries engage in business or have plans to engage in business.” Additionally, the Court noted that “the qualifying term ‘within any geographical area’ is unclear and does not provide any degree of certainty as to where Mr. Ward may work without violating the provision.” Second, the Court held that the “duration of the non-compete clause -- 24 months by default and 30 months if Mr. Ward breaches his obligations under the agreement during the prior 24 months – is very lengthy.” The Court agreed with Ward that where “temporal and geographic restrictions on an employee’s conduct are broad . . . the agreement’s activity restrictions should be correspondingly narrowly drawn to protect the employee’s ability to be employed in his chosen field.”

Because the Court found that the non-compete was “significantly overbroad in several ways,” it refused to modify or “blue-pencil” it.

Though not a path breaking decision, this case is nevertheless a reminder about the narrowness of the inevitable disclosure doctrine and the need to draft non-compete clauses as tightly as possible to address a company’s legitimate needs.

We are pleased to announce that an updated version of our guide, “Non-Compete Laws: Illinois,” is now available in PDF format. The updated guide reflects the recent decision of the Illinois Supreme Court in Reliable Fire Equipment Company v. Arredondo, et al., which resolved several years of confusion over the appropriate standard for enforcing non-compete agreements in Illinois. The guide is part of a series of guides written and published by our firm, EpsteinBeckerGreen, and the Practical Law Company.

On December 1, 2011, the Illinois Supreme Court issued its opinion in Reliable Fire Equipment Company v. Arredondo, et al., which resolved several years of confusion over the appropriate standard for enforcing non-compete agreements in Illinois.

The Confusion

For years, Illinois courts consistently explained that they would only enforce a non-compete agreement if: it was no more restrictive than necessary to protect an employer’s legitimate business interests; enforcement would not impose an undue burden on the employee; and enforcement would not injure the public. As a result, substantial case law focused on what would, and what would not, constitute a legitimate business interest sufficient to support the enforcement of a non-compete agreement.

In 2009, however, the Illinois Fourth District Appellate Court issued its opinion Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (2009). In that case, the court dismissed the requirement of a legitimate business interest as “judicial gloss” and explained that a non-compete agreement simply should be enforceable where its time and territory restrictions are reasonable. (According to the court, that analysis included consideration of whether enforcement would create an undue hardship on the employee or hurt the public.) The next year, the Illinois Second District Appellate Court issued its opinion in Steam Sales Corp. v. Summers, 405 Ill. App. 3d 442 (2010). While declining to directly address whether the Fourth District was correct in Sunbelt Rentals, the court nevertheless intimated that a 2006 Illinois Supreme Court case had imposed a standard different than the commonly used legitimate business interest test. Because Illinois courts generally follow the appellate courts in the jurisdiction in which they are located, after Steam Sales, the five appellate districts in Illinois were using at least three different approaches to analyze the enforceability of non-compete agreements.

The Fix

In May 2011, the Illinois Supreme Court agreed to hear an appeal in the case of Reliable Fire Equipment Company v. Arredondo, et al. to resolve this confusion.

On December 1, 2011, the Illinois Supreme Court issued its decision in Reliable Fire. In that decision, the court rejected the analyses of Sunbelt Rentals and Steam Sales Corp. and reaffirmed that a non-compete agreement is enforceable in Illinois only if: it is no greater than required to protect a legitimate business interest; it does not impose undue hardship on the employee; and it does not injure the public. The court also explained that whether or not an employer has a legitimate business interest depends on the totality of the facts and circumstances in each case. Some of the factors to be considered include the near-permanence of customer relationships, the employee’s acquisition of confidential information through employment, and the time and territory restrictions. However, the court also explained that those factors are merely some of the considerations, that they are not meant to be an exhaustive list of considerations, and that none of those factors carries any more weight than any other. Additionally, the court expressly stated that appellate court precedent concerning what will, and what will not, constitute a legitimate business interest remains intact, but that those cases should only be considered non-conclusive guidance.

The Practical Implications

While the Reliable Fire decision puts to rest any confusion caused by Sunbelt Rentals and Steam Sales, it provides little guidance to employers who are trying to craft or enforce non-compete agreements. Accordingly, employers will still need to pay close attention to the responsibilities of each position in crafting appropriate non-compete agreements, and pay close attention to the facts and circumstances of each potential violation to determine whether and how to enforce their non-compete agreements.

Several attorneys from the national law firm of EpsteinBeckerGreen contributed to the December 2011 issue of the Practical Law Company’s “Labor and Employment.” In that periodical’s “State Q&A” section, addressing the reasonable duration and geographic scope of non-compete agreements in various states, Peter A. Steinmeyer and David J. Clark authored the section regarding Illinois and George B. Breen, Frank C. Morris, Jr., and Casey M. Cosentino authored the section regarding Virginia.

Invalidating a non-compete agreement it found enforceable over 20 years earlier, on November 4, 2011 the Supreme Court of Virginia, in Home Paramount Pest Control Companies, Inc. vs. Shaffer, No. 101837, 2011 Va. Lexis 222 (2011) reaffirmed the position that a non-compete is enforceable if it is “narrowly drawn to protect the employer’s legitimate business interest…”.

Justin Shaffer, an employee of Home Paramount Pest Control Companies, Inc. (“Home Paramount”) signed an employment agreement containing a non-compete provision. The relevant portion of the provision was as follows:

The Employee will not engage directly or indirectly or concern himself/herself in any manner whatsoever in the carrying on or conducting the business of exterminating, pest control, termite control and/or fumigation services as an owner, agent, servant, representative, or employee, and/or as a member of a partnership and/or as an officer, director or stockholder of any corporation, or in any manner whatsoever, …”

About 7 months after signing the non-compete, Shaffer resigned and subsequently became employed by a competitor. Home Paramount sued alleging, among other things, that Shaffer had violated the non-compete. Shaffer responded by challenging the non-compete on the basis that it was overbroad and therefore unenforceable. The Circuit Court agreed.

On review, acknowledging that it had enforced an identical non-compete provision involving the same company in 1989, the Supreme Court noted that it considers the “function, geographic scope, and duration” elements of the restriction together, rather than as three separate issues. Looking at the function element, the Court reminded that it consistently examined whether “the prohibited activity is of the same type as that actually engaged in by the former employer”. Finding, on its face, that the agreement prohibited Shaffer from working for any business in the pest control industry in any capacity, even from engaging in an indirect manner, the Court held that the agreement was unenforceable. While it noted that this was a change from its prior holding, the Court pointed to a gradual refinement of its position over the years. It further noted that the clear overbreadth of the agreement rendered it unsaveable by a narrow tailoring of geographic scope or duration.

Home Paramount reminds employers seeking to utilize non-compete agreements that to be valid and enforceable, those agreements must be narrowly drawn - prohibiting activity of the same type as that actually engaged in by the employee while employed by the former employer.
 

Restrictive covenants such as non-compete and non-solicitation agreements are frequently used in connection with acquisitions to protect the underlying value of the transaction. After all, an acquiring company typically values the target company based in part on the revenue it generates from its stable of customers. Therefore, the acquiring company often requires the target company’s employees to execute restrictive covenants that limit their ability to “jump ship” after the acquisition closes and erode the value of the transaction by luring away customers. Recently, the United States Court of Appeals for the First Circuit issued a decision which underscores the importance of carefully examining and understanding any restrictive covenant that may be acquired through a transaction.

In OfficeMax, Inc. v. Levesque, et al., Case No. 10-2423 (1st Cir. 2011), a company called LS&H had required employees to execute restrictive covenants in 1996 just before it was acquired by Boise Cascade. The agreements provided that the restrictive covenants would continue for “12 months after termination of…employment with LS&H.” Under the agreements, the employees also agreed that they would sign restrictive covenants in “substantially the same form” if requested by Boise Cascade after the acquisition. After the transaction closed, Boise Cascade did in fact request that the employees execute restrictive covenants in “substantially the same form,” but they refused. When OfficeMax later acquired Boise Cascade, OfficeMax too requested that the employees execute new restrictive covenants, but again they refused. In 2009 and 2010, two employees who had executed the restrictive covenants with LS&H terminated their employment with OfficeMax. OfficeMax sued them and obtained a preliminary injunction based on those agreements from the trial court. On appeal, however, the First Circuit vacated that injunction. The Court observed that the plain language of the agreements did not state that they ran for “12 months after termination of…employment with LS&H or any of its successors or assigns.” Furthermore, the Court explained that there would be no reason for the agreements to require that the employees sign substantially similar agreements with the successor if the restrictive covenants were already designed to run from 12 months after the employees separated employment with that successor. As a result, the Court concluded that the restrictive covenant period ended 12 months after Boise Cascade’s acquisition of LS&H in 1996, and had already expired by the time the employees left OfficeMax in 2009 and 2010.

The opinion thus serves as a cautionary tale for companies to make sure that they review the language and structure of restrictive covenants that they may be purchasing as part of an acquisition.
 

When drafting no-competes, questions about the required level of detail always arise; more detail is generally better than less, but not always. The required level of detail in a no-compete was among the questions addressed by the Ohio Court of Appeals last week in Osei-Tutu Owusu, M.D. v. Hope Cancer Of Northwest Ohio, Inc., a no-compete case involving a physician, Dr. Owusu.

During negotiations over the terms of his no-compete, Dr. Owusu rejected a proposal that he be restricted from practicing within a specific 35-mile radius. Nevertheless, he ultimately signed a no-compete which defined his post-employment restricted area as “the primary service area of Lima, Ohio and the primary service area of Van Wert, Ohio.”

At trial, “Dr. Owusu acknowledged that he was aware that the Agreement he signed contained a Non-Compete Clause referring to the ‘primary service area,’ but claimed he did not understand what that meant and argued that it was vague and unenforceable.” His former employer, in contrast, argued that the term “‘primary service area’ was a term commonly used in the healthcare industry, and that it could easily be ascertained by using patient zip codes to statistically determine what was the geographic area from which a hospital or practice drew the majority of its patients.”

The trial court sided with Dr. Owusu, holding that “the language of ‘primary service area’ was too indefinite and uncertain to be enforceable,” based partly on testimony that the signers of the agreement “did not know specifically what geographical area that terminology encompassed at the time they signed the Agreement.”

The Ohio Court of Appeals, however, disagreed, holding that the “[l]ack of a specific definition for this phrase did not make the contract void or indefinite but merely required the trial court to use rules of construction to determine what would be a reasonable meaning for the terminology.” It further explained that “[t]here are numerous examples of cases where a contract contained an industry ‘term-of-art’ that may not have been defined in the agreement, but could easily be construed based upon industry standards and common usages.” Thus, rather than invalidating a key portion of the no-compete, “[t]he trial court should have determined the meaning and the extent of the primary service area . . .”

While this case does not set down any universal guideposts on the required degree of detail in a no-compete, it certainly highlights the issue and the accompanying risks for all parties.
 

Illinois’ appellate courts are divided into five districts. Illinois’ lower (or trial) courts typically follow the decisions of the appellate district in which they are located. Unfortunately for employees and employers alike, those districts currently disagree about the appropriate standard for enforcing non-compete agreements. As a result, the enforceability of non-compete agreements in Illinois currently depends in part on where a lawsuit is filed.

The most recent appellate case that added to this confusion was the Illinois Court of Appeals for the Second District’s December 2010 opinion in Reliable Fire Equipment Company v. Arredondo, which we blogged about here. However, earlier this year, the Illinois Supreme Court granted leave to appeal in that case so that it could resolve the disagreement in the various appellate districts. Oral argument in that case has now been set for September 22, 2011. As a result, we may be one step closer to resolving the current confusion in Illinois non-compete law. Stay tuned.
 

Restrictive covenant agreements often contain “tolling” provisions which extend the duration of the covenants by the time of any violation. Sometimes, employers do not include tolling provisions in their restrictive covenant agreements, but nevertheless subsequently request that a court use its discretion to extend the duration of those covenants by the time of a violation anyways. A recent opinion from the United States Court of Appeals for the First Circuit highlights the danger in not including a tolling provision in a restrictive covenant agreement.

In EMC Corporation v. Arturi, __ F.3d __ (1st Cir. Aug. 26, 2011), EMC requested a preliminary injunction prohibiting its former employee from using its confidential information, from competing with EMC, and from soliciting EMC customers. The trial court issued a preliminary injunction prohibiting the disclosure of confidential information. However, the trial court refused to issue an injunction prohibiting the former employee from competing or soliciting EMC’s customers because the one-year time periods in those restrictive covenants had already elapsed and there was no tolling provision to extend them. On appeal, the First Circuit affirmed the trial court’s refusal to extend the non-compete and non-solicit provisions absent a tolling provision. The court explained that under the governing Massachusetts law, “when the period of restraint has expired, even when the delay was substantially caused by the time consumed in legal appeals, specific relief is inappropriate and the injured party is left to his damages remedy.” The First Circuit also specifically pointed out that “EMC could have contracted…for tolling the term of the restriction during litigation, or for a period of restriction to commence upon preliminary finding of breach. But it did not.”

Thus, EMC serves as a cautionary reminder to employers to include tolling provisions in their restrictive covenant agreements if they want to increase the likelihood that a court will subsequently extend the duration of those restrictive covenants by the period of any violation.
 

Co-authored by Betsy Johnson and Viktoria Lovei.

Contrary to popular perception, California law does not bar all restrictive covenants in the employment context. Rather, in certain very narrow circumstances (i.e., non-competes arising in connection with the sale or dissolution of certain businesses), non-competes are permissible under California law.

The General Prohibition of Non-Competes Under California Law

Under California Business and Professions Code § 16600, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Profs. Code § 16600 (2008). In Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), the California Supreme Court confirmed the viability and breadth of section 16600 and expressly rejected a line of Ninth Circuit cases which had upheld sufficiently narrow restrictive covenants that only barred a party from pursuing a small or limited part of its business. Id. at 948-49. The California Supreme Court in Edwards held that “noncompetition agreements are invalid, even if narrowly drawn, unless they fall within the applicable statutory exceptions of section 16601, 16602, or 16602.5.” Id. at 955. These three exceptions are discussed below.

Non-Competes Arising From the Sale of a Business

The first exception arises in the context of the sale of a business entity. Section 16601 permits a party selling the goodwill or all of their ownership interest in a business to agree to refrain from competition within the business’s geographic area, so long as the buyer intends to carry on a like business therein. Cal. Bus. & Profs. Code § 16601. See Vacco Industries, Inc. v. Van Den Berg, 5 Cal.App.4th 34, 47 (1992) (upholding the enforceability of a non-compete agreement lasting as long as the employer conducted business in the area against shareholder/officer who sold all of his shares in the company pursuant to a stock sale). A merger agreement, whereby an employee sells his business interest in a company in exchange for shares of the newly merged company, is considered to be a transaction within the exception of section 16601. Hilb, Royal & Hamilton Ins. Services v. Robb, 33 Cal.App.4th 1812, 1824-1825 (1995) (upholding agreement entered into in conjunction with merger which prohibited competition in several countries for a 3-year period of time). Section 16601 thereby allows the buyer of a business to protect its investment by enforcing a covenant not to compete against the seller. However, this exception is only applicable to business owners (or persons who own at least a material portion of business); it would not, for example, be used to justify a non-compete for a seller (or selling employee) who only owns a very small percentage of a business entity. There is no “bright-line” definition for determining what is a material portion of the business.

Non-Competes Arising in Conjunction With the Dissolution Of Or Dissociation From a Partnership

 Section 16602, the partnership exception to California’s ban on non-compete agreements, permits, in the event of a dissolution of or dissociation from a partnership, an agreement that the departing partner not compete within the specified geographic area of the partnership’s business, so long as any other member of the partnership intends to carry on the business in the specified area. Cal. Bus. & Profs. Code § 16602. Unlike section 16601, there is no requirement under the partnership exception that compensation for goodwill in the partnership be transferred. South Bay Radiology Medical Associates v. Asher, 220 Cal.App.3d 1074, 1083 (1990). Section 16602 has been held applicable to partnerships involving accountants, attorneys, and physicians. See Swenson v. File, 3 Cal.3d 389 (1970); Howard v. Babcock, 6 Cal.4th 409 (1993); South Bay Radiology, 220 Cal.App.3d 1073. Courts have found that such covenants, rather than prohibiting competition, place a price on competition by, for example, permitting the departing partner to contract for compensation in return for refraining from engaging in competing business activity, or vice versa. Babcock, 6 Cal.4th at 417-24.

Non-Competes Arising in the Context of the Dissolution Of a Limited Liability Company

Like the partnership exception to California’s non-enforcement of covenants not to compete, section 16602.5 provides that in the event of the dissolution of a limited liability company, any member may agree not to carry on a similar business within the specified geographic area where the company’s business was transacted, so long as any other member intends to carry on the business in the specified area. Cal. Bus. & Profs. Code § 16602.5. Currently, there is no case law interpreting section 16602.5, which became effective in 2007. However, the section’s similarity to section 16602 indicates that it will be applied in a comparable manner by courts.

Despite California’s general hostility towards the enforcement of covenants not to compete in the employment context, these exceptions provide employers with valid methods under California law to protect their business interests from potential competitive harm caused by sellers and departing partners or members. Nevertheless, given the scarcity of case law interpreting these provisions, employers should proceed cautiously before relying on them. 
 

Peter A. Steinmeyer of Epstein Becker & Green, P.C. will be speaking in an upcoming live phone/web seminar entitled "Noncompete Agreements: Latest Litigation Developments" scheduled for Thursday, August 11, 1:00pm-2:30pm EDT.

As readers of this blog well know, employers frequently use noncompete agreements to protect confidential business information from misappropriation by departing employees. With continuing layoffs and business information easily accessible via computers and the Internet, enforceable noncompetes are critical in today’s economy.

Employment attorneys crafting noncompete agreements must avoid unreasonable and overbroad provisions. Courts are increasingly scrutinizing and, in some instances, refusing to enforce agreements that go too far to restrict employee activity.

This program was developed to prepare employment counsel to craft clear and enforceable non-compete agreements that are likely to stand up in court, and will also include discussion of litigation strategies for employment counsel pursuing or defending noncompete litigation.

Perspectives and guidance on these and other critical questions will be offered:

• How can noncompete agreements be structured to avoid being found an unfair restraint on trade and competition?
• What are the key steps for employers to follow, beginning with hiring and prior to a termination, to reinforce the confidentiality of company information with employees?
• What legal considerations should employment counsel take into account when deciding whether litigation is the most appropriate means for addressing an alleged breach of a noncompete agreement?

After presentations of the program’s panelists, there will be a live question and answer session with participants -- to answer your questions about these important issues directly.

For more information or to register >
 

Peter Steinmeyer and I are pleased to announce that our guide, “Non-Compete Laws: Illinois,” written with Christie Tate, is now available in PDF format. See below for more information about this series of guides written and published by our firm, EpsteinBeckerGreen, and the Practical Law Company:

EpsteinBeckerGreen, in Conjunction with Practical Law Company, Wrote and Published Statewide Guides on Non-Compete and Trade Secret Laws

The national law firm of EpsteinBeckerGreen, in conjunction with the Practical Law Company, recently wrote and published statewide guides on the non-compete laws of Illinois, Massachusetts, and New Jersey and on the trade secret laws of the District of Columbia.

These guides, which were written by EpsteinBeckerGreen's attorneys in a "question and answer" format, address non-compete agreements, or trade secret and confidentiality laws, between employers and employees. The three non-compete law guides focus on enforcement and drafting considerations for restrictive covenants, such as post-employment covenants not to compete and the non-solicitation of customers and employees. The trade secret law guide focuses on the legal requirements related to protecting trade secrets and confidential information.

Here is a list of the aforementioned guides:

• "Trade Secret Laws: District of Columbia" – written by Kara M. Maciel and George B. Breen

• "Non-Compete Laws: Illinois" – written by Peter A. Steinmeyer, David J. Clark, and Christie Tate

• "Non-Compete Laws: Massachusetts" – written by Barry A. Guryan

• "Non-Compete Laws: New Jersey" – written by James P. Flynn and Amy E. Hatcher

Guides for Connecticut, Maryland, and Virginia, as well as a guide regarding Illinois Trade Secrets, will be published soon.

Update: “Non-Compete Laws: Connecticut" – written by David S. Poppick – is now available. 

Last week, in the case of Lucht's Concrete Pumping, Inc. v. Horner, the Colorado Supreme Court held that the continued employment of an at-will employee is adequate consideration for a noncompetition agreement.  The Court explained that if this was not the case, employers would have an incentive to terminate at-will employees and condition their re-hire on the execution of a noncompetition agreement.

Nevertheless, the Court explained that “all noncompetition agreements must be assessed for reasonableness” and that such a “reasonableness” inquiry is fact-specific.  Accordingly, “[t]o the extent that an employer enters into a noncompetition agreement with an employee with the intention of terminating the employee immediately afterwards, the agreement may fail for lack of consideration.” 

Less clear is what would happen if an employer did not have such a malicious intention at the time it required an at-will employee to sign a noncompetition agreement, but nevertheless discharged the at-will employee shortly after obtaining the employee’s signature.  The Colorado Supreme Court’s quotation from a Maryland decision holding that “[w]ere an employer to discharge an employee without cause in an unconscionably short length of time after extracting the employee’s signature to a restrictive covenant through a threat of discharge, there would be a failure of the consideration” suggests that this is an issue to be resolved in future Colorado court cases.

Will treating an individual as an employee rather than an independent contractor – when the parties have agreed to an independent contractor arrangement – preclude enforcement of a non-compete agreement? The Third Circuit Court of Appeals recently answered this question affirmatively, affirming a District Court Order denying an employer’s application for a preliminary injunction.

In Figueroa v. Precision Surgical, Inc., No. 10-4449 (April 12, 2011), Precision and Joseph Figueroa entered into an independent contractor agreement which contained a number of restrictive covenants, including a non-competition provision for a twenty-four month period following the expiration of the agreement. When Precision moved toward treating Figueroa as an employee rather than a contractor, Figueroa balked at the new arrangement and Precision terminated the agreement. Figueroa then commenced a lawsuit against Precision alleging that the restrictive covenants were unenforceable. Precision counter-claimed for injunctive relief, asserting that Figueroa had violated the agreement by working as an independent sales representative for one of its direct competitors.

The Third Circuit affirmed the District Court’s holding that Precision could not demonstrate a substantial likelihood of prevailing on the merits because it appeared that Precision did not abide by the terms of the agreement. The District Court had concluded that Precision had likely breached the agreement by treating Figueroa as an employee, rather than providing him the flexibility of an independent contractor required by the agreement. Additionally, the District Court had found that Precision had failed to pay Figueroa commissions called for by the agreement when it made certain deductions from the commission payments. The court never analyzed the non-compete provision itself.

Although unpublished, this case reminds us that an employer’s breach of a contractual arrangement may impair its ability to enforce a restrictive covenant. What makes this case unusual, however, is that the so-called breach appeared to place the employer in compliance with the law because at first blush, it appeared that the individual was not truly an independent contractor and that the employer properly sought to treat him as an employee.
 

For noncompete and trade secret lawyers in the healthcare industry, the recent Michigan Court of Appeals case of Isidore Steiner, DPM v. Bonanni highlights the importance of understanding applicable state privacy laws as well as the federal Health Insurance Portability and Accountability Act (HIPAA).

In Steiner, the plaintiff claimed that the defendant (a former employee) stole its patients after separating employment. The plaintiff moved to compel the former employee to provide his patient list in discovery, but the trial court denied the motion. Even though the plaintiff claimed it needed the patient list to prove elements of its case and the amount of damages, the Court of Appeals subsequently affirmed. The Court of Appeals reasoned that, while HIPAA asserts supremacy over state law, it allows for the application of state law regarding physician-patient privilege if the state law is more protective of patients’ privacy rights. The Court then observed that, unlike HIPAA, Michigan’s law does not provide for disclosure in judicial proceedings, does not authorize disclosure under a qualified protective order, and protects the mere existence of a physician-patient relationship from disclosure. Thus, the Court held that Michigan’s privacy law was more restrictive than HIPAA, that it applied, and that it protected the names addresses, and telephone numbers of the defendant’s patients from disclosure.

Be sure to understand applicable state privacy laws in addition to HIPAA when analyzing your ability to obtain information in discovery to prove liability and damages.

In Optical Partners, Inc. v. Dang, the Supreme Court of Arkansas recently refused to enforce a non-compete in a lease agreement -- which clearly had been violated -- because it did not arise out of a contract of employment or contract for the transfer of goodwill or property.

For several years, Kevin Dang, d/b/a Dang Eye Care & Associates, P.A., and Optical Partners, Inc. ran complementary businesses at virtually the same location. Dang performed eye exams and wrote prescriptions for glasses and contact lenses using office space leased in a location right next to his landlord Optical Partners, Inc., which (doing business as Pearle Vision) provided optician services, including filling eyeglass prescriptions and dispensing and fitting eyeglasses.

The lease agreement provided that for one year after its termination, Dang would not engage in the practice of optometry or the dispensing of optical products within a radius of three miles of the premises. On February 17, 2009, Dang stopped seeing patients at the Pearle Vision location and began practicing optometry at another location less than three miles away -- an unequivocal breach of the non-compete provision of the lease agreement.

With regard to Optical Partners, Inc.’s effort to enforce the non-compete provision, the Arkansas Supreme Court affirmed the trial court’s holdings that despite the indisputable violation of the non-compete language, that covenant was not enforceable because Optical Partners, Inc. did not have a legitimate business interest to protect, particularly because the underlying contract did not involve an employment relationship or a transfer of goodwill or property. The covenant was held to be unreasonable because the litigants were not in direct competition with each other. Their businesses, while complementary, provided different services and served different functions. Dang had no obligation to refer patients to Optical Partners to get their eyeglass prescriptions filled, and in fact it would have been illegal to do so.

Thus, while Optical Partners, Inc. was on to a good thing in having its tenant provide services which, as a practical matter, resulted in more customers going to Optical Partners, Inc., it could not prevent that tenant from moving his practice to a different location within the restricted area because that tenant was not actually competing with Optical Partners, Inc.

In summary, the non-compete provision in the lease agreement was a nice try by Optical Partners, Inc. to safeguard its business, but in the end, there was no legally recognized legitimate business interest sufficient to support that covenant, rendering it effectively worthless.
 

Non-compete litigation is generally fast and furious, with witness interviews, fact gathering, drafting, requests for injunctive relief, and expedited discovery all happening within a very compressed timetable. Accordingly, a recent decision issued by the Indiana Court of Appeals (Think Tank Software Development Corporation v. Chester, Inc., et al.) in a case filed in April of 2002 is a “head scratcher”: how could any non-compete case take nine years to resolve? The short answer is that after some initial skirmishing over a restraining order, a change of venue, and the dissolution of that restraining order, the case apparently went dormant for two years. Then, after an unsuccessful motion to dismiss the case for want of prosecution in 2004, the case lurched into discovery which lasted until November 30, 2009. The defendants then successfully moved for summary judgment, after which the case moved on to the Court of Appeals, which affirmed in part and reversed in part, sending the case back to the trial court . . . for still further proceedings.

Apart from its Dickensian length, the case is noteworthy for its recitation of Indiana no compete law on many frequently encountered issues, including the following:

• “[a] covenant may not be enforced to preclude a former employee from soliciting a customer that was not a customer during the employee’s employment”;

• “a covenant not to compete may even be enforced absent a territorial limitation where the covenant sufficiently restricts the class of prohibited contacts”;

• “when objectionable and nonobjectionable terms appear in a contract, the contract may be divisible and the reasonable limits may be enforced”;

• “[a] word may be added to the covenant ‘for the simple purposes of making the clause grammatically correct”;

• “[t]he proper measure of damages for breach of a covenant is the plaintiff’s lost net profits”; and

• “[a] damage award ‘does not require any specific degree of certainty, so long as the amount awarded is supported by the evidence and is not based on speculation or conjecture.’”
 

In October of 2009, the Illinois Court of Appeals for the Fourth District decided Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (4th Dist. 2009). In that opinion, the Court rejected the requirement that an employer must have a legitimate business interest in order to enforce a non-compete agreement -- a requirement in Illinois Courts for decades. According to the Court in Sunbelt Rentals, an employer need only show that a non-compete agreement has a reasonable geographic limitation and lasts for a reasonable period of time in order to enforce that agreement. Since that decision, few courts have cited to Sunbelt Rentals and those that have cited to it have declined to squarely address whether it was correctly decided.

In December of 2010, however, the Illinois Court of Appeals for the Second District decided Reliable Fire Equipment Company v. Arredondo, et al., ___ Ill. App. 3d ____ (2d Dist. 2010). In that case, the Court directly addressed Sunbelt Rentals and ultimately rejected its analysis. According to the Court in Reliable Fire, restraints on trade have long been disfavored by the Courts and the "legitimate business interest test" remains an important "threshold question" which allows the Court to analyze "whether the employer has an interest other than suppression of ordinary competition."

Additionally, the Court's lead opinion acknowledged that prior decisions had generally recognized legitimate business interests in only two situations: 1) where the employer had near-permanent customer relationships and the employee would not have had contact with those customers but for his or her employment; or 2) where an employee was exposed to the employer's confidential or trade secret information during his or her employment. However, that opinion went on to explain that limiting the analysis to whether the employer's interest fell into one of those two categories "may be unduly restrictive. Other criteria may exist that warrant protection under the law beyond those enumerated in the two traditional prongs of the legitimate-business-interest test." Consequently, the Court left the door open to recognize legitimate business interests beyond the two traditional situations.

Unfortunately, the significance of the lead opinion in Reliable Fire is muddled by a special concurrence and a dissent – both of which are more critical of the traditional formulation of the legitimate business interest test and both of which are open to a more flexible analysis of what constitutes a protectable business interest sufficient to warrant a non-compete. Indeed, as stated by the dissent, the decision in Reliable Fire “will serve only to confuse bench and bar and the employers and employees of Illinois.”

Illinois Courts follow the Appellate Courts in their district. As a result, now more than ever, employers must be cognizant of the different standards for enforcing non-compete agreements; they now differ from Chicago, to Chicago's suburbs, to down-state Illinois.
 

Last year, I reported on the status of a new non-compete bill that, for the first time in Massachusetts, attempted to codify its non-competition law. After summarizing the details of the bill in April, I reported in October that the bill had died in Committee. However, as stated at that time, Senator Brownsberger, one of its sponsors, promised to present a new bill on the same subject in a future session. Well, the future is now.

The new bill clarifies and modifies the old bill, mostly in an attempt to satisfy businesses that found portions of the bill unacceptable. As modified, the new bill appears to have a good chance of passing this coming spring. Rather than summarize each provision of the modified bill, this article highlights some of its unique provisions.

Highlights of the Modified Bill

1. The new non-compete bill is limited to employment agreements. The bill specifically does not include: agreements not to solicit or hire employees from the employer; agreements not to solicit customers of the employer; non-competition agreements made in connection with the sale of a business; or agreements by employees not to reapply for employment after termination.

2. The new bill limits the length of a valid non-compete agreement to one year, however, it re-introduces the concept of garden leave, which is the only method in which one can extend the covenant not to compete to two years.

3. Unlike the old bill, the modified bill excludes any salary that one must exceed for the agreement to be enforceable. Instead, the new bill simply states that the employee’s compensation be “reasonably adequate,” thus allowing the court to take into consideration the economic impact on the employee.

4. In addition to non-competition agreements entered into at or in anticipation of hire, the new bill also deals specifically with agreements that are entered into during the term of employment. No longer is “continued employment” adequate consideration alone, a concept that some Massachusetts courts have already questioned. If the bill becomes law, the employee must also receive “fair and reasonable” consideration if the agreement is signed during the term of employment.

5. The new bill provides that the non-compete agreement must be in writing and signed by both parties, along with prescribed minimum notice requirements to the employee, before it becomes effective.

6. The new bill rejects the inevitable disclosure doctrine.

7. The new bill creates presumptions of what constitutes reasonable duration and scope of the non-compete agreement, thus providing some guidance to the parties.

There are other important provisions in the attached bill and I am sure that amendments will be proposed before the final bill is presented for a vote. As always, I will keep you posted.
 

In a January 21, 2011 opinion and order, a federal district court in Alabama denied a request for a preliminary injunction from clothing manufacturers Fruit of the Loom, Inc. and Russell Brands, LLC, seeking to prohibit a former employee from continuing to work for a competitor. (Fruit of the Loom, Inc. and Russell Brands, LLC v. Lonnie C. Bishop, Middle District of Alabama 2:2010cv01058). Plaintiffs requested the injunction pending their lawsuit to enforce a Kentucky non-compete agreement against the former employee. Although Kentucky courts generally enforce non-compete agreements where the restraint is no greater than reasonably necessary, this case demonstrates the practical difficulties of enforcement. Even in cases where an employer is successful in an action to enforce a non-compete agreement, the benefit of the agreement can be substantially eroded where a former employee is not immediately prohibited from working for the employer’s competitor.

The court in the Fruit of the Loom, Inc. case found that Plaintiffs failed to show a “substantial likelihood of success on the merits” of their claim that the non-compete agreement was enforceable, or that Plaintiffs would suffer “irreparable injury” if the injunction were not granted. Defendant began working for Russell Brands LLC (owned by Fruit of the Loom, Inc.) in July 1993, and voluntarily resigned to take a job with their competitor, Gildan Activewear Charleston, Inc. Defendant held similar positions with Russell Brands and Gildan Activewear as a distribution center manager. Approximately four months before his resignation, Defendant signed a non-compete agreement with Russell Brands. (Under Kentucky law, non-compete agreements signed by current employees are enforceable even absent additional consideration). The agreement stated that for a period of 12 months following the termination of his employment, Defendant would not “work or provide services for a Competitor…in an area, position or capacity in which you gained particular knowledge or experience during your employ with [Russell Brands], involving the sale, design, or manufacture of Competitive Products…”.

The Parties agreed that Defendant was employed “in an area, position or capacity” with his new employer “in which [he] gained particular knowledge or experience” from his former employer. The court doubted, however, that a reasonable fact-finder would view Defendant’s work in the distribution centers as involving the “sale” of products. Based on this interpretation, the court concluded that Plaintiffs did not show a “substantial likelihood of success on the merits” of their case to enforce the non-compete agreement.

The court also held that Plaintiffs did not meet their burden of showing that they would suffer “irreparable injury” if the injunction was not granted. The court noted that Plaintiffs had presented no evidence that their business interests had been harmed during Defendant’s two month tenure with the competing company. Plaintiffs also failed to identify any specific information that Defendant may not have already shared with the competing company, and that would be protected by the injunction. The court also noted that there was no evidence of loss of customers or goodwill as a result of Defendant’s employment with Plaintiffs’ competitor. Finally, the court found that there was no reason why monetary damages would not sufficiently compensate Plaintiffs should they be successful in the litigation to enforce the non-compete agreement.

In addition to the above reasons for denying the injunction, the court found that forcing Defendant to quit his job while the lawsuit was pending would place a significant hardship on him and his family, “especially considering how long civil lawsuits generally take to resolve in the federal court system.” By comparison, the court felt that denying the injunction would not impose a similar hardship on Plaintiffs, or otherwise be adverse to the public interest.
 

Co-authored by Christie O. Tate.

As we reported in this blog on March 1, 2010, last year the proposed “Illinois Covenants Not To Compete Act” was introduced in the Illinois House of Representatives. If passed, it would have substantially altered the law regarding non-competition agreements in Illinois. We have been monitoring the progress of the bill, which was re-introduced on January 12, 2011 as House Bill 0016 in exactly the same form as last year. As before, the bill has not attracted significant public attention or commentary, but we will continue to monitor it. For a detailed analysis of the proposed law, please see our original post on March 1, 2010.

A December 30, 2010 decision of New York’s Appellate Division, Fourth Department, in James V. Aquavella, M.D., P.C. v. Viola, should be noted by legal practitioners dealing with issues of enforceability of non-competition agreements.

The plaintiffs -- an ophthalmologist named James V. Aquavella, M.D. and his professional corporation -- sued Ralph S. Viola, M.D., an employee who in 2002 resigned and opened a competing practice within 300 yards of the plaintiffs’ practice. Plaintiffs claimed breach of a non-compete provision that, they argued, barred Viola from competing with plaintiffs for two years.

In 1996, Viola began working for Urban Oncology Service, P.C. (which eventually sold assets of the ophthalmology practice to plaintiffs) pursuant to a written contract that included a provision prohibiting Viola from competing with that entity’s business for two years after termination of Viola’s employment. In 1998, Viola entered into an oral employment agreement with plaintiffs. According to plaintiffs, this oral agreement incorporated all of the terms and conditions of the 1996 written agreement, including the non-compete clause.

In 2002, Viola resigned and began competing against plaintiffs by opening his own practice just 300 yards away. Plaintiffs sued, and secured a jury verdict determining that Viola had violated the non-compete clause, and that Viola was liable to plaintiffs for damages of nearly $250,000. Viola moved for judgment notwithstanding the verdict, and the trial court (Supreme Court, Monroe County) granted his motion. The Appellate Division, Fourth Department has now affirmed.

The Appellate Division reasoned that the non-compete clause that plaintiffs sought to enforce sets forth a two-year time period, and thus is subject to New York’s statute of frauds. Further, the Court rejected the argument that the 1996 written agreement satisfied the statute of frauds, because there was no writing evidencing the incorporation of the 1996 written agreement into the 1998 oral employment agreement. This lack of writing led the Court to find that plaintiffs’ version of the 1998 oral agreement is unenforceable and void under the statute of frauds.

The lesson for practitioners here is that a non-compete provision extending for one year or more may not be orally extended in a subsequent agreement. Best practice dictates that non-compete clauses of such duration always be evidenced by a writing signed by the employee.
 

Co-authored by Kenneth G. Menendez.

Back in May, on the last day of the 2010 session of the Georgia General Assembly, lawmakers passed a bill totally revamping Georgia’s restrictive covenant law (House Bill 173). Unlike most laws, however, this Act was not effective either upon passage by the General Assembly or upon signature by the Governor. Rather, this Act became effective on the day following the 2010 general election, if ratified in the form of an amendment to the Georgia Constitution providing for the enforcement of restrictive covenants in commercial contracts that limit competition.

On November 2, 2010, by a margin of more than two-to-one, Georgia voters ratified this Constitutional amendment and, as a result, effectuated the total restructuring of Georgia’s restrictive covenant law. Thus, upon certification of the election results, Georgia will have a new restrictive covenant law, which will apply on a going-forward basis to all contracts entered into on and after such effective date.

Highlighting the new Georgia law is the authorization for the courts to “blue-pencil” or modify restrictive covenants, in cases where the contractual covenants are partially unenforceable or overly broad, so as to grant only the relief reasonably necessary to protect the interests of the parties and achieve the original intent of those parties to the extent possible. Historically, in the context of restrictive covenants contained in employment agreements, Georgia courts have refused to blue-pencil overly broad covenants or covenants otherwise determined to be unenforceable. Thus, prior to the new law, if any portion of a restrictive covenant (or accompanying covenants not to solicit clients or pirate employees) was found to be unenforceable, all of the covenants contained in the applicable agreement were determined to be unenforceable as well.

The new Georgia law goes further, in terms of identifying those contracts which, in the future, may include restrictive covenants; included are contracts between employers and employees, distributors and manufacturers, lessors and lessees, partnerships and partners, franchisors and franchisees, sellers and purchasers of businesses, and two employers. The law also identities categories of employees who may be subject to restrictive covenants, and those categories of employees who may not. Finally, the new law puts the burden of proof on the party challenging the restrictive covenant, once the party seeking to enforce the restrictive covenant establishes by prima-facie evidence that the restrictive covenant is in compliance with the provisions of the new law.

Georgia’s new restrictive covenant law should provide some much-needed clarity and guidance, in terms of allowing lawyers to craft restrictive covenants which will stand up under scrutiny from the courts, rather than relying upon a case-by-case analysis of the covenants (along with the factual situations involved) to determine the legality of those covenants. Additionally, courts will now be empowered to blue-pencil overly broad or unenforceable restrictive covenants, and it will be interesting to see how the courts accept and handle this authorization.
 

Last April, I summarized in detail a pending bill (House No. H4607) which would amend the current law on noncompetes. (See April 13, 2010 Blog Entry).  The bill was considered a compromise bill since there was other legislation filed that sought to make all noncompetes in Massachusetts unenforceable (similar to California).  While that bill has not progressed at all, many observers thought that the “compromise bill” would have support, even though it would have made many current agreements unenforceable and would have made it more difficult for employers to protect proprietary information.

Last week, the bill died in Committee.  Obviously, the hearings that were supposed to occur this coming January will not happen.  In essence, the current law on noncompetes in Massachusetts remains intact.  However, one of the bill’s sponsors, Senator Brownsberger, stated to the press last week that he plans to introduce another bill on the same subject.

As in the past, we will continue to monitor the progress of this new legislation and keep you posted.
 

In October 2010, in Xplore Technologies Corp. v. Killion, CV10-5013459S, a Connecticut state court examined whether a non-competition clause that had no specified geographic requirement was enforceable. The Court enforced the clause and held that the geographic area was defined by the uniqueness of the product at issue and the limited potential customers for it.

The plaintiff engineers, develops and markets rugged computer tablets intended for work under extreme conditions, such as the military or outdoor work for a company such as AT&T. The plaintiff’s only competitors in the business are Panasonic, Dell and the defendant DRS Technologies, Inc. (“DRS”). A former employee, who was employed by the plaintiff for approximately six years, agreed to join DRS to promote products and services, including the rugged computer, to businesses like AT&T. When the plaintiff sought an injunction to enforce the non-competition clause, DRS argued, among other things, that the clause was unenforceable because it had no geographic limit.

The Court rejected DRS' defense and concluded that the geographic area was defined by the territory where the three competing companies marketed the rugged computer. The Court stated that with the technical advancements in Internet sales, a set of number of miles from an office is a useless measure in a non-compete agreement because in marketing a new computer product, the world is at your fingertips. The Court held that the geographic area and territory of the rugged computer is restricted only as to the three direct competitors attempting to gain the business from the same client base – Dell, Panasonic and DRS – and that the potential customers for the one product was limited to companies such as AT&T and the military. The Court held that the geographic area is based upon that market area, the unique product and the limited customers. Therefore, that no specific miles are stated in the clause is not a basis to determine that the geographic area element of a non-competition agreement was not satisfied. The Court enjoined DRS from employing Killion in violation of the non-competition clause.
 

Readers of this blog know that, in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant (i.e., before an Illinois court will address the reasonableness of a restrictive covenant, the employer must first establish that it is supported by a “legitimate business interest” – a tall order given how that term is defined in Illinois).

Since then, we have been closely following Illinois state and federal no-compete cases to monitor the impact of Sunbelt Rentals. To date, its holding remains limited to Illinois’ Fourth District Court of Appeals (i.e., central Illinois, but not Chicago or any of its suburbs) as no court in Illinois has followed its reasoning in a published decision. (One federal district court in Indiana did apply Sunbelt Rentals, in CDW LLC et al. v. Netech Corporation, 2010 WL 2710626 at * 7 (S.D.Ind. July 7, 2010), but it did so without acknowledging or analyzing the split of authority on the issue.)

Last week, in Steam Sales Corporation v. Brian Summers, the first Illinois Appellate District other than the Fourth District re-visited the issue of whether the “legitimate business interest” still applied. While the Court in Steam Sales noted that Sunbelt Rentals’ “rejection of [the “legitimate business interest”] test does merit some consideration,” the Court did not rule on the issue because even under the “legitimate business interest” test, the restrictive covenant at issue was enforceable.

Notwithstanding its failure to address the crux of Sunbelt Rentals, certain aspects of Steam Sales may signal a thawing of judicial attitudes in Illinois toward no-competes.

First, the Court held that the reason why the employer had a legitimate business interest sufficient to support the no-compete was because it has “near permanent customer relationships.” Showing that an employer has “near permanent customer relationships” is one of the two established means in Illinois of establishing a legitimate business interest, but it “is generally absent from businesses engaged in sales.” Lawrence and Allen, Inc. v. Cambridge Human Resource Group, Inc., 292 Ill.App.3d 131, 142 (Ill. App. Ct. 1997). Rather, “near permanent customer relationships” are more typically found in professional services businesses. The employer in Steam Sales sold and maintained boilers. Because boilers are a long-term investment and because long-standing relationships are required to service the equipment and sell new equipment, the Court held that even though the employer was engaged in sales, it had “near permanent customer relationships” and therefore had a legitimate business interest sufficient to support the no-compete at issue.

Second, in Steam Sales, the Court upheld a two-year no-compete. While there is precedent to support a no-compete of such length, many employers today shy away from two-year restrictions out of concern that a Court will find them too long.

Finally, while Illinois courts have sometimes been seen as somewhat hostile to no-competes in employment contracts, the Steam Sales opinion is notably unsympathetic to the employee. Indeed, the Court stated that “[r]egardless of which party initiated the agreement, [the employee] had the option of either not signing it or asking [the employer] to modify the terms of the restrictive covenant. . . . As in Sunbelt Rentals, [the employee] risked the enforcement of the restrictive covenant after he chose to sign it.”

Hence, while Steam Sales did not follow the holding of Sunbelt Rentals with respect to the continuing validity of the “legitimate business interest test,” it nevertheless may signal a thaw in judicial attitudes toward no-competes in Illinois.

As for the long-term impact of Sunbelt Rentals . . . stay tuned.
 

Applying Missouri law, the United States Court of Appeals for the Eighth Circuit recently affirmed an award of $1,369,921 in liquidated damages stemming from the alleged violation of non-solicitation agreements by four former employees of accounting firm Mayer Hoffman McCann. Mayer Hoffman McCann, P.C. v. Thomas L. Barton et al., Case No. 09-2061 (8th Cir. August 11, 2010). In pertinent part, these agreements provided that for two years following the termination of employment, the employees could not solicit clients and employees of their former employer. The agreements also contained a liquidated damages provision.

The Court held that the two year duration was reasonable and further held that the absence of a geographic restriction was not a problem, because “a customer restriction may substitute for an explicit geographical restriction.”

Regarding the liquidated damages provision, the Court explained that

the issue here is whether the parties intended the provision to be a form of recoverable compensation – liquidated damages – or an unenforceable penalty provision meant to compel performance. In order to distinguish between the two, we ask whether: ‘(1) the amount fixed as damages [is] a reasonable forecast for the harm caused by the breach; and (2) the harm [is] of a kind difficult to accurately estimate.’

Because the Court found that both requirements were met in this case, it affirmed the trial court’s award of $1,369,921 in liquidated damages, calculated based upon gross billings to 124 former clients who moved their business after being improperly solicited.
 

Co-authored by Ted A. Gehring.

On July 30, 2010, in Silguero v. Creteguard, Inc., the California Court of Appeal (2nd District) held that an employee could state a claim for wrongful termination against her subsequent employer when that employer terminated her after having been informed by her former employer that the employee was subject to a non-compete clause.  The decision will have important consequences for companies with California employees in industries where non-competition and non-solicitation agreements are common.

The plaintiff, Rosemary Silguero,  began employment with Floor Seal Technology Inc. (“FST”)  in 2003 as a sales representative.  In 2007, FST threatened to terminate her employment unless she signed a confidentiality agreement which contained a non-competition clause that prohibited her from all sales activities for 18 months following either her departure or termination from FST.  Silgureo's employment was subsequently terminated by FST.  She was then hired by Creteguard Inc.  FST contacted Creteguard requesting its cooperation in enforcing the confidentially agreement.  Creteguard then terminated Silguero’s employment, citing the non-competition clause.  Notably, in terminating her, Creteguard acknowledged the invalidity of the non-competition agreement, but noted it was terminating Silguero "to keep the same respect and understanding" with Creteguard's "colleagues" in the same industry.

Silguero filed suit against Creteguard, alleging wrongful termination.  She also sued FST in a separate lawsuit, alleging that FST had intentionally interfered with her contract with Creteguard.

Silguero contended that the non-competition agreement with FST was void under California Business and Professions Code Section 16600 and that her termination by Creteguard pursuant to that agreement was against public policy.   Creteguard demurred, arguing that that there was no clearly delineated public policy prohibiting an employer from honoring a non-competition agreement by an employee and a former employer.  Creteguard argued that if there was any violation of public policy, the violation was by FST.  The trial court granted Creteguard’s demurrer, finding it was not against public policy for a subsequent employer to honor a previous agreement entered into by an employee and former employer. Silguero appealed.

On appeal, the Court of Appeal reversed, holding that Silguero's allegations supported a claim for wrongful termination pursuant to Tameny v. Atlantic Richfield.  In reversing the ruling of the trial court, the Court held that Section 16600 was a clear legislative declaration of a fundamental public policy that forbid discharge based on a non-competition agreement.  The Court of Appeal did not address Silguero's claims against FST.

Creteguard argued that, notwithstanding the legislative policy against non-competition agreements, nothing in Section 16600 evidenced any legislative intent to impose third-party liability.  Imposing liability on Creteguard for a violation of Section 16600, Creteguard argued, went beyond the legislative intent evidenced by Section 16600.  The Court of Appeal disagreed, noting that California courts had previously rejected as unenforceable "no-hire" agreements between employees.  The Court of Appeal found that Creteguard's desire to keep an "understanding" with its competitors in the industry operated as a no-hire agreement.

In a recent decision issued by the Supreme Court of the State of New York, New York County, a lawsuit brought by Marsh USA Inc. against two former employees and a competitor was sustained in the face of the defendants’ challenge to the complaint on grounds of forum non conveniens and failure to state a cause of action.  The decision is notable for its application of New York non-competition law to California residents, and Marsh’s inclusion of forum selection clauses and choice of law provisions in its agreements with the individual defendants appears to have enabled it to avoid the draconian effect of California law upon those individual’s non-compete agreements.

The decision denying defendants’ motion to dismiss, by Justice Bernard J. Fried, was entered on July 23, 2010 in the matter of Marsh USA Inc. v. Hamby, Index No. 600636/10.

The individual defendants, John A. Hamby and Lida Davidians, both reside in California and worked over five years in Marsh’s Entertainment Practice, in which they were senior employees.  The complaint alleges that Hamby and Davidians each breached several non-compete agreements, misappropriated confidential information, and unfairly competed when they went to work for DeWitt Stern Group, Inc. in late January 2010.  After their resignations, in short order, numerous clients terminated their relationship with Marsh and appointed DeWitt as their new insurance broker, and 8 of 20 employees of Marsh’s Los Angeles Entertainment Practice abruptly defected to DeWitt.

The defendants moved to dismiss the complaint first on the ground that the New York court is an inconvenient form.  The Court refused to dismiss on this ground, because both Hamby and Davidians had signed multiple agreements containing forum selection clauses and choice of law provisions that obligated the parties to litigate in New York, applying New York law.  Defendants’ arguments that connections to California outweighed connections to New York, and that California’s public policy would render the non-compete agreements void under California law, did not convince the New York court to dismiss.  The New York court noted, among other things, that a lawsuit commenced by defendants against Marsh in the Superior Court of the State of California, No. BC 430457, seeking a determination that the agreements were unenforceable under California Business and Professions Code Section 16600, was stayed upon Marsh’s motion, allowing the dispute to be heard in the New York court.

Defendants’ second motion to dismiss, for failure to state a cause of action, focused on Marsh’s allegations of misappropriation of trade secrets, which defendants argued were conclusory and did not identify what trade secrets had been stolen.  The New York court found that the defection of numerous Marsh employees and clients quickly following Hamby and Davidians’ resignations raised a strong enough inference of misappropriation of trade secrets, that the complaint would therefore survive the motion to dismiss.

As we noted in a blog post in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant. At the time, we noted that the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

As of early December 2009, only one other court had cited to the Sunbelt decision. In that decision (which we discussed in an earlier blog post), federal district court judge Robert Gettleman declined to follow Sunbelt, noting that “[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the applications of the legitimate business interest test.”

Since that time, there has been only one other published decision citing Sunbelt. In Rayco Management, Inc. v. Lancaster, No. 09 CH 18611, 2009 WL 6521389 (Cir. Ct. Cook Ct. Dec. 9, 2009), a trial judge in the Circuit Court of Cook County similarly declined to follow Sunbelt, concluding that he was bound by the precedent of the First District Appellate Court which still applies the “legitimate business interest” test.

Approximately nine months after Sunbelt was decided, no appellate court has issued a published decision addressing the holding of that decision and both lower courts that have been presented with a Sunbelt argument have declined to follow that decision absent direction from the appropriate appellate or higher level court. We will continue to monitor this issue, as it has significant ramifications on the enforceability of restrictive covenants in Illinois.
 

On June 17, 2010, in Ontario v. Quon, the United States Supreme Court decided that the City of Ontario, California could review the non-work-related text messages to and from a City police officer on a City-issued electronic pager. Because the opinion involved a governmental employer and was largely grounded in a 4th Amendment analysis, many private employers have paid Quon little attention. But that would be a mistake, especially for those facing trade secret and non-competition matters. Quickly accessing and collecting so-called “private communications” can play a vital role in amassing the evidence needed to support a restraining order or preliminary injunction. Despite the fact that much of the analysis in Quon would be irrelevant in the private employment context, the Supreme Court expressly held that the review of the officer’s personal text messages on the employer-issued pager “would be ‘regarded as reasonable and normal in the private-employer context.’” (Slip op. at 16). Consequently, knowing what was done and how it was done in Quon may provide even private employers with a roadmap for approaching such issues, and then provide from the highest court in the land legal support for the reasonableness of the employer’s conduct.

Quon’s facts, and the assumptions that the Supreme Court made about them, are worth a brief review. First, the Court noted that the City “reserve[d] the right to monitor and log all network activity including e-mail and Internet use, with or without notice. Users should have no expectation of privacy or confidentiality when using these resources,” but that the policy “did not apply, on its face, to text messaging.” Slip op. at 2. Further, “[a]lthough the Computer Policy did not cover text messages by its explicit terms, the City made clear to employees, including Quon,” through statements at various meetings and in a written memorandum that “[text] messages sent on the pagers ‘are considered e-mail messages. This means that [text] messages would fall under the City’s policy as public information and [would be] eligible for auditing.’” Id. at 3 (bracketed language in original). On the other hand, Quon argued that he could reasonably expect that his text messages would remain private based on the City’s past practice. Each pager issued to officers was allotted a limited number of characters sent or received each month. Id. at 2. According to Quon, the City told him that an audit of his text messages would be unnecessary if he paid the excess charges for any use that exceeded the monthly limit. Id. at 9. Because he paid for those excess charges, id. at 3, Quon argued that he had a reasonable expectation that the City would not review the contents of his text messages.

Rather than resolve this dispute, the Supreme Court assumed for the purpose of its analysis that “Quon had a reasonable expectation of privacy in the text messages sent on the pager provided to him by the City,” slip op. at 12, yet nonetheless found that the City’s review of the personal text messages was appropriate and reasonable for the governmental employer acting without a warrant. Slip op. at 12-13. Important factors supporting the Court’s finding of reasonableness were (i) the City did not search any text-messages sent during off-duty hours; and (ii) the City searched only a sample – i.e., only two months of messages sent by Quon rather than all of the months during which he exceeded his monthly character allotment. The Court concluded that, despite any expectation of privacy, such a search was reasonable for a government employer and would have been “‘regarded as reasonable and normal in the private-employer context.’” (Slip op. at 16).

Central to that conclusion was the concept that the recognition of an employee’s expectation of privacy was not tantamount to conceding that such privacy would remain wholly inviolate:

Even if he could assume some level of privacy would inhere in his messages, it would not have been reasonable for Quon to conclude that his messages were in all circumstances immune from scrutiny. Quon was told that his messages were subject to auditing. As a law enforcement officer, he would or should have known that his actions were likely to come under legal scrutiny, and that this might entail an analysis of his on-the-job communications. Under the circumstances, a reasonable employee would be aware that sound management principles might require the audit of messages to determine whether the pager was being appropriately used. …From [the Ontario Police Department]’s perspective, the fact that Quon likely had only a limited privacy expectation, with boundaries that we need not here explore, lessened the risk that the review would intrude on highly private details of Quon’s life. OPD’s audit of messages on Quon’s employer-provided pager was not nearly as intrusive as a search of his personal e-mail account or pager, or a wiretap on his home phone line, would have been. That the search did reveal intimate details of Quon’s life does not make it unreasonable, for under the circumstances a reasonable employer would not expect that such a review would intrude on such matters. The search was permissible in its scope. (slip op. at 14).

The Court expressly noted that, given the employee’s limited privacy expectation (based on the City’s electronic communication policy, the fact he was told that his text messages might be audited and the fact that his position as a police officer might require an analysis of his on-the-job communications) the government employer would not reasonably to expect that an employee would place highly private details of his life into messages on his employer’s physical device. (slip op. at 14). When the Court later expressly concludes that such a “search would be ‘regarded as reasonable and normal in the private-employer context,’” the Supreme Court can be said to be validating for a private employer that same right reasonably to expect that an employee would avoid placing highly private details of his life into messages on his employer’s physical device when the employee had been advised his employer might audit such communications.

In the wake of decisions like Stengart v. Loving Care [see previous blog post here], where the New Jersey Supreme Court dictated much less latitude for employers, even the brief mentions in Quon that reference private employers are welcome ones.

There are some practical tips for employer communication policies. Such policies should be all inclusive – covering cell phones, e-mail, text messaging, etc. The fact that the written policy in this case did not expressly cover text messages caused some confusion. Also, although the Supreme Court tried to state that it was not opining as to how advances in communication technology may impact an employee’s expectation of privacy, it went on to make several such statement (much to the dismay of Justice Scalia). For example, the Court observed that, on the one hand, the pervasive use of cell phones and text message means that some people may consider them to be “necessary instruments for self-expression, even self-identification” which would strengthen the case for an expectation of privacy; but the Court also noted that “the ubiquity of those devices has made them generally affordable, so one could counter that employees who need cell phones or similar devices for personal matters can purchase and pay for their own.” (slip op. at 11). This later point also provides some practical guidance—perhaps employers should add to their electronic communications policy a statement along the lines of the following: An employee who desires to send or receive personal communications unreviewable under this policy should purchase and use his/her own cell phone/text messaging device and service plan.
 

In Pharmethod, Inc. v. Caserta, __ F.3d __ (3d Cir. 2010), the Third Circuit vacated and remanded the district court’s entry of a preliminary injunction enforcing a no-compete based on the trial judge’s failure to fully explain his factual and legal conclusions. The case is noteworthy because the Third Circuit provided what amounts to a primer on Pennsylvania non-compete law to help guide the district court on remand. Here is a summary of the Third Circuit’s guidance:

• Restrictive covenants are not favored in Pennsylvania and, due to the inherently unequal bargaining positions of employer and employee, such agreements are closely scrutinized. The court is required to balance the employer’s protectable business interest against the employee’s interest in earning a living in his or her chosen profession, and then balance the result against the public interest.

• In balancing such equities, some Pennsylvania courts are reluctant to enforce restrictive covenants against an employee who was involuntarily terminated.

• In Pennsylvania, post-employment restrictive covenants are enforceable if: (i) they are incident to an employment relationship between the parties; (ii) the restrictions imposed by the covenant are reasonably necessary for the protection of the employer; and (iii) the restrictions imposed are reasonably limited in duration and geographic extent.

• Legitimate business interests that may be protected by a restrictive covenant include protecting trade secrets, confidential information, good will or unique/extraordinary skills. Eliminating competition or gaining an economic advantage do not constitute legitimate business interests.

• Geographic restrictions must also be reasonable. Courts will uphold restrictive covenants with broad geographic limits only where the employee’s duties and customers were equally broad.

• Pennsylvania courts may “blue pencil” restrictive covenants by granting enforcement that is limited to those portions which are reasonably necessary for the protection of the employer. However, Pennsylvania case law favors non-enforcement of gratuitously overbroad restrictive covenants.
 

Peter A. Steinmeyer and Jake Schmidt recently published an updated and expanded guide to drafting enforceable non-competition agreements in Illinois. The article, which was first published by the Illinois State Bar Association's publication "The Corporate Lawyer," can be downloaded by clicking here. As updated, it addresses the Illinois Appellate Court's Sunbelt Rentals decision and the proposed "Illinois Covenants Not to Compete Act."

There has been a serious push to clarify the way Massachusetts regulates noncompetition agreements. Many legislators and those in the high tech industries have voiced concern that the current approach hampers Massachusetts companies from competing with California high tech businesses where noncompetition agreements are not enforceable because they are contrary to public policy. The advocates of this approach feel that the freer movement of employees between competitors would create more innovation and competition. But the issue is not clear cut. There are many that want to enforce noncompetition agreements with no change in approach to protect innovation that the company has created.

A bill that attempts to reach a compromise between these two views has been making its way through the legislature. Recently, the latest version of House No. H4607, is now with the House Committee on Steering and Policy which decides when the bill will be considered by the full House. The following is a summary of the highlights of the bill which amends Chapter 149 of the General Laws by inserting a new section 24L.

While the amendment allows noncompetition agreements, it provides the following:

I. EXCLUSIONS

- Noncompetition agreements made in connection with the sale of a
business, sale of assets of a business, or otherwise outside the employment relationship.
- Agreements by which the employee agrees to not reapply for
employment to the same company after termination.

II. ELEMENTS NECESSARY TO BE VALID AND ENFORCEABLE

- A separate agreement in writing signed by employee and employer.
- Applicable to an employee with average annualized federal gross income
of at least $75,000 plus $1,500 for each full year from the amendment’s effective date.
- If a condition of employment, to the extent feasible, must provide copy
7 days before commencement of employment with notice that it is a condition of employment.
- If entered into after commencement of employment, must be supported
by adequate consideration which cannot be continued employment. 10% or more of current annual pay is presumptively adequate.
- Must protect one of the types of legitimate business interests
listed in the bill.
- Reasonable duration, but in no case more that 1 year from cessation of
employment. Duration of no more than 6 months is presumptively valid. Tolling is allowed under certain circumstances.
- Reasonable geographical scope in relation to interests served. Area
limited to where employee provided service or had influence is presumptively reasonable.
- Limited in scope of proscribed activities. If limited to type of service
that employee is performing at the time presumed reasonable.

III. GENERAL

- The Court can reform an agreement in its discretion to make agreement
valid and enforceable.
- The Court can refuse to enforce the agreement if:
- Against public policy.
- In extraordinary circumstances.
- Necessary to avoid a harsh result.
- Based on common law or equitable factors that would militate
non-enforcement.
- The Court can award attorneys’ fees to the employee or the employer
under certain circumstances outlined in the bill.
- No choice of law allowed that would avoid Massachusetts law if the
employee has been a resident and working in Massachusetts for at least 30 days.

According to prevailing views about the pending legislation, additional changes will certainly be made. We will report on its progress.
 

On February 4, 2010, the United States District Court for the District of Maryland granted summary judgment to Plaintiff TEKsystems, Inc. (“TEK” or the “Company”), a leading technical staffing and services company, and enjoined its former Director of Strategic Accounts, Jonathan Bolton (“Bolton”), from violating certain restrictive covenants contained in his Employment Agreement.

Pursuant to the Employment Agreement, Bolton was prohibited from competing with the Company within a fifty (50) mile radius of the office in which he worked at the time his employment was terminated, for a period of eighteen (18) months following the termination of his employment. Although Bolton worked in New York City, the Employment Agreement at issue was executed in Maryland and the contract specifically provided that Maryland law would govern all disputes.

Less than two weeks after resigning from TEK, Bolton began working for another IT-staffing company as their Managing Director of New York City. Bolton worked out of his home in Wayne, New Jersey, which is located less than 50 miles from his prior office at TEK. Approximately one month later, TEK issued Bolton a cease and desist letter requesting that he provide written assurances that he would abide by the terms of his Employment Agreement. However, Bolton never provided any response to the Company. Consequently, TEK filed a lawsuit to enforce the restrictive covenant and sought an award of injunctive relief and damages.

In analyzing the restrictive covenant pursuant to Maryland law, the court concluded that it was reasonable in terms of both geographic scope and duration. The court noted that covenants imposing a far broader limitation than 50-miles had previously been upheld by courts in Maryland, especially where, as here, the Company operates on a nationwide and international level. Likewise, the 18-month duration of the restrictive covenant was clearly compliant with the norms governing the temporal scope of restrictive covenants.

The court also found that the covenant not to compete served to protect TEK’s legitimate business interest, as the Company’s success in the IT-staffing industry overwhelmingly depends upon the ability of its employees to make and maintain personal connections with clients, and Bolton was privy to TEK’s client contacts and confidential information. And, while the covenant could create some inconveniences for Bolton by prohibiting him from working in the New York City area for the next 18 months, the Court did not find that such inconveniences rose to the level of undue hardship. Finally, the court considered the public interest at stake and noted that “the public benefits from the enforcement of reasonable restrictive covenants” which serves to “facilitate and protect business growth, especially in technology-related and information based fields.”

Based on these conclusions, the court awarded a permanent injunction barring Bolton from operating in the New York City area for 18 months from the date of the court’s order. Because the court found that there was insufficient evidence showing that any of TEK’s customers had paid any fees to Bolton for his work with his new employer, the court declined to rule on damages, choosing instead to allow the parties to further brief that specific issue.

This case demonstrates that Maryland is a favorable forum for enforcing non-compete agreements, even where there is no proof that an employer has suffered a loss of profits. Thus, Maryland employers who wish to protect their legitimate business interests should not hesitate to utilize and maintain appropriate restrictive covenants, so long as such covenants are reasonable in terms of scope, geographic area and duration, do not unduly restrict an employee from earning a living, and do not limit fair competition.
 

A bill recently introduced in the Illinois House of Representatives, the “Illinois Covenants Not To Compete Act,” would substantially alter the law regarding non-competition agreements in Illinois. In most respects, it would limit the enforceability of no-competes and make them easier for individuals to challenge. However, in certain respects, the bill would make no-competes easier to enforce. The same bill was introduced last year and went nowhere.

In pertinent part, the bill would limit the enforceability of no-competes by providing as follows:

• No-competes would be unenforceable against everyone other than a “key employee” or “key independent contractor” (categories which are actually fairly broadly defined in the bill);

• Mere continued employment would no longer be adequate consideration to support a no-compete; rather, the employer would have to provide “a material advancement or promotion” or “a material bonus or material increase” in salary; and

• There would be rebuttable presumptions that: any restriction exceeding one year is unenforceable; any geographic restriction that extends beyond the region in which the individual provided services is unenforceable; and any restriction on an individual’s ability to perform services other than services of the same type performed for that employer is unenforceable.

The bill would also make it far easier for an individual to challenge a no-compete, because it provides that any individual can bring a declaratory judgment action to challenge the enforceability of his/her no-compete and if the challenge is successful, the employer would have to pay his/her legal fees (but if the individual loses, they would not have to pay the employer’s fees).

In a related vein, the bill would make it riskier for many employers to try to enforce no-competes, because it provides that any “one way” fee shifting provision in a no-compete (i.e., a clause providing that if an employer has to incur attorney’s fees to enforce the agreement, the individual must pay the employer’s fees) shall be construed to provide for “two way” fee shifting (i.e., loser pays, regardless of which side loses).

Notwithstanding the foregoing provisions, in certain respects the bill would actually make no-competes more enforceable because it would make it far easier to establish the existence of a legitimate business interest sufficient to justify a no-compete (a high threshold to clear under current Illinois law) and because it expands the ability of judges to modify restrictions in a no-compete to make them enforceable.

Additionally, the proposed law contains a number of broad exceptions. Specifically, it would not apply to anti-raiding provisions (which bar former employees from recruiting their former colleagues); anti-solicitation clauses (which bar customer solicitations); confidentiality agreements (which protect confidential information); “employee choice” clauses in incentive compensation programs (which require the forfeiture of incentive compensation in the event an individual engages in prohibited conduct); and agreements between corporations, partnerships, limited liability corporations or partnerships, and their shareholders, partners, and members.

As of this writing, the bill has not attracted significant public attention or commentary, but we will monitor its progress in the months to come.
 

An article recently published in the New York Law Journal explores an employee's duty of loyalty and the permissible steps that employee may take, prior to termination of employment, in preparing to compete with the employer.

* Co-authored by Kathryn T. McGuigan.

In the recent case of Dowell v. Biosense Webster, Inc., No.B201439, the California Court of Appeal stated in dicta that it doubted the continued viability of the common law trade secret exception to covenants not to compete. The Dowell Court left open the question as to whether or to what extent courts will enforce agreements to protect trade secrets.

On January 29, 2010, in an unpublished opinion, Majestic Marketing, Inc. v. Nay, No. E047085 (Fourth District, Division Two), at least one California Court of Appeal appears to have recognized the viability of the trade secret exception to California Business & Professions Code ¶16600 prohibition of employee non-competition agreements.

The Majestic Marketing employee handbook included a clause which, among other things, identified company trade secrets and prohibited employees from using those trade secrets. Majestic brought suit against two former employees claiming that while they were still employed and after, the employees had misappropriated trade secrets (customer lists), in violation of the clause to form another company. The trial court entered a preliminary injunction prohibiting the defendant employees from using any Majestic customer information and barred them from doing business with about 3,000 Majestic customers for the two-year prohibition period contained in the employee handbook. The employees were also required to return all Majestic information and property. The Court of Appeal affirmed.

The Court agreed with the trial court that Majestic’s customer information was a protectable trade secret as defined under the clause in Majestic’s handbook and stated that “[d]espite California’s broad prohibition against noncompetition agreements, covenants not to compete may be enforced to the extent that enforcement is necessary to protect a company’s trade secrets.”

The Majestic Court decision therefore gives some indication that the trade secret exception may operate where the employer can establish that the information at issue is a trade secret. However, the California Supreme Court has yet to weigh in and for now, the viability of the trade secret exception remains an open issue.
 

The U.S. Court of Appeals for the Third Circuit recently held that a stock sale did not invalidate an employee’s non-compete. Zambelli Fireworks Manufacturing Co., Inc. v. Wood et al., Case No. 09-1526 (January 15, 2010).

In Zambelli, a company brought suit against a former employee to enforce his non-compete. The employee responded, in part, by arguing that the non-compete was invalid because, when a majority of the company’s stock had been sold, there was no specific assignment of the employee’s non-compete to the buyer of the stock.

Although this would not seem to be a novel question, the Third Circuit explained that it found no Pennsylvania appellate decisions which addressed “the impact of a stock sale on the enforceability of a non-compete agreement.” Nevertheless, relying on Pennsylvania cases holding that (a) “a stock sale, unlike a sale of assets, does not necessitate an assignment in order for the corporation to enforce an employment agreement” and (b) “the transfer of a corporation’s stock does not destroy the corporate entity” because its existence is “irrespective of, and entirely distinct from, the persons who own its stock,” the Third Circuit concluded “that the transfer of some or all of the stock of a corporation has no effect on its ability to enforce a non-compete agreement.”

Accordingly, the Third Circuit rejected the employee’s challenge to his non-compete based on the lack of an assignment agreement at the time of the stock sale. The Third Circuit added that if the non-compete was intended to be contingent on the company remaining a family-owned business, that should have been set out as a material condition to the agreement.
 

In a case applying Ohio law, the Indiana Supreme Court recently held that, for purposes of a non-competition agreement, competition with a subsidiary corporation also constituted competition with the parent.  Baker v. Tremco Incorporated, No. 29S02-0902-CV-00065 (Ind. 2009).

In Tremco, the parent corporation was a manufacturer of roofing-related products. It had a subsidiary which provided services related to roofing projects. The parent had one of its salespersons, who sold products for the parent and services for the subsidiary, sign a post-employment non-competition agreement which barred the employee from competing “in any aspect” of the parent’s business for 18 months.

The salesperson eventually left and started a new business which he conceded directly competed with the subsidiary. However, he argued that because he was not competing with the parent, he was not in violation of his non-competition agreement with the parent.

This argument was rejected by the Indiana Supreme Court, which noted that while the salesperson was employed by the parent, he sold for both the parent and the subsidiary and all compensation was paid by the parent, regardless of whether commissions were earned for selling the parent’s products or the subsidiary’s services. Thus, the Court held that competition with the subsidiary was competition with the parent.

Non-compete cases are always fact and language-specific; in this case, both weighed in favor of enforceability.
 

*Co-authored with Jake Schmidt.

As we noted in a blog post in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant. At the time, we noted that the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

Although we expect that the reasoning of Sunbelt will be at issue in virtually every lawsuit seeking to enforce or invalidate an Illinois restrictive covenant, to date only one published decision, Aspen Marketing Services, Inc. v. Russell, No. 09 C 2864, 2009 WL 4674061 (N.D. Ill. Dec. 3, 2009), has cited Sunbelt. In that case, federal district court judge Robert Gettleman noted his awareness of Sunbelt and its rejection of the legitimate business interest test, but he applied the test anyway, noting that “[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the applications of the legitimate business interest test.” Judge Gettleman did not otherwise elaborate on his decision to apply the legitimate business interest test.

We will continue to monitor this issue, as it has significant ramifications on the enforceability of restrictive covenants in Illinois.
 

* Co-authored with Kathryn T. McGuigan.

In Edwards v. Arthur Andersen, LLP, 44 Cal.App. 4th 937 (2008) the California Supreme Court adopted an expansive interpretation of California Business & Professions Code §16600, holding that §16600 prohibits employee non-competition agreements unless the agreement falls within a statutory exception which are non-competition agreements associated with certain business sales transactions, dissolution of partnerships, or termination of a member’s interest in a limited liability company. The Edwards Court specifically rejected the “narrow restraint” exception adopted by the Ninth Circuit and which no California court had endorsed, finding that even limited restraints on post-termination competition are unlawful under California law.

However, the Court was careful to note that its opinion did not invalidate restraints necessary to protect trade secrets, stating that it was not required to address the applicability of the so-called trade secret exception to section 16600 because it was not germane to the claims raised by the employee. Edwards, supra, 44 Cal.4th at 946, fn. 4.

On November 19, 2009, the California Court of Appeal in Dowell v. Biosense Webster, Inc., No. B201439, in refusing to enforce broad and expansive noncompete and nonsolicitation clauses in employment agreements, did not reach the trade secret exception issue either. The Dowell Court stated in dicta that it doubted the continued viability of the common law trade secret exception to covenants not to compete, but was not resolving the issue because the noncompete and nonsolicitation clauses in the agreements before it were not narrowly tailored or carefully limited to the protection of trade secrets, but were so broadly worded as to restrain competition. The Dowell Court left open the question as to whether or to what extent courts will enforce agreements more narrowly tailored to protect trade secrets.

Even if a court does not enforce a nonsolicitation covenant tethered to even a narrow definition of trade secrets, an employer will still have protection under common law and the California Trade Secrets Act if the employee is using trade secret information to solicit. Given the direction that the California courts appear to be headed, however, employers in California should weigh the value of including any nonsolicitation covenant against the risk created by the inclusion of such a covenant, which may violate public policy.
 

On October 22, 2009, in a case entitled Astro-Med, Inc. v. Nihon Kohden America, Inc. and Kevin Plant, on appeal from the U.S. District Court for the District of Rhode Island, the First Circuit Court of Appeals affirmed a jury verdict granting Astro-Med, Inc. ("Astro-Med") damages of more than $1 million against Nihon Kohden America, Inc. ("Nihon") and employee Kevin Plant ("Plant") for violating non-compete and non-disclosure clauses which Plant signed when he was first employed by Astro-Med in 2002.

Astro-Med and Nihon were competitors in the life sciences equipment market. In 2002, Astro-Med hired Plant as a Product Specialist at its Rhode Island facility. Upon his hire, he signed an Employment Agreement which contained a non-competition clause and a trade secrets clause. The Agreement was governed by the laws of Rhode Island.

After significant training from Astro-Med, Plant transferred to a Sales Representative position at Astro-Med's Florida facility. In 2006, Nihon, a California corporation, hired Plant as a Sales Representative in Florida. Shortly thereafter, Astro-Med sued Plant in federal court in Rhode Island for breach of contract, misappropriation of trade secrets and unfair competition. Astro-Med later added Nihon as a defendant, alleging claims including misappropriation of trade secrets. After losing before the jury, both Nihon and Plant appealed to the First Circuit Court of Appeals.

On appeal, Nihon and Plant alleged nine separate claims of legal error, each of which was rejected by the First Circuit. The Non-Competition clause and the Trade Secrets clause stated that Rhode Island law applied. On appeal, Nihon argued that as a California business, it should not be subjected to the jurisdiction of Rhode Island concerning its hiring of a Florida resident to sell its product in Florida. The Appeals Court disagreed, finding that Rhode Island had jurisdiction. It also found that Astro-Med and Plant entered into the agreement in Rhode Island and that Nihon hired away Plant with full knowledge of the agreement. Because Astro-Med was headquartered in Rhode Island, that was one of the places where the harm occurred.

Specifically with respect to the Non-Competition and the Trades Secrets provisions, defendants raised numerous arguments. The two most interesting are discussed below:

First, Nihon argued that the Non-Competition clause that Plant signed when he was first hired at Astro-Med was unenforceable because after Plant signed it, his duties materially changed. It is true that Plant's job changed at Astro-Med when he transferred to the salesperson job in Florida. Nihon relied on a Massachusetts case (AFC Cable Sys. Inc. v Clisham, 62 F. Supp. 2d 167 (D. Mass. 1999), for the proposition that a change in an employee's job can void a non-competition clause. Massachusetts case law provides that "each time an employee's employment relationship with the employer changes materially such that they have entered into a new employment relationship a restrictive covenant must be signed." Lycos, Inc. v. Jackson, No. 2004-3009, 2004 Mass. Super. LEXIS 348 (Mass. Super. Ct. Aug. 24, 2004). After a substantial discussion of the genesis and intent of the Massachusetts decision which turns on the parties' intent to abandon the non-competition agreement upon the change in duties, the First Circuit held that even if Rhode Island adopted the Massachusetts approach, the facts in the instant case did not support a finding that the parties intended mutual abandonment and rescission of the non-competition provision.

Second, with respect to the Trade Secret Misappropriation claim, relying on Massachusetts common law, Nihon argued that since no evidence was established at trial that either Plant or Nihon ever used any of Astro-Med's confidential information, there can be no violation. However, the First Circuit, which also hears appeals from Massachusetts, said Nihon's reliance on Massachusetts law was misplaced. Rhode Island law applied and the Rhode Island Uniform Trade Secrets Act, R.I. Gen. Laws Sect. 6-4-1, et seq. defines "misappropriation" as including disclosure of a trade secret by one who acquired it while under a duty to maintain its secrecy and the acquisition of a trade secret by one who knew it was obtained from someone who had a duty to keep it secret. Under Rhode Island law, it is not necessary to show that either Plant or Nihon used Astro-Med's trade secrets. The First Circuit noted that disclosure or acquisition is sufficient to prove a misappropriation, subjecting defendants to liability for actual loss and unjust enrichment caused by the misappropriation.

This case illustrates that it is important to check the applicable state law to determine if an individual has violated a restrictive covenant like the Non-Competition or Trades Secrets clauses discussed in this summary. Appellants Nihon and Plant relied on principles from Massachusetts which were different than the applicable law of Rhode Island. The growing Massachusetts case law regarding material changes in employment and the Massachusetts doctrine that misappropriated trade secrets must be used before they can be the subject of an actionable claim, have not been adopted by other states and did not help Nihon and Plant.
 

A trial court in Chicago recently held that because a restrictive covenant did not contain a provision extending the restricted period during any time of breach, there was no basis to re-write the contract to extend the restricted period. The court also declined to extend the restricted period on any equitable basis.  The lengthy decision is attached in two parts here and here. 

This decision illustrates the importance of including a “tolling” provision in a restrictive covenant. See, e.g., Prairie Eye Center v. Butler, 329 Ill.App.3d 293, 304-305 (Ill. App. 2002) (enforcing a contractual provision extending the period of noncompetition for “a period of time equal to that period beginning when such violation commenced and ending when the activities constituting such violation shall have terminated.”) Otherwise, by the time a party learns of a violation of a restrictive covenant and rushes in to court to seek injunctive relief, much of the restricted period may have already expired.
 

We previously wrote about the June 26, 2009 Memorandum Decision and Order in which the U.S. District Court for the Southern District of New York denied a preliminary injunction sought by IBM to prevent its former employee David L. Johnson from continuing his employment as Senior Vice President of Strategy at Dell Inc.

When presented with a non-compete agreement by IBM, Johnson, who was then hoping to be promoted at IBM, purposefully signed the agreement on IBM’s signature block rather than his own in order to allow himself more time to consider whether to commit to signing the agreement. The District Court held that IBM could not show a likelihood of success on the merits and denied IBM’s preliminary injunction motion, because IBM’s actions after receiving the agreement incorrectly signed by Johnson indicated that it did not really consider the agreement to be valid. IBM immediately appealed to the Second Circuit Court of Appeals.

While the Second Circuit appeal was pending, IBM sought leave from the District Court to bring a second motion for a preliminary injunction against Johnson.  In a July 30, 2009 Memorandum Decision and Order, the District Court denied such leave to IBM, on the grounds that the proposed motion (a) sought “essentially the same relief that IBM requested in its first motion,” (b) was “based on information that has been in IBM’s possession since well before” the hearing on the first motion, and (c) “might well encroach upon the Second Circuit’s review of IBM’s appeal.” IBM sought a writ of mandamus from the Second Circuit to vacate this July 30 order, and also appealed the order.

All three of IBM’s pending applications were rejected by a Second Circuit Panel in a Summary Order, dated October 22, 2009.  In affirming the June 26, 2009 Order, the Second Circuit found the District Court’s conclusions “well-supported by the court’s finding that Johnson was extremely credible, and that IBM’s designated witness was much less credible chiefly because IBM’s witness lacked familiarity with documents bearing on the controversy.” With respect to the mandamus petition, the Second Circuit agreed with the District Court’s July 30, 2009 Order that the pending appeal “temporarily divested the district court of jurisdiction to consider a second motion arising from the same facts even if IBM asserted a nominally different cause of action.” Finally, with respect to the appeal of the July 30, 2009 Order, the Second Circuit noted that any “conceivable challenge to the appealed-from order would essentially duplicate the arguments we have already rejected with respect to the mandamus petition.”

In this heavily litigated matter, it now appears that IBM may be out of options in its attempt to prevent Johnson from continuing to work for Dell Inc., for which he has been employed since June. However, IBM’s underlying District Court action against Johnson, seeking damages, may continue.
 

The following article by Peter A. Steinmeyer and Jake Schmidt appeared in Law360 on October 23, 2009. 

In advising against the blind application of legal doctrines, Justice Oliver Wendell Holmes wrote that “[i]t is revolting to have no better reason for a rule of law than that so it was laid down in the time of Henry IV.” O.W. Holmes, The Path of the Law, 10 Harv. L. Rev. 457, 469 (1897). In this spirit, an Illinois appellate court recently reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. In doing so, the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

From the mid-1970s until a few weeks ago, Illinois law in this area was clear: employers seeking to enforce a restrictive covenant first had to establish that the covenant was necessary to protect either confidential information or a near permanent customer relationship – the two recognized “legitimate business interests” sufficient to support a restrictive covenant under Illinois law. During the last three decades this rule has been recognized and applied by every appellate court in Illinois.

In late September 2009, the Fourth District Court of Appeal in Sunbelt Rentals, Inc. v. Ehlers, No. 4-09-0290, 2009 WL 3052369, __ Ill. App. 3d __, __ N.E.2d __, (Ill. App. Ct. Sept. 23, 2009), determined that the “legitimate business interest” test was not supported by any decision of the Illinois Supreme Court. Accordingly, the Sunbelt court held that, in determining whether a restrictive covenant is enforceable under Illinois law, “[a court] should evaluate only the time-and-territory restrictions contained therein.” Id. at *8. In doing so, the Fourth District Court of Appeals departed from the clearly established case law of all appellate courts in Illinois (and also previous decisions of the Fourth District).

Barring further action by the Illinois Supreme Court, the Sunbelt court’s rejection of the “legitimate business interest” test will be one of the primary issues argued in all future restrictive covenant cases in Illinois. This circuit split within the Illinois appellate court system is emblematic of the flux nationally regarding the enforceability of restrictive covenants, with states moving in different directions. Practitioners on either side of the issue, whether practicing in Illinois or elsewhere, should review the Sunbelt decision and evaluate the potential applicability of such an argument or similar arguments to their cases.

The Sunbelt Decision

As noted above, for the last thirty-plus years, every Illinois appellate court agreed that a threshold inquiry when evaluating the enforceability of a restrictive covenant is whether it is necessary to protect a “legitimate business interest.” Such an interest “exists where: (1) because of the nature of the business, the customers’ relationships with the employer are near permanent and the employee would not have had contact with the customers absent the employee’s employment; and (2) the employee gained confidential information through his employment that he attempted to use for his own benefit.” Hanchett Paper Co. v. Melchiorre, 341 Ill. App. 3d 345, 351, 792 N.E.2d 395, 400 (Ill. App. Ct. 2003). This has become known as the “legitimate business interest” test.

The Sunbelt court analyzed Illinois Supreme Court case law from 1896 to the present and concluded that “the Supreme Court of Illinois has never embraced the ‘legitimate-business-interest’ test[.]” Id. at *5.

The Sunbelt court also concluded that the “legitimate business interest” test is inconsistent with recent Illinois Supreme Court decisions concerning restrictive covenants – specifically, Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85 (Ill. 2006). According to the Sunbelt court, the Illinois Supreme Court determined that the restrictive covenants at issue in Mohanty were enforceable solely by analyzing the reasonableness of the time and territory restrictions contained therein. Sunbelt, 2009 WL 3052369, at *6 (noting that “the [Illinois] [S]upreme [C]ourt made no mention of the ‘legitimate-business-interest’ test, despite over three decades of its use by the appellate court.”).

Based on its review of the law in this area and its conclusion that the Illinois Supreme Court has never endorsed the “legitimate business interest” test, the Sunbelt court held as follows:

[Illinois] courts at any level, when presented with the issue of whether a restrictive covenant should be enforced, should evaluate only the time-and-territory restrictions contained therein. If the court determines that they are not unreasonable, then the restrictive covenant should be enforced. Thus, this court need not engage in an additional discussion regarding the application of the “legitimate-business-interest” test because that test constitutes nothing more than a judicial gloss incorrectly applied to this area of law by the appellate court.

Id. at *8.

Are Cases Involving Medical Professionals Different From Other Cases?

Except for one case from 1896 involving an undertaker, Hursen v. Gavin, 162 Ill. 377, 44 N.E.2d 735 (Ill. 1896), all of the Illinois Supreme Court decisions discussed by the Sunbelt court concern the enforceability of restrictive convenants in the medical professional context. Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85 (Ill. 2006) (group of doctors); Cockerill v. Wilson, 51 Ill. 2d 179, 281 N.E.2d 648 (Ill. 1972) (veterinarian); Canfield v. Spear, 44 Ill. 2d 49, 254 N.E.2d 433 (Ill. 1969) (group of doctors); Bauer v. Sawyer, 8 Ill. 2d 351, 134 N.E.2d 329 (Ill. 1956) (doctor); Ryan v. Hamilton, 205 Ill. 191, 68 N.E.2d 781 (Ill. 1903) (doctor). Other courts that have reviewed these same cases have concluded that the Illinois Supreme Court simply assumes the presence of a legitimate business interest in cases involving medical professionals. For example, the First District Court of Appeal has held that “the Illinois Supreme Court’s consistent enforcement of such covenants in the medical professional field, where the duration and geography scope is reasonable, demonstrates its recognition that a professional medical practice is a protectable business interest.” Retina Services, Ltd. v. Garoon, 182 Ill. App. 3d 851, 856, 538 N.E.2d 651, 653 (Ill. App. Ct. 1989).

Justice Steigmann’s unanimous opinion in Sunbelt does not address whether restrictive covenants in the medical professional context are treated differently. However, in his dissenting opinion in Lifetec (an opinion that reaches the same conclusion as the majority opinion in Sunbelt), Justice Steigmann rejected this notion:

It makes no sense to place a greater burden on employers of salespeople than on employers of physicians when the enforceability of noncompete covenants is at issue. Surely the physician-patient relationship and access to medical care are more societally significant concerns than any concerns related to the relationship between a retailer of medical products and its sales force. I find support in this view in Justice Freeman’s partial concurrence in Mohanty, where he wrote, “a strong case exists for abolishing all physician restrictive covenants as being against public policy. However, I agree that this decision is for the General Assembly to make.”

Lifetec, Inc. v. Edwards, 377 Ill. App. 3d 260, 280, 880 N.E.2d 188, 204 (Ill. App. Ct. 2007) (Steigmann, J. dissenting) (internal citation omitted).

Going forward, whether or not other appellate courts follow Sunbelt may turn on whether those courts agree with Retina Services or Justice Steigmann’s dissenting opinion in Lifetec.

Restrictive Covenant Litigation Post-Sunbelt

Like many attorneys who practice in this area, we often advise clients regarding the enforceability of restrictive covenants. Regardless of whether a client wishes to enforce or invalidate a restrictive covenant, our analysis always starts with the same question: does the client have a legitimate business interest in need of protection? After addressing that question and analyzing the reasonableness of the applicable time and territory restrictions, we advise the client regarding the likelihood that a court would enforce the covenant. The Sunbelt decision, however, has injected significant uncertainty into this analysis. Any company or individual seeking to enforce or invalidate a restrictive covenant in Illinois must now ask additional questions: Is the employer or the employee located within the Fourth District (i.e., central Illinois, including the state capital, Springfield)? If you are seeking to invalidate a covenant, how will you respond to an argument that the court should adopt the holding of Sunbelt? In arguing this point, you will most likely have to address whether or not a legitimate business interest is presumed to exist in the medical professional context, and whether such a presumption is the reason for the Illinois Supreme Court’s silence on this issue. If the court rejects the “legitimate business interest” test, how confident are you staking your entire case on the reasonableness (or unreasonableness) of the time, activity, and territory restrictions contained in the restrictive covenants?

The Sunbelt decision is also instructive for those practicing in other jurisdictions. Whether a restrictive covenant is supported by a legitimate business interest is a threshold inquiry in many jurisdictions. Are such tests and rules subject to a Sunbelt-style attack? Another lesson of Sunbelt is the need to stay on top of the law in this area. For example, there are bills pending in the Massachusetts legislature which would significantly alter the legal rules for restrictive covenants in that state and make the enforcement of such agreements more difficult. In contrast, in the November 2010 general election in Georgia, voters will decide on a proposed amendment to the Georgia Constitution that would make it much easier to enforce restrictive covenants.

The bottom line is that any court that follows Sunbelt is much more likely to enforce a restrictive covenant, because that case eliminates one of the main tools used to invalidate such agreements in Illinois. If other Illinois appellate courts or the Illinois Supreme Court follow this precedent, Illinois will change from a state traditionally somewhat hostile to restrictive covenants to a state that is much more accepting of them.

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A federal judge in Illinois recently held that a contractual requirement that a professional race car driver pay post-employment royalties to his former employer is unenforceable.

The case arose from a colorful set of facts. Specifically, a young race car driver who the judge described as “not educated or skilled in any profession other than racing,” signed an agreement with his then employer (a racing team) providing that for ten years after he stopped driving for that team, he was to pay royalties to that team of 25% of his future race-related earnings. After he stopped racing for the team, the driver challenged the enforceability of the royalty provision, arguing, among other things, that it was an unenforceable post-employment restraint of trade. In contrast, the team argued that the royalty provision did not constitute an activity restriction and therefore was not a restraint of trade.

Addressing what is apparently a question of first impression under Illinois law, the court held that even though the royalty provision did not expressly restrict the driver’s post-employment activities, because it constituted “a sufficient penalty,” it should be analyzed as though it was a covenant not to compete. The court therefore applied Illinois’ analytical framework for no-competes and concluded that the royalty provision was unenforceable. As a threshold matter, the court held that the team did not establish that it had a legitimate protectable interest sufficient to justify the post-employment restriction (i.e., the protection of “near permanent” customer relationships or trade secrets or other confidential information). Thus, the team’s position could not even make it over the starting line. Alternatively, the court held that even if the team had a legitimate protectable interest, the royalty provision would still be unenforceable because its 10-year term was too long and because it lacked a geographic restriction.
 

It is well-established Illinois law that “substantial continued employment” is sufficient consideration to support a post-employment restrictive covenant signed by an existing employee. The issue, however, has been what constitutes “substantial continued employment.” Courts have held that continued employment of only seven months is not sufficient consideration, but that continued employment for two years is sufficient.

A federal judge in Chicago recently weighed in on this issue, holding that continued employment for less than one year was not sufficient consideration for a post-employment restrictive covenant. The Court therefore refused to enforce the provision.
 

In January, Massachusetts State Representative William Brownsberger filed a bill which would seek to void any contract that restricts an employee’s ability to search for and obtain another position with a different employer. While this bill has gained some support, it is unclear whether this will resolve the issues regarding non-compete agreements in Massachusetts. The Small Business Association of New England is working with Representative Brownsberger to draft a compromise bill which would limit who can be covered and the duration for which the agreements can last.

With the pending legislation in Massachusetts to do away with non-compete agreements, both sides are struggling to find the solution to the problem. The question is: How can Massachusetts make itself more attractive to the tech community? Is the answer to do away with non-compete agreements or to simply modify them and restrict their duration and scope?

Supporters of the current Massachusetts laws regarding non-compete agreements argue that such agreements foster competitiveness between companies, prevent confidential information from being shared, and protect business relationships which may be hurt when an employee leaves a company. Many large companies believe that non-competes are essential to attracting employees. Such employers argue that non-competes are voluntary in that they are not required by all companies and employees are not required to sign them although refusing to sign may result in a potential employee not being hired.

Opponents of non-competes believe that such agreements are restricting the growth of the tech industry in Massachusetts because they make it more difficult for employees to move between companies, thereby encouraging employees to take positions with larger companies to the detriment of smaller start-ups. Additionally, opponents argue that employees gain more knowledge and experience as they change positions and move from company to company. Further, opponents believe that the elimination of non-competes will make Massachusetts a competitor with Silicon Valley and will encourage the start-up of tech companies in Massachusetts. 

For now, the question still remains: Will the elimination or modification of non-compete agreements in Massachusetts make the state a better, more attractive location for the tech industry and help to boost the economy or will it diminish competitiveness between companies? Public hearings for Representative Brownsberger’s bill are scheduled for sometime this fall, during which we expect these questions and many others to be addressed. We intend to follow the legislation and report on its progress in this blog.
 

Florida law, specifically section 542.335, Florida statutes, generally authorizes courts to enforce non-compete and other post-employment restrictive covenants, provided the agreements are in writing and signed by the employees against whom enforcement is sought, are reasonable in time, area, and line of business, and are supported by one or more legitimate business interests supporting the restrictive covenants.

Section 542.335 is fairly detailed. The statute defines what a reasonable time period is (it depends on the nature of the restrictive covenant), it lists several legitimate business interests, and it even addresses potential defenses. For example, it states that the court "[s]hall not consider any individualized economic or other hardship that might be caused to the person against whom enforcement is sought."

Still, section 542.335 leaves several issues unaddressed, leaving the courts to sort them out. Several of those issues are addressed in a 48 page opinion issued recently by the Eleventh Circuit Court of Appeals in Proudfoot Consulting Co. v. Gordon (11th Cir., July 30, 2009). The Eleventh Circuit affirmed the district court's injunction, but reversed the $1.66 million damages award to the former employer.

Here are some key points to take away from the court's decision:

• Where a non-compete covenant does not contain a geographic limitation, the court can supply a reasonable geographic scope. And where, as here, the employee had been assigned to a territory that included all of North American and Europe, this geographic area is reasonable.

• The court expressed doubt that a broad non-compete agreement that prohibits the former employee from working for a competitor, irrespective of which clients he is serving, would be reasonably necessary to protect an employer's interest in the relationships that the former employee developed with its clients.

• The court also expressed doubt that such a broad non-compete agreement would be reasonably necessary to protect client-specific confidential information, if restrictions that prevent the employee from contacting, or working for, those clients would be sufficient to protect that information.

• On the other hand, the court stated that where an employee has access to confidential business information crucial to the success of the employer's business, the employer has a strong interest in enforcing a covenant not to compete, irrespective of whether the employee improperly retains and uses that information in his new employment. But the court noted that it is unclear under Florida case law precisely when confidential information will justify a broad non-compete covenant. Is it sufficient that the employee be in a position at his new employer to use the former employer's confidential information? Or must the former employer meet the higher burden of proving that disclosure of the confidential information by the employee would be inevitable in the employee's new position? The court declined to answer this question, finding that under the facts of this case, where the employee had actually retained some of his former employer's confidential business information, the potential disclosure of that information to his new employer justified the enforcement of the non-compete covenant.

• It is not necessary that the former employer prove that the employee intentionally breached the restrictive covenants at issue in order to receive injunctive relief. The employee's good faith, reasonable belief that he is not in breach of a restrictive covenant is no defense.

• With respect to damages, the fact that the new employer profits from a breach of its employee's non-compete agreement with his former employer is irrelevant absent a finding that the employee directly caused his former employer to lose profits. "Damages for breach of a non-compete are intended to make the prior employer whole, not to punish employees." Furthermore, "disgorgement of profits earned is not a remedy for breach of contract," especially where the new employer is not even a party to the litigation.
 

Not many lawsuits under the Employee Retirement Income Security Act (“ERISA”) turn on whether an employer legitimately insisted that an employee sign a no-compete agreement in order to receive benefits, but a federal court lawsuit currently pending in Chicago presents that very scenario.

Specifically, in a case brought by a former Bank of America employee against Bank of America and others, Charles Corbisiero alleges that he was lured into continuing to work for Bank of America by a promise of certain allegedly vested bonuses and other benefits, only to be told upon his termination that he could only receive such bonuses and benefits if he signed what Corbisiero describes as “an unconscionable non-compete agreement.” Corbisiero refused to sign, Bank of America refused to pay, and the end result was this rare mix of ERISA and a no-compete.

Bank of America recently moved, successfully, to dismiss Corbisiero’s state law claims (on the grounds that they are preempted by ERISA), but the Court denied Bank of America’s motion to dismiss Corbisiero’s claim that Bank of America is equitably estopped under ERISA from providing the bonuses and benefits at issue.

Although the Court was unwilling to dismiss the equitable estoppel claims at this juncture, it noted in its decision that at the summary judgment stage, Corbisiero will need actual evidence to prove up his allegations.
 

A high-profile no-compete case currently pending in Chicago may turn on whether merely “preparing to compete” constitutes “engaging in” contractually prohibited business activities. The case was brought by Citadel Investment Group LLC against several former employees who left to help start a rival firm. Citadel alleges, among other things, that the former employees are in breach of their no-competes with Citadel.

The former Citadel employees responded to Citadel’s lawsuit by filing a Motion to Dismiss in which they argue that they are not “engaged in” prohibited activities (and therefore not in violation of their no-competes) because their new entity has yet to actually open for business. Their argument is premised on a line of Illinois cases holding that it is not a breach of fiduciary duty for a current employee to prepare to compete with his or her employer, so long as no actual competitive activities are undertaken. The former Citadel employees argue that if it is not a breach of fiduciary duty for a current employee to prepare to compete, then they, too, ought to be able to prepare to compete without being found to have engaged in wrongful competition.

Stay tuned for Citadel’s response.
 

A recent decision illustrates the importance for employers of making sure non-competition agreements are correctly executed by employees.

On June 1, 2009, IBM sought a preliminary injunction in the United States District Court, Southern District of New York, enjoining its former Vice-President of Corporate Development, David L. Johnson, from continuing his employment as Senior Vice President of Strategy at Dell Inc.  On that date, doubt was raised as to whether Johnson’s alleged non-competition agreement with IBM had ever been duly executed, and the Court ordered expedited discovery on the issue and another hearing on June 22, 2009.

At the June 22 hearing, the evidence showed that at the time Johnson was first asked to sign the agreement, he was hoping to be promoted, and so in an effort to extend the time during which he could consider whether to enter into the agreement, Johnson purposefully signed the non-competition agreement not on his own signature block, but on the signature block designated for IBM.  Johnson testified that he believed that doing so would prevent the agreement from becoming valid and would allow him more time to consider whether to commit to the IBM non-compete agreement.

As the Court noted, Johnson’s “gambit appears to have worked just as he envisioned.”  Although IBM argued to the Court that the non-competition was valid, on numerous occasions IBM had sought to have Johnson properly sign the agreement, indicating that IBM did not actually consider the incorrectly signed agreement to be valid. Moreover, with respect to Johnson’s incorrectly signed document, IBM had not followed its usual protocols of sending it to an IBM representative for signature or retaining an original copy of the document in its files.

In view of the evidence, the Court found that IBM could not show a likelihood of success on the merits of its breach of contract claim.  The Court also found that the balance of equities favored Johnson, and it denied the preliminary injunctive relief sought by IBM.

A lesson for employers from this decision is that no ambiguity should be accepted as to whether the employee has assented to a restrictive covenant.  Particularly given the public policy of New York and other jurisdictions disfavoring non-competition agreements, when it is time to seek enforcement of such an agreement, the employer must be able to show that the employee unequivocally agreed to its terms.
 

A recent article in Lawyer USA discusses how litigation over noncompetition and nonsolicitation agreements has been on the rise in recent years. Currently, when employers’ most valuable assets are their people and ideas, and the spread of technology has lead to increased concerns regarding theft of confidential information, employers have dramatically stepped up their use of noncompetition agreements to limit what departing employees can do.

In recent weeks, we have been following the fascinating case between Massachusetts-based EMC Corp. and Hewlett Packard Co., located in California.  EMC won the first round by stopping a former executive, David Donatelli, who was VP in charge of EMC's Storage Division, from starting his job at HP.  The Massachusetts Court held that to allow Donatelli to work for HP would violate a non-compete agreement he signed at EMC.  The Massachusetts Court enforced the non-compete even though Donatelli had filed an action for declaratory relief in California asking that Court to declare the non-compete unenforceable under California law.  In the Massachusetts action, however, the Judge allowed Donatelli to present additional evidence in a subsequent hearing to demonstrate that his job at HP would have minimal overlap with his former position at EMC.

On May 26, 2009, after hearing additional evidence, the Massachusetts Court modified the preliminary injunction it had issued against Donatelli by allowing him to start working for HP in California.  However, both sides are claiming victory because Donatelli will not be able to take the job he wanted, i.e., Executive VP of StorageWorks, due to the restrictions in the order.  While HP expressed its pleasure with the Court's decision to allow Donatelli to start working at HP as a Senior VP of Enterprise Servers and Networking, EMC stated it was also pleased with the Court's ruling because it upheld "the terms of EMC's key employee agreement."  EMC's statement went on to say that, "The judge entered an order as proposed by EMC that precludes Mr. Donatelli from being engaged in any aspect of HP's business that overlaps or competes with EMC's storage business for a 12-month period."  The case is EMC Corp. v. David A. Donatelli, case number 09-1727-BLS2 in the Suffolk County Superior Court in Massachusetts.

We don't know if the case is over, but for now, it appears that everyone got something of value from the case. The Massachusetts Court issued a narrow order tied to the protectable interest of EMC while at the same time, not depriving Donatelli his opportunity to pursue his livelihood in a competitive business.
 

Last week, we wrote briefly about EMC v. Donatelli, a case that is being litigated simultaneously in California and Massachusetts. On May 4, the Superior Court in Massachusetts ruled that EMC, a Massachusetts corporation, could obtain injunctive relief preventing Mr. Donatelli, who had been President of one of EMC’s major divisions, from starting a job at HP in California even though California has a statutory prohibition on covenants not to compete. The Court made some important findings in its decision which are summarized below.

Choice of Law - The court relied on the language of the agreement that Donatelli signed to find that Massachusetts law applied. Rejecting Donatelli’s argument that California’s fundamental policy against enforcement of non-competes made it futile for EMC to proceed in Massachusetts, the Massachusetts Court stated it “did not agree that California’s legislative policy, at least in this case, is somehow more ‘fundamental’ than, and therefore trumps, Massachusetts’ common law.”

Equitable Considerations - Donatelli also argued that Massachusetts should defer to California’s strong policy of protecting its workers. The Massachusetts Court rejected this argument as well, finding that Donatelli was not a California resident, and therefore not one of its workers. He was still a Massachusetts resident.  The Court also took Donatelli to task for “escaping” the obligations of the non-compete where the expectations of the parties were that he would be bound by it.

Enforceability of Covenant Under Massachusetts Law - The Court dealt with two issues that are of particular interest to practitioners in Massachusetts. The first is whether there was adequate consideration for the covenant even though it was signed 15 years after Donatelli started working at EMC. In ruling in favor of EMC, the Court found that even though the law in Massachusetts on this issue is somewhat unclear, under the facts of this case, continued employment constituted adequate consideration. However, regarding the breadth of the covenant, the Court allowed Donatelli to supplement the record to demonstrate that the covenant was broader than necessary to protect EMC’s interests.

The ball is now in the California Court. The Massachusetts Court was clear in ruling that California’s law against enforcement of non-competes did not trump Massachusetts’ common law in enforcing them, at least with respect to Massachusetts residents who move to California to escape the obligations of a Massachusetts non-compete. We will continue to follow this case as it no doubt progresses through the courts.
 

An executive’s resignation and intention to begin work for a competitor of his former employer has resulted in a bicoastal battle of lawsuits over the terms of a noncompete clause in his employment agreement.

On April 27, 2009, David Donatelli resigned his position as president of EMC Corp.’s storage division. That same day, Donatelli filed a lawsuit in California state court asking for a declaratory judgment voiding the noncompete clause in his employment agreement with EMC Corp. Donatelli’s attorneys are no doubt cognizant of California law’s hostility to noncompete clauses and sought to establish jurisdiction where the chances of enforcement of the noncompete are minimal. Donatelli intended to begin working at Hewlett Packard on May 5, 2009.

Placing a close second in the proverbial race to the courthouse, on April 28, 2009, EMC Corp. filed a suit in the Superior Court, Suffolk County, Massachusetts, alleging that Donatelli violated the noncompete in his employment agreement. EMC Corp. quickly moved for preliminary injunctive relief, and on May 4, 2009, Judge Stephen E. Neel issued a temporary injunction preventing Donatelli from starting his new position at Hewlett Packard as planned, pending a full hearing, noting: “Donatelli’s intention to work for HP in California, which has a statutory prohibition on covenants not to compete, does not warrant denial of EMC’s request for injunctive relief.”

It will be interesting to see if the California court renders a decision prior to the hearing in the Massachusetts court, and whether one court will defer to the other.
 

States vary widely in their willingness to enforce noncompetition agreements. Some states, such as California, are openly hostile and will not enforce them, while others will do so so, subject to varying degrees of judicial scrutiny.

My home state of Illinois, for example, will enforce a noncompetition agreement, but only after fairly rigorous judicial scrutiny. Notwithstanding such scrutiny, Illinois employers can draft enforceable noncompetition agreements. The attached article that I published in the April 2009 Illinois Bar Journal offers practical guidance on how to do so.
 

Employers across all sectors of industry rely on narrowly tailored employment agreements to prevent employees from unfairly competing and stealing clients and customers post-employment. Last week, the adult nightclub chain, Penthouse Club, filed a suit seeking a temporary restraining order and other injunctive relief against a former director for violating a noncompete and nondisclosure agreement.

Penthouse claims that after the former director was fired for cause, he became employed at a rival nightclub not far from the Penthouse Club. Such mere employment allegedly directly violated the terms of his noncompete agreement. Penthouse also alleges that he is now using his contacts and intimate knowledge of Penthouse’s customers and employees to bring business to his new employer. As a result of his high-level position, which included access to the club’s VIP room where members pay a $2,500 fee to join and then a $1,000 fee each year, the former director obtained extensive knowledge concerning the real names of members and exotic dancers who worked there. Penthouse is relying on the “inevitable disclosure” theory to assert that it would be inevitable that the former director would use his knowledge of clients and employees to his and his new employer’s competitive advantage.

The agreement that the former director signed in 2004 contained restrictive covenants including a noncompete, nondisclosure, and nonsolicitation provisions. Penthouse is relying on the unique nature of its business, and, in particular, the fact that its exotic dancers and entertainers specifically attract particular customers, in order to establish its legitimate business interests and the competitive disadvantage that the former director’s solicitations could cause to Penthouse.

Penthouse attempted to resolve the dispute informally through a cease and desist letter but ultimately filed suit in federal court in Illinois seeking an injunction and monetary damages in excess of $75,000.
 

I recently reported on a decision of Florida’s Fourth District Court of Appeal in which the appellate court reversed the issuance of an ex parte temporary injunction because the order failed to specify why it was granted without notice to the other party.

In a recent case, Florida’s Third District Court of Appeal ("DCA") reversed the issuance of a temporary injunction for a similar reason: it failed to specify with reasonable particularity the conduct being enjoined. The case is Angelino v. Santa Barbara Enterprises, LLC, Case No. 3D08-1066 (Fla. 3d DCA, February 18, 2009).

The case involved a business dispute between the appellant, Sabrina Angelino, and Santa Barbara Enterprises, LLC, each of whom owned a fifty percent interest in Starbridge Networks, LLC, which sells telecommunications products and related technical services. Santa Barbara alleged that Angelino and her husband set up two competing companies, SILA Networks, LLC and SILA Networks, C.A., through which they usurped business opportunities that belonged to Starbridge Networks. Santa Barbara also alleged that Angelino interfered with Starbridge Networks' relationships with its customers and suppliers.

In its order, the trial court found that Angelino, through SILA Networks, competed and interfered with Starbridge Networks' business relationships in Venezuela. The trial court therefore enjoined Angelino, both individually and as an employee of SILA Networks LLC, her agents, servants, employees and attorneys from: (a) competing against Starbridge Networks; (b) usurping Starbridge Networks' business opportunities, customers and suppliers; (c) using Starbridge Networks' proprietary information and technology; and (d) interfering with Starbridge Network's relationships with its customers and suppliers, including through the use of derogatory comments about Starbridge Networks, its officers, managers or employees.

The trial court also imposed a constructive trust. The trust encompassed any purchase orders, contracts or other business that Angelino, her agents, servants, employees and attorneys, may have obtained from Starbridge Networks' customers.

The Third DCA reversed both the injunction and the imposition of a constructive trust. Citing the Fifth DCA's decision in Clark v. Allied Assocs., Inc., 477 So. 2d 656, 657 (Fla. 5th DCA 1985), the court noted:

The trial court enjoined Angelino from competing against Starbridge Networks. But there is no mention of any acts that may be considered competitive in nature. The trial court enjoined Angelino from usurping Starbridge Networks' business opportunities, customers, and suppliers. There is no mention, however, of any customers and suppliers with whom Angelino may not compete. The trial court also enjoined Angelino from the use of Starbridge Networks' proprietary information and technology. There is no mention of any specifics upon which Angelino can rely to determine what information and technology he cannot use. This type of vague language is precisely the type that the district court contemplated in Clark, and we cannot uphold to support the entry of a temporary injunction.

The portion of the temporary injunction in which the trial court imposed a constructive trust is likewise overly broad. The trial court failed to mention with sufficient particularity “what purchase orders, contracts, or other business” Angelino is obligated to hold in a constructive trust. Angelino is left in doubt as to what he is required to do to comply with the trial court's directives. This portion of the injunction is thus defective.

The takeaway from this court is clear. When drafting a proposed temporary injunction order, attorneys should use precise language that makes it abundantly clear what the other side can and cannot do. Trial judges in the state court system are extremely busy, and they may not be inclined to tailor language to the specific facts of the case. But that is what is required to avoid the reversal of the injunction on appeal. The Fifth DCA's advice in Clark is worth reciting here:

An injunctive order should never be broader than is necessary to secure the injured party, without injustice to the adversary, relief warranted by the circumstances of the particular case. The order should be adequately particularized, especially where some activities may be permissible and proper. Such an order should be confined within reasonable limitations and phrased in such language that its requirements can be met, without resert to portions of the record or facts outside the ‘four corners' of the injunction itself. One against whom an injunction is directed should not be left in doubt as to what he is required to do.

Clark, 477 So.2d at 477-78.
 

As the enforcement of non-competition agreements becomes more crucial than ever, some employers are including provisions that require or promise payments to the former employees during the post-employment period of non-competition. If properly crafted, such a payment may act as the additional consideration needed for the promise not to compete and may dissipate the former employee's argument of undue hardship during the non-competition period. Employers promising to make such payments must be prepared to follow through with their promises, as the Eighth Circuit recently held.

On February 25, 2009, the Eighth Circuit upheld a district court's decision to award Roger Bannister, a former Director of Technical and Product Development for Bemis Company, Inc. ("Bemis"), nine months worth of his salary, based on a promise in his non-competition agreement. See Bannister v. Bemis Company, Inc., No. 08-1634 (8th Cir. Feb. 25, 2009).

The Agreement

Bannister had worked at Bemis since 1990 and signed a Confidentiality and Non-Competitive Agreement in 2000 which prevented him from, among things, working for a competitor for 18 months following the termination of his employment. The agreement further provided that in the event that his employment with Bemis terminated, and Bannister "was unable to obtain employment consistent with [his] abilities and education solely because of the [non-competition provisions]" such provisions continued to bind him only as Bemis, in its sole discretion, made payments to him equal to his monthly base salary at the time of his termination. In order to receive such payments, the agreement provided that Bannister needed to provide Bemis with a detailed written account of his "good faith and aggressive effort[s]" to obtain employment and a sworn statement that, although he had made a good faith effort, the non-compete was the sole reason for his unemployment.

Bannister Wished to Work for a Competitor

In early 2004, Bannister informed, Bemis, his then current employer that he wished to be released from his non-compete obligations to accept employment with a competitor, Mondi Packaging ("Mondi"). Bemis refused to provide him with permission to do so. Thereafter, Mondi and Bemis were involved in a litigation arising out of Mondi's hiring of Bemis employees. The case was settled. Pursuant to the settlement, Mondi agreed to a 18 month no-poach of employees subject to noncompetition agreements. In December, Bemis offered Bannister a severance package of $40,000 and a release from the non-compete provisions other than for Mondi. Bannister declined the offer and was terminated in January 2005.

In February, Bannister sought payment pursuant to the agreement because of his unemployment. He told Bemis that he had been told by Mondi that it wished to hire him but could not do so because of his noncompetition agreement. He also sent a job contacts log to Bemis as support for his payment request. Thereafter, Bannister was informed that he was released from his non-competition obligation as to all companies, other than Mondi. Bemis took the position that the former employee could not work for Mondi because of the no-poach agreement between the two companies. Bannister remained unemployed for nine months and sought pay for that period of unemployment

The Court's Decision

The Eight Circuit found that the non-competition agreement was unambiguous and clearly provided the company with discretion as to whether to enforce the noncompetition provisions by paying the monthly salary during the unemployment period. As the company refused to provide a full release from the non-compete (and tried to prevent him from working for Mondi), the company was required to pay when Bannister provided proper documentation. The Court found that the clearly written contract did not provide for a partial release -- only a full one. Thus, the company did not have the option to only offer a partial release from the non-competition agreement and try to enforce the remainder of it. The fact that Mondi and Bemis had separately negotiated a no-poach agreement was on no consequence because it only applied to individuals subject to non-competition agreements and it was in Bemis' discretion whether to enforce the former employee's agreement. Consequently, Bemis was ordered to pay over $80,000 to the former employee.

The Bottom Line

For all employers - whether or not they are within the Eighth Circuit - this case stands as a reminder to only promise what you are prepared to do and make efforts to comply with the terms of the contract. While this case involved a clear agreement, in instances of ambiguity, such questions are decided against the drafter. Thus, employers considering whether to include a provision to pay during a non-compete must keep in mind that if they do so, they will need to follow through on their promises of payment.
 

When a former employee is in violation of a non-compete agreement, the former employer often files suit not just against the former employee for breach of contract, but also against the new employer for tortious interference. Under Florida law, the elements of a tortious interference claim are as follows:

(1) the existence of a business relationship; (2) knowledge of the relationship on the part of the defendant; (3) an intentional and unjustified interference with the relationship by the
defendant; and (4) damages to the plaintiff as a result of the breach of the relationship.

The Second District Court of Appeals' recent decision in Fiberglass Coatings v. Interstate Chemical, Inc., Case No. 2D-08-1847 (Fla. 2d DCA, February 27, 2009), illustrates an interesting defense to a tortious interference claim.

Fiberglass Coatings, Inc. (FCI) had a non-compete agreement with its salesman Robert Hutchens. Hutchens left FCI to work for a competitor, Polymeric. Hutchens left Polymeric after a short time to work for another competitor of FCI's, Interstate Chemical, Inc. While at Interstate, Hutchens allegedly solicited FCI's customers. FCI filed suit against Interstate for tortious interference. On a motion for summary judgment, Interstate argued that FCI could not meet the causation element of its tortious interference claim because Hutchens was predisposed to breaching his non-compete agreement, as evidenced by Hutchens' employment with Polymeric. The trial court agreed with Interstate, concluding that Interstate did not cause or induce Hutchens to breach his non-compete agreement.

The Second DCA affirmed, citing Florida case law and the Restatement (Second) of Torts:

Causation requires a plaintiff to "prove that the defendant manifested a specific intent to interfere with the business relationship." [Chicago Title Ins. Co. v. Alday-Donalson Title Co. of Fla., Inc. 832 So. 2d 810, 814 (Fla. 2d DCA 2002) (citing Tamiami Trail Tours, Inc. v. Cotton, 463 So. 2d 1126, 1127 (Fla. 1985))]. No liability will attach unless it is established "that the defendant intended to procure a breach of the contract." Id. " 'One does not induce another to commit a breach of contract with a third person under the rule stated in this Section when he merely enters into an agreement with the other with knowledge that the other cannot perform both it and his contract with the third person.' " Martin Petroleum Corp. v. Amerada Hess Corp., 769 So. 2d 1105, 1107 (Fla. 4th DCA 2000) (quoting Restatement (Second) of Torts § 766 cmt. n (1977)). As noted by the Fourth District, Florida follows this section of the Restatement in these circumstances. Id.

Under this prevailing case law, we conclude that the circuit court did not err in granting summary judgment under the "employment" theory of liability set forth in paragraph 29 of the amended complaint. As explained by comment n of the Restatement (Second) of Torts, section 766, Interstate merely entered into an employment agreement with Hutchens knowing that he could not honor his covenant not to compete with FCI and at the same time work for Interstate.

The takeway from this case is that, absent evidence that the new employer induced the former employee to violate his non-compete agreement, merely hiring an employee whom the employer knows to be in violation of a non-compete agreement may not be sufficient to sustain a tortious interference claim under Florida law.

Having said that, it should be noted that the Second DCA did not let Interstate completely off the hook. Because Hutchens had allegedly solicited FCI's customers, the court held that Interstate could be held liable for tortious interference under a "solicitation of customers" theory. In other words, although Interstate may not have crossed the line in hiring Hutchens despite his non-compete agreement, it may have crossed the line by inducing him to solicit FCI's customers in violation of that agreement. The court therefore affirmed in part, and reversed in part, the trial court's summary judgment order.
 

Under Florida law, where an employment contract expires by its terms and the parties continue to perform as before, an implication arises that they have mutually assented to a new contract containing the same provisions as the old.

But this principle does not apply to non-competes and other restrictive covenants contained in employment contracts, as illustrated by a recent decision by the Third District Court of Appeal, Zupnik v. All Florida Paper, Inc., Case No. 3D08-1371 (Fla. 3d DCA, Dec. 31, 2008).

Zupnik had signed a two-year employment contract with All-Florida. The contract provided that "during the Employment Term and within twelve (12) months from the termination of said term, he or she will not directly or indirectly … compete against ALL FLORIDA, within a fifty (50) mile radius of where ALL FLORIDA then engages in business[.]" The contract further provided that "[a]t the expiration of this two (2) year contract, the employee can exercise an option to remain in ALL FLORIDA’S employ as an at-will employee." But the contract did not contain language specifying that the restrictive covenants would continue beyond the two-year term if Zupnik remained an at-will employee after the two-year term expired.

After the expiration of the initial two-year term, Zupnik remained an All Florida employee for an additional two years, but the relationship was not formalized in a written document. Zupnik then formed his own company intending to serve his long-standing customers. All-Florida sued Zupnik and the trial court entered an injunction enforcing the non-competition covenant. The Third DCA reversed. Citing its decision in Sanz v. R.T. Aerospace Corp., 650 So. 2d 1057 (Fla. 3d DCA 1995), the court held that "post-termination restrictions expire upon the termination of an agreement for a specific term, even if an employee remains an at-will employee after the term of the written agreement expires."

For employers, the Zupnik case highlights the importance of drafting non-competes and other restrictive covenants carefully. Where an employment contract is for a specified term (e.g., two years), employers should include language in the contract which provides that the restrictive covenants contained in the contract continue beyond the specified term if the employee remains an at-will employee after the term has expired.
 

A Florida trial court should not have entered a temporary injunction enforcing a non-compete agreement against a former employee on an ex parte basis, i.e., without notice to the employee, according to Florida’s Fourth District Court of Appeals in a recent decision, Bookall v. Sunbelt Rentals, Case No. 08-26291 (Fla. 4th DCA, December 3, 2008).
 
The employer, a company that rents construction equipment, employed the former employee until February 7, 2008, under a written agreement containing a non-compete and non-solicitation provision. Shortly after the employee resigned, he began to work at a competing company. Upon discovering this, the employer sent the former employee a letter advising him of the breach of the agreement. The former employee’s counsel responded that the employee understood and would comply with his obligations under the agreement.

Upon learning that the former employee continued to work for the competitor, the employer filed a verified complaint with supporting affidavits and an ex parte emergency motion for temporary injunction. The motion sought a temporary injunction against the former employee and the competitor based on the noncompete and non-solicitation provisions of the employment agreement. The duty judge assigned to the case entered the temporary injunction.

In its opinion, the Fourth DCA noted that under the Florida Rules of Civil Procedure, a temporary injunction "may be granted without written or oral notice to the adverse party only if: (A) it appears from the specific facts shown by affidavit or verified pleading that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party can be heard in opposition; and (B) the movant's attorney certifies in writing any efforts that have been made to give notice and the reasons why notice should not be required." Furthermore, "[e]very temporary injunction granted without notice . . . shall define the injury, state findings by the court why the injury may be irreparable, and give the reasons why the order was granted without notice if notice was not given." See Fla. R. Civ. P. 1.610(a).

According to the Fourth DCA, the injunction suffered from a "fatal defect": it failed to give the reasons why the order was granted without notice. The court noted that "[t]his deficiency could have been cured if the employer articulated in its complaint or motion reasons why notice should be dispensed with....Unfortunately for the employer, neither the complaint nor the motion cured the deficiency in this case."

One lesson from the Bookall decision is clear: follow the civil procedure rules carefully. The rules are just that - rules - not guidelines or suggestions. The employer's and the court's failure to articulate why the order was granted without notice required a reversal of the injunction order under a plain reading of Rule 1.610(a).

One might surmise that there was no good reason why notice was not given to the former employee. After all, the opinion notes that the former employee was represented by counsel. How hard is it to fax, email and/or call opposing counsel before a hearing, even on an emergency motion?

But perhaps the former employee's counsel was on vacation or otherwise unavailable to receive notice of the hearing. In that case, an ex parte injunction may have been appropriate, and the employer's and the court's failure to state why the order was granted without notice a mere oversight.

However, even where an ex parte injunction is appropriate, employers and their counsel should be aware that it may be short-lived. Under Fla. R. Civ. P. 1.610(d), "[a] party against whom a temporary injunction has been granted may move to dissolve or modify it at any time. If a party moves to dissolve or modify, the motion shall be heard within 5 days after the movant applies for a hearing on the motion." Thus, if a court enters a temporary injunction on an ex parte basis, the employer's counsel should clear his calendar for the next week. The employee is entitled to a file a motion to dissolve and obtain an expedited hearing, and he may stand a good chance of getting the injunction modified or dissolved entirely once he tells his side of the story.