Matthew Savage Aibel

In Acclaim Systems, Inc. v. Infosys, the U.S. Court of Appeals for the Third Circuit recently rejected a claim for tortious interference with a non-compete, because the plaintiff introduced no evidence of actual knowledge that the individuals in question were covered by non-competes.

Infosys, an IT services company, bid on a job from Time Warner Cable (“TWC”) that had been serviced by a competitor, Acclaim. TWC decided to transfer the project over to Infosys, but wanted Infosys to hire four contractors who previously worked with Acclaim on the project.

Infosys acceded to TWC’s request, but first reached out to the contractors to inquire about any possible non-competes in their contracts with Acclaim. One contractor affirmatively stated in an email, “I do not have a non-compete clause with Acclaim.”  That same contractor also represented on an employment application that he did not have any contractual restrictions, including non-compete covenants.  The other three contractors verbally represented that they were not subject to any non-compete agreements, and their subcontractor employer, when asked, also did not inform Infosys of any non-compete.  In fact, all four contractors had non-competes in their contracts with Acclaim.

Acclaim filed suit against Infosys for tortious interference with these non-competes (i.e., intentional interference with contract).  The District Court granted summary judgment to Infosys.

The Court of Appeals found that to have “intent” to harm a contractual relationship, a party must have knowledge of that relationship. Here, the Court found that Infosys did not have knowledge of the non-competes, so it could not have had the intent necessary to commit tortious interference.  Acclaim argued, based on circumstantial evidence and the industry custom of non-competes in IT services, that the existence of the non-competes could be inferred.  Acclaim also argued that by asking the contractors themselves, Infosys did not ask the correct parties and instead should have asked the subcontracting employers.  Acclaim alleged that Infosys conducted a “sham” due diligence process such that it was willfully blind to the existence of the non-competes.

The Court of Appeals found that by asking multiple times about the non-competes, Infosys could not be held to be “willfully blind,” and further found that Acclaim’s arguments regarding asking questions to the wrong party were an improper attempt to imposed a negligence standard of care on an intentional tort.

This case shows that when onboarding employees, companies should exercise due diligence in ascertaining the existence of a possible non-compete. Steps that can be taken as part of such due diligence include having counsel review any existing contracts to which a potential new hire is subject and having potential hires and contractors sign certifications regarding the existence of non-competes or other contractual restrictions on their ability to perform the duties of their proposed new position.

Illinois Capitol BuildingIllinois recently became one of the first states to ban non-compete agreements for low wage workers when it passed the Illinois Freedom to Work Act. The law, which takes effect on January 1, 2017 and applies to agreements signed after that date, bars non-compete agreements for workers who earn the greater of 1) the Federal, State, or local minimum wage or 2) $13.00 an hour.  At present, because the State minimum wage is below $13.00 per hour, $13.00 an hour is the operative figure in Illinois.

While Illinois is one of the first states to enact this type of blanket ban on non-competes based on the employee’s salary status, in other states, including New Jersey and Maryland, legislation based on eligibility for unemployment compensation has been proposed. Moreover, as we have previously blogged, the New York Attorney General has sought to prohibit companies from agreeing to non-competes with low wage workers.  The White House has also weighed in on the issue of non-compete agreements for low wage workers, questioning whether they protect  legitimate business interests or instead merely hamper labor mobility.

In sum, the political winds are clearly blowing against non-compete agreements for low-wage workers. Employers should be wary of attempting to secure stability in their low wage workforce through non-compete agreements and employers in Illinois should review and, if necessary, revise their employment agreements in light of this new law.

Matthew Savage Aibel
Matthew Savage Aibel

On May 6, the White House released a report entitled: “Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses” (the “White House Report”).  This report comes on the heels of the United States Department of Treasury’s Office of Economic Policy releasing a similar report about non-competes in March 2016 (the “Treasury Report”).  While the U.S. economy has recovered since the last recession, the Obama Administration has identified a decline in competition for workers as a structural problem worth tackling in its final months.  The Administration believes that non-competes restrict workers’ ability to move between jobs.  Both reports rely heavily on a study performed by three economics professors and draw on popular news stories to show the potential downsides of non-competes.  While the reports take a largely dim view of non-competes, they do provide some ideas employers should consider when drafting and implementing non-compete agreements and also highlight some of the benefits of non-competes.

Both reports consider protection of trade secrets a “beneficial” use of non-competes, but believe there are very few alternative justifications for non-competes.  This view establishes non-competes as a “problem” in the economy because “[o]nly 24 percent of workers report that they possess trade Secrets.” (White House Report at 4).  The characterization of non-competes, however, may be one instance where a lack of understanding of real world conditions informs the Administration’s view on the subject.  The White House Report does not consider client lists or relationships in its discussion of noncompetes and instead relies only on trade secrets as a legitimate business interest worth protecting; the Treasury Report acknowledges them, but does not afford them any weight.  “For instance, a trade secret involving intellectual property may be the product of expensive investments. If the investment had not been made, none of the benefits of the property would have been realized. By contrast, the client, and their need for a good or service, presumably exist independently of any investment made by the employer.” (Treasury Report at 7n.5).

The problem with this view is that it fails to acknowledge that businesses invest time and money into client relationships.  Those investments deserve a degree of protection, especially from a potentially disloyal employee who might attempt to leave a company and take valuable client relationships with him.  Thus, most non-competes, often in the form of non-solicitation provisions, recognize that for some period of time after the employment ceases the former employee cannot  solicit or service clients of a company.  Courts in many states routinely enforce these types of agreements, while carving out any pre-existing client relationships as falling outside the scope of the employee’s non-compete.  There are incentives for employers to hire individuals if the companies know that workers who they hire and enable to establish client relationships will not be able to steal such clients when they leave.  Thus, non-competes help align incentives between the employer and employee.  Both reports recognize this fact as they acknowledge the strong correlation that non-competes have with increased worker training.  Where an employer is less worried about employees leaving, the employer is incentivized to provide on the job training for employees.

The White House Report identifies other problems with the way non-competes are implemented and employers should consider these factors in their hiring process:  1) workers often do not understand they have signed a non-compete, 2) workers are asked to sign a non-compete only after accepting the job offer, and 3) many firms ask workers to sign unenforceable non-competes. (White House Report 7).  All of these issues are problematic from a legal perspective.  Basic issues of contract law, consideration, modification or a meeting of the minds, could be grounds for an employee to use the legal system to disregard non-compete obligations.  Thus, employers should be cognizant of when and how the issue of non-competes is presented to new employees, and must also consider the jurisdiction in which the company operates when crafting the provision.  Courts in many jurisdictions will not enforce overbroad restrictive covenants.

The White House Report pointed to a turning tide against non-competes, especially for low-wage workers.  Many states have recently passed some sort of prohibition or limits on them, including Hawaii, New Mexico, Oregon and Utah. (White House Report at 7).  Recent news stories have also highlighted when use of a non-compete by an employer seems burdensome and unfair to workers.  As the Obama Administration moves into its final months, the Report mentions that it plans to “convene a group of experts in labor law, economics, government and business to facilitate discussion on non-compete agreements and their consequences.” (White House Report at 3).  In light of this push, companies should evaluate whether their use of non-competes complies with best practices, focusing on the necessity of the clauses in protecting a legitimate business interest.

Restrictive covenant agreements are traditionally governed by state law and thus subject to various jurisdictions’ rules regarding enforceability. They stand on a different footing than most other contracts, in that their enforcement is typically susceptible to a court’s equitable powers, and may not always be enforced as written, if at all. States differ on whether their courts will deny enforcement of a restrictive covenant deemed overbroad as written by the parties or instead modify it to meet the particular state’s standards of enforceability. In those states where such modification is authorized, a court may strike out (or “blue pencil”) certain terms of the covenant and, in a few states, even insert or modify provisions as deemed necessary to validate the covenant (known as “equitable reformation”).

Recent Court Decisions Involving Blue-Penciling

New York courts had traditionally been receptive to blue-penciling an overbroad restrictive covenant. However, in a recent case, the Court of Appeals (New York State’s highest court) emphasized that under New York law, restrictive covenants will not be blue-penciled if there is “coercive use of dominant bargaining power” to achieve their formation.[1]

In Brown & Brown, the Court of Appeals remarked that because the employee was unemployed at the time that she signed the covenant, there were questions over whether that “caused her to feel pressure to sign the agreement rather than risk being unemployed.”[2] The Court of Appeals further noted that a “case-specific analysis” is necessary to determine these surrounding circumstances and found factual issues precluding summary judgment there.

In January 2016, Brown & Brown was applied when a New York Supreme Court, in Aqualife Inc. v. Leibzon, found such unequal bargaining power in the creation of an overbroad restrictive covenant and refused to blue-pencil it, granting instead defendants’ motion to dismiss.[3]

New York is not alone in its judicial philosophy regarding the blue-pencil doctrine. In late October 2015, an Illinois Appellate Court refused to judicially modify overbroad restrictive covenants because the court deemed their deficiencies “too great to permit modification.”[4] Even though that agreement contained a clause allowing for judicial modification, the court refused to do so, explaining that “[i]n determining whether modification is appropriate, the fairness of the restraints contained in the contract is a key consideration.”[5]

At least one other state has taken a dim view lately of a non-compete agreement in which the parties agreed to allow a court to modify any provision deemed overbroad. In Beverage Sys. of the Carolinas, LLC v. Associated Bev. Repair, LLC, the Supreme Court of North Carolina recently refused to modify an overbroad agreement, notwithstanding the agreement containing a clause empowering the court to rewrite the offending provisions.[6] The court determined that such a clause was in violation of the state’s “strict blue-pencil” doctrine, which only allowed for provisions to be stricken and did not allow for any equitable reformation.[7]

While there appears to be a growing hesitancy among courts to blue-pencil or equitably reform agreements that may be overbroad, some recent decisions show that there is still a place for the practice. In Turnell v. CentiMark Corp., the U.S. Court of Appeals for the Seventh Circuit recently applied Pennsylvania law to modify an overly broad agreement.[8] Similar to New York law, the Seventh Circuit initially noted that where “the restrictions are so ‘gratuitous[ly]’ overbroad that they ‘indicate[] an intent to oppress the employee and/or to foster a monopoly,’ a court of equity may refuse to enforce the covenant at all.”[9] But generally, “absent bad faith, Pennsylvania courts do attempt to blue-pencil covenants before refusing enforcement altogether.”[10]

What Employers Should Do Now

  1. As has always been the case, look at the provisions within your restrictive covenants to ensure that they are tied to protecting a legitimate business interest and that their scope is narrowly tailored such that they would not be viewed as oppressive or overreaching.
  2. Consider the interaction between the forum selection clause, the choice-of-law provision, and the covenant itself in terms of what state law might apply to any potential blue-penciling or equitable reformation.
  3. In states that allow for equitable reformation, make sure that the agreement itself indicates that it can be modified by a court.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?

[1] Brown & Brown Inc. v. Johnson, 25 N.Y.3d 364, 371 (2015).

[2] Id. at 372.

[3] Aqualife Inc. v. Leibzon, 2016 N.Y. Misc. LEXIS 6, 2016 NY Slip Op 50002(U), 1, 50 Misc. 3d 1206(A) (N.Y. Sup. Ct. Jan. 5, 2016).

[4] AssuredPartners Inc. v. Schmitt, 2015 IL App. (1st) 141863 (Ill. App. 2015).

[5] Id. at ¶ 51.

[6] Beverage Sys. of the Carolinas, LLC v. Associated Bev. Repair, LLC, 2016 N.C. LEXIS 177, *6 (N.C. Mar. 18, 2016).

[7] Id. at *17.

[8] Turnell v. CentiMark Corp., 796 F. 3d 656, 664 (7th Cir. 2015).

[9] Id. at 663 (citations omitted).

[10] Id.

Matthew Savage Aibel
Matthew Aibel
Anthony J. Laura
Anthony Laura

With remote access technology becoming standard across industries, companies readily engage a multi-state workforce, with many employees residing outside of the employer’s home state.  While an expanded access to talent may be beneficial, one drawback is the ability to enforce restrictive covenants with out of state employees in a consistent manner and in the employer’s home state.  The case of Numeric Analytics, LLC v. McCabe, et al., offers insight into that issue. 2:16-cv-00051-GAM (E.D. Pa. 2/9/16).

Background

Numeric Analytics, a web analytics and marketing consulting company based in Pennsylvania, engaged employees working remotely in various states across the country.  Its President left the company to start a competing business and in the process, recruited four other employees to join her.  All the employees worked remotely in other states and had signed offer letters that included Non-Solicitation Agreements.  Those agreements provided that Pennsylvania law controlled, but lacked any forum-selection provision.  Numeric brought suit in Pennsylvania against its former employees seeking to enforce the Non-Solicitation Agreements and alleging various tort claims as well.

Jurisdiction Analysis

After noting that it did not have general jurisdiction over the non-resident defendants, the court proceeded with a specific jurisdiction analysis.  Numeric alleged that the employees directed their activities to Pennsylvania because they “signed employment contracts with a Pennsylvania company, continuously communicated with a Pennsylvania company about their employment, ran all invoices for the work they performed through Pennsylvania, and were paid by their Pennsylvania employer.” (Id. at 6-7).  Additionally, Numeric presented evidence that the employees needed to contact the Pennsylvania office to resolve payroll, benefits, or other problems throughout the course of their employment; that medical coverage, medical benefits, and retirement plans were administered from Pennsylvania; that each employee’s timekeeping, billing of customers, and email were managed by the Pennsylvania office; and that Numeric paid Defendants’ salaries using a Pennsylvania bank. (Id. at 7).

The court held that all of those factors “are characteristic of a traditional employer-employee relationship, except for location.” (Id.).  The court decided that the claim for breach of the restrictive covenant arose out of and related to the Defendants’ contract, and that exercising specific jurisdiction over them with respect to that claim was fair and reasonable given the circumstances.  The court remarked, however, that the lack of a forum selection clause in the contract made this a much more difficult issue, and that such a clause “would be the preferred method of resolving such ambiguity.” (Id. at 8).  The court declined to exercise specific jurisdiction with respect to all of the tort claims (except for the fiduciary duty and tortious interference claims against the former president), finding that the tortious conduct on those claims was not directed at the forum nor caused sufficient injury in the forum in a manner sufficient to support specific jurisdiction.

Takeaways

As the court sums up: “[I]n a business with its operations and personnel widely distributed across state or even national boundaries, questions of jurisdiction can become significantly more complicated.” (Id. at 2).  One obvious solution to this problem is to have a forum selection clause in all employment agreements, especially those with out-of-state employees.  Such a provision will usually control the analysis and enable a company to seek to enforce the agreements in its preferred locale.   This case should serve as a cautionary tale for employers with remote employees and should remind all legal and human resource departments to check on the contracts they currently have with remote employees to ensure they contain forum selection clauses.

A recent case out of Ohio offers an instructive lesson for those looking to probe the geographical limits of a non-compete agreement.  A dentist sold his dental practice and also continued to work as an employee there.  As part of the sale, he agreed not to compete for five years and was prohibited from working “within 30 miles” of the practice.  The relationship between the parties deteriorated and the dentist went to work for a competing firm.  The purchaser dentist filed suit claiming a breach of the non-compete.

The trial court ruled against the seller, noting that although the new practice was more than 30 miles away from the old one when driving, it was less than 30 miles measured by a straight line.  An Ohio appellate court affirmed the trial court’s decision on how to track miles.  The appellate court held that despite the assertion that “within 30 miles” is subject to differing interpretations, Ohio courts have consistently measured the geographical limits as straight lines or “as the crow flies.”  (Ginn v. Stonecreek Dental Care, Ohio Ct. App., CA2015-01-001, 10/26/15).

The prevailing party was awarded $125,000 in damages, plus interest, by a jury.  Additionally, the breaching party had to pay nearly $100,000 in legal fees as a result of the loss.  As is the case in many jurisdictions, in Ohio, damages are typically calculated by measuring lost profits.  This figure can be assessed using historical business data, as it was here, and an expert is not necessary to prove damages for all cases.  In this case, the fact that the seller had worked as an employee for six months prior to breach gave fairly reliable data as to the damage caused as a result of moving to a competitor.

For someone looking to craft a non-compete agreement that uses mileage as a measurement of distance, one should be aware of the way different state courts interpret such language.  It is also worthwhile considering the practical effects of a mileage condition on a non-compete, such that when a practice is sold, a customer is unlikely to leave with the seller.