It is fairly uncommon for a circuit court to opine on the reasonableness of a restrictive covenant. In Ag Spectrum Co. v. Elder, No. 16-3113, 2017 U.S. App. LEXIS 14128 (8th Cir. Aug. 2, 2017), the Eighth Circuit issued a decision holding that an independent contractor’s non-compete was unreasonable and unenforceable.

Applying Iowa law, the Eighth Circuit explained that reasonableness depends on the circumstances, including consideration of several factors such as: (1) the employee’s closeness to customers; (2) the employee’s peculiar knowledge gained through employment that provides a means to pirate the customer; (3) the amount and sophistication of employer-provided training and the nature of the business; and (4) matters of basic fairness. The Court stated that the fundamental goal is to prevent unjust enrichment.

In this case, Ag Spectrum’s 3-year noncompete provision with independent contractor Vaughn Elder was unreasonable for three reasons:

First, it was not reasonably necessary to protect Ag Spectrum’s business (selling fertilizer, nutrients and crop-management services). Essentially, like any ordinary reseller, Elder purchased Ag Spectrum product and sold it at a markup. Ag Spectrum did not offer any special training and support, and Elder’s knowledge of Ag Spectrum’s product did not give him an advantage after he left his arrangement with the company. Importantly, as an independent contractor, Elder made and developed his own contacts.   In such a situation, the noncompete allowed Ag Spectrum not to protect a proprietary customer base, but instead to capture customers that Elder himself had provided.

Second, the provision burdened Elder out of proportion to the benefit to Ag Spectrum because enforcing the provision would have required him to rebuild his customer base from scratch. Although Elder conceivably could have sold noncompeting products to his same customers or sold competing products to new customers, such a workaround would have been unreasonable given how little protectable benefit Ag Spectrum had in the parties’ independent-contractor relationship.

Finally, there was no evidence that restricting Elder’s business would harm the public.

Accordingly, the Eighth Circuit held that requiring Elder to forsake the customers that he had brought to Ag Spectrum as an independent contractor would be unreasonable under the circumstances, and thus the noncompete was unenforceable.

It is rare that a trade secret / restrictive covenant lawsuit makes it all the way to trial, much less a jury verdict. The passage of time, accumulating legal expenses, bad facts, and/or the risk of losing at trial all can conspire to sap litigants of the desire to take their cases to the finish line.  Settlements and withdrawals of claims abound.  Sometimes, however, the parties dig in and roll the dice in court, as recently occurred in a case in the Southern District of New York.

On November 29, 2016, after more than 10 days of trial, a jury delivered a verdict in favor of the plaintiff Tesla Wall Systems LLC (“Tesla Wall,” an architecture and construction company) against its former president Michael Budd, and awarded $14.5 million in damages.  Budd had been president of Tesla Wall for less than two years when he resigned in 2014.  He was subject to contractual provisions prohibiting him post-employment from interfering with any of Tesla Wall’s actual or potential business relationships for six months and from soliciting any Tesla Wall employee for nine months.

Tesla Wall alleged that while president of Tesla Wall and thereafter, Budd secretly organized a competing curtain wall company (based on Tesla Wall’s business plan for future operations); negotiated the purchase of land in Pennsylvania, various investments and tax credits for the new company’s manufacturing facility; and hired all of Tesla Wall’s employees to work for the new venture. Pursuing claims of breach of contract, breach of fiduciary duty, and violation of the Delaware Uniform Trade Secrets Act, among others, Tesla Wall was awarded $14.5 million in damages against Budd.

Although the publicly available record does not reveal the calculations which underlie this award, the jury’s verdict is a reminder of what can be achieved by an aggrieved employer in the trade secrets/restrictive covenants arena, when the facts are favorable and the employer sees the lawsuit to its conclusion.

Employers seeking to require an existing employee to sign a restrictive covenant should consider current litigation trends surrounding what constitutes “adequate consideration.” Under the traditional rule followed by a majority of states, continued employment, standing alone, is adequate consideration for a restrictive covenant signed by an at-will employee. Several courts, however, have recently reexamined this issue, so employers must be aware of differences among the states as to whether some consideration beyond mere continued at-will employment is required.

Fifield v. Premier Dealer Services, Inc.

For example, the Illinois Appellate Court held in Fifield v. Premier Dealer Services, Inc.,[1] that, absent other consideration, at least two years of continued employment are required to constitute adequate consideration for a restrictive covenant. Under Fifield, the two-year rule applies regardless of whether the employee signed the restrictive covenant as a new or existing employee and regardless of whether the employee voluntarily resigned or was fired.

Although Fifield has been followed in subsequent Illinois state appellate decisions,[2] multiple federal district courts in Illinois have refused to apply Fifield’s bright line, two-year rule. For example, last month, the U.S. District Court for the Northern District of Illinois concluded that the Illinois Supreme Court, which has not yet ruled on the issue, “would reject a two year bright-line rule in favor of a fact specific test.”[3] Therefore, while “[t]wo years may be sufficient to find adequate consideration,” “it is not always necessary,” particularly when considering other factors, like compensation, raises and bonuses, and the terms of the employee’s termination.[4]

Differing State Rules

Since Fifield, other state courts have similarly grappled with the issue of what constitutes adequate consideration for a restrictive covenant. Kentucky, North Carolina, and Pennsylvania courts each have issued decisions requiring some consideration beyond mere continued employment to enforce a non-compete.[5]

In contrast, the Wisconsin Supreme Court recently held in Runzheimer Int’l, Ltd. v. Friedlen,[6] that employers may require existing at-will employees to sign non-compete agreements without offering additional consideration beyond continued employment, although the court did not provide clear guidance as to the period of time that the employment must continue after the non-compete is signed.

Courts in New York and New Jersey have been relatively consistent regarding the required consideration for a restrictive covenant. Both states consider continued employment to constitute adequate consideration for a restrictive covenant signed by a current employee, provided that the employer forbears from discharging the employee for a “substantial” period of time.[7]

What Employers Should Do Now

In light of this judicial focus on appropriate consideration and given the number of states that have recently addressed adequacy of consideration, employers nationwide should monitor this issue—even in states where the law is currently stable.

In terms of addressing this issue, employers should consider these options:

  1. Where there is a plausible nexus to a state with more favorable laws regarding the enforceability of restrictive covenants, include a choice-of-law provision designating the law of that state (e.g., the state where the employer’s headquarters is located or where the employee actually works). Courts generally enforce contractual choice-of-law provisions unless they violate the fundamental public policy of a state with a materially greater interest in the situation or where the parties and contract do not have a substantial relationship with the chosen state.
  2. Provide consideration in addition to an offer of employment or continued employment. Examples of such possible “additional consideration” include a cash payment, stock options, training, education, a raise, additional paid time off, guaranteed severance, or a promotion. In the absence of judicial guidance, it would be prudent to be as generous as possible and to provide consideration that is more than de minimis. Regardless of the “additional consideration” ultimately decided upon, the restrictive covenant itself should both explicitly recite the consideration provided to the employee for signing it and further provide that the employee acknowledges the consideration and its adequacy.
  3. Agree to continue the employee’s salary during any restricted period, thereby alleviating concern about consideration being illusory.
  4. Consider trying to evade consideration concerns entirely by having employees agree to a “garden leave” or “required notice” clause, rather than a traditional non-compete or non-solicit clause. Under such a provision, an employee is required to give advance notice of his or her resignation (e.g., 30 – 90 days) and, during the notice period, the employee remains on your payroll and owes you a fiduciary duty of loyalty (and therefore cannot work for a competitor during that period). Because the employee remains on the payroll and because garden leave provisions tend to be shorter in duration than traditional restrictive covenants, they are less onerous to the individual and thus more likely to be enforced.

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

[1] Fifield v. Premier Dealer Services, Inc., 2013 IL App. (1st) 120327.

[2] See, e.g., Prairie Rheumatology Assocs., S.C. v. Francis, 2014 IL App. (3d) 140338; McInnis v. OAG Motorcycle Ventures, Inc., 2015 IL App. (1st) 142644).

[3] R.J. O’Brien & Assocs., LLC v. Williamson, No. 14 C 2715, 2016 U.S. Dist. LEXIS 32350, at *7 (N.D. Ill. Mar. 10, 2016).

[4] Id. at *7-9.

[5] See, e.g., Charles T. Creech, Inc. v. Brown, 433 S.W.3d 345 (Ky. 2014) (mere continued at-will employment does not constitute adequate consideration); Emp’t Staffing Grp., Inc. v. Little, 777 S.E.2d 309, 314 (N.C. App. 2015) (upholding as adequate a $100 payment made to defendant in conjunction with signing a mid-employment non-compete); and Socko v. Mid-Atl. Sys. of CPA, Inc., 126 A.3d 1266, 1275 (Pa. 2015) (an existing employee must receive some “new” and valuable consideration in exchange for signing a mid-employment non-compete agreement, even where the employee expressly “inten[ded] to be legally bound” by the agreement).

[6] Runzheimer Int’l, Ltd. v. Friedlen, 2015 WI 45 (Wis. 2015).

[7] See Int’l Paper Co. v. Suwyn, 951 F. Supp. 445, 448 (S.D.N.Y. 1997) (under New York law, continued employment for a “substantial period” following the execution of the agreement is sufficient consideration for a restrictive covenant); Hogan v. Bergen Brunswig Corp., 153 N.J. Super. 37, 43 (Super. Ct. App. Div. 1977) (continued employment is sufficient consideration to support a restrictive covenant found in an original or post-employment contract).

Readers of this blog know that long settled understandings regarding what constitutes adequate consideration for a restrictive covenant in Illinois were turned upside down when the First District Appellate Court in Illinois held in Fifield v. Premier Dealer Services Inc., 2013 IL App. (1st) 120327 that, absent other consideration, two years of employment are required for a restrictive covenant to be supported by adequate consideration, regardless of whether the covenant was signed at the outset of employment or after, and regardless of whether the employee quit or was fired.

The Illinois Supreme Court declined to hear Fifield, but at least three federal district court judges in Illinois have refused to apply Fifield.

Just recently, another federal district court judge in Illinois also refused to apply Fifield.  This time it was Judge Robert M. Dow, Jr., who held in Traffic Tech, Inc. v. Kreiter, Case No. 14-CV-7528 (N.D. Ill. Dec. 18, 2015), that the “Illinois Supreme Court is not likely to adopt a two-year, bright line rule in assessing whether an employee was employed for a ‘substantial period of time’ so as to establish adequate consideration to support a post-employment restrictive covenant.”   The essence of Judge Dow’s ruling is that Fifield is a mis-reading of Illinois law, and that “Illinois law does not require a strict application of the two-year rule in assessing the enforceability of a non-solicitation clause (or any similar restrictive covenant).”

Because the case was before him on a motion to dismiss, Judge Dow did not ultimately rule on whether the defendant had received adequate consideration.

Given the split between the Illinois appellate court and at least four Illinois federal district court judges over the merits of Fifield, this will remain a hot issue for Illinois employers.   Unless and until the Illinois Supreme Court weighs in, Illinois employers hoping to enforce a restrictive covenant within two years after the signing date should be prepared to distinguish Fifield factually or legally.

One of the top stories on Employment Law This Week – Epstein Becker Green’s new video program – is about a bad leaver and the hefty price he had to pay.

A former VP of Fortinet, Inc., must pay nearly $1.7 million to the company, after poaching three of his subordinates when he left his job for a competitor. The former VP joked in an email that the employees he took with him were “three bullets to the back of the head” of his former employer. In the arbitration, a former California state judge ruled that the employee had breached his fiduciary duty and his contractual obligations not to recruit employees of the company for a year after he left.

See below to view the episode (the story starts circa 1:30) and read our own Peter Altieri’s blog post about this decision.

A couple years ago, the Illinois First District Appellate Court decided the case of Fifield v. Premier Dealer Services, 2013 IL App. 120327.  There, the Court held that, absent other consideration, two years of employment are required to constitute adequate consideration for a restrictive covenant, regardless of whether the covenant was signed at the outset of employment or after, and regardless of whether the employee quit or was fired.  Since then, some Judges in the United States District Court for the Northern District of Illinois have applied Fifield, and others have declined to do so.

Earlier this week, the United States Court of Appeals for the Seventh Circuit issued its first opinion reviewing a decision in which the District Court applied, or refused to apply, FifieldInstant Technology LLC v. DeFazio, (Case Nos. 14-2132 & 14-2243).  In the District Court, Judge Holderman applied FifieldIn its opinion, however, the Seventh Circuit simply reviewed the District Court’s factual determinations, determined that they were not clearly erroneous, and did not discuss Fifield or its application by the District Court at all.  The Court did, though, spend some time discussing an anti-raiding clause that was also at issue.  The Seventh Circuit explained that, because Instant Technology had such high workforce turnover (77% of the people who worked there two years before the trial left in the interim), it could not argue that its interest in maintaining the stability of its workforce was a legitimate business interest sufficient to support an anti-raiding clause that prohibited former employees from soliciting Instant Technology employees to join competing companies.

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.

In a decision, dated January 26, 2009, in the matter Epiq Systems, Inc. v. Hartie, Index No. 111950/08, the Supreme Court of the State of New York, New York County, by Judicial Hearing Officer (and retired Justice) Ira Gammerman, denied a preliminary injunction in aid of arbitration sought by plaintiffs Epiq Systems, Inc. and related companies (collectively, “Epiq”). Epiq claimed that it faced inevitable disclosure of its trade secrets by three individual defendants formerly employed at Epiq and their new employer Kurtzman Carson Consultants LLC (“KCC”) with respect to three computer programs, including one web-based system, developed and used by Epiq to solicit ballots and tabulate ballot results in Chapter 11 bankruptcy proceedings, and in analogous foreign proceedings, involving widely-held public securities.

Epiq sought to enforce restrictive covenants in its employment agreements, which barred the individual defendants from disclosing Epiq’s confidential, proprietary or trade secret information, competing against Epiq or soliciting Epiq’s customers for one year after termination, and soliciting Epiq’s employees during employment and for one year after termination. After a two-day hearing in September 2008, the Court entered a temporary restraining order specifically limiting, although not prohibiting, the individuals’ employment with KCC.

Although the Court held that any arbitration award to which Epiq might ultimately be entitled apparently would be rendered ineffectual absent preliminary relief, it declined to issue a preliminary injunction against defendants, finding that Epiq had not satisfied any of the elements of the traditional tripartite test for injunctive relief: likelihood of success on the merits, showing of irreparable harm, and balance of equities favoring the movant.

Key findings for the Court were that the individual defendants did not know any part of the source code or the underlying algorithms of Epiq’s programs, even though they had worked at length with Epiq’s programmers, and so they could not disclose such information to KCC. In addition, KCC already had its own software program that allowed KCC to perform bankruptcy-related solicitation and tabulating projects in-house. Moreover, the Court held that even if the defendants would seek to improve KCC’s software, their knowledge brought to bear on such a project would not constitute a trade secret under the definition of trade secret under section 757, comment b, of the Restatement of Torts, which applies under New York law. In finding a lack of irreparable harm, the Court also noted that it had been presented with no real evidence that defendants had committed or were about to commit commercial piracy.

Epiq filed a notice of appeal on February 11, 2009.