Some Thoughts As the Year Concludes

Unlike 2008, this year was not particularly interesting for notable developments in non-compete law. IBM got involved in another high-profile dispute, and this time it lost, while Illinois courts have reached an irreconcilable conflict among various districts that will require the Supreme Court (or General Assembly) to step in at some point. Aside from that...well, not much of any real interest or consequence.

I review each reported case throughout the United States, and I still come to the same conclusion. Courts will be inclined to enforce non-compete agreements if any of the following three factors are present: (1) misappropriation or a physical taking of corporate information; (2) direct solicitation of key accounts right after departure; or (3) acts of pretermination competitive activity, deceit or dishonesty in the months leading up to resignation.

How to defend a potential non-compete claim, or avoid it altogether? This is never an easy question, and as a practice, I won't give absolutes to clients when they seek my bottom-line advice. However, I can describe some general parameters and place likelihood of success on a clear continuum. In order, my advice is as follows: (1) find a defect in contract formation; (2) demonstrate the post-termination activity falls outside the non-compete; (3) show the agreement is unreasonable in scope; (4) argue it does not protect any legitimate business interest; or (5) rely on equitable factors or an affirmative defense, such as release, estoppel, involuntary termination, or prior breach. The first two strategies are based on a finding that there was no breach in the first place, where as the other three ask the court to excuse it.

In my own practice this year, I have seen fewer non-compete disputes ripen into actual lawsuits, though the threats are still (and will always be) there. This is hardly a surprise, given the expense associated with pursuing and defending litigation. On the flip side, I don't recall a year when clients have asked me to draft as many non-compete/non-solicit contracts or audit ones currently in place. Given that a substantial part of my practice involves the review of existing contracts, I am amazed - stunned even - at the way contracts are drafted. On occasion, I will see an agreement that I save for future reference because I feel it is particularly well done.

But what I see most is an inadequate, form document that is not at all tailored to an individual employee or totally divorced from the prevailing law of the jurisdiction which governs it. I also see horribly over-lawyered documents that use language straight out of the 15th century or can't seem to express a basic restriction in less than 10 pages. We're not paid by the word, but apparently some firms still don't realize this. None of this looks good when a judge has to examine the reasonableness of the agreement.

In my judgment, employees have started to take their non-compete obligations more seriously. In the past, I used to get more calls after a dispute began and where I can't assist in directing and making the relevant facts. Now more clients call before embarking on a transition decision.

Employees always must be prepared, too. As Rob Radcliff notes in his outstanding (and aptly named) blog, Smooth Transitions, it is vital employees keep contracts, amendments, policy statements, handbooks and any correspondence mentioning their non-compete agreements. We can't advise you properly without this, and even though employees generally have full rights to review their personnel files, any request to do so will raise an immediate red flag. Most of all, it is critical that employees respect their employers' proprietary data, avoid taking any corporate information (digital or paper), and return anything stored on a portable or personal hard-drive. I can't emphasize this enough. Equities rule in these cases.

Well, that's a wrap. Stick a fork in 2009, it's done. For the more than 20,000 people who have visited my blog this year, who have offered me their e-mails and comments, and especially to the many who have become my clients, I offer my sincere thanks and wishes for a safe New Year!

Employee's Tortious Interference Claim Depends on Validity of Non-Compete Agreement (Hidy Motors v. Sheaffer)

Yesterday, I wrote about the practical difficulty of pursuing employee-side non-compete claims. These almost always arise in the context of a declaratory judgment claim, where an employee seeks a court ruling (or declaration) that a non-compete is void and unenforceable. However, if an ex-employer has taken affirmative steps to interfere with competitive employment - often through a cease and desist letter to the new company - an employee may have a claim in tort for interference with employment expectancy.

A recent case in Ohio confirms that the validity of a tortious interference claim often is tied to the enforceability of the non-compete itself. In Hidy Motors v. Sheaffer, the ex-employee (Sheaffer) accepted a general manager position at an auto dealer in alleged violation of his non-compete clause. His former employer then phoned the new car dealership and informed Sheaffer's boss that his hiring violated a non-compete clause. In response, Sheaffer was fired.

Hidy Motors sued seeking a declaration that the non-compete agreement was enforceable, and Sheaffer countersued. One of his claims was based on tortious interference with employment, given that Hidy Motors' threatening phone call about the non-compete clearly was the proximate cause of his termination. Hidy Motors obtained summary judgment on the tortious interference claim, as the court held that its actions were privileged.

The appellate court reversed, holding that the trial court failed to conduct the requisite analysis into whether the non-compete was valid. According to the appellate court, "the trial court erred in assuming that the covenant not to compete could be relied on as the basis for Hidy's privilege defense to Sheaffer's tortious interference claim." In Ohio, therefore, the defense of privilege depends on the validity or enforceability of the non-compete.

The law in other states is substantially the same. When an employer raises privilege (or justification) as an affirmative defense, courts generally apply a test found in the Restatement of Torts which requires an employer to prove that the interference does not creat or continue an invalid restraint of trade. If a non-compete is unenforceable and overbroad under the law, the employer won't be able to prove the elements of the justification defense. Based on my review of other cases with similar facts, an ex-employer may be liable for punitive damages in certain circumstances, although I doubt a garden-variety case would support such an award. There must be some gratuitous interference, such as when there is no substantial competitive relationship between the two companies.

Avoiding interference claims, though, is rather easy. An employer simply should avoid contacting any prospective employers about an ex-employee's non-compete. It should direct any cease-and-desist letters to the employee only, in which case an interference claim won't stand at all. My good friend, former boss, and mentor, Bill Schaller of Baker & McKenzie, aptly wrote about this issue in his 2001 law review article "Jumping Ship: Legal Issues Relating to Employee Mobility in High Technology Industries." He writes that "[c]ommon sense does not necessarily track common law, and thus caution is important in investigating and litigating these complex, high-speed cases. Complexity and speed present an explosive mix, making it imperative that inside and outside counsel map their strategy as thoroughly and as soon as possible."

Indeed, outside counsel ought to be the voice of restraint and advise corporate clients not to act too rashly in making threats and demands when issues of potential unfair competition arise. Legal counsel can and must serve as a check to ensure that pre-litigation and litigation strategy strikes the appropriate balance between protecting a client's business interests and minimizing unnecessary risk.

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Court: Court of Appeals of Ohio, Second Appellate District
Opinion Date: 7/31/09
Cite: Hidy Motors, Inc. v. Sheaffer, 916 N.E.2d 1122 (Ohio Ct. App. 2009)
Favors: Employee
Law: Ohio

Legal Precedent Thin on Whether Employee Can Seek Injunctive Relief Preventing Enforcement of Invalid Non-Compete (Frank v. Wesco Distribution)

At least ninety percent of all non-compete disputes start with an employer filing a lawsuit and seeking some form of injunctive relief to prevent a further breach of contract. It is the rare case where an employee initiates a claim against an ex-employer, where the preferred remedy is a declaration that the non-compete is invalid.

The employee-side claim can arise in a number of situations. Perhaps an employee's non-compete concerns a forfeiture-for-competition covenant, in which the employee needs to determine the validity of an agreement before risking forfeiture of stock options or deferred compensation. In some cases, a non-compete term could be lengthy enough that the litigation won't run its course by the time a non-compete expires. And in other cases, the employee may use the litigation as leverage to effectuate a settlement on less restrictive terms. But in all of these cases, the relief available to an employee is fairly narrow and does not pose any immediate problem for the defending employer.

I recently litigated a case where I represented an employee who filed a declaratory judgment claim seeking to have his non-compete invalidated on grounds of overbreadth. After four lengthy months, we prevailed and my client was able to take the job that - mercifully- had not been filled while the litigation was pending. For (mostly) tactical reasons, though, we initially aimed for another remedy - a preliminary injunction prohibiting the employer from attempting to enforce the non-compete agreement or interfere with any prospective job opportunities through threats of enforcement.

The trial judge denied my emergency petition, not on the grounds that such relief was automatically unavailable but rather on practicality. He did not feel the injunction, if granted, would cause the prospective employer to hire my client. My personal view on this is that the judge may have been correct; I'm still not sure. The issue, though, is not easily resolved.

We as lawyers are not guided by much in the way of precedent on this issue. I have located only four reported decisions approving of an injunction in the scenario I have just described: Brenneman v. NVR, Inc., 2007 U.S. Dist. LEXIS 12761 (S.D. Ohio Feb. 9, 2007), Bryan v. Hall Chemical Co., 993 F. 2d 831 (11th Cir. 1993) (Georgia), Caras v. The American Original Corp., 1987 Del. Ch. LEXIS 467 (Del. Ch. July 31, 1987), and a recent appeal (cite below) in New York, Frank v. Wesco Distribution, Inc. Because so few disputes arise in this procedural posture, I don't expect we'll see cases like Wesco Distribution all that often. But attorneys representing employees should be aware of them nonetheless.

As a practical tip, however, I would recommend that any lawyer seeking preliminary injunctive relief like this clearly define what he or she wants the court to do. Simply asking the court to bar an employer from "enforcing" a non-compete probably is too broad of a request and almost sounds like it is asking for a court to enjoin a future court proceeding (perhaps in a different venue or in a different court system). The better practice, it seems, is to request (in addition to this) that the court prohibit the ex-employer from interfering with a specific job opportunity or from representing to third-parties that an employee is barred from working on account of a non-compete agreement.

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Court: Supreme Court of New York, Appellate Division, First Department
Opinion Date: 12/22/09
Cite: Frank v. Wesco Distribution, Inc., 892 N.Y.S.2d 348 (N.Y. App. Div. 1st Dep't 2009)
Favors: Employee
Law: New York

Disspelling the "Right-to-Work" Myth

Since about one-half my practice involves the representation of employees (rather than companies), I consult frequently with individual clients over the enforceability or applicability of their existing non-compete agreements. The advice I render often times deals with dispelling what I call "Youth Soccer Myths." The conversation usually starts along the lines of the following: "a friend of mine told me at my daughter's soccer game that non-competes were never enforceable." Or some variant.

One myth that I have had to address many times concerns the concept of "right-to-work." Many clients tell me that they don't think a non-compete can be enforced because "I live in a right-to-work state."

It is true that several states (a minority, actually) are "right-to-work", but this simply refers to a person's ability to work regardless of membership status in a labor organization. "Right-to-work" laws are common in the South and West, but rare in the Midwest and Northeast. The notion of "right-to-work" is perhaps an understandable misnomer, given that non-competes are restraints of trade. But whether a state is "right-to-work" or not simply has no bearing on whether non-compete covenants are enforceable in that state.

Discovery Dispute In Trade Secrets Action Symptomatic of Fishing Expedition (IKON Office Solutions v. Konica Minolta)

Trade secrets actions are notorious for creating intractable discovery thickets. The fundamental problem usually revolves around interrelated concepts: the defendant's request to know exactly what trade secrets are at issue, and the plaintiff's need to know what the defendant has. The former automatically implicates grave intellectual property protection concerns, while the latter often is a ruse to obtain more information than really should be at issue.

Very few jurisdictions place the burden on the plaintiff to disclose the precise nature of trade secrets at the outset of the case. California mandates this by statute. Illinois should have, but legislation on this issue stalled while the General Assembly tried to clean up its own act.

In almost every trade secrets suit, the defendant issues initial discovery requests seeking to place some parameters on the case by asking for an identification of what the specific trade secrets are that the defendant is alleged to have misappropriated.

In a dispute between direct competitors in the office equipment business, this tension led to a common discovery log-jam. IKON Office Solutions, the plaintiff in the case, sued Konica Minolta and William Cimler (an ex-IKON employee) under a non-compete and trade secrets misappropriation theory. Not surprisingly, the defense wanted to know what trade secrets were the subject of the complaint.

IKON balked and would not disclose the precise trade secrets at issue, identifying only a broad range of customer information. This is inadequate and abusive, particularly in a case where the crux of the dispute focuses on customer solicitation.

But litigation is a common tactic over this issue, even in cases like the IKON-Konica Minolta case where the employee's non-compete expired prior to the start of litigation and the ex-employer defaults to a trade secrets claim. Not surprisingly, Konica Minolta prevailed in its contentious discovery battle, as the court would not allow IKON to simply identify broad categories of information and to fish for Konica's own confidential business information through vague, abusive written discovery requests. The intent in cases like this is obvious: the plaintiff wants to use the litigation process to unearth for itself who its ex-employee has contacted or solicited.

In a trade secrets action, plaintiffs can and should be required to identify the allegedly misappropriated trade secrets at the outset. It is a mystery why plaintiffs don't use the procedure Judge Milton Shadur approved of years ago and simply move for an order requiring the defendant to turn over any documents or electronically-stored information in his possession so that the Plaintiff can see what he or she has taken. There is nothing wrong with waiting for this to play out prior to disclosure of a trade secrets identification statement. Without some procedural safeguards and active court involvement in discovery, trade secrets claims frequently become an abyss of litigation, bogged down in discovery squabbles where the merits of the lawsuit are tertiary and only sometimes related to one party's desire to fish around for competitor information.

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Court: United States District Court for the Western District of North Carolina
Opinion Date: 11/25/09
Cite: IKON Office Solutions, Inc. v. Konica Minolta Business Solutions, U.S.A., Inc., 2009 U.S. Dist. LEXIS 116372 (W.D.N.C. Nov. 25, 2009)
Favors: Employee
Law: North Carolina, Federal Rules of Civil Procedure

Failure to Identify Company on List of Prohibited Competitors Proves Fatal to Non-Compete Claim (Carrier Vibrating Equip. v. Andritz Separation)

Specificity in a non-compete agreement is certainly viewed by courts more favorably than vague, overbroad restrictions. However, it can create enforcement problems.

In Carrier Vibrating Equipment v. Andritz Separation, a district court in Kentucky granted an ex-employee and his new employer summary judgment on competition claims arising out of a narrowly tailored non-compete agreement he signed in 2005. As is sometimes the case, the agreement specifically enumerated a list of competitors for whom the employee could not work following the termination of his employment.

One of the listed competitors sold part of its business to Andritz Separation in 2004, before the employee signed the contract, but Andritz itself was not identified on the "Direct Competitors" list. In reality, it was a competitor; the dispute arose after the employee, Hauptmann, left in April of 2006 and immediately began competing with it on a bid for the sale of industrial machinery. The customer initially chose Carrier Vibrating, but because of Hauptmann's involvement, the customer switched and gave the job - at a price of $6 million - to Andritz.

Carrier Vibrating sued, contending that the list of "Direct Competitors" should be read to include Andritz based on the fact that it purchase a portion of a listed company's business as a compliment to its existing product line, in effect assuming the company's identity. The court found that the agreement was clear, and that evidence outside the contract was barred by the parol evidence rule. The court noted that Carrier Vibrating never sought to amend the list of "Direct Competitors" in the non-compete and that the sale to Andritz took place prior to the time Hauptmann executed his agreement. Because Andritz was not listed in the agreement, Hauptmann was not liable.

Attorneys representing employers walk a fine line between making an agreement too broad (and potentially unenforceable) and too specific (subject to circumvention). The practice the employer used in this case, drafting a "Direct Competitors" list, is a smart one - provided there is some contractual mechanism allowing for additions to the list and provided the employer is diligent about identifying its true competitors at the time the agreement is signed.

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Court: United States District Court for the Western District of Kentucky
Opinion Date: 12/17/09
Cite: Carrier Vibrating Equipment, Inc. v. Andritz Separation, Inc., 2009 U.S. Dist. LEXIS 117600 (W.D. Ky. Dec. 17, 2009)
Favors: Employee
Law: Kentucky

Utah Refuses to Imply Equitable Tolling Remedy (Systemic Formulas v. Kim)

A federal district court in Utah has denied an employer's request to extend the time of a non-compete agreement past its expiration date based on the theory of equitable tolling. That remedy provides that a post-employment covenant can be extended past its stated term for a period of time in which an employee actually was in breach. So, for instance, if an employee violated a covenant for six months and was subsequently enjoined prior to trial, a term of six months could be added on to the covenant to give the employer the benefit of its bargain.

However, the remedy is not automatic. Courts largely do not have a problem with the remedy in concept but consider it a drafting issue. Illinois is one such jurisdiction; unless the contract confers on the employer the right to extend the non-compete for a period of breach, a court will not imply the remedy. This is not much of a surprise, since it amounts to a rewrite of a contract that already is supposed to be strictly construed against an employer. This was the essence of the Utah court's holding. Drafting an equitable tolling clause is simple and should be part of a corporate counsel's form document.

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Court: United States District Court for the District of Utah
Opinion Date: 12/14/09
Cite: Systemic Formulas, Inc. v. Kim, 2009 U.S. Dist. LEXIS 116038 (D. Utah Dec. 14, 2009)
Favors: Employee
Law: Utah

Failure to Pay Commissions Is Not a Valid Defense Under the Theory of Unclean Hands (Central Texas Orthopedic Products v. Espinoza)

When trying to break a non-compete, it is very common for an employee to raise the affirmative defense of unclean hands and air his ex-employer's dirty linens.

Rarely is this defense successful. As I noted last month, the defense often revolves around an employer's practice in hiring employees away from competitors. This is not really a defense at all, for there often is no connection between recruitment practices and protection of a customer base relating to a departing employee.

A Texas appellate court recently offered a second example: failure to pay commissions owed. In some cases, this may amount to a material breach of contract - meaning the employer cannot enforce a non-compete contained in the same agreement. But it is not a defense based on the employer's unclean hands. The nature of that defense means the wrongdoing must be connected to the same matter raised in the litigation.

The unclean hands defense is sometimes successful. Suppose, for instance, an employer ordered an employee to overcharge customers or to allocate territories with a marginal competitor. A subsequent attempt to enforce a non-compete could run into a problem under the unclean hands defense. Enforcement of a covenant would undermine any protectable interest in the non-compete itself. Under the above example, a pricing structure or market allocation scheme may not be confidential (and hence protectable); it could be illegal. The defense would relate to an element of proof the employer would have to establish regarding enforceability, and so the unclean hands doctrine may properly apply.

As a general rule, the unclean hands defense is exceedingly narrow and only rarely will prevail. Courts are wary of employees who assert a vague list of employment grievances wholly unconnected to the restriction.

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Court: Court of Appeals of Texas, Fourth District
Opinion Date: 12/9/09
Cite: Central Texas Orthopedic Products, Inc. v. Espinoza, 2009 Tex. App. LEXIS 9355 (Tex. Ct. App. Dec. 9, 2009)
Favors: Employer
Law: Texas

Illinois Courts Still Torn Over Sunbelt Rentals (Aspen Marketing Svcs v. Russell)

Illinois may not get a resolution any time soon to whether an employer is required to prove that a non-compete covenant must support a recognized, legitimate business interest. By now, lawyers and commentators are fully aware of the Fourth District's ruling in Sunbelt Rentals, Inc. v. Ehlers and its repudiation of a decades-long test used to determine the validity of non-competes. Though that test had a somewhat bizarre development, courts throughout Illinois recognized it.

Applying the test in practice perversely has made litigation more expensive for employees, as cases frequently devolved into lengthy discovery disputes over the so-called protectable interest and whether it was threatened. Often times the concept of "reasonableness" gets lost in the shuffle. Still, many employers lost cases after failing to prove a legitimate business interest was at stake.

But Ehlers settled his case with Sunbelt Rentals, and so there won't be a decision from the Illinois Supreme Court any time soon on the inter-district conflict. For now, that means that outside of the Fourth District, courts are still applying the legitimate business interest test. District Judge Gettleman recognized as such this week in Aspen Marketing Services v. Russell, when he denied a motion to dismiss a non-compete suit. Gettleman expressly noted the ruling in Sunbelt Rentals and declined to apply it, noting that the Illinois Supreme Court and other Illinois courts outside the Fourth District haven't weighed in.

On a separate note, the idea of challenging the validity of a non-compete on a motion to dismiss is rarely a good one. Almost invariably, this results in an early loss for the defendant, since the concept of "reasonableness" cannot be examined under the pleadings alone. Unless there is some obvious defect (such as a nationwide covenant when the contract specifies a very limited area of responsibility), lawyers ought not to count on dismissal of a non-compete claim until at least summary judgment.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 12/3/09
Cite: Aspen Marketing Svcs., Inc. v. Russell, 2009 U.S. Dist. LEXIS 112982 (N.D. Ill. Dec. 3, 2009)
Favors: Employer
Law: Illinois

Confusion Over Protectable Interest Creates Enforcement Problems (ANSYS, Inc. v. Computational Dynamics North Am.)

Most states require that a non-compete agreement protect a legitimate business interest. Illinois may be moving away from this requirement, as evidenced by the recent Sunbelt Rentals case. However, any attorney analyzing a non-compete dispute must ask what interest the restriction purports to serve.

In theory, this may sound reasonable, but in practice the analysis can lead to weird results, particular if the restrained employee is not one that has extensive client contact. The case of ANSYS, Inc. v. Computational Dynamics North America is a good example of how a court may analyze an employer's interest in "trade secrets" or "confidential information."

Specifically, what must a court do when an employer proves that an employee had access to certain confidential information (in ANSYS, it was source code) but its proofs are less clear as to the employee's attempts or threats to use it?

In ANSYS, the result was employee-friendly; the court held the employer did not prove the employee was likely to use any protected information in the course of his new employment with a competitor. In Illinois (at least assuming Sunbelt Rentals won't be adopted elsewhere), that result is probably correct: an employer must demonstrate an employee attempted "to use" confidential information learned during his or her employment with the former employer.

But Judge Easterbrook in a federal case some years back disagreed with this proposition, effectively noting that no such threatened use must be shown. This is related to the idea that confidentiality agreements are really too hard to enforce; non-competes, though clearly a restraint of trade, carry with it an easier enforcement mechanism. The better analysis would seem to focus on access, not use. If an employer can introduce evidence about the type of confidential information to which the employee had access, then the inquiry should devolve to reasonableness and not get hung up over whether a legitimate interest is at stake.

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Court: United States District Court for the District of New Hampshire
Opinion Date: 11/25/09
Cite: ANSYS, Inc. v. Computational Dynamics North America, Ltd., 2009 U.S. Dist. LEXIS 111021 (D. N.H. Nov. 25, 2009)
Favors: Employee
Law: New Hampshire

Oregon Case Illustates Realistic Approach to Deciding Complex Non-Compete Issue (Epiq Class Action v. Prutsman)

At the beginning of 2008, the Oregon legislature passed reforms to the state's law governing non-competition agreements. The statute is so specific it likely will create loopholes as lawyers and their clients devise ways to circumvent the law's requirements.

Prior to the 2008 amendments, the statute attempted to govern the enforceability of non-compete agreements by dictating they were enforceable only if signed at the inception of employment or upon a bona fide advancement. Agreements signed prior to the effective date of the new law are still governed by the previous iteration, and so we can expect a runoff of cases decided under the old statute.

One such case involved Jim Prutsman, a former IT chief and sales employee of Epiq Class Actions and its predecessors. When Prutsman was promoted from IT to sales in 2003, he signed a two-year non-compete agreement. Subsequently, his employer was acquired in a stock purchase by ECA. Following the closing, Prutsman signed a new non-compete agreement - which reduced his post-termination restriction from two years down to one.

As the court noted, the consideration for the agreement did not meet either criteria for enforceability - it was not signed upon the commencement of his employment and not pursuant to a bona fide advancement at ECA. However, the court took a realistic view of the statute and disagreed with Prutsman's consideration argument. Specifically, the court held that the impact of the new agreement was to reduce Prutsman's burden; he was barred from competing for only one year, not two. The court noted that enforcing the less onerous agreement was consistent with the legislature's intent in prohibiting non-competes where the employer foists a new document on an employee under threat of discharge.

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Court: United States District Court for the District of Oregon
Opinion Date: 11/13/09
Cite: Epiq Class Action and Claims Solutions, Inc. v. Prutsman, 2009 U.S. Dist. LEXIS 108129 (D. Or. Nov. 13, 2009)
Favors: Employer
Law: Oregon

Scope of Arbitration Submission Renders Decision on Non-Compete Remedy Unreviewable (Comprehensive Orthopaedics v. Axtmayer)

A physician and his former medical practice became embroiled in a dispute over his former employment, and like many such cases, the cause was submitted to arbitration. One of the issues in dispute concerned the physician's non-compete agreement, and the practice's assertion he breached it.

As part of the arbitration submission, the arbitrator was charged with awarding attorneys' fees to the plaintiff if the medical practice prevailed under its non-compete claim. The arbitrator rendered an award for the practice, but found that - as written - the non-compete claim was overbroad in its restrictions and that the liquidated damages should be reduced from $150,000 to $75,000. It declined to award attorneys' fees due to the reformation.

Was this decision proper?

Maybe, but according to the Supreme Court of Connecticut, that is not really the issue. When a matter is submitted to binding arbitration, the only reviewable issue is whether the arbitrator had the authority to reach the issue decided - not whether the decision was factually or legally correct.

Clearly, the parties disagreed as to whether the medical practice ultimately "prevailed" by winning - in essence - half of what it requested. The counterview of this is the physician may have won, just as much as the medical practice lost. Perhaps his benefit from the breach exceeded $75,000, and he considered the award not a loss at all, but rather a victory.

Ultimately it doesn't really matter. The Supreme Court of Connecticut was absolutely correct to hold that the parties' decision to kick the issue to an arbitrator meant judicial review was exceedingly narrow.

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Court: Supreme Court of Connecticut
Opinion Date: 10/20/09
Cite: Comprehensive Orthopaedics and Musculoskeletal Care, LLC v. Axtmayer, 980 A.2d 297 (Conn. 2009)
Favors: Employee
Law: Connecticut

Connecticut Court Rejects Unclean Hands Defense In Non-Compete Case (Drummond American v. Share Corp.)

There is a big difference between a justification and an excuse. In a non-compete case, many times an employee - being in a position of having to admit breach - offers only a litany of excuses, rather than a legal justification.

Such was the case in a summary judgment decision involving a claim against a sales agent for a chemical products distribution company. The ex-employee, Mahoney, sold commercial grade chemicals to large customers - and only a couple of dozen, at that - on behalf of Drummond American. She signed a two-year customer non-compete clause, barring her from soliciting sales of competing products relating to accounts she serviced at Drummond.

Drummond had to admit a breach - despite her new employer's admonition against violating the non-compete contract, she sold chemical products to 12 of her 26 former Drummond accounts. In defense, Mahoney offered an array of excuses for her breach, it being generally acknowledged that the covenant was reasonable under Connecticut law.

The court rejected, rather easily, each defense. Of particular note was Mahoney's contention that the doctrine of unclean hands applied to her argument that Drummond hired employees from competitors and encouraged them to violate non-compete contracts. This "defense", if one can call it that, is one I see frequently. However, it is irrelevant, at best.

Even assuming the defense is true, no two employees are alike. One employee may have little value to an ex-employer (perhaps she was an underperformer), so the cost of litigating almost certainly would outweigh any benefit from obtaining an injunction. The company from whom another employee is hired may be exiting the market entirely and not likely to pursue a claim. There really are an unlimited number of reasons.

But the doctrine of unclean hands requires a showing that the plaintiff acted inequitably as to the particular controversy at issue. Airing your ex-employer's dirty linens in an unrelated matter not only is a poor defense, it generally shows the court the employee can offer nothing more than flimsy excuses for a contract breach.

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Court: United States District Court for the District of Connecticut
Opinion Date: 11/12/09
Cite: Drummond American LLC v. Share Corporation, 2009 U.S. Dist. LEXIS 105965 (D. Conn. Nov. 12, 2009)
Favors: Employer
Law: Connecticut

Temporary Restraining Order In Non-Compete Case Requires Showing of Immediate Harm (Ride-Away Handicap Equip. v. Tracey)

Employer seeking immediate redress from threatened competitive harm have to move fast. The preferred remedy in most non-compete disputes is an injunction, and for extreme emergencies, an employer can seek a temporary restraining order - in effect, a paper trial before the court hears live evidence.

TROs are important because the employer will be largely in control of the documents. At a preliminary injunction, the defense has the benefit of time - time to amass evidence, prepare witnesses and find helpful third-party testimony.

But TROs require exigency. Illustrating this key point is a decision from earlier in the week in Florida federal court. In Ride-Away Handicap Equipment v. Tracey, the employer waited four months after sending a "cease and desist" letter to two ex-employees (and its new employer) to file a TRO petition. It also appears the employer gave no notice of the TRO to the defendants. Notice is not required in some circumstances, but the moving party must show why irreparable injury would result from lack of notice.

The court was unimpressed with the employer's delay and denied the TRO petition without a response. There is no bright-line rule for when an employer must move for injunctive relief. Immediacy, in fact, can arise during the pendency of a dispute, for example if an ex-employee suddenly starts poaching other co-workers or discloses confidential information to a customer in violation of a contract. But in a case where the breach is known to the employer, and the employer waits a few months to seek an injunction to stop that breach, it risks losing a valuable equitable right.

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Court: United States District Court for the Middle District of Florida
Opinion Date: 11/10/09
Cite: Ride-Away Handicap Equipment Corp. v. Tracey, 2009 U.S. Dist. LEXIS 104984 (M.D. Fla. 2009)
Favors: Employee
Law: Federal Rules of Civil Procedure

Failure to Present Employee With Contemplated Non-Compete Agreement Fatal to Employer's Claim (Workflow Solutions v. Lewis)

Can an employer seek a court order requiring an employee to sign a non-compete agreement he previously agreed to execute? The answer is, and should be, no.

On a couple of different occasions this year, courts have weighed in on a strange issue going more towards contract formation than enforceability. The Second Circuit in a high-profile dispute involving IBM refused to enforce a non-compete against an employee who never manifested his intent to be bound. Earlier this week, I wrote about a bizarre Louisiana case where an employer tried to enforce an agreement against an employee who only signed a non-compete not personally, but only in her capacity as a representative of the employer.

Today, it is worth pointing out a Virginia case that deals with a more common scenario, although the facts of this case are a little more unique. In 2003, Mark Lewis resigned from Workflow Solutions, LLC, a nationwide print broker. Lewis apparently resigned under contentious circumstances, and the general allegation appears to be that he engaged in pre-termination solicitation of accounts. Several months later, Lewis and Workflow Solutions reached a settlement agreement whereby he agreed to continue working on an at-will basis for a six-month trial period, after which he could continue if the parties mutually agreed to do so. The agreement specifically contemplated that at the end of the probationary period, Lewis would have to sign a non-compete similar to what he previously signed (and apparently breached).

Lewis did continue to work at Workflow Solutions, for several years in fact. But he never signed the non-compete (which was an exhibit to the settlement agreement) and there was no indication the employer pushed him to execute it. When Lewis left to compete in 2008, Workflow Solutions sued to compel him to execute the non-compete contract and have him bound to the same.

The court dismissed the case, finding that the allegations could not possibly sustain a claim against Lewis. As a matter of contract construction, the court held that it could not bind Lewis to a contract he never signed. The settlement agreement contemplated that his signature on a new agreement was essential, and the employer simply never demanded it. Under those circumstances, the court was powerless to enforce anything.

Lewis and his counsel deserve credit for not agreeing to a non-compete in the first instance as a key term of the settlement agreement. There is no indication why Workflow Solutions capitulated on this when the dispute arose in 2003 or 2004, but it would seem that it should have demanded Lewis sign a non-compete and not agree to address the issue sometime down the road. It is possible that Lewis had leverage - perhaps his original agreement was unenforceable or Workflow Solutions created a problem on its own that would have made enforcement difficult. But the case illustrates a powerful lesson for employers: If you want a valid non-compete agreement, obtaining a signature on the document is always advisable...

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Court: Circuit Court of the City of Norfolk, Virginia
Opinion Date: 12/12/08
Cite: Workflow Solutions v. Lewis, 77 Va. Cir. 186 (Va. Cir. Ct. 2008)
Favors: Employee
Law: Virginia

Louisiana Affirms Common Sense Rule That Non-Compete Cannot Be Breached In Absence of...Actual Agreement (Action Revenue Recovery v. eBusiness Group)

In what may be the year's dumbest non-compete case, a Louisiana appellate court has affirmed a judgment that an employee did not violate a non-compete agreement she did not sign.

Though that sentence may appear confusing, it is the essence of the holding in Action Revenue Recovery, LLC v. eBusiness Group, LLC. The plaintiff sued to enforce a non-compete agreement its general manager did not sign, and indeed refused to sign. The employer's theory - bizarre as it was - rested on the notion that the employee signed agreements for other employees as a representative of the company, and therefore that she had to be bound individually to those trade restrictions.

Surprisingly, there was no discussion of frivolous litigation or fee-shifting in the appellate decision, but it is hard to believe this lawsuit could have had a good-faith basis in law or fact. The case is notable in one substantive respect. The non-compete - had it been signed - did not contain a reasonably specific geographic term under Louisiana statute. That law requires that the non-compete identify the parishes or municipalities to which it applies; otherwise, the contract is invalid.

In this case, the non-compete agreement the employee did not sign only described the restricted territory as applying to "all parishes [plaintiff] covers on a like business in said parishes or counties." Aside from being virtually unintelligible and gramatically challenged, the non-compete failed for lack of specificity.

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Court: Court of Appeal of Louisiana, Second Circuit
Opinion Date: 9/19/09
Cite: Action Revenue Recovery, LLC v. eBusiness Group, LLC, 17 So. 3d 999 (La. Ct. App. 2009)
Favors: Employee
Law: Louisiana

Employer's Statements About Limiting Scope of Non-Compete Barred by Parol Evidence (New Life Cleaners v. Tuttle)

It is not at all uncommon for an employee to ask questions about the scope of his non-compete agreement before signing it. Employers can, and often do, run into trouble by advising an employee that the agreement isn't as broad or restrictive as it appears on paper.

However, an employee who fails to secure such limitations in writing is also asking for trouble. A perfect illustration comes by way of a recent Kentucky case, New Life Cleaners v. Tuttle. In that case, the employer presented Chad Tuttle with an employment contract about two years after he started working for it. The agreement contained two garden-variety restrictive covenants - a two-year business covenant prohibiting Tuttle from rendering carpet cleaning services in certain Kentucky counties, and a two-year client covenant prohibiting Tuttle from providing carpet cleaning services to New Life customers.

Tuttle had issues with the contract's scope. During a discussion about the non-compete, one of New Life's owners indicated to Tuttle that the contract was only meant to prohibit actual solicitation of New Life's clients. Tuttle, apparently satisfied with what New Life said, signed the contract unchanged from the original language.

When Tuttle left about two years after signing the covenant, he opened up a competing cleaning service in violation of the business covenant. New Life, apparently, was okay with this. However, things changed when one of New Life's clients called looking for Tuttle and was told he was no longer there. The client actively sought out Tuttle, who took the business away from New Life. There appears to be no dispute that the client was the onle who actively sought Tuttle out, and that Tuttle did not solicit the client 's business.

After the trial court entered judgment in Tuttle's favor - holding in effect that the oral statement made "modified" the non-compete terms - the appellat court reversed and entered judgment for New Life. The court did so on the grounds that the parol evidence rule barred introduction of extrinsic evidence, in this case evidence about oral statements limiting the non-compete. Accordingly, the court found New Life's contract was embodied fully within the written document, not some outside modification pre-dating signature.

It should be noted Tuttle acted without counsel - even at the appellate stage. And in that regard, the court did not address any defense of estoppel that might have been available to Tuttle. Also, the court apparently did not consider a laches defense. New Life apparently was fine with Tuttle violating the business covenant, but only took action several months later when Tuttle was able to take away a client. Tuttle might very well have been lulled into believing New Life would not take any action at all since it was fully aware he had been violating the contract.

The case serves as an obvious reminder to employees to get any modifications to non-competes in writing before executing the contract. However, employers should read too much into this case. It appears New Life lucked out on appeal given its rather careless conduct before the dispute.

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Court: Court of Appeals of Kentucky
Opinion Date: 8/7/09
Cite: New Life Cleaners v. Tuttle, 292 S.W.3d 318 (Ky. Ct. App. 2009)
Favors: Employer
Law: Kentucky

Court Will Not Convert Broad Non-Disclosure Agreement Into a Non-Solicit Restriction (Softchoice Corp. v. MacKenzie)

We often confront a situation where an employee has jumped ship to compete directly with his ex-employer, only to be bound by a garden-variety non-disclosure clause. Inevitably, the non-disclosure clause contains a lengthy, non-exhaustive list of potentially "confidential information," almost always including something along the lines of client identities, preferences, and purchasing details (such as rebates or discounts).

The question becomes whether use of this so-called confidential information can form the basis for an injunction prohibiting direct client competition - even in the absence of a restrictive covenant. The answer should depend on whether the information alleged to have been taken or used was truly confidential.

The case of Softchoice Corp. v. MacKenzie illustrates the usual outcome. In that case, the employee pointed to a wide range of third-party sources to demonstrate clearly that identities of customers were widely known in the industry of computer technology resellers. He identified social networks, leads websites, and other sites made available to all resellers, each of which contained the very information Softchoice claimed was confidential and therefore off limits. The employee also introduced evidence that customers themselves readily disclosed information to vendors to obtain the best possible pricing and services.

The court was unwilling to conclude that the employee misused any confidential information by targeting Softchoice's customers and entered summary judgment in the employee's favor. In so holding, the court noted: "Softchoice...could have limited MacKenzie's contact with his former customers, and consequently protected its pricing information, through a narrowly drawn, valid and enforceable covenant not to compete, but it did not do so. Softchoice cannot achieve by way of a nondisclosure agreement what it could have obtained via a nonsolicitation agreement."

Softchoice's dilemma illustrates the problem with relying only on non-disclosure clauses: they are incredibly hard to enforce. Any relief from breach usually is narrowly limited and does not extend to what is necessary to secure client relationships or goodwill.

Of course, there can be situations when confidential information is truly misused - perhaps brazenly so - and a court will retain the discretion to create a broader activity-based restriction. However, many judges are unwilling to take this step for fear that the injunction order extends beyond what is necessary to strike the proper balance of competing rights.

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Court: United States District Court for the District of Nebraska
Opinion Date: 7/2/09
Cite: Softchoice Corp. v. MacKenzie, 2009 U.S. Dist. LEXIS 56513 (D. Neb. July 2, 2009)
Favors: Employee
Law: Nebraska

Preliminary Injunction Ruling Brings More Clarity to Trade Secret/Confidential Information Distinction (SKF USA v. Bjerkness)

I wrote not long ago about a Missouri court which made the (rather difficult) distinction between trade secrets and confidential information. Most states have enacted a version of the Uniform Trade Secrets Act, which provides for an independent cause of action relating to theft of economically valuable information - whether prohibited by contract or not.

Similarly, many employees in the digital age are now bound by some form of non-disclosure agreement, limiting their use or disclosure of certain types of confidential business information after their employment ends. Often times, courts blur the distinction between trade secrets and other forms of confidential information.

In Illinois, courts have long hinted that such a distinction exists. For instance, a non-compete agreement can protect an employer's legitimate interest in misuse of confidential information, whether that rises to the level of a trade secret or not. Without actually formulating a test, Judge Shadur has noted that the concepts are not at all identical. Still, practitioners can find with relative ease a number of reported cases where judges misapply the trade secrets test to other forms of confidential information, usually concluding that a non-disclosure covenant has not been breached or that a non-compete is not enforceable.

In a recent federal district court case, Judge Pallmeyer took the analysis a bit further, actually defining what "confidential information" was and noting the distinction between it and trade secrets. In SKF USA v. Bjerkness, the court concluded confidential information is "particularized information disclosed to [the employee] during the time the employer-employee relationship existed which [is] unknown to others in the industry and which give[s] the employer advantage over his competitors."

The key analytical difference between confidential information and a trade secret? Judge Pallmeyer notes: "Confidential information, then, does not necessarily require positive steps by the employer to maintain the secrecy of the information, though such efforts may be relevant in the court's consideration of whether the information is truly confidential."

Customer information is an example of where this distinction may be meaningful in practice. Many cases hold that customer-specific quotes, price sheets or invoices (which may reveal buying habits, rebates, volume discounts and key contact information) does not rise to the level of a trade secret because the customer is free to do with this as he pleases. However, it may be confidential in the objective sense because in most cases the information would only be available to a select few and not publicly advertised (such as a retail price sheet, for instance).

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 4/24/09
Cite: SKF USA, Inc. v. Bjerkness, 636 F. Supp. 2d 696 (N.D. Ill. 2009)
Favors: Employee
Law: Illinois

Two Views of the Computer Fraud and Abuse Act (Brekka and Pullen)

Cases under the Computer Fraud and Abuse Act arising out of employee competition continue to head down two divergent paths.

In particular, courts are faced with a decision on whether to interpret the CFAA broadly or narrowly when an employer claims an ex-employee has acted "without authorization" or has "exceeded authorization" in accessing computer-stored information prior to termination of employment.

As I have written before, the more narrow view has gained substantial favor, illustrated by the Ninth Circuit's ruling in LVRC Holdings LLC v. Brekka. That case (originating from Nevada) arose out of a claim that an ex-employee improperly e-mailed company documents to himself prior to his resignation. Of note, the employer had no policy against this, and the documents were apparently sent to facilitate the ex-employee's potential buy-in to the company as a member. Put differently, when the deal soured - and after Brekka quit - the company had very few equities weighing in its favor. Whether that affected the Ninth Circuit's decision or not is not clear.

But the court rejected the argument that the term "authorization" was somehow linked to whether the employee acts contrary to his employer's interest or in defalcation of a fiduciary obligation of loyalty. Rather, the court looked to the plain meaning of the CFAA's terms - and the fact it is at heart a criminal statute - to find Brekka used LVRC's computer system in a manner totally consistent with the access previously granted to him as an employee.

The First Circuit, however, is less sympathetic to an employee's arguments for a narrow construction of the CFAA and reads the Act more broadly. In Guest-Tek Interactive Entertainment Inc. v. Pullen, a district court from Massachusetts denied an employee's motion to dismiss on the same grounds as raised in Brekka. While not directly adopting Judge Posner's influential opinion in the Seventh Circuit's Citrin case, the court rebuffed an employee's effort to dismiss a case after he allegedly transferred thousands of confidential files to a personal USB storage device before resignation. Unlike Brekka, the equities in this case decidedly militated in favor of the plaintiff.

The court in Pullen noted the progressive expansion of the CFAA from its relatively limited origins, as well as the fact employers are customarily using the statute to - essentially - federalize trade secrets claims. How this is at all relevant is not clear, but the court deemed it worthy of mention. The First Circuit, therefore, will interpret the CFAA in a broad fashion, analogous to how the Seventh Circuit does in the aftermath of Citrin.

Having considered the divergent views of federal courts, one issue is perfectly clear. Employers have to be out in front of this issue to eliminate difficult questions of statutory construction. Specifically, employers can be more diligent about protecting digitally stored information by formulating clear computer usage policies concerning use of company data on personal computers, migration of data to internet-based e-mail accounts, and the transfer of data for competitive purposes even while still employed. Including these policies within an employee handbook can help define the scope of authorization, regardless of what the CFAA default position is.

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Brekka

Court: United States Court of Appeals for the Ninth Circui
Opinion Date: 3/13/09
Cite: LVRC Holdings LLC v. Brekka, 581 F.3d 1127 (9th Cir. 2009)
Favors: Employee
Law: Federal

Pullen

Court: United States District Court for the District of Massachusetts
Opinion Date: 10/19/09
Cite: Guest-Tek Interactive Entertainment Inc. v. Pullen, 2009 U.S. Dist. LEXIS 98737 (D. Mass. Oct. 19, 2009)
Favors: Employer
Law: Federal

Value of Non-Compete Usually Meets "Amount In Controversy" Minimum (Sarfraz v. Vohra Health Services)

If an employee challenges the validity of a non-compete in federal court on the basis of diversity jurisdiction, will the minimum amount in controversy ($75,000) be met?

Generally, the answer is yes. The value of equitable relief - as opposed to damages - is fairly difficult to determine from the face of a complaint, but courts err on the side of giving the plaintiff the benefit of the doubt. Sometimes, the analysis is easy - as it was in a decision issued by a New York federal court. In Sarfraz v. Vohra Health Services, the non-compete barred each physician from providing wound care services for a period two years within thirty miles of Long Island.

The non-compete was sweeping in scope and potentially could keep each plaintiff out of the profession for two years. Given their base salary of $150,000, the court found that the jurisdictional amount was easily met since the value of prevailing on a declaratory relief claim exceeded the statutory minimum.

It is conceivable that for short-term covenants or those for relatively inexpensive employees, the jurisdictional analysis may yield a different outcome. For activity covenants (such as a no-hire or no-solicit clause), the question becomes a little more nuanced and a plaintiff seeking a declaration of his or her rights may need to plead more facts to set forth the basis for diversity jurisdiction. In regards to non-disclosure clauses, courts seem more inclined to retain jurisdiction. Though the intangible nature of confidential information is hard to quantify, a plaintiff easily could satisfy the jurisdictional minimum by alleging that it has invested more than $75,000 in developing, storing and protecting confidential business information.

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Court: United States District Court for the Eastern District of New York
Opinion Date: 10/20/09
Cite: Sarfraz v. Vohra Health Services, PA, 2009 U.S. Dist. LEXIS 99413 (E.D.N.Y. Oct. 20, 2009)
Favors: N/A
Law: Federal

Nasty Employment Row Highlights Importance of Duty of Loyalty, Underscores Cost of Litigation (Lawlor v. North American Corp.)

The Chicago Tribune's business reporter, Ameet Sachdev, writes this morning on the hotly contested dispute between Kathleen Lawlor and North American Corp. of Illinois, a case recently tried to judgment in the Circuit Court of Cook County.

The dispute touches upon a number of hair-trigger employment law issues, including rights to privacy, unpaid commissions, theft of confidential information and threats to steal customers. It also makes an oblique reference to another issue that always underscores the difficulty of employment litigation: Lawlor's attorneys' fees have approached $1 million.

The case involves the marketing services industry, and the dispute arose right after Lawlor, a successful salesperson, left in 2005. She claimed she was owed accrued commissions, and her employer feared she would steal customers. It also had her followed by a somewhat amateur gumshoe, a fact that would later prove to be damaging to North American.

There was no hint in Sachdev's article that Lawlor was bound by a non-compete contract, so North American was left to pursue common-law remedies. It found potential smoking guns when a North American consutant swore out an affidavit that Lawlor offered to introduce him to a competitor before she quit, and when Lawlor disclosed historical sales and margin data to a competitor on a job interview.

This conduct directly implicated Lawlor's duty of loyalty to her then-employer. That duty prohibits an employee from disclosing confidential information, facilitating a mass exodus of co-workers, and diverting business opportunities away from the employer. Employees must take this duty seriously - a violation can result in salary forfeiture during a period of disloyalty, an injunction against competitive conduct (even in the absence of a non-compete agreement), and punitive damages.

At trial, the parties appeared to split their claims against one another. Lawlor ended up prevailing on her invasion of privacy claim, after North American's overzealous investigators improperly obtained Lawlor's phone records and gave them to the company. North American, on the other hand, was able to obtain some measure of compensation forfeiture, presumbably based on Lawlor's pre-termination activity with existing customers or improper disclosure of North American financial data. Despite relatively low actual damages ($78,781), the trial judge imposed punitive damages of $551,467 - a multiple of seven.

Aside from the enormous fees generated in this case, the litigation serves as a reminder that the absence of a non-compete agreement does not - by any stretch - sanitize an employee's conduct on the way out the door. Breach of the common law duty of loyalty provides for extensive legal and equitable remedies. Proving such a claim can be difficult for an employer, but if the employer is able to marshall evidence of improper pre-termination activity (often learned through a forensic examination of the ex-employee's computer), it may be able to put a halt to anti-competitive conduct and obtain significant monetary relief.

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Court: Circuit Court of Cook County, Chancery Division (Transferred to Law)
Opinion Date: N/A
Cite: Lawlor v. North American Corp. of Illinois, 2005 CH 13876
Favors: N/A
Law: Illinois

Breach of Non-Compete Agreement Can Occur Before Blue-Pencil Order (Astro-Med v. Nihon Kohden America)

In a hard-fought non-compete case originating in Rhode Island, the First Circuit Court of Appeals rejected an employee's unique defense under the blue-pencil rule. Specifically, the defendant did not argue that the district court failed to narrow the non-competition covenant properly, but rather contended that the court could not find that he "breached" a covenant which was only made reasonable by virtue of the blue-pencil rule.

The court rejected the defendant's position and held that it would "give the promisor in a non-competition agreement one free breach requiring a prior judicial order before the provision could be said to have been violated." A contrary result would have yielded a clear result the court was unwilling to sanction: for all but the most narrowly tailored non-compete agreements, an injunction may be the only effective remedy to protect the employer. Allowing a prior breach to fall within a broad safe-harbor would leave many employers without redress, even in the most egregious situations, and would deprive the employer of the benefit of his bargain even if it could show actual damages.

There is some limited support, however, for the opposite view. In Texas - generally an employer-friendly state - the governing non-compete statute provides that damages cannot be awarded before an order of reformation. Of course, Texas has a public policy that overbroad covenants must be reformed to make them reasonable, and apparently the legislature determined that a limitation on damages was a proper trade-off in favor of the employee. It is notable that the First Circuit did not even cite the Texas statute.

The First Circuit's decision confirms that such an unprecedented interpretation of a non-compete agreement is not something a court should decide. In the absence of a specific statute or contract clause, a prior breach of a modified non-compete is still a "breach" - and can support a damages award.

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Court: United States Court of Appeals for the First Circuit
Opinion Date: 10/22/09
Cite: Astro-Med, Inc. v. Nihon Kohden America, Inc., 2009 U.S. App. LEXIS 23298 (1st Cir. Oct. 22, 2009)
Favors: Employee
Law: Rhode Island

Defection At Citadel's High-Frequency Trading Unit Warrants Injunction - To A Degree (Citadel Investment Group v. Teza Tech.)

One of the most high-profile non-compete disputes in the Chicago area has resulted in a victory for Citadel Investment Group and a set-back for two executives who defected to start their own high-frequency trading firm.

In a 36-page memorandum opinion and order Judge Mary K. Rochford enjoined Mikhail Malyshev and Jace Kohlmeier from violating non-compete restrictions contained in their Citadel employment agreements for the balance of the nine-month term. Effectively, this means that both Malyshev and Kohlmeier may be free to compete as soon as February of 2010, since the court refused to extend the non-compete term on an equitable basis for the period in which the defendants were in breach.

The case involves a shadowy, but highly profitable business known as high-frequency trading (HFT). In essence, HFT relies on powerful computers to enter trade orders (often without human intervention), with algorithms deciding on specific aspects of the trade such as how much to buy, when, and at what price. HFT is a relatively new phenomenon, but it yields enormous profits. A disproportionate amount of equity trading volume is conducted by HFT firms.

Citadel itself invested heavily in HFT. It paid off - Citadel's HFT unit reaped earnings of $1.15 billion in 2008. Malyshev and Kohlmeier were instrumental, key employees for Citadel's HFT group. Neither had HFT experience prior to joining Citadel. For quite some time, each considered leaving to start his own proprietary trading firm. And each had a non-compete agreement, barring employment with a "Competitive Enterprise" for a period to be selected by Citadel upon departure, ranging from 0 to 9 months.

Upon their departure, Citadel elected the maximum 9-month period and paid Malyshev and Kohlmeier to sit on the sidelines. No surprise, there, given their access to proprietary information and involvement in recruiting R&D talent to Citadel. However, both ex-employees formed Teza Technologies and hired 15 employees, essentially daring Citadel to file suit.

It did.

Citadel pursued each aggressively and sought preliminary injunctive relief. The court dispatched with a number of the arguments raised by the defense. Given that one of the defendants deleted a fair amount of Citadel information (despite a court order not to do so), the court really did not have to address whether a legitimate business interest supported the non-compete. The adverse inference it could draw about the document deletion was more than enough to demonstrate the defendants had access to and attempted to use Citadel's confidential information.

The defendants also seemed to challenge the non-compete due to the fact that they really weren't actively trading, but merely preparing the firm's trading infrastructure to compete eventually. However, nothing in the non-compete allowed the defendants to wash their hands of liability based on this "preparing to compete" theory, and the theory itself ignored the fact that HFT firms depend heavily on building infrastructure. By getting a headstart in developing a trading platform, the defendants were essentially entering the market much faster than they agreed to under their employment contracts.

The most important feature of the decision, though, concerned the length of the injunction. And it is here where the defendants probably were able to take some solace in defeat. The court refused to extend, or equitably toll, the non-compete period for the time in which the defendants were in breach. The court looked at the Second District Appellate Court's decision from two years ago to hold that, under Illinois law, a contract must specifically provide for an equitable tolling, or extension, remedy. Otherwise, the court will not imply the term under the contract.

This, of course, does nothing to mitigate the defendants' damages during the non-compete period. But it does serve as a cautionary tale for counsel in drafting non-compete clauses. Unless an equitable tolling remedy is clearly contained in the contract, the court will not agree to extend it even if the defendants were in breach leading up to the injunction order.

UPDATE X1: Both parties have filed a notice of appeal with the Circuit Court.

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Court: Circuit Court of Cook County, Chancery Division
Opinion Date: 10/16/09
Cite: Citadel Investment Group, LLC v. Teza Technologies, LLC, 09 CH 22478 (Cook Cty. 2009)
Favors: Employer
Law: Illinois

Court Declines to Award Attorneys' Fees Against Employer Who Aided Breach of Restrictive Covenant (Bauer v. Dilib, Inc.)

Florida contains a highly favorable body of law that favors employers attempting to enforce non-compete agreements.

The statute, Section 542.335, significantly altered Florida law with regards to non-competes entered on or after July 1, 1996. Some of the significant changes included a fairly wide range of interests that can be protected by a non-compete, a presumption of reasonableness for non-competes lasting six months or less, a repeal of contract construction rules favoring narrow construction of a non-compete, and discretionary attorneys' fees awards even in the absence of a contractual provision.

At issue in the Fourth District's case of Bauer v. Dilib, Inc. was a novel issue pertaining to the statutory provision concerning attorneys' fees. Specifically, the court addressed the question of whether a third-party new employer could be held liable for attorneys' fees for aiding and abetting a breach of a non-compete. In this particular case, the circuit court in Broward County held the statute should be construed to permit recovery against the employer who interfered with the non-compete contract.

On appeal, the court reversed and held that Section 542.335(1)(k) could not be construed to permit such a recovery. According to the court, the employer was not a party to the non-compete agreement, and the only reasonable construction of the entire statute was that the plaintiff ex-employer could not enforce the non-compete against the new employer. Because of this, a discretionary grant of fees under the statute was inappropriate. The court rejected a number of arguments advanced by the plaintiff, ultimately reasoning that statutory fee-shifting provisions must be narrowly construed because they are in derogation of the common law.

Courts have always retained the ability to enjoin parties who are non-signatories from aiding or abetting a breach of a non-compete agreement. Statutes governing injunction procedure almost always provide for this specifically. Further, to fashion complete equitable relief, an injunction order logically must extend beyond mere contract parties. However, this does not mean other facets of relief will automatically be available to third-parties. In this case, the ex-employer's remedy for tortious interference could conceivably encapsulate claims for attorneys' fees as part of a punitive damage award. But the ex-employer has no statutory remedy for fees separate and apart from other relief.

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Court: Court of Appeal of Florida, Fourth District
Opinion Date: 9/16/09
Cite: Bauer v. Dilib, Inc., 16 So. 3d 318 (Fla. Dist. Ct. App. 2009)
Favors: N/A
Law: Florida

Failure to Produce Non-Compete Agreement at Trial Not Fatal to Employer's Case (CBM Geosolutions, Inc. v. Gas Sensing Technology)

The Supreme Court of Wyoming affirmed the issuance of a preliminary injunction in a non-compete case filed against two former employees. The case involved the business of measuring coal bed methane gas. Two employees, Bret Noecker and Brian LaReau, had been employees of Gas Sensing Technology's predecessor, WellDog. A few months after they departed, WellDog sold substantially of its assets to Gas Sensing Technology.

On one of the schedules to the asset purchase agreement, Noecker's August 2004 non-compete agreement was listed as a purchased asset. At trial, however, the plaintiff did not produce the agreement. On appeal, Noecker contended the plaintiff's failure to produce a written non-compete violated the statute of frauds, which prohibits contracts that cannot be performed in less than a year unless the same are in writing. The Court rejected Noecker's argument, reasoning that there was enough evidence produced to demonstrate Noecker in fact signed such an agreement.

I have dealt with a number of situations when an employer cannot produce a non-compete, either because the record-keeping is poor, an employee is suspected of taking the agreement, or (as in this case) an acquisition has complicated the process of locating old agreements. My experience is that too much is made of this particular issue, and if there is a reasonable amount of evidence that an employee actually signed an agreement, the fact it's missing usually is irrelevant. The existence and content of the agreement can be proven with secondary evidence. With the advent of the digital workplace, there is no reason anymore why employers should not scan in and save non-competes or other key contracts on its information technology system.

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Court: Supreme Court of Wyoming
Opinion Date: 9/14/09
Cite: CBM Geosolutions, Inc. v. Gas Sensing Technology Corp., 215 P.3d 1054 (Wyo. 2009)
Favors: Employer
Law: Wyoming

Supreme Court of Wisconsin Rules on Several Important Restrictive Covenant Issues (Star Direct v. Dal Pra)

Wisconsin has long been known as an employee-friendly state when it comes to interpreting non-compete agreements. One of the primary reasons involved a previous construction of that state's governing statute, which leaned heavily against enforcement of any part of a non-compete clause if even one part was deemed unreasonable or overbroad. Without the ability to sever part of a non-compete covenant, employers often lost the balance of their case because of the strict rule on divisibility.

That will now change, given the Supreme Court of Wisconsin's decision in Star Direct v. Dal Pra. The case arose out of dispute between Star Direct, a seller of novelties and sundries to gas stations and convenience stores, and one of its former route salesmen, Eugene Dal Pra. As is often the case, Dal Pra began looking for other employment opportunities when his former employer was sold. In this case, Star Direct took over the business from CB Distributors. Eventually, Dal Pra went off and started his own business, exploiting many relationships he had developed as a CB Distributors (and later Star Direct) employee.

Dal Pra won in the circuit court, successfully challenging three separate restrictive covenants - an industry non-compete extending 50 miles from Rockford, Illinois; a customer non-solicitation clause; and a confidentiality clause. The court of appeals affirmed. In the Supreme Court, Dal Pra did not achieve the same success.

The Court concluded the industry-wide non-compete was invalid, but upheld the other two covenants. Most interestingly, the Court discussed the overbreadth of the non-compete clause, as well as Wisconsin's severability rule.

First, the Court found that the non-compete was too broad since it prohibited Dal Pra from engaging in any business "which is substantially similar to or in competition with the business of the Employer." The phrase "substantially similar to" ultimately invalidated the provision. The Court held that, by definition, the clause extended to businesses not in competition with Star Direct, because to hold otherwise would virtually ignore the terms "substantially similar to." The only logical interpretation was that Star Direct intended the capture more than just competitors, and a clause this broad served no protectable interest. Because of Wisconsin's statutory prohibition, the Court could not blue-pencil or strike the offending words, and the entire clause was invalid as an overbroad restraint of trade.

The second issue is related to this last point. Previous cases sanctioned a broad interpretation of Wisconsin's statute and suggested that contract provisions were indivisible if they governed similar types of activities. In practice, this would mean that a customer non-solicitation clause in another paragraph often would fall if the industry non-compete were held invalid. Additionally, confidentiality agreements met a similar fate, despite the fact they are not true restraints of trade. The end result is that employers who ended up drafting an enforceable agreement in all but one respect lost the entire benefit of the bargain.

The Court has now changed that rule. The contract in Dal Pra contained separate paragraphs governing the non-compete, non-solicit and non-disclosure clauses. They were not textually linked in any way and could operate independently of one another. So for instance, if the non-compete were simply taken out entirely, the non-solicit could stand on its own without any cross-reference or dependence on the non-compete clause. In view of this, the Court found the otherwise valid confidentiality and customer non-solicitation covenants could stand.

For practitioners in Wisconsin, covenants should be separately labeled and contained in different paragraphs. Defined terms, such as "Competing Business" or "Restricted Territory", should be in their own contract section and not contained in the same paragraph as any restrictive covenant. Failure to separate these terms out could jeopardize otherwise enforceable restrictions.

The decision in Dal Pra, at least pertaining to severability, injects some common sense into Wisconsin law. Business attorneys can at least draft agreements with some modicum of confidence that they will be upheld and not struck down on a technicality.

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Court: Supreme Court of Wisconsin
Opinion Date: 7/14/09
Cite: Star Direct, Inc. v. Dal Pra, 767 N.W.2d 898 (Wis. 2009)
Favors: Neutral
Law: Wisconsin

Anti-Raiding Clause Narrowly Interpreted Following Stock Sale (Cenveo Corp. v. Diversapack, LLC)

In 2007, Cenveo purchased the outstanding stock of Commercial Envelope Manufacturing from the Kristel family for roughly $230 million. As is customary in business sale transactions, the sellers had to agree to certain restrictions on competitive activity. The agreements signed by the Kristel shareholders restricted them from recruiting or hiring away employees for a period of five years.

About a year later, the Kristels purchased an equity interest in Diversapack and hired at least 12 Cenveo employees. Cenveo sued, seeking to enjoin Diversapack from hiring its employees given the anti-raiding provisions contained in the stock sale documents.

But the court noted a basic problem with Cenveo's case: Diversapack is not a competitor of Cenveo. The anti-raiding provisions provided the selling shareholders could not recruit away employees to work for a competing business. Cenveo appeared to make a half-hearted attempt to bring Diversapack within the agreements' definition of competing business by alleging that Diversapack planned to install some specialized equipment that was similar to that used by the Kristel family in the business it sold to Cenveo. In addition to being vague, this allegation was hardly convincing.

Cenveo also had another problem: New York courts construe anti-raiding (also called "no-hire") clauses under the same standards as a non-compete agreement, meaning they are considered restraints of trade and are examined under a reasonableness test. The court found that, not only did the sale agreements not prohibit the hiring at all, but also that no legitimate business interest could support the anti-raiding covenants. Hiring ex-Cenveo employees did not threaten the disclosure of confidential information since Diversapack was not a competitor. And nothing indicated that the employees offered "unique services" to Cenveo, an interest recognized by New York courts.

In view of all that, the court had little trouble concluding that Cenveo was unlikely to succeed on enforcing the anti-raiding provisions. Aside from the rather obvious question of why Cenveo filed suit in the first place, the case demonstrates that no-hire provisions must be drafted and examined carefully. Not all states treat them as classic restraints of trade (probably because they aren't). But some states like New York will look at them under the same test - meaning counsel must tailor them narrowly to protect an employer's business interest.

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Court: United States District Court for the Southern District of New York
Opinion Date: 10/1/09
Cite: Cenveo Corp. v. Diversapack, LLC, 2009 U.S. Dist. LEXIS 91535 (S.D.N.Y. Oct. 1, 2009)
Favors: Employee
Law: New York

Fourth District in Illinois Rejects "Legitimate Business Interest" Test for Non-Compete Cases (Sunbelt Rentals, Inc. v. Ehlers)

The Fourth District Appellate Court of Illinois may have just made it substantially more difficult for employees to break their non-compete agreements - at least in some parts of the state.

Justice Steigmann authored an opinion that built upon his special concurrence two years ago in Lifetec, Inc. v. Edwards, a case where he called into question the applicability of the so-called "legitimate business interest" test used by Illinois courts to analyze restrictive covenants. This time around, Steigmann succeeded in convincing his robed colleagues to abandon the test altogether, overturning a number of Fourth District cases in the process. The decision does nothing to alter the test in other districts, and each of those still uses the test which is widely believed to be employee friendly.

By way of brief background, Illinois courts have essentially used a two-part analysis to determine whether a non-compete agreement is valid. First, it must be reasonable in scope. Second, it must protect a legitimate business interest. The second part of the test demanded an employer show that it had an interest in misuse of confidential information or near-permanent customer relationships acquired through the employee's association with the employer. This is not a marked departure from what other states require, though some would argue Illinois is fairly narrow in not recognizing other types of business interests, such as special training. However, Justice Steigmann could not find Illinois Supreme Court authority for part two of the test.

By reviewing Supreme Court precedent, Steigmann is correct in that the Court never formally adopted the test which has been used for years by all five district appellate courts. He casually neglects to mention that in the past 60 years, the Court has taken on a grand total of six non-compete cases, and several of those looked at covenants outside the employment context. His analysis is not entirely accurate because his discussion also neglects to confront one of the Court's leading precedents, House of Vision v. Hiyane. That case was authored by Justice Schaefer, probably Illinois' most famous jurist.

In House of Vision, the Court specifically discussed at length the interest of a business in protecting customer relationships. It even distinguished prior precedents (also cited by Justice Steigmann) where the Court noted that in a sale-of-business non-compete, the legitimate interest to be protected concerned intangible goodwill. Covenants ancillary to a sale of a business are always easier to uphold, and it may well be true that a legitimate business interest is virtually presumed in such circumstances. But it seems illogical that the Court would discuss a legitimate business interest in connection with a sale-of-business covenant, and then deem the test inapplicable to more problematic employment covenants. Steigmann has assured us the Court will have to take an employment non-compete case soon to resolve the tension between the Fourth District and the rest of the state's appellate courts.

Justice Steigmann's analysis defaults to the reasonablenes test he cites from what he considers binding precedent: an employer must show that the covenant is no greater than is necessary for its protection. As applied to the facts involving Sunbelt Rentals and Neil Ehlers, the court concluded the 50-mile non-compete was reasonable even though the employment agreement also contained a well-drafted client non-solicitation clause.

It's hard to see, though, how a court can determine whether a covenant is "no greater than is necessary for its protection" without analyzing what business interest it seeks to protect in the first place. The legitimate business interest test fills that vacuum and allows a court to fashion an appropriate restraint, or strike one entirely if the employer can't articulate the need for a restriction.

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Court: Appellate Court of Illinois, Fourth District
Opinion Date: 9/23/09
Cite: Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (4th Dist. 2009)
Favors: Employer
Law: Illinois

Kelly Bires' Deal With TD Racing Held Unfair Restraint of Trade (Bires v. WalTom)

To what extent are compensation forfeiture provisions adjudicated under non-compete standards?

This is a question that has vexed Illinois courts - state and federal - for many years, and the case precedents yield no clear answer. Jurisdictions are split on whether forfeiture-for-competition provisions should be analyzed as a de facto restraint of trade or under ordinary freedom of contract principles.

Recently, a case involving a high-profile athlete has shed new light on how courts view forfeiture clauses. Kelly Bires is a successful NASCAR driver who previously signed a "Driver Agreement" with WalTom (since sold to TD Racing Development). Among other provisions, Bires agreed to pay a 25% royalty on future race-related earnings to WalTom for a period of ten years following the time in which he ceased driving on the WalTom team.

Bires, in a wide-ranging dispute, challenged the royalty provision as an unenforceable restraint of trade under Illinois law. Bires just recently inked a new deal with JR Motorsports, which is managed by the Earnhardt family. A federal court in Chicago agreed with him and granted him a judgment declaring the royalty provision unenforceable.

The court relied on a 1973 precedent from the Appellate Court of Illinois, which involved a true forfeiture-for-competition clause in the insurance industry to conclude that a provision which is not a restraint in the actual sense (that is, WalTom could not prevent or enjoin Bires from competing for another racing team) can be considered one if the intent of the clause is to discourage competition. The court examined WalTom's statement that it expected to earn close to $7 million from the royalty provision and had little trouble concluding that the contract had to be examined under the strict scrutiny standard applicable to non-compete agreements.

Under that analysis, the court's task seemed fairly simple. The royalty provision had no geographic term, but the court rightfully downplayed this as a significant factor. (NASCAR competes everywhere, so a geographic term would have little meaning). However, the ten-year post-affiliation royalty provision was overbroad - as was the definition of "race-related earnings" to which the royalty rate attached. It included virtually any income derived from any entertainment medium, extending well beyond true race earnings.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 9/23/09
Cite: Bires v. WalTom, LLC, 662 F. Supp. 2d 1019 (N.D. Ill. 2009)
Favors: N/A
Law: Illinois