Illinois Legislator Introduces Covenants Not to Compete Act

Yesterday, Rep. Rosemary Mulligan filed HB 4040 concerning employment covenants not to compete. The proposed legislation is comprehensive, with the following highlights:

(a) it limits non-compete agreements to "key employees" as defined by the act, but does not impact non-solicitation, no-hire or non-disclosure covenants;

(b) blue-penciling of unreasonable terms is discretionary, but will not allow an employer to obtain damages for any breach occurring before an order of modification;

(c) requires 2 weeks notice before an employee is asked to sign a non-compete (unless there is a bona fide advancement or promotion);

(d) defines legitimate business interests;

(e) creates rebuttable presumptions as to reasonableness regarding time (1 year), geography and type of activity;

(f) addresses attorneys' fees in the context of one-sided agreements or declaratory judgment claims.

The proposed act does not apply to stock forfeiture agreements, confidentiality agreements, restrictions among partners, or activity restraints.

Garden-Leave Provision Strictly Construed Against Employer (Bannister v. Bemis Co.)

Garden-leave clauses, which essentially pay an employee for a post-termination non-compete, originated in the United Kingdom and are becoming increasingly popular in the United States. The reason is obvious: employers face uncertainty when seeking injunctive relief to enforce a non-compete claim against an ex-employee. Though relatively few cases have addressed garden-leave provisions, they have been met with favorable opinions.

In Bannister v. Bemis Co., Inc., a variant of a garden-leave clause was at issue. Roger Bannister served as director of technical and product development for Bemis. In 2000, he signed a non-compete agreement which contained an 18-month post-employment restriction against working for a competing entity. However, Bannister's contract provided he could receive his continued base-salary from Bemis if he was "unable to obtain employment consistent with his abilities and education solely because of the [non-compete clause."

Four years later, Bannister requested a release from his non-compete clause so he could join Mondi, a Bemis competitor. Apparently, Bannister was not the only employee seeking to leave Bemis for Mondi; around the same time, Bemis sued Mondi and ex-Bemis employees who accepted positions with Mondi. That suit (to which Bannister was not a party) settled with a covenant providing Mondi would not hire for 18 months any Bemis employees who were subject to non-compete agreements.

After refusing severance, Bannister was terminated a few months after the Mondi-Bemis suit was settled.

Bannister then sought his garden-leave pay from Bemis, claiming he could not find a suitable position because of his non-compete. He provided monthly statements to Bemis regarding his efforts to find work. Bemis resisted, arguing Bannister could not work for Mondi anyway because of the settlement agreement in the lawsuit. Bemis offered to release Bannister from his non-compete for all other companies except Mondi.

The Eighth Circuit had little trouble affirming a damages judgment in favor of Bannister for the nine months in which he could not find comparable work. The court rejected Bemis' arguments that the Mondi settlement had any impact on Bannister's rights: "To the extent that the Mondi settlement is relevant, the only reason it prevented Mondi from hiring Bannister is because of Bannister's [non-compete] with Bemis. Thus, even considering the settlement agreement, the [non-compete] was still the sole cause of Bannister's ability to be hired by Mondi."

Garden-leave provisions are likely to be considered by employers as more and more employees are severed without cause. Courts may have more sympathy for workers subject to restrictions who are involuntarily terminated, reasoning the application of a covenant imposes an undue hardship on the employee. Further, a garden-leave provision can yield more certainty than a non-compete clause, because the latter always carries with it some risk for the employer that its covenant will be declared invalid.

If such provisions are drafted and because garden-leave is still a new concept in American courts, counsel should still consider drafting restraints narrowly and pay careful attention to those jurisdictions like Virginia, Wisconsin and Georgia where a strict blue-pencil rule can threaten an entire agreement.

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Court: United States District Court for the Eighth Circuit
Opinion Date: 2/25/09
Cite: Bannister v. Bemis Co., Inc., 2009 U.S. App. LEXIS 3648 (8th Cir. Feb. 25, 2009)
Favors: Employee
Law: Arkansas

Connecticut Court Allows Non-Compete Agreement to Extend to Potential Customers (Webster Financial v. McDonald)

Non-compete agreements which contain activity restrictions - usually termed non-solicitation clauses - generally are viewed more favorably by courts than outright bans on employment with a competitor. I have previously written that for salespersons and those employees whose primary responsibility is client service, employers should consider utilizing a non-solicitation provision rather than a general non-compete clause.

Despite the fact these restrictions are inherently less problematic, a non-solicitation covenant still is a restraint on trade and must protect the employer's legitimate business interest rather than prevent competition. To that end, courts have taken widely different approaches in assessing the concept of reasonableness when a non-solicitation clause is challenged in court.

For starters, a geographic limit frequently does not work with non-solicitation clauses. Unless a salesperson is assigned a specific territory, a geographic restriction can appear arbitrary. In this respect, courts generally will uphold a non-solicitation clause without a geographic term. In Illinois, the rules are fairly strict - if there is no geographic term tied to a non-solicitation clause, then it must be narrowly drawn to prevent the employee only from contacting those customers with whom he or she developed a relationship during the course of employment. Other states permit non-solicitation clauses that capture a broader range of clients.

In Webster Financial v. McDonald, a Connecticut trial court had occasion to consider this issue when an employee tried to dismiss a non-compete claim at the initial pleading stage. The court refused to do so, holding that the clause, which barred the defendant from soliciting even "potential clients" of his ex-employer, could be reasonable. In Illinois, this would be too broad because the term "potential client" is vague and does not fall within the ambit of protectable relationships.

However, the court in Connecticut held that the case could not be dismissed - at least not without some discovery as to the agreement's reasonableness. The court gave the employer the benefit of the doubt on the contract language, relying on the fact that geographic-based restrictions would logically preclude contact with even potential clients. Because courts have always upheld geographic restrictions that are reasonable, there was nothing wrong with a non-solicitation covenant covering potential clients.

Again, because the was rendered in response to a motion to dismiss, the court had to take all facts as true and was left determining whether the covenant was per se unreasonable. At least at this stage, it could not make such a finding.

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Court: Superior Court of Connecticut, Judicial District of Waterbury
Opinion Date: 1/27/09
Cite: Webster Financial Corp. v. McDonald, 2009 Conn. Super. LEXIS 169 (Conn. Super. Ct. Jan. 27, 2009)
Favors: Employer
Law: Connecticut

Unclear Territorial Restriction Renders Non-Compete Invalid (Asheboro Paper and Packaging v. Dickinson)

In virtually all states, non-compete agreements are subject to the rule of reasonableness. Reduced to its essentials, the rule requires that post-employment covenants be reasonable as to time, geography, and scope of activity. It is the last two elements that are frequently the subject of reasonableness challenges by departing employees.

Such was the case in Asheboro Paper and Packaging v. Dickinson. Asheboro Paper is a distributor of packaging products and hired Dickinson as a sales representative. His post-employment non-compete prevented him from working for one year in any capacity for a competing organization within 150 miles of Asheboro Paper's "branch offices in North Carolina and Virginia."

It was undisputed the parties intended for Dickinson - who previously worked at Unisource Worldwide - to establish and grow a branch office in Richmond, Virginia. However, at the time of hiring, Asheboro Paper had no office or physical presence of any kind in Virginia. In fact, Asheboro Paper contracted with a logistics company to rent a distribution and warehouse center for the purpose of storing inventory. Dickinson did not have unfettered access to the facility.

About two years after he started, Dickinson quit and went back to Unisource in Richmond. Asheboro Paper sued to enforce the non-compete and prevent Dickinson from working for Unisource within 150 miles of Richmond.

The court denied Asheboro Paper's motion for preliminary injunction on the grounds the non-compete was overbroad (both in terms of geography and scope of activity), and that Asheboro Paper was unlikely to succeed on the merits. The most interesting part of the opinion dealt with the territorial restriction in the non-compete.

Asheboro Paper failed to demonstrate the existence of a "branch office" in Virginia. Though it was clearly the parties' intent for Dickinson to help establish one, it never materialized. Further, the court held that Dickinson's home - where he worked and made sales calles - did not constitute a branch office. The court also remarked that Asheboro Paper failed to introduce in evidence any customer lists to justify the 150-mile radius. That radius would nominally prevent Dickinson from working in parts of Delaware, Maryland, the District of Columbia and West Virginia. Yet, Asheboro Paper conceded it had no clients in those locations.

The case presents an example of why employers should be wary of requiring salespersons to sign general non-compete agreements with bright-line territorial restrictions. A good defense attorney will generally be able to demonstrate the overbreadth of such a restriction. The better practice is to include a separate, narrowly tailored customer non-solicitation provision (either as a substitute for the non-compete or a back-up), so that questions about where an employer does or does not conduct business become moot. In Asheboro Paper, the agreement did not contain a severable non-solicitation provision, so the entire covenant failed.

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Court: United States District Court for the Middle District of North Carolina
Opinion Date: 2/19/09
Cite: Asheboro Paper and Packaging, Inc. v. Dickinson, 599 F. Supp. 2d 664 (M.D.N.C. 2009)
Favors: Employee
Law: North Carolina

Georgia Case Highlights Strict Application of Blue-Pencil Rule (Global Link Logistics v. Briles)

Legal practitioners in Georgia may not see non-compete rulings like this for much longer. As reported extensively in Seyfarth Shaw’s blog, Trading Secrets, the Georgia legislature may be on the move with respect to recasting employee non-compete law.

The pro-employee bent to Georgia’s law deals with the blue-pencil rule; any overbroad provision can kill a non-compete agreement. From this practitioner’s viewpoint, some of the handwringing over the blue-pencil rule is way overblown. Lawyers responsible for drafting these contracts ought to be more pragmatic. If an employee has an overbroad contract, at least he or she has a predictable result should the agreement be challenged. The fluidity associated with the blue-pencil rule yields uncertainty.

In Global Link Logistics v. Briles, the employee's non-compete barred him from working for a competitive business for two years in any capacity whatsoever. It was this last part - the lack of any activity restriction whatsoever – that doomed his former employer.

In Georgia, like Illinois and many other states, a non-compete must be reasonable in terms of (a) time, (b) geography, and (c) scope of activity. As to the third reasonableness component, the non-compete should put some parameter on the type of work that is off-limits. Generally, if there is a reasonable nexus between the employee's actual job function and the restricted job classification in the non-compete, a court is likely to find it reasonable. Patently overbroad clauses that bar a wide range of job activities or a complete ban on working in an industry, however, won’t cut it under Georgia law or the law of many jurisdictions.

So Briles’ non-compete failed. The result was obviously correct. The better analysis for non-compete agreements is to put the employer under an obligation to draft it reasonably and suffer the consequences for shoddy work. If a blue-pencil rule is sanctioned by a court, it at least ought to have some bite - such as foreclosing the opportunity for damages or fee-shifting to the employer.

Conducting an analysis based on the rule of reason (itself an antitrust derivative) is more preferable than having have courts get wrapped up in the fact-intensive, expensive process of determining whether a legitimate business interest supports the covenant. That rule has led to inconsistent and, frankly, bizarre results.

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Court: Court of Appeals of Georgia, First Division
Opinion Date: 2/18/09
Cite: Global Link Logistics, Inc. v. Briles, 674 S.E. 2d 52 (Ga. Ct. App. 2009)
Favors: Employee
Law: Georgia

Termination of Employment Will Not Constitute "Abandonment" of Non-Compete (EBI Holdings v. Butler)

The impact of involuntary termination of employment on the enforceability of a non-compete is not amenable to a quick summary. I wrote an article in the DePaul Business & Commercial Law Journal in 2002 canvassing the law on this subject, and it took me over 40 pages of dense analysis to opine that there is no real clear-cut answer. In Illinois, a 1994 case seems to hold that a non-compete agreement cannot be enforced if an employee is discharged without cause. But since that time, no cases have explained this holding or if it in fact means what it says.

In EBI Holdings v. Butler, an Illinois federal district court this week got close to addressing the issue, but ultimately declined. Since the employee's non-compete agreement was governed by New Jersey law, perhaps Butler is not a good test case on the interpretation of an Illinois case now 15 years old.

However, the plaintiff - a discharged medical products salesman - made an interesting argument. He claimed that his termination from a distributor amounted to abandonment of a post-employment covenant. The court struck his affirmative defense and noted that the agreement contemplated termination of his employment, so that abandonment under New Jersey law could not be a viable defense. It's not clear the employee raised a defense that the non-compete was unenforceable by reason of his discharge.

The case also did not address a circumstance where a discharge was inconsistent with the terms of the employment agreement. In such a case, an employee may have a viable claim that the non-compete is not enforceable because his termination was not valid or proper under the governing contract.

In a separate opinion, the court in Butler clarified the preemption doctrine in a trade secrets case. Often times, an employer will include common law claims arising out of the same operative facts as trade secrets misappropriation, such as conversion, unjust enrichment, tortious interference with contract, or civil conspiracy. The court clarified that the Seventh Circuit's decision in Hecny Transp., Inc. v. Chu limits the preemption theory to claims which rest on trade secrets theft. The test is "whether the plaintiff's claim would lie if the information at issue were non-confidential." Old district court cases taking a much broader view of preemption, and dismissing a lot of common law claims, are no longer reliable precedents.

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Court: United States District Court for the Central District of Illinois
Opinion Date: 2/17/09
Cite: EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11558 (C.D. Ill. Feb. 17, 2009) and EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11535 (C.D. Ill. Feb. 17, 2009)
Favors: Employer
Law: New Jersey, Illinois

Strict Construction Rule Prevents Enforcement of Non-Compete Agreement in Washington Case (Fluke Corp. v. Milwaukee Electric Tool)

Employers should always be aware that non-compete agreements will be strictly construed against it as the party in charge of drafting the contract; presumptions regarding ambiguities almost always devolve in favor of an employee. It is here where lawyers need to be particularly scrupulous in drafting agreements that reflect the intentions of the employer and guard against potential loopholes.

A recent Washington appellate case illustrates what happens when the precise contract language renders a non-compete totally ineffectual, such that traditional notions of reasonableness and protectable interests never even get addressed.

Fluke Corp. v. Milwaukee Electric Tool involves a dispute over the termination of Jonathan Morrow, who left Fluke to begin work for Milwaukee Electric in its Test and Measurement Field. But Morrow was initially hired by Jacobs Chuck Manufacturing, a subsidiary of Danaher Corporation. Fluke was a separate subsidiary of Danaher.

Morrow's two-year, broad non-compete restriction was contained in a contract with Jacbos Chuck; Fluke was not a party to it and the definition of "Company" in the preamble to the agreement referenced only Jacobs Chuck as a division of Danaher.

The non-compete clause broadened the definition of Company to include any affiliate of Danaher, but the expanded definition of Company was limited just to the non-compete term. Morrow was transferred to Fluke after he signed the non-compete contract, and he never signed a new agreement with Fluke.

Fluke balked when Morrow quit to join a competitor. Reversing the trial court's order of injunctive relief, the appellate court held that the unambiguous contract language rendered the non-compete unenforceable by Fluke against Morrow.

The reasoning: Morrow's transfer to another subsidiary - Fluke - constituted a termination of the employment agreement. It was critical that other contract provisions not at issue stated that a transfer of Morrow to another affiliate of Danaher would not constitute a termination of the agreement. However, by limiting the effect of transfer to just a few paragraphs, the fact the non-compete section was silent on this issue meant Morrow's transfer to Fluke was a termination for purposes of the non-compete covenant.

Finally, the agreement did not provide for automatic assignment to a subsidiary in the case of a transfer. Had it, the outcome may have been different - or at least the court would have been forced to address the substance of the non-compete.

The decision is an example of how employers must be careful in analyzing when the non-compete purports to operate, either in terms of an inter-company transfer, a termination or an assignment following an acquisition. It is critical that terms in one paragraph match up with another so that employees cannot argue that the strict construction rule releases them from any post-employment obligations.

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Court: Court of Appeals of Washington, Division One
Opinion Date: 2/17/09
Cite: Fluke Corp. v. Milwaukee Electric Tool Corp., 2009 Wash. App. LEXIS 364 (Wash. Ct. App. Feb. 17, 2009)
Favors: Employee
Law: South Carolina

Illinois Decision Demonstrates Difficulty of Proving Protectable Interest in Customer Relationships (Brown & Brown v. Ali)

One of the most nebulous areas of non-compete law concerns the scope of a protectable business interests. While many states recognize similar interests that support a restrictive covenant, the devil always lies in the details.

In Illinois, only two protectable interests will validate an otherwise enforceable non-compete agreement: (1) confidential information an employee has attempted to use for his own benefit; and (2) near-permanent relationships with customers that the employee would not have had but for his affiliation with the employer.

Attorneys representing employers should exhaust every avenue to invoke the first protectable interest - use of confidential information. This rather undefined term gives an attorney the flexibility to be creative and make his or her case for why a departed employee has purloined information and tried to use it for his own self-interest. No physical taking of documents is necessary; use of confidential information can come from one's memory.

The second business interest is harder to justify, and a recent federal district court bench-trial confirms why this is so. In Brown & Brown v. Ali, the defendant was a highly paid, highly regarded executive for a wholesale insurance broker, specializing in the placement of insurance for public entities and non-profit insurance pools or trusts. His two-year client non-solicitation agreement prohibited him from contacting all of Brown & Brown's customers after his departure.

Despite the fact insurance brokerage is a highly competitive, relationship-driven business, the court found Brown & Brown could not establish a protectable interest in near-permanent customer relationships. The court relied on a number of Illinois decisions holding that, ordinarily, an employer engaged in sales has no protectable interest in its customer relationships because business is highly mobile and fluid.

Ultimately, the issue was of little consequence, and perhaps Brown & Brown's proof that Ali misused and took its business information impacted its presentation of evidence on customer relationships. Still, the ruling serves as a cautionary tale for employers relying on near-permanency to support its non-compete.

Additionally, the court again invalidated a choice-of-law provision - this time one favoring application of Florida law. The court relied on another state court decision involving the same employer and same agreement to conclude that public policy mandated application of Illinois law, rather than the chosen law by contract. Florida law prohibits consideration of whether a non-compete will impose a hardship on an employee, while Illinois courts have long considered this issue under the rubric of reasonableness.

The choice-of-law ruling demonstrates courts in Illinois will take a close look at an out-of-state's substantive law to determine whether applying it would be consistent with public policy in Illinois.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 1/7/09
Cite: Brown & Brown, Inc. v. Ali, 2009 U.S. Dist. LEXIS 10252 (N.D. Ill. Jan. 7, 2009)
Favors: Employee
Law: Illinois

Texas Strictly Construes Forfeiture-for-Competition Clause (Valley Diagnostic Clinic v. Dougherty)

Not all restraints of trade are treated equally. In virtually all jurisdictions, covenants ancillary to an employment contract are subject to strict scrutiny for reasonableness and undue hardship. On the other hand, courts readily enforce sale-of-business covenants. And non-compete clauses which are ancillary to other relationships, such as distributorship agreements, can fall into either category depending on the facts and the bargaining position of the parties involved.

Another category of covenants has received comparatively little judicial scrutiny over the years. Forfeiture-for-competition clauses do not, technically, restrain an employee from working in a particularly industry, but they exact a price for doing so. A typical forfeiture covenant arises when an employer provides an incentive to an employee to stay with the company for a period of time. The incentive typically is some form of deferred compensation or stock options. Agreements are written to grant an employer the ability to not only forfeit unpaid compensation or vested options, but also to clawback income paid out pursuant to the incentive plan for, say, the year preceding termination.

Courts have taken two general approaches to resolving the validity or enforceability of these restraints. The majority view does not view a forfeiture provision as a restrictive covenant, and in jurisdictions adopting this view, the forfeiture clause will not be subject to a reasonableness inquiry. Courts in Missouri, Indiana and New York follow this line of reasoning.

A second, and minority, line of cases will examine the forfeiture clause as a restrictive covenant, reasoning that the intent of the arrangement is to restrain competition - if not in language, then certainly in impact. Nebraska, Wisconsin and Connecticut take a more dim view of forfeiture provisions. In Illinois, the cases cut both ways.

Add Texas to the minority. In Valley Diagnostic Clinic v. Dougherty, the Court of Appeals of Texas held that a forfeiture-for-competition clause within a medical practice's bylaws will be construed under Texas' Covenants Not to Compete Act because the intent was clearly to restrain competition with the medical practice by a departing shareholder. Under the facts of the case, the forfeiture provision was invalid because it was not designed to enforce any return promise on the part of the shareholder. The precise holding was based on an antiquated and confusing line of Texas cases interpreting its ancillarity requirement for non-competes.

The decision holding that a forfeiture clause is subject to strict non-compete scrutiny arguably contravenes a 1975 Texas case, Dollgener v. Robinson Fleet Services. That case clearly held that a forfeiture provision within a non-contributory profit-sharing plan was not subject to a restrictive covenants analysis because it was not a negative employment covenant. Though the court did not discuss Dollgener, it is possible the Texas legislature's enactment of the Covenants Not to Compete Act abrogated the older line of cases. Still, had it done so, the court should have discussed the ruling and clarified the law in this regard.

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Court: Court of Appeals of Texas, Thirteenth District
Opinion Date: 2/12/09
Cite: Valley Diagnostic Clinic, P.A. v. Dougherty, 287 S.W.3d 151 (Tex. App. 2009)
Favors: Employee
Law: Texas

Drafting Oversight Voids Employee's Non-Compete Agreement in Sale of Business (Herring Gas v. Pine Belt Gas)

Most non-compete are ancillary either to an employment relationship or a sale-of-business transaction. Regarding the latter, a party seeking to escape any competitive restrictions usually meets with little success if its effort is based on protectable business interests or reasonableness as to the contract's scope. A fair number of sale-of-business cases, therefore, turn on the contract language and whether a restrictive covenant survives an acquisition.

The Supreme Court of Mississippi recently held that an employee's non-compete agreement was not enforceable when the governing asset purchase agreement made no reference to existing non-compete agreements as a "purchased asset." In Herring Gas Co., Inc. v. Pine Belt Gas, Inc., the buyer sought to enforce a non-compete covenant against Jimmy Rutland, an employee of Broome LP Gas, the entity which sold its assets to Herring Gas. The deal closed on April 19, 2006, and Rutland quit to join a competitor five days afterwards. A few weeks later, Broome assigned Rutland's non-compete agreement to Herring Gas.

About a month after the closing, Herring Gas wrote a cease and desist letter to Rutland challenging his decision to work for another purveyor of propane gas within the restricted territory (75 miles from Purvis, Mississippi). Herring Gas chose not to file suit for another six months.

The trial court held that Herring Gas, as the entity acquiring Broome's assets, could not enforce the covenant against Rutland. The Supreme Court affirmed for two reasons: (1) the language of the asset purchase agreement precluded enforcement by Herring Gas; and (2) the assignment failed because Rutland had already quit.

The first issue demonstrates the care with which counsel should approach employee non-compete agreements during the due diligence and closing phases of a transaction. The definition of purchased assets mentioned nothing about employment contracts or non-competes, and there was a specific exclusion of all other assets not identified in the contract of sale. Moreover, the parties failed to effectuate any assignment of the employment agreements at the time of closing. These facts ultimately precluded enforcement by Herring Gas.

In most jurisdictions, when a key employee signs a restrictive covenant concurrent with the sale of assets, that contract - even though styled as an employment agreement - will be examined in accordance with the more lenient enforceability standard where a protectable interest is virtually presumed.

However, this rule will not apply when the non-compete is an existing obligation that arose well before the sale date. The problem with Rutland's contract could have been avoided had the issue been addressed specifically in the closing documents.

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Court: Supreme Court of Mississippi
Opinion Date: 2/12/09
Cite: Herring Gas Co., Inc. v. Pine Belt Gas, Inc., 2009 Miss. LEXIS 65 (Miss. Feb. 12, 2009)
Favors: Employee
Law: Mississippi

Kansas Court Enforces 2-Year, 250-Mile Non-Compete Agreement (Chem-Trol v. Christensen)

Often times, when a court enforces a non-compete agreement, the restraining order or injunction won't match up with the language of the covenant. This usually is the result of the blue-pencil or judicial reformation doctrine. In a previous post, I outlined where each of the 50 states stands on the ability of courts to pare back, or sever, overbroad non-compete covenants.

However, on other occasions, a court will issue an injunction where a non-compete is modified but there is no discussion of the blue-pencil doctrine whatsoever. And that's what happened in Chem-Trol v. Christensen. In that case, Chem-Trol was engaged in the vegetation management services business, servicing utilities and rural electric cooperatives in maintaining right-of-ways and utility easements.

The plaintiff, Lyle Christensen, was clearly a key employee for Chem-Trol, serving as Area Manager for the Iowa facility. He was discharged in August of 2008, and after a few months, began servicing his former customers, doing business as Midwest Spray Team & Sales, Inc. Chem-Trol filed suit, seeking preliminary injunctive relief.

The non-compete agreement at issue prohibited Christensen for two years from going "into business alone or in conjunction with one or more others, or in the employ of any other person or legal entity where the business of such employment shall be the same or similar to that of [Chem-Trol], within a 250 mile radius of Hamlin, Iowa."

The court enforced the covenant, finding it reasonable and supportive of a legitimate business interest. The latter issue was easy to resolve: Christensen had long relationships with key accounts, and he himself was Chem-Trol's face in Iowa. Moreover, the scope of the non-compete did not appear unreasonable under the facts: the 250-mile radius - though wide - was reasonable because the nature of vegetation management services frequently stretched hundreds of miles per job. The two-year term also did not appear problematic since Christensen testified that it takes one to two years to form solid customer relationships in his business.

(Parenthetically, the fact Christensen was terminated involuntarily did not matter in this case - Kansas precedent (which the court did not cite) makes no distinction in cases where an employee is terminated and faces a non-compete obligation. Other states, like New York and Illinois, view that issue differently.)

What was odd, though, was the court's conflation of the non-compete terms with a separate non-solicitation of customers covenant. The injunction order only prevented Christensen from soliciting or providing services to Christensen's Chem-Trol accounts (which was not, apparently, disputed), as long as those accounts were within 250 miles of Hamlin, Iowa.

However, the non-solicitation clause - on which the court remarked - had no 250-mile restriction on it. It was a separate paragraph in the agreement, and its scope was very broad; it barred Christensen from contacting any Chem-Trol account, not just his own. Also, the non-compete clause containing the geographic limit purported to bar Christensen from working for any entity or providing any competitive services, whether those activities concerned Chem-Trol accounts or not. In other words, it seems as if the court lost track of two separate covenants it was analyzing.

That said, the ruling makes some sense. Chem-Trol, for its part, did not appear hell-bent on putting Christensen out of work in the industry as long as he avoided his accounts. Given his key role in the company, that seemed to be a reasonable position to take. The end result was the non-compete was not really enforced, and the non-solicitation clause was enforced, but under the geographic scope written into the non-compete clause.

If that makes sense...

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Court: United States District Court for the District of Kansas
Opinion Date: 2/10/09
Cite: Chem-Trol, Inc. v. Christensen, 2009 U.S. Dist. LEXIS 9894 (D. Kan. Feb. 10, 2009)
Favors: Employer
Law: Kansas

On Preliminary Injunction Hearing, Court Enforces Non-Compete Agreement Against Kris Elliott (Hal Wagner Studios v. Elliott)

I wrote several weeks ago about a temporary restraining order partially granted in the case of Hal Wagner Studios v. Elliott, a non-compete dispute out of the Southern District of Illinois. At that time, the court granted the plaintiff only part of what it requested - a TRO requiring the defendants to return certain business documents taken from their former employer prior to their sudden departure at the end of 2008. I also noted that the court declined to enforce the covenant not to compete against the main defendant, Kris Elliott. That said, the court warned Kris Elliott that - in essence - he was proceeding at his own peril.

Less than a month later, Hal Wagner Studios was able to obtain the broad relief it initially requested. As my previous post indicates, the dispute arises out of the photography services business. HWS sells photography and yearbook services to schools in a number of different regions, including Missouri and Southern Illinois. Kris Elliott was in the same business in 1994, at which time HWS purchased the assets of Elliott's business. Apparently, Elliott's non-compete agreement was signed at or around the time he sold his business to HWS.

The non-compete was fairly narrow, particularly for one arising out of the sale of a business. In essence, it barred Elliott from competing with school photography accounts in a defined territory which appears commensurate with the geographic region he serviced before the sale to HWS.

As with many change-in-control situations where the seller party is retained following a sale, the relationship deteriorated. At least from the court's opinion, it appears the source of Elliott's grievance with HWS concerned the amount of money he was being paid and his bonus structure. At the end of 2008, Elliott and his wife, Pam, led a mass exodus out of HWS' Edwardsville, Illinois location. The resignations were abrupt and an array of key business documents and electronic files were missing. Pam Elliott, in an effort to avoid her husband's non-compete restrictions, solicited at least 21 accounts in the former Elliott territory.

The primary issue at the preliminary injunction stage concerned the enforceability of the non-compete agreement in Kris Elliott's contract. The contract was governed by Missouri law. Elliott's main defense concerned his argument that HWS was in breach of its obligation to him by reducing his income and salary. In this respect, Elliott's own words appeared to do him in.

The court cited a number of exhibits where it appeared Elliott agreed to the changes in bonus structure and salary rate, indicating that Elliott confirmed the alterations with Hal Wagner and appeared - at least at the time - satisfied with what he was being paid. Though it appears HWS could have been more diligent in complying with the requirement that any modifications be in writing, the court clearly had little sympathy for Elliott - particularly since he did not voice any objections about the change in pay and actually documented his consent to them.

The case did not discuss whether the non-compete agreement should be adjudicated under the traditional employee standard or the less stringent sale-of-business standard. In Illinois, it seems clear that the non-compete would be viewed under the sale-of-business standard, which in essence presumes that a legitimate business interest exists in favor of the promisee (here, HWS). The non-compete Elliott signed was incidental to the sale of assets to HWS. Whether it was included within the asset purchase agreement, a covenant not to compete, or an employment agreement is irrelevant.

Given the patently reasonable terms of the non-compete (a covenant far less restrictive than those typically seen in a sale of business) as well as the insufficient evidence adduced as to HWS' alleged breach of contract, Elliott appears to have little hope of avoiding a permanent injunction for the balance of his non-compete term.

Finally, the injunction order issued by the court prohibited Pam Elliott, Kris' wife, from soliciting accounts as well - despite the fact she had no governing non-compete agreement. This was an easy call for the court, as Pam's work in recruiting HWS clients at her husband's direction presented a paradigm case of impermissible indirect solicitation.

There are a number of obvious signs when a court will enforce a non-compete agreement, and this dispute presented quite a few of them, including:

(1) a non-compete signed in an arms-length transaction;
(2) the taking or misappropriation of important company documents;
(3) deletion of corporate data;
(4) surprise resignation or an orchestrated mass exodus of employees;
(5) trying to crawl through a non-compete loophole by funneling sales activity to someone not a party to the agreement; and
(6) confused third-party customers.

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Court: United States District Court for the Southern District of Illinois
Opinion Date: 2/6/09
Cite: Hal Wagner Studios, Inc. v. Elliott, 2009 U.S. Dist. LEXIS 8892 (S.D. Ill. Feb. 6, 2009)
Favors: Employer
Law: Missouri

Nebraska Court Sides With Expansive Reading of Computer Fraud and Abuse Act (Ervin & Smith Advertising v. Ervin)

Illustrating the ambiguity and interpretation problems created by the Computer Fraud and Abuse Act, a Nebraska district court has taken an expansive reading of the statute directly contrary to other recent holdings - including the Lugo case and the Bridal Expo case posted below.

Once again, the controversy centers around the meaning of "authorization" in the context of employee appropriation of electronic data during the course of his or her employment. In a conventional (a)(4) or (a)(5) claim under the CFAA, an employer always has to demonstrate that an employee's use of a protected computer was unauthorized. The meaning of that term has been subject to two general interpretations by federal courts.

In this case, the defendants - former executives in an advertising and public relations firm - e-mailed documents to their home computers as they were preparing to compete against their firm. Unlike the Bridal Expo case, there was no dispute in this case that the computer access was done prior to the end of the employment relationship. Arguably, then, the access was authorized.

But following the line of cases in the Seventh Circuit and elsewhere, the court found that principles of agency law - a principle articulated nowhere in the CFAA - essentially rendered the employee's self-interested acts "unauthorized" under the federal statute. The case follows an expansive reading of the CFAA, articulated most notably in the Citrin case from the Seventh Circuit. Many courts have declined to follow Citrin and its progeny.

Please read the entry concerning Lugo for an example of a more narrow reading of the CFAA.

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Court: United States District Court for the District of Nebraska
Opinion Date: 2/3/09
Cite: Ervin & Smith Advertising and Public Relations, Inc. v. Ervin, 2009 U.S. Dist. 8096 (D. Neb. Feb. 3, 2009)
Favors: Employer
Law: Federal

Purloined Data In Wedding Expo Case Won't Support Computer Fraud Claim (Bridal Expo v. Van Florestein)

With federal courts taking diametrically opposing positions on the reach of the federal Computer Fraud and Abuse Act, it should not be long before the Supreme Court steps in to clarify exactly what type of unfair competition this law actually protects.

As I have written before, courts are split in terms of whether misuse of confidential business data is included within the statutory definition of "damages." Another issue dividing courts concerns what type of employee conduct exceeds "authorized access" to a protected computer for purposes of what is known as an (a)(4) claim.

Under Section 1030(a)(4), an aggrieved employer may pursue a claim for unauthorized access of a protected computer with the intent to defraud. Courts are split over what type of computer access is unauthorized within the meaning of the statute.

The facts of a recent case involving the wedding exposition industry illustrate the legal tension perfectly. Two employees of Bridal Expo, who had announced their departure from the company, were escorted out of their place of employment at 4:30 p.m. on their last day of work. Their boss took their keys. However, later that evening, they returned and began using one of Bridal Expo's computers.

Their boss asked them why they returned, and each claimed she had "more work to do" before leaving. One employee stated she was sending farewell by e-mail to vendors and employees. Importantly, their boss was aware they had returned and that the employees were using work computers.

Eventually, it was clear that the two employees had established a competing wedding expo company, Wedding Showcase, and the employees admitted that upon returning to work after being escorted out, they downloaded a vendor list, brides list, inventory list, company forms, and payment spreadsheet. The forensic analysis of the computer cost $13,000. The defendants' new company used the vendor list and database to mail advertisements to vendors for a new wedding showcase in the Houston area.

After losing a state court injunction proceeding, the plaintiff non-suited the case and refiled in federal court, adding - among other things - a claim under Section 1030(a)(4) of the CFAA for unauthorized access to a protected computer with intent to defraud. The court, noting the tension in the case law, denied a second injunction motion and dismissed the CFAA claim outright.

The court declined to follow the agency theory case law developed in the Seventh Circuit and others, which basically says that when an employee violates an agreement or his duty of loyalty he is no longer a true agent of the employer and exceeds any access previously granted to him. Other courts have viewed this reasoning with a healthy dose of skepticism.

The court in Bridal Expo took the more conservative, literal approach in declining to extend the CFAA's reach under an (a)(4) claim. It would not equate "authorization" with any duty of loyalty. Important to the court's ruling were the following factors:

(1) no confidentiality agreement between the employees and Bridal Expo;
(2) the employees were authorized to use the computers in this manner; and
(3) the supervisor saw them working on the computers after they had been escorted out of the office and did not complain about it.

The last factor may have been the most important. Had the defendants' snuck in to the office, and had their use of a work computer been completely unknown to a supervisor, the court might have had a basis for keeping the (a)(4) claim alive.

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Court: United States District Court for the Southern District of Texas
Opinion Date: 2/3/09
Cite: Bridal Expo, Inc. v. Van Florestein, 2009 U.S. Dist. LEXIS 7388 (S.D. Tex. Feb. 3, 2009)
Favors: Employee
Law: Federal

Ohio Court Denies More Expansive Temporary Restraining Order for Trade Secrets Misappropriation (The Right Thing v. Brown)

In trade secrets litigation, the scope of any injunctive relief is always a hotly contested issue. Courts retain wide latitude to fashion an order to achieve equity. Often times, this means a court will go beyond prohibiting a defendant from using or disclosing certain, listed types of information that were improperly used or disclosed. To that end, if a court finds that more robust restrictions on competitive activity are needed, the injunction can extend to solicitation of certain accounts about whom the employee misused or accessed confidential information, or even to prohibition on taking a job altogether.

In The Right Thing v. Brown, the court determined that a former recruiter who left an outsourcing firm to join Manpower e-mailed to her personal account a number of her ex-employer's documents containing arguably sensitive business information, such as client information, price lists, and financial data. The allegedly purloined documents were sent around the time Brown quit and just before she started with Manpower.

The court had little trouble concluding that, for purposes of the temporary restraining order motion, the ex-employer was likely to prevail on claims of trade secrets misappropriation. Accordingly, it entered an (arguably vague) order barring Brown from using certain types of documents or information of her ex-employer.

Still, the court refused to take the next step and prevent Brown from working at Manpower. Aside from the problematic e-mails, there was little to indicate Brown had intended to use the information taken to target specific accounts or market segments. In light of this lack of additional, damaging evidence, the more expansive TRO request was denied.

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Court: United States District Fourt for the Northern District of Ohio
Opinion Date: 2/2/09
Cite: The Right Thing, LLC v. Brown, 2009 U.S. Dist. LEXIS 7464 (N.D. Ohio Feb. 2, 2009)
Favors: Employer
Law: Ohio

Non-Compete Payments for Sale of Business Will Be Taxed As Ordinary Income (Muskat v. United States)

If a seller of a business receives a substantial payment for a non-compete agreement, can that be characterized as income subject to capital gains tax?

Not according to the First Circuit Court of Appeals which strongly denounced the efforts of one Irwin Muskat.

The case arose out of the sale of Muskat's business, Jac Pac Foods (based in Manchester, New Hampshire). It seems beyond dispute Muskat was highly successful at growing the family business, whose signature line was the distribution of meat products to restaurant chains. In 1998, Corporate Brand Foods America bought Jac Pac's assets for $34,000,000. Above the purchase price, CBFA paid Muskat nearly $4,000,000 for a covenant not to compete. About one-quarter of that was paid up front.

Muskat filed his 1998 tax return and listed the payment as ordinary income, paying income and self-employment taxes accordingly. However, he had a change of heart and filed an amended return for 1998, seeking to recharacterize the income as a capital gain. Because of the lower rate for capital gains income, he sought a tax refund of $203,434.

After the Internal Revenue Service denied the request, Muskat filed suit.

The First Circuit affirmed the trial court's judgment in favor of the United States. In its holding, the court made a number of important findings that business sellers will want to keep in mind:

(1) payments received in exchange for a non-compete are usually taxed as ordinary income;

(2) payments received for the sale of goodwill are usually taxed as capital gains;

(3) when a party seeks to vary a written allocation of income, that party bears the burden of submitting "strong proof" that the contracting parties actually intended the payments to compensate for something different; and

(4) the "strong proof" rule is analogous to the clear and convincing evidence standard familiar to litigants.

Applying these precepts to the IRS' ruling, Muskat was doomed. Muskat negotiated the sale of business documents - including his own employment and non-compete agreements - and those agreements clearly said the money paid to Muskat was to protect Jac Pac's (not Muskat's goodwill) and to prevent Muskat from competing with CBFA after the closing.

Muskat could not muster up any evidence that the payments were intended for something different, i.e., his personal goodwill. Exactly what Muskat argued in support of this proposition is not at all clear. In fact, the sale documents showed CBFA paid $16,000,000 for Jac Pac's goodwill, making any separate goodwill payment to Muskat "implausible."

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Court: United States Court of Appeals for the First Circuit
Opinion Date: 1/29/09
Cite: Muskat v. United States, 554 F.3d 183 (1st Cir. 2009)
Favors: N/A
Law: Federal

Georgia Legislature Considering Non-Compete Reform

Add Georgia to the ever-growing list of states intent on reforming non-compete laws.

In recent years, Idaho and Oregon have passed significant legislation, and Massachusetts is contemplating an outright ban on non-competes. Georgia is unquestionably one of the five most employee-friendly states in terms of non-competes - up there even with California and Montana.

A copy of the Georgia House of Representatives Final Report on non-compete reform can be found by clicking here. Seyfarth Shaw's blog, Trading Secrets, contains an excellent discussion of the legislative action down in Georgia.

Michigan Appellate Court Upholds 5-Mile Non-Compete Against Hair Stylist (Lockworks v. Keegan)

Non-compete agreements are always judged by the concept of reasonableness, and in most states, whether they protect a legitimate business interest. Frequently, the scope of protectable interests focuses on business-to-business, rather than consumer, services. Indeed, non-competes can be enforced in the retail context, protecting employers engaged in so-called Main Street.

A case-in-point involves hair stylists. Non-competes are more common for hair stylists than one might think, and the case law suggests that because of the inherently personal nature of the services provided by a hair stylist to a customer, there is no question that a covenant not to compete can protect a legitimate business interest of the salon.

In Lockworks, Ltd. v. Keegan, the Court of Appeals of Michigan recognized this and enforced a 1-year, 5-mile non-compete against a hair stylist. With personal services businesses, the geographic scope of a non-compete often takes paramount importance in the analysis. Simply put, consumers will not travel great lengths to receive certain services - whether it be personal training, veterinary care, or in this case, hair cuts.

Here, the trial court committed reversible error when it determined that Keegan's new competitive job did not violate the non-compete, even though she went to work for a salon 4.16 miles from her old position with the plaintiff. In essence, the trial court blue-penciled the contract to find Keegan not in breach, determining that just over 4 miles was enough of a distance to protect the plaintiff. According to the appellate court, this was improper. Because 5 miles was a "modest distance", the customers with whom Keegan developed a relationship would not be deterred from driving the extra mileage to see her.

Accordingly, the court reversed and remanded for a determination of damages. Because the non-compete expired, the issue of an injunction appeared to be moot.

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Court: Court of Appeals of Michigan
Opinion Date: 1/27/09
Cite: Lockworks, Ltd. v. Keegan, 2009 Mich. App. LEXIS 157 (Mich. Ct. App. Jan. 27, 2009)
Favors: Employer
Law: Michigan