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

Narrow Injunction Issued Against Graphic Arts Sales Manager (Oldham Graphic Supply v. Cornwell)

The case of Oldham Graphic Supply v. Cornwell is one of those non-compete opinions that has just about everything. Nothing is particularly earth-shattering or consequential about the decision itself. But it provides a great template for lawyers and clients to see how a court resolves a fairly typical case.

Though the case originates from Kansas, Illinois law applied to the non-compete contract. David Cornwell was a long-time Wichita-based salesman in the competitive field of graphic arts and printing equipment. Prior to joining Oldham Graphic Supply in 2004, Cornwell had vast industry experience and cultivated important client relationships - a fact that is crucial under Illinois law. When Cornwell started with Oldham in 2004, the company had no real presence in Wichita. But as a result of an acquisition, Oldham penetrated the Wichita market and brought Cornwell aboard to grow it.

Not surprisingly, Cornwell migrated to Oldham about 50 accounts. He later became the general manager of Oldham's branch office in Springfield, Missouri but only spent about one day per month there. The rest of the time he worked from his home office. Like most managers, he supervised other salespersons' accounts and managed some of his own, and he was paid by way of salary and commission.

Cornwell signed a two-year non-compete barring competitive employment within 200 miles "of each Oldham Graphic Supply office." He also agreed to a two-year customer non-solicitation covenant covering clients with whom he had contact while employed at Oldham. This necessarily captured Cornwell's pre-existing relationships.

Over the past couple of years, Cornwell's compensation structure at Oldham became decidedly less favorable. His commission percentage was reduced and he lost other benefits. Eventually, Cornwell had enough and (with a little urging from a supervisor) found another job - a competitive one with Xpedx. Prior to his departure, he encouraged a few of his customers to move with him and transfer their graphic arts business to Xpedx.

Though this may not have been the most advisable thing to do, Cornwell was careful in other respects when leaving Oldham. His new employer crafted his sales territory to avoid the 200-mile radius restriction in the non-compete, and it doesn't appear Cornwell took or used any proprietary documents.

The court first addressed whether Oldham had a protectable interest to enforce by way of a covenant not to compete. Though the opinion is somewhat meandering, it eventually found that Oldham did have such an interest in some limited confidential business information for certain accounts Cornwell developed solely on Oldham's dime - particularly cost information for those accounts where Kodak was the original supplier. The court properly noted that some of the business information in which Oldham tried to claim a protectable interest (e.g., customer pricing and information for his long-time customers) was really not confidential or unique, particularly given well-known industry customs, the rate at which such operational information becomes stale, and Cornwell's vast experience.

But the more salient part of the court's opinion concerns the reasonableness test - the second part of the inquiry after a court examines whether there is anything legitimate to protect at all. The court found that the covenant had to be modified to make it reasonable. Most importantly, the court noted that Cornwell's pre-existing accounts were not protectable and the injunction could not extend to them. However, for accounts he developed first while working for Oldham (there were only a few), the court did find that Oldham's request for injunctive relief was appropriate.

The court also rejected Oldham's core argument that the 200-mile non-compete clause should extend from Cornwell's "home office." The court construed the agreement's questionable ambiguity (it really wasn't ambiguous at all) against Oldham and held that the branch office to which the non-compete language applied was the Springfield, Missouri office. Since his Wichita contacts fell outside the 200-mile radius, Oldham basically could claim victory through the narrow reading of the non-compete. Apart from having to avoid a few customers until next year (the court also pared back the non-solicit from 2 years to 1, given the fluctuating nature of the graphic arts business), Cornwell can continue working for Xpedx with only minor inconvenience.

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Court: United States District Court for the District of Kansas
Opinion Date: 9/17/09
Cite: Oldham Graphic Supply, Inc. v. Cornwell, 2009 U.S. Dist. LEXIS 85214 (D. Kan. Sept. 17, 2009)
Favors: Employer
Law: Illinois

Prospective Buyer of Video Rental Business Free to Compete Following Failed Acquisition (Movie Gallery US v. Greenshields)

One of the most significant risks facing a business seller is the cost associated with educating a potential purchaser in the event a deal falls through. It is standard practice to require any potential acquirer to execute a non-disclosure agreement, but the breadth of that contract can go a long way to mitigating the seller's risk.

Most buyers will balk at an industry non-compete clause following failed negotiations. Indeed, in most cases, the buyer will already have substantial experience in the seller's business. But often times, a general non-disclosure clause will not be enough to protect the seller. A recent case out of Alabama serves as a compelling example.

In 2006 and 2007, an entrepreneur named Mark Greenshields became interested in purchasing a video-racking division owned by Movie Gallery US, LLC. This business involves placing movie rentals in racks at consumer locations, such as grocery or convenience stores. The deal fell through in May of 2007, and Greenshields started his own video-racking business shortly thereafter. He hired three former Movie Gallery employees within a few months after the transaction imploded, and the new business eventually took about ten former Movie Gallery customers.

It's not at all clear that the defendants' monetary exposure was that great. Movie Gallery itself had been losing money in this business and was trying to jettison the video-racking division to focus on more profitable business segments. However, it sued Greenshields and the entities he formed for breach of the transaction non-disclosure clause.

The court, ruling under Alabama law, found that Movie Gallery failed to prove that the defendants breached any confidentiality obligation. Noting the evidence largely was circumstantial, the court highlighted the following as important flaws in Movie Gallery's theory of breach:

(1) Less than half of the defendants' new customers were ex-Movie Gallery customers;
(2) Ten customers was a relatively small number given that three former employees were working full-time in the business;
(3) No profitability analysis was ever conducted on the lost customers, suggesting that there was no evidence defendants targeted profitable, quick-paying accounts;
(4) The supply sources were known by the new employees given their long history in the business;
(5) The customer lease agreements were drafted by defendants' counsel, and the terms were generally known in the business and ascertainable simply by asking the customers themselves.

The court was unable to make the leap in logic demanded by Movie Gallery: that Greenshields had to be using information disclosed to him during due diligence of the failed transaction. The following summarizes succinctly the quandary faced by the court, which suggests it believed Movie Gallery should have required Greenshields to sign a more extensive non-disclosure agreement:

"The fact that Greenshields may have, through viewing confidential information over the course of several months, become more familiar with the specific accounting and business principles involved in a racking operation surely is not the equivalent of his using specific pieces of confidential information....[The non-disclosure] agreement specifically contemplated that Greenshields may compete, and it is only logical that Movie Gallery could not expect him to rid his mind of general knowledge acquired through his months of studying an industry new to him."

At a bare minimum, a seller of a business ought to require a buyer not to hire or engage a seller's employees for a period of time. In a case like Greenshields', his lack of experience in the business was not a deterrent to opening a competitor rather quickly; he took three long-time employees away from Movie Gallery to do the leg work.

Additionally, sellers need to consider limited customer non-solicitation covenants requiring a purchaser to avoid certain accounts following the termination of a potential deal. Sellers also can line-out customer names until the transaction negotiations reach a certain point, but in many cases this is neither feasible nor acceptable.

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Court: United States District Court for the Middle District of Alabama
Opinion Date: 9/1/09
Cite: Movie Gallery US, LLC v. Greenshields, 648 F. Supp. 2d 1252 (M.D. Ala. 2009)
Favors: N/A
Law: Alabama

Pre-Termination Admissions Prove Fatal to Departing Employees (Highway Technologies v. Porter)

Attorneys can add (or eliminate) a significant amount of value by how they advise clients who are preparing to compete. For instance, counsel must discuss the need not to misappropriate or transfer an ex-employer's corporate information (particularly through digital means), and must emphasize why business documents have to be returned upon departure. Just as importantly, counsel must stress the perils of deleting any business information - whether that be stored at work, on a portable storeage device, or on a home computer hard-drive. Failure to advise a client as to these issues can have major consequences.

But other more subtle tactics can also backfire. Take the recent case of Highway Technologies v. Porter, a preliminary injunction proceeding to enforce a 2-year non-compete agreement against two departing employees in the highway safety services business. In that case, an Arizona court enforced the covenant, finding that both Rodd Jose and David Porter intended to compete directly for their ex-employer's clients upon termination.

Two admissions, which occurred before the lawsuit even started, proved damning to both Jose and Porter. First, the business plan the defendants drafted stated that one of the strengths of their ex-employer was the relationship the defendants built with the ex-employer's customers, and that the ex-employer was "very susceptible" if Jose and Porter left the company. The court found this to be an indicator that the plaintiff's customer relationships were directly threatened by the defendants' competing venture.

In an ideal world, counsel for departing employees would review and scrutinize any documents which may discoverable - business plans included - to determine if any admissions could backfire in the event of litigation. Business plans, usually done at the urging of a bank or private equity partners, often provide a fertile ground for revealing who an ex-employee intends to targetcertainly forseeable.

But the second document that hurt Jose and Porter at the preliminary injunction hearing was more curious. The court cited their notice of resignation, which specifically stated that if the non-compete was unenforceable, Jose and Porter would be "free to go into active competition with [HT] and they expect that many customers would indeed move their business." The court found that this too foreshadowed their intent, and deemed it important when determining whether a protectable interest was under threat.

Counsel can, and should, play an important advisory role in even the most mundane, ministerial tasks when a client is departing and contemplating active competition. Review of a resignation letter is a key part of this, and counsel ought to scrutinize how any statements in that letter will be interpreted by a court.

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Court: United States District Court for the District of Arizona
Opinion Date: 6/26/09
Cite: Highway Technologies, Inc. v. Porter, 2009 U.S. Dist. LEXIS 57607 (D. Ariz. June 26, 2009)
Favors: Employer
Law: Arizona

Illinois Appellate Ruling Will Impact Preliminary Injunction Procedure (Rochester Buckart Action Group v. Young)

The preferred remedy in any unfair competition case is a preliminary injunction to halt, prior to a full trial, customer solicitation or disclosure of confidential business information. Depending on the type of evidence an employer is able to obtain prior to the beginning of discovery, it may be able to make a fairly compelling case for immediate relief.

But the law on non-compete claims is exacting, and Illinois remains a fairly pro-employee state - at least in cases where there is an absence of bad faith or blatant customer poaching. If an employer wins at the preliminary injunction stage, but ultimately loses on the merits of the case, what remedy does an employee have.

Depending on the breadth of the injunction order, the damages occasioned by the entry of an immediate order can be significant. In Illinois state court, the code of civil procedure speaks to a party's ability to obtain damages or fees when an injunction is dissolved. However, the case law interpreting these code provisions has been somewhat confusing. Previous courts have interpreted the provisions as demanding that the defendant prove an injunction was "wrongfully" issued.

A recent case arising out of the Fourth District has helped clarify when a defendant may be able to recover damages and attorneys' fees if an injunction has been reversed. For starters, there is no additional requirement - as some have suggested - that a defendant prove an injunction was "wrongfully" entered. Reversal by the trial court, or appellate court, is enough. The term "wrongful" connotes something more than a finding that the plaintiff's case lacks merit. Simply put, if a plaintiff prevails on a preliminary injunction proceeding, but ultimately cannot back up its case and loses on the merits, the defendant will be given an opportunity to prove and obtain damages caused by the entry of an injunction.

In competition cases, this certainly will be measured by lost sales opportunities if a defendant is enjoined from contacting or working with certain customers, and perhaps lost goodwill to the business as a result of the injunction's impact.

UPDATE X1: The State-Journal Register in Springfield reports the Plaintiff is appealing this ruling to the Supreme Court of Illinois.

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Court: Appellate Court of Illinois, Fourth District
Opinion Date: 9/8/09
Cite: The Rochester Buckhart Action Group v. Young, ___ Ill. App. 3d ___ (4th Dist. 2009)
Favors: N/A
Law: Illinois

Rewriting Customer List Constitutes Trade Secret Misappropriation (JPMorgan Chase v. Kohler)

JPMorgan Chase has prevailed against a number of financial services executives on a preliminary injunction involving claimed misappropriation of a customer list.

The defendants serviced a number of high net worth clients and, according to their counsel, "merely wrote down the names of clients and later got their contact information from the internet." The court was unpersuaded that this absolved them from liability under the trade secrets act, reasoning that the defendants' actions were not akin to simply accessing customers from the phone book or through an internet search. Instead, the customers' names (and presumably their financial information and fee structure with JPMorgan) were not readily available or known to others in the industry.

The case serves as a reminder for employees that trade secrets misappropriation is still a somewhat ill-defined concept. Memorization or mere access to trade secrets can still lead to a misappropriation claim through the theory of inevitable disclosure. An employee's act in trying to recreate a company document or somehow recast it at his or her own often times will not serve as a convincing defense, as the JPMorgan case shows. Anything created by an employee on company time is work-for-hire and belongs as a matter of law to the employer.

Though not discussed by the court (somewhat inexplicably), it appears the employees each had a client non-solicitation agreement with JPMorgan. By taking client information and subsequently contacting them, this would appear to have given the court an easier basis on which to issue a temporary injunction.

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Court: United States District Court for the Western District of Kentucky
Opinion Date: 9/8/09
Cite: JPMorgan Chase Bank, N.A. v. Kohler, 2009 U.S. Dist. LEXIS 81387 (W.D. Ky. Sept. 8, 2009)
Favors: Employer
Law: Kentucky

Capitalization of Income Not Appropriate for Liquidated Damages Clause (Perry v. H&R Block Eastern Ent.)

Liquidated damages are a common remedy for breach of a non-compete in the tax-preparation and accounting field. Most agreements I have drafted or reviewed usually forecast liquidated damages according to a capitalization of income or revenue derived from a misappropriated client. The Illinois courts, which decidedly favor actual over liquidated damages, have interpreted similar clauses as embodying reasonable money damage estimates.

However, even this type of formulation is not always failsafe. The case involving Donna Perry and H&R Block is illustrative of the point that liquidated damages provisions are always frowned upon and viewed with judicial skepticism.

In that case, the court reviewed H&R Block's evidence of liquidated damages, which nominally allowed it to recover: (a) two times the "average fee" charged by Perry during the course of her employment, times (b) the number of non-returning clients; times (c) the employee's client retention percentage. The problem for H&R Block, in the court's view, was that the formula did not account for commissions received by tax preparers. Because of this, H&R Block would always get more than its actual damages.

The court held the clause was not a reasonable approximation of actual damages and awarded H&R Block nominal damages of $1. While H&R Block was not precluded from recovering lost profits or traditional contract damages, it failed to put on any competent proof of the same.

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Court: United States District Court for the Eastern District of Pennsylvania
Opinion Date: 8/19/09
Cite: Perry v. H&R Block Eastern Enterprises, Inc., 2009 U.S. Dist. LEXIS 73759 (E.D. Pa. Aug. 19, 2009)
Favors: Employee
Law: Pennsylvania, Missouri

Contesting Trade Secret Claim May Impede Preemption Defense (E.I. DuPont de Nemours v. Kolon Industries)

In those states which have adopted some version of the Uniform Trade Secrets Act, a commonly litigated defense concerns statutory preemption. Most versions of the UTSA provide expressly that the statute preempts, or displaces, other common-law or statutory remedies for trade secrets misappropriation.

For years, defendants have been filing motions to dismiss ancillary claims tossed into a trade secrets action, such as conversion, breach of fiduciary duty and deceptive trade practices violations. At one point in time, these defenses were successful as courts broadly applied the UTSA's preemption clause.

Now, courts are taking an opposite approach.

A case out of Virginia highlights a couple of issues related to the preemption defense. In E.I. DuPont de Nemours v. Kolon Industries, the plaintiff filed a six-count complaint charging that the defendant engaged in a pattern of conduct designed to misappropriate DuPont's technical process for manufacturing high-strength fiber used in ballistics and protective apparel. The defendant denied that the information at issue constituted a trade secret under Virginia's version of the UTSA.

The court denied the defendant's motion to dismiss the ancillary claims for the simple reason that the preemption provision could not apply if the defendant contended that the purloined information was ever a trade secret to begin with. For all intents and purposes, a denial in an answer will effectively negate a motion to dismiss those other claims.

On the substance of each claim, the court still found preemption inappropriate. Without belaboring the point, for preemption to apply in a minority-view state like Virginia, the claim needs to be founded entirely on an allegation that the wrongful conduct involves trade secrets misappropriation. Merely arguing that the conduct arises out of the same core of operative facts won't cut it.

So, if for instance an employer alleges that an employee stole a chemical formula critical to the employer's business which constituted a trade secret, and also alleges the employee misappropriated lesser protected confidential information (say, financial information), a claim for breach of fiduciary duty relating to the latter would not be preempted. The reason: the employer need not prove that the confidential information was a trade secret in order to prevail. Keep in mind the law is split on this, and the majority of courts take a broader view of preemption.

Admittedly the difference is slight. However, the key principle is that in minority-view states, preemption only applies when the wrongful conduct depends on trade secret misappropriation.

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Court: United States District Court for the Eastern District of Virginia
Opinion Date: 8/27/09
Cite: E.I. DuPont de Nemours & Co. v. Kolon Industries, Inc.
Favors: Employer
Law: Virginia

Kansas Court Takes Broad View of Protectable Customer Relationships (Fee Insurance Group v. Martin)

A recent appellate decision out of Kansas illustrates the importance of analyzing the permissible breadth of protectable interests under non-compete law.

As I've written before, states vary widely in their application of the general rule that non-competes - to be valid - must support a protectable (or, legitimate) business interest. In Kansas, a protectable interest can include "customer contacts." In Fee Insurance Group v. Martin, the employee (an insurance sales representative) signed a one-year non-compete clause that prohibited him from competing for any customer belonging to Fee Insurance Group at the time his employment ended.

In many states (Illinois, for one), this clause arguably would be overbroad and invalid as extending beyond an employer's legitimate business interest. Martin, in fact, argued as such, reasoning that the prohibition could not extend to all 4,500 of his ex-employer's accounts. (He tacitly conceded that those accounts with whom he had a relationship were proper subjects of a valid non-compete clause).

The Kansas court, however, had little trouble in rejecting Martin's argument. Its court precedent allows employers to draft customer non-compete (or non-solicit) clauses to protect all customer relationships, not just those the employer facilitated or cultivated.

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Court: Court of Appeals of Kansas
Opinion Date: 8/14/09
Cite: Fee Insurance Group v. Martin, 2009 Kan. App. Unpub. LEXIS 620 (Kan. Ct. App. Aug. 14, 209)
Favors: Employer
Law: Kansas