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