Supreme Court of South Carolina Holds Trial Court Cannot Rewrite Territorial Restriction (Poynter Investments v. Century Builders of Piedmont)

South Carolina is a state with a fairly strict blue-pencil rule, meaning that drafting is at a premium. Because judges cannot rewrite parties' agreements for them, a non-compete will stand or fall on its own, with courts able to strike only certain terms to avoid overbreadth problems.

The Supreme Court of South Carolina issued another ruling illustrating the narrow scope of its blue-pencil rule in a sale-of-business non-compete. The trial court determined that the seller of a business should be enjoined from violating the covenant, but issued a ruling which modified the geographical scope of the contract beyond what South Carolina courts permit.

The non-compete at issue contained a step-down clause (a topic on which I recently wrote), first providing that it would extend to an area of 75 miles from the principal place of business. If that were unenforceable, the covenant would be limited to Greenville County and any county that borders it. If that were unenforceable, the covenant then would be limited to just Greenville County.

The court went with the last step-down clause and enforced the covenant only in Greenville County. Its error was apparently trying to craft some compromise among the various step-down provisions. The court held the seller was enjoined from competing within Greenville County and an area within 15 miles from the principal place of business.

The latter part of the order, the 15-mile restraint, was an addition to the non-compete's geographic term. While it may not seem unfair or unreasonable, the court's modification of the covenant went beyond what South Carolina courts permit. In a state that employs the equitable modification rule, the result likely would have survived appellate scrutiny.

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Court: Supreme Court of South Carolina
Opinion Date: 5/24/10
Cite: Poynter Investments, Inc. v. Century Builders of Piedmont, Inc., 694 S.E.2d 15 (S.C. 2010)
Favors: Employee
Law: South Carolina

What Are the Limits on "Preparing to Compete"?

Most jurisdictions recognize that employees are able to plan, outfit and form a competitor prior to the time they quit without running afoul of their fiduciary duty of loyalty. The law concerning fiduciary duties is best understood as a gap-filler that will prohibit unfair competition, particularly when a non-compete agreement is absent or unenforceable.

This doctrine - allowing an employee to prepare to compete - has its limits, of course, and like much of the law concerning unfair competition, a lot has to do with the equities.

What is permissible? Again, that all depends, but here is a basic list of permissible preparatory activities:

1. Incorporating or organizing a business entity
2. Developing a business plan
3. Negotiating an office lease
4. Establishing a bank account
5. Raising capital
6. Purchasing a competing business (if those intentions are disclosed prior to closing)
7. Identifying potential clients or sources of supply

What is prohibited? The touchstone inquiry will be demonstrable, actual competition, not preliminary steps to compete. Another non-exhaustive list:

1. Using employer information to develop account lists
2. Selling or making sales proposals to customers prior to resignation
3. Downloading ex-employer confidential information for use in the new venture
4. Failing to follow through on sales leads in the hopes of saving that account for future competitive activity
5. Taking a corporate opportunity and failing to tender it to the employer

An employee can certainly plan a competing venture so that on the day following resignation, she is able to start contacting customers and generating sales. Most courts will look at how active an employee was in actually competing - not just preparing to compete - in assessing whether the employee has violated a common law fiduciary duty of loyalty.

Remember: this body of law tends to place limits on competition in the absence of a non-compete. Just because an employee has no post-employment non-compete agreement in place does not mean the preparing to compete doctrine can somehow be extended or rendered inapplicable.

Recently, I have seen a number of employee non-compete agreements that contain not only customer covenants, but also prohibit an employee by contract from preparing to compete. It is not clear to me that this type of restriction has any real teeth, or how a court would analyze such a restriction in light of the common law preparing to compete doctrine. In fact, it is difficult to assess what the remedy would be for such a breach as long as there is no actual competition prior to resignation.

Another Illinois Court Fails to Cite to Sunbelt Rentals (Peckham v. Metal Management, Inc.)

Perhaps the Sunbelt Rentals case will not have the impact in Illinois that many lawyers think.

As many readers know by now, one district of the Illinois Appellate Court last year tried to work a sweeping change to the way non-compete contracts are scrutinized by courts. Prior to last year's decision in Sunbelt Rentals v. Ehlers, courts in Illinois generally followed the majority of jurisdictions in looking at two primary factors to determine whether a non-compete contract was enforceable:

(1) Is it reasonable in terms of time, territory and scope restrictions?

and

(2) Does the covenant support, or protect, a legitimate business interest?

In Sunbelt Rentals, the Fourth District Appellate Court held there was no binding Supreme Court precedent allowing the second inquiry to proceed. Accordingly, in one division of the Illinois Appellate Courts, a non-compete contract is judged solely under the reasonableness criteria.

However, the ruling has not had much impact outside the Fourth District. In several cases, both state and federal, courts have either discounted Sunbelt Rentals as an outlier case of little value, or have ignored it altogether.

And so it happened again.

This time, the case arose in Southern Illinois in a dispute between Robert Peckham and Sims Metal Management. When Peckham was fired from SMM in 2010, he sued to declare his non-compete contract unenforceable. SMM countersued and sought preliminary injunctive relief. In denying the injunction, the court examined whether the non-compete covenant supported a legitimate business interest in customer contacts or access to proprietary information.

Not only did the court not cite Sunbelt Rentals, it relied on the case Sunbelt Rentals purported to overrule when finding that the non-compete supported no legitimate business interest.

Also of consequence, the court found no consideration to support the non-compete agreement. The court believed that a six-month term of employment with no payment for the covenant itself rendered the agreement unenforceable. It is not clear whether Peckham worked at SMM prior to signing the covenant or whether it was signed at the inception of his employment. If it was the latter, the court's finding almost certainly would be erroneous.

The court had to be persuaded by the fact that Peckham was terminated involuntarily. This case is another example of a court ruling in favor of the employee wearing the white-hat. It was clear SMM went after Peckham when he posed no real threat to it, and when there was no evidence Peckham competed unfairly with SMM by using misappropriated information. Particularly given the involuntary termination, SMM was swimming upstream from the start on this one.

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Court: United States District Court for the Southern District of Illinois
Opinion Date: 5/5/10
Cite: Peckham v. Metal Management, Inc., 2010 U.S. Dist. LEXIS 43784 (S.D. Ill. May 5, 2010)
Favors: Employee
Law: Illinois

"Nominal Damages" Really Means Nominal (Roberson and Penhall Co. v. C.P. Allen Construction)

Virtually all jurisdictions provide that if a plaintiff cannot prove actual, recoverable damages for a breach of contract claim, it may still be entitled to receive nominal damages. Outside of triggering fee-shifting, there is really no utility to exploring issuesconcerning nominal damages at all.

Except when a court determines that nominal damages imposed against a dispatcher for violating a non-solicitation covenant should be $25,000.

That non-sensical ruling arose out of an Alabama case involving a breach of an employee non-solicitation agreement. James Roberson solicited his ex-employer's customers in violation of a two-year non-solicitation covenant. The employer had a hard time establishing actual damages - perhaps because the plaintiff's corporate representative admitted at trial that he had "no idea" how much business his company had lost on account of the breach. An admission like this usually means your chances of recovery are slim.

So the court, incredibly, awarded "nominal damages" for the contract breach in the amount of $25,000 against Roberson. The appellate court had little trouble concluding that this amount was not nominal and reversed for entry of a new judgment awarding the plaintiff, if you can believe this, "a minimal amount of nominal damages." Apparently, this is different than a substantial amount of nominal damages.

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Court: Court of Civil Appeals of Alabama
Opinion Date: 5/7/10
Cite: Roberson and Penhall Co., Inc. v. C.P. Allen Construction Co., Inc., 50 So. 3d 471 (Ala. Ct. App. 2010)
Favors: Employee
Law: Alabama

Georgia Non-Compete Reform Up To Voters In November

It seems like non-compete reform in Georgia has been a slow marathon, but the finish line appears to be in sight.

As readers of this blog probably have found out, Georgia is one of those employee-friendly states where non-compete agreements are enforced much less frequently than in other jurisdictions. The reason largely has to do with Georgia's strict blue-pencil rule, which ends up invalidating a good percentage of contracts on technicalities. Even the slightest degree of overbreadth can render the entire agreement void and unenforceable.

The Georgia legislature has approved a constitutional amendment that will change non-compete law should voters ratify it in November. A simple majority is required for the constitutional amendment to take effect, which then will make non-competes easier to enforce and yield a lot less handwringing by attorneys who draft them.

There are a number of revisions that will go into effect if the amendment passes, including a grant of authority to Georgia courts to blue-pencil covenants. In addition, non-solicitation clauses can include a prohibition on acceptance of business from clients. This would overturn a line of Georgia cases that ruled such a restraint on so-called "passive" solicitation is overbroad and void against public policy. The law also sets presumptively reasonable non-compete durations: for employment, 2 years; for franchisee or distributors, 3 years; and for a seller of a business, the longer of 5 years or the time during which payments are made for the sale.

Finally, the law only applies to new agreements entered into after the effective date. Agreements existing before the effective date of the law would be examined under the old law. Georgia business attorneys should gain a nice stable of employment contract drafting work over the next year or so, assuming this constitutional amendment passes.

IMG Dispute Over Employee Poaching Likely to Raise Cross-Jurisdictional Fight

Very interesting article today in the Wall Street Journal concerning IMG Worldwide's non-compete claim against agent Matthew Baldwin, who jumped ship to Hollywood talent firm CAA.

As the article notes, IMG has non-compete agreements with agents prohibiting them from soliciting clients. In the IMG-Baldwin dispute, the clients are high profile coaches and star athletes. IMG has lost a number of star clients, such as Derek Jeter and Tony Gonzalez, in recent years.

CAA's playbook appears to rely on California's long-standing public policy against employee non-compete agreements to lure talent away from heavy hitters like IMG. The WSJ article indicates that the outcome of a case between IMG and Baldwin, a junior agent making less than $100,000 per year, could establish the template for how to avoid non-compete restrictions.

As the article notes, Baldwin left IMG with almost no notice, moved to California (where CAA is based), established residence there and immediately sued in California court seeking to declare his legal rights to work in that state. Presumably, he also has sought a temporary restraining order to prohibit IMG from enforcing the non-compete agreement.

In reality, though, these cases involving cross-jurisdictional fights have been filtering through the courts for years, especially when there is some California connection. The most high-profile case involves David Donatelli's departure from EMC to work at Hewlett Packard. In that case, Donatelli and EMC both filed suits - Donatelli in California where HP is based (similar, no doubt, to Baldwin's complaint), and EMC in Massachusetts.

IMG, though, has strong precedent on its side, and it would be well-advised to rely on the Massachusetts court's holding in Donatelli which not only restrained Donatelli from working for HP in certain capacities but also declined to stay its own proceeding in deference to Donatelli's first-filed case.

Assuming IMG follows EMC's lead from the Donatelli case and files suit in Minnesota (where Baldwin worked) or Ohio (where IMG is based), either jurisdiction could decline to stay the IMG suit on the grounds that it has a compelling interest in upholding its own policy regarding non-compete agreements. Both Minnesota and Ohio are relatively neutral to employer-friendly regarding enforcement. Given Baldwin's overnight establishment of California residence, a Minnesota or Ohio court may decide that California's interest in the suit is not so compelling to stay its own legal proceedings.

Are "Step-Down" Provisions Enforceable?

Corporate attorneys in strict "blue-pencil" states have to be extra-careful when drafting non-compete covenants. For instance, if a court will only strike or delete overbroad provisions (and decline to reform them by adding or changing terms), practitioners need to separate out activity restrictions into distinct paragraphs. Additionally, lawyers will want to think about adding alternative provisions that relate to prohibited competition, so that if one provision is struck down, an alternative may give the employer a fall-back enforcement position.

This issue, though, becomes tricky when you start talking about geographic and time restrictions. One drafting technique that attorneys are starting to use is called a "step-down" provision. In theory, the idea is simple. Draft the non-compete so that the restriction is for 2 years, but if a court finds it to be unenforceable or overbroad, then the agreement is automatically pared back to 9 months. The same idea applies to geographic scope. It can define a restricted territory as the State of Illinois, but if the same is held unreasonable, then it applies only to those counties in which the defendants were assigned accounts at the time of termination.

There are several issues that step-down provisions raise, including the notion that the contract may not be properly formed in the first place on account of the fact that the parties never had a "meeting of the minds" as to key terms. Also, the provision may not be definite and certain, and may even violate public policy. On the other hand, in a jurisdiction that employs the equitable modification rule, it is hard to see how using step-down provisions is all that different than what occurs during litigation. It may even be better, since the step-down restriction could be less onerous than what a court could impose after ruling on the reasonableness of the covenant.

To the best of my knowledge, no court has ruled on the enforceability of step-down clauses. In my judgment, courts in strict blue-pencil states may find them unenforceable as a matter of public policy.