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Bank Executive's Non-Compete Dispute Promises To Be Year's Most Interesting Case

John Kanas is a legendary figure within the New York banking community. Five years ago, he sold his highly successful North Fork to Capital One Financial. In the course of doing so, Kanas received a $200 million payout. Kanas stayed on with Capital One, but clearly the match was not working out. Capital One agreed to let Kanas resign earlier than his original contract called for.

Once he resigned, Kanas decided not to hit the country club circuit. Instead, he orchestrated an acquisition of BankUnited, a failed Florida bank that had been seized by the FDIC. Kanas did so with a private equity group featuring such prominent names as Wilbur Ross, who is known for restructuring failed companies in the steel and coal industries. In recent interviews, Kanas has made it clear he wants back into the New York market.

Problem: his Capital One non-compete has not yet expired. Under Kanas' reworked non-compete arrangement, he is prohibited from competing in consumer or commercial banking within New York, New Jersey, and Connecticut. The restrictions are set to expire August 7, 2012.

Capital One claims certain activity by Kanas through BankUnited rises to the level of unfair competition and has enlisted heavy-hitter Orin Snyder of Gibson Dunn & Crutcher to litigate the the non-compete case. Kanas, and co-defendant John Bohlsen, responded with perhaps the nation's best attorney, David Boies.

The suit is interesting on several levels. Capital One's claim really centers on four key facts which it claims constitutes a non-compete violation:

(1) BankUnited already had a banking portfolio which contained mortgages on New York and New Jersey properties at the time Kanas and Bohlsen acquired BankUnited.

(2) BankUnited has planned to construct and open branches in New York and has advertised for open positions at these locations.

(3) Kanas placed a bid for the Bank of Ireland's New York commercial banking portfolio on behalf of BankUnited. (Bank of Ireland has been forced by that country's financial regulators to sell off a significant percentage of its foreign loan portfolio, and many of the real estate properties are located in New York).

(4) BankUnited has entered into an agreement to acquire Herald National Bank, a commercial bank located in Manhattan specializing in small to mid-size commercial lending.

The defendants have answered the complaint and from their statements, it is clear they do not believe that alleged activity constitutes a non-compete violation. They are contesting the reasonableness of the agreements they signed and believe that they constitute unenforceable restraints of trade if they were interpreted as Capital One proposes.

Interestingly, there is no motion for preliminary injunction on file. The complaint does seek an extension of the non-compete period commensurate with the period of breach, which could be ongoing until next August - depending on what the Court views as a breach. Capital One also is seeking a disgorgement of consideration paid to Kanas and Bohlsen for signing the non-competes, but it's not clear if this would need to be some sort of prorated amount based on the time period each sat out. However, given the dollars paid to both Kanas and Bohlsen (who pocketed $100 million), the claim for disgorgement at least would be well into the 7 figures.

This is one of those cases where you can anticipate a discovery fight. The interpretation of the defendants' conduct, and how it fits into the non-compete contracts, will be front and center. That should mean high-stakes depositions and costly document production. It is unlikely that the court would view the non-competes signed in exchange for millions of dollars to be unenforceable restraints. More likely, if the defendants prevail, the court will have to find that Capital One's interpretation is incorrect. Other high-profile executive disputes, such as that involving involving Mark Hurd, have settled quickly, so perhaps all sides will determine that a confidential settlement is the best option.

Virginia law governs the non-compete contracts, so that state's blue-pencil rule could pose a problem for Capital One if the court finds that the contracts contain some overbroad terms. Virginia's Supreme Court has not approved of a blue-pencil rule, though the case law there is employee-friendly in many respects and courts "discourage" modification of overbroad covenants.

In Pennsylvania, Termination Only a Factor to Consider on Enforceability (Colorcon, Inc. v. Lewis)

Several years ago, a Pennsylvania court used sweeping language to deem a non-compete unenforceable against an employee who had been terminated without cause, allegedly due to poor performance. Since that time, the courts in Pennsylvania have pared back on any hint of a per se rule and have noted that termination is only "an important factor" to be considered in the overall reasonableness analysis.

A recent case out of Pennsylvania demonstrates, though, that courts are still skeptical of enjoining employees who have been terminated involuntarily for reasons other than cause. In Colorcon, Inc. v. Lewis, the court denied an employer's effort to enforce a non-compete against a terminated salesperson. After finding that her new employment did not even place her in breach, the court proceeded to analyze the enforceability question in light of her prior termination.

The court noted a couple of key factors in this fact-intensive inquiry:

(1) While the employee signed a severance agreement, she only obtained $21,000 severance pay. The court noted that pay was for more than just reaffirming her non-compete: she also released her employer from any and all claims against it.

(2) The employee and new employer took extra precautions to make sure she was in a different line of work than her previous job, and even avoided contacting certain customers that may have been problematic under the non-compete's language.

(3) The employee had searched for other employment and could not find anything outside her industry that did not require her to either take a substantial pay cut or relocate.

My experience has been that courts are sympathetic to employees who have been laid off, particularly when the non-compete agreement is broad and includes jobs that potentially are not in line with what they previously were doing. As always, courts will assess a wide range of fact specific hardship questions as well.

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Court: United States District Court for the Eastern District of Pennsylvania

Opinion Date: 5/31/11

Cite: Colorcon, Inc. v. Lewis, 2011 U.S. Dist. LEXIS 58637 (E.D. Pa. May 31, 2011)

Favors: Employee

Law: Pennsylvania

Does a Trade Secrets Defendant Have Insurance Coverage?

Trade secrets litigation can be very expensive. For the type of clients that I frequently advise - small business owners - the litigation can extend to significant document production, retention of experts, and complex damages analysis. Defense costs almost always are well into the six figures.

Clients often ask whether they have insurance for these types of claims. Like most things, the answer is "it depends." Usually, for trade secrets defendants, it is worth exploring whether a commercial general liability policy contains an advertising injury endorsement. If so, it is possible that there may be some coverage for defense and liability costs arising out of trade secrets misappropriation.

However, I caution clients not to get their hopes up. The newer advertising injury endorsements often contain exclusions for a wide range of intellectual property claims, including those arising under the law of trademark, trade dress, and trade secret. Even if there is no such exclusion, the opportunity for coverage may be limited. In these circumstances, counsel will need to examine whether the allegations of the complaint truly implicate "advertising" activity.

Advertising generally means the promotion of a product or service to the general public. It usually does not include customer solicitation. So, in the case where a trade secret is a customer list, and a defendant is improperly using that list to target key accounts, it would be much more difficult to claim that this injury is based on "advertising."

However, many types of trade secrets are included within products or services offered to the public. For instance, if a trade secret is used to design a consumer product, and that product is then marketed generally to the public, a claim that the misappropriation resulted in an "advertising" injury would seem to have more merit.

So to conclude, it is important to first look at your liability policy for endorsement and exclusion language that may directly touch upon trade secret claims. Absent such language, you will need to scour the allegations of the complaint to determine if there is a colorable argument that the injury resulted from an effort to sell to the public, not just certain targeted customers.

California's "Trade Secret" Exception Depends on Contract Language (Richmond Techs, Inc. v. Aumtech Business Solutions)

California courts have long been hostile to restraints on trade. This strong public policy is embodied in Section 16600 of the Business and Professions Code. Most attorneys agree that general non-competition covenants (outside a sale of business or partnership agreement) are generally unenforceable.

In Edwards v. Arthur Andersen, LLP, the California Supreme Court rejected a "narrow restraint" rule which would have exempted restrictions that did not totally foreclose an employee from working in his chosen profession. Put another way (and more simply), customer non-solicitation covenants aren't enforceable.

The more difficult, lingering issue California courts have not squarely addressed has to do with another narrow class of covenants: the "trade secrets" exception. California hasn't exactly been clear whether a covenant designed to protect trade secrets can be enforced. A recent federal district court case seems to suggest there is some continuing vitality to this doctrine.

But here is the key. Unlike other states where access to trade secrets can be the protectable interest supporting the covenant, California puts a premium on how the covenant is drafted. To walk the fine line between protecting trade secrets and honoring the letter of Section 16600, the courts which have invoked the trade secrets exception require that the covenant, as drafted, only prohibit competition that requires the use of trade secret material.

The Richmond Technologies case is illustrative of this somewhat esoteric principle. The dispute in that case centered on a vendor's alleged misuse of source code to supply competing enterprise resource planning software. The non-compete was broken down into three parts: a general non-solicitation of the plaintiff's employees, a similar non-solicitation of the plaintiff's customers, and a more general non-competition clause barring competition with the plaintiff "using its technology."

Paradoxically, the court held that the two non-solicitation clauses - which usually are more limited - were likely invalid under Section 16600. But because the non-competition clause prohibited the vendor from offering a similar ERP software product using the technology it agreed to provide to the plaintiff, the clause was actually quite narrowly drafted to protect trade secrets. Had the clause barred the vendor from providing a similar product or service generally to the marketplace (without reference to the specific technology it developed for the plaintiff), then the court likely would have found that the "trade secrets" exception could not apply.

Again, in California, when considering this exception, it is imperative to focus on the contract language used. California (in many ways) is not like other states. The fact that the interest to be protected by a non-compete is trade secrets is not relevant. The covenant itself must only prohibit competitive activity requiring the use of trade secrets.

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Court: United States District Court for the Northern District of California
Opinion Date: 7/1/11
Cite: Richmond Technologies, Inc. v. Aumtech Business Solutions, 2011 U.S. Dist. LEXIS 71269 (N.D. Cal. July 1, 2011)
Favors: N/A
Law: California

A Summary of Georgia's New (Employer-Friendly) Non-Compete Statute

Loyal readers of my blog (yes, there are quite a few!) surely know that there are a handful of red-flag states out there which have unique non-compete rules. Georgia, historically, has been such a jurisdiction. Employees have met with a high degree of success in challenging non-compete obligations, often succeeding because covenants are facially overbroad and capture too much competitive activity.

All that changed with the passage of a new statute in Georgia, which recently went into effect. The new statute is decidedly more employer-friendly. Because the new law only affects covenants entered into after its effective date, employers now have a strong incentive to redraft agreements and bind key employees to new covenants.

The changes are fairly extensive, so I will summarize some of the main points that I would expect to come up frequently.

(1) Class of employees: non-competition agreements can be enforced against employees who regularly solicit customers, regularly engage in sales, perform the duties of a "key employee", or supervise others.

(2) A term will be presumed reasonable if it is (a) 2 years for employees, (b) 3 years for arms-length business transactions (such as a license or franchise agreement), and (c) 5 years for a sale of business.

(3) Non-solicitation covenants need not have an express geographic territory tied to them.

(4) Burden of proof: the employer will need to establish that the covenant protects a legitimate business interest, which is expansively defined and includes goodwill, confidential information, customer relationships, and specialized training. If the employer demonstrates the covenant meets the statutory terms, the burden shifts to the employee to show it is unreasonable.

(5) Blue-pencil rule: the impetus behind the statute was Georgia's strict rule prohibiting any modification for overbreadth, which also generally resulted in an entire covenant being struck down as void. Courts are now empowered to modify overbroad restraints.

Again, keep in mind, the old Georgia law is still relevant because the law is not retroactive. Employers would be well advised to have their agreements audited and redrafted to suit the new law. Prospective employees must now pay careful attention to their agreements and be vigilant about negotiating terms. They can no longer count on courts to save them from a bad deal.

Discovery Requests Can Play Important Role In Determining Reasonableness of Non-Compete (SNS One v. Hage)

Many clients are under the impression that a non-compete agreement can be analyzed strictly by looking at the four corners of the document.

While in some cases this may be true, the vast majority of non-compete issues turn on specific facts that fall outside the terms of the agreement. When a non-compete dispute ripens into a lawsuit, discovery plays a big role in determining whether a covenant is reasonable or overbroad. Counsel for an employee always will need to determine how to frame discovery requests to try to lock in an employer. Conversely, an employer must carefully consider how it responds to a discovery request and assess the implications of its answer.

A recent case out of Maryland illustrates the importance discovery plays in non-compete disputes. In SNS One v. Hage, the employee's non-compete agreement prohibited him from being employed by a competitor for a one-year period after termination. The employee's attorney requested of the employer a list of who those competitors were. The employer repeatedly refused to do so, and on a motion to compel, the court even warned the employer that its refusal to respond may lead to an inference that the covenant was overbroad.

And that's just what the court found at summary judgment. In so holding, the court stated an important maxim for attorneys to remember: "An employee needs firm, solid guidance on what he can and cannot do if he leaves his employer." In that case, the employer provided no such guidance and never really tried.

At a bare minimum, the employer should have provided a preliminary, good faith list of competitors that it considered off-limits. Had it done so, the court might have concluded that the agreement was reasonable. Employers would be well-advised to keep a list of actual or potential competitors so that responding to this type of discovery does not cause a fire drill or result in an incomplete list. The same is true of particular customers that an employer contends falls within a non-solicitation clause.

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Court: United States District Court for the District of Maryland
Opinion Date: 7/11/11
Cite: SNS One, Inc. v. Hage, 2011 U.S. Dist. LEXIS 74718 (D. Md. July 11, 2011)
Favors: Employee
Law: Maryland

Covenant Not to Solicit Clients Implied When Goodwill Sold With Business (Bessemer Trust Co. v. Branin)

Last year, a client called me and described a familiar problem. He had purchased an insurance business from another agent in town, who had worked for a while during the transition but quickly became dissatisfied. When the relationship finally soured, the agent left and started a competing agency, soliciting away his former clients.

The buyer clearly purchased the agency's goodwill and client list, but the covenants in the closing documents were a mess. Still, the buyer believed that the integrity of the transaction depended on the agent not soliciting his former customers away. He's correct, at least under most states' laws.

The Court of Appeals of New York clarified the "implied covenant" rule in Bessemer Trust Co. v. Branin, which dealt basically with the above scenario in the financial services world. The Court clarified that a seller may not actively solicit the patronage of his former clients when the goodwill of an established business is sold.

The Court addressed a related question: what assistance can the seller provide the new employer with respect to those clients? Several factors were addressed.

First, the custom of the industry is always relevant.

Second, a court must assess whether the seller initiated contacted with his old customers, or whether the customers reached out to the seller's new firm.

Third, a seller may advertise generally to the public, but cannot send targeted mailings or make individualized telephone calls to former clients.

Fourth, when a client seeks "factual information" about the seller's new firm, the seller cannot explain why he believes his products or services are superior to that offered by his former firm.

Fifth, a seller cannot convey proprietary information about his former customers to his new employer.

Sixth, a seller can assist his new employer in making a sales pitch to a former client and may be present during such a meeting, but must limit his responses to "factual matters."

Keep in mind that these factors are to be considered when there is no restrictive covenant contained in the business sale documents. When a business purchases a competitor's goodwill, carefully drafted covenants must be included both in the sale documents and in any transition or stay-on employment agreements. Those covenants can, and should, prohibit much broader restrictions that would prohibit the type of activity the Court of Appeals described above. They also should provide a panoply of self-executing remedies for breach, such as extension of the restriction and, when appropriate, liquidated damages.

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Court: Court of Appeals of New York

Opinion Date: 4/28/11

Cite: Bessemer Trust Co. v. Branin, 16 N.Y.3d 549 (Ct. App. 2011)

Favors: N/A

Law: New York