Old Georgia Law Still Invalidates Many Restrictive Covenants

When the Georgia General Assembly passed the Restrictive Covenant Act in 2009, it substantially changed the playing field between employers and employees. Under the common law, it was exceedingly difficult for employers to enforce anything but the most perfectly worded and narrowly tailored covenant. Cases repeatedly failed on the facial ambiguity or overbreadth of the covenant, leading to judicial invalidation. And the blue-pencil rule was not available to save overbroad (even slightly overbroad) contracts.

But the new Act did not become effective until 2010 and only applies to contracts entered into after November 3, 2010. A great many employees and independent contractors signed agreements well before that, and their enforceability continues to be subject to the old common law.

A recent district court summary judgment decision illustrates how strict this old common law actually is.  The case involved a dispute in the credit-card merchant processing industry. This is a rapidly growing market where companies provide merchants - often, retailers - a wide range of credit-card processing services. Those services range from simple payment processing to mobile processing to "tokenization" (a fancy way of saying that the processing company will enable merchants to store credit card data safely and securely).

The defendant was an independent contractor who marketed the processor's services to merchants for a fee. In his Independent Contractor Agreement, he agreed to two broad covenants:

(1) An in-term non-compete restriction that prohibited him, during the term of his relationship with the plaintiff, from entering into agreements to solicit merchants for the merchant-acquiring program of any bank or third-party financial institution, or from entering "into any relationship with any organization...that would effect an indirect relationship with any" organization.

(2) A 5-year, post-termination non-solicitation restriction that prevented him from calling on the plaintiff's customers, regardless of whether he had a relationship with those customers.

The district court had little trouble under Georgia common law striking down both clauses. The ruling on the non-solicitation covenant was not much of a surprise, since Georgia law (like some other states) generally does not look favorably upon non-solicitation covenants that extend to customers the employee did not serve - particularly when there is no geographic restriction. And the 5-year term was well beyond the 2-year rule Georgia courts long have advocated.

The more surprising aspect of the ruling is the fact the court struck down the in-term non-compete arrangement. It held the general rules pertaining to non-compete agreements apply, even though it did not prohibit any post-termination activity. In-term covenants rarely are litigated because in an at-will environment, employees (or, as here, independent contractors) simply terminate the relationship before leaving to compete.

The court, though, struck the non-compete and held that its activity scope was unreasonable - mainly due to the quoted, italicized language above. The court found that the prohibition on the defendant from entering "into any relationship" with a bank was ambiguous and ill-defined. In reality, it didn't appear to be as broad as the court held. Rather, it seems the clear intent of the covenant was to prohibit the defendant from entering into a similar arrangement with another credit-card processor while he was soliciting merchants for the plaintiff. The language of the non-compete which the court deemed problematic only appeared to further restrict the plaintiff from circumventing this fairly clear covenant in a more indirect manner.

Still, the ruling indicates that courts often are troubled by restrictive covenants and their impact on competition as a whole. I've written before about how judges sometimes will gloss over a contract's intent to find an ambiguity, even though it's questionable such an ambiguity exists. That seems to be what happened here as well.

Inevitable Disclosure Doctrine Inapplicable to Contract Damage Claims

As readers of this blog may know, the "inevitable disclosure" doctrine is a theory of trade secrets misappropriation.

A plaintiff need not show either actual or threatened misappropriation if it can prove that it's inevitable a defendant either will use or disclose trade secrets. In many competition cases, a plaintiff asserts an inevitable disclosure claim in tandem with breach of contract claims. For remember that most employees who join a competitor (and who are worth the expense of a lawsuit) probably have some sort of non-disclosure agreement.

This raises the issue of whether a plaintiff can use the inevitable disclosure doctrine to prove breach of contract. There are relatively few cases that seem to address the issue, although the logical answer seems to be "no." The better way to apply the inevitable disclosure doctrine is to use it as a means to seek preliminary injunctive relief, as a recent Arkansas federal district court did.

In Nanomech, Inc. v. Suresh, the court rejected the plaintiff's effort to extend the inevitable disclosure doctrine to a breach of contract claim for damages, stating:

"The doctrine has only been applied in Trade Secrets Act cases, particularly where plaintiffs have alleged the 'threatened misappropriation of trade secrets,' a discrete violation of the Act that is inherently speculative in nature."

When asserting a claim for damages, it makes little sense to use the inevitable disclosure doctrine. Damages presume that some wrong already has occurred and caused an economic loss. If disclosure of trade secrets is merely "inevitable," then it's illogical to conclude the plaintiff incurred a loss. By definition, the wrong would not have occurred. Rather, the only use for the doctrine would appear to be securing injunctive relief.

This raises a related issue. Many times a non-disclosure covenant will be written in such a way as to bar a threatened disclosure of confidential information. In this circumstance, a plaintiff - faced with imminent disclosure - probably doesn't need to wait until actual breach and can instead sue on the contract. However, it's easy enough to just allege a violation of the contract, along the lines of anticipatory breach, for pleading purposes
. Too, until such time as there is an actual disclosure, a plaintiff's request for a remedy should be limited to an injunction.