North Carolina Court Upholds 10-Year Restrictive Covenant Between Employer and Former Employee

When one thinks of a “reasonable” temporal scope for a restrictive covenant between employer and employee, usually that period is measured in months or years, not decades. But as a recent North Carolina decision reminds us, context is everything, and a 10-year restriction can be enforceable in the right circumstances.

In KNC Techs., LLC v. Tutton, 2021 NCBC LEXIS 38 (N.C. Super. Ct. Apr. 8, 2021), Eric Tutton (“Tutton”) entered into a Non-Compete Agreement during his employment with KNC Technologies, LLC (“KNC”). Around his resignation from KNC in 2013, Tutton allegedly violated the Non-Compete Agreement and misappropriated KNC’s confidential information, leading KNC to sue Tutton (“Tutton I”).

KNC and Tutton entered into a negotiated Settlement Agreement resolving Tutton I that prohibited Tutton from “solicit[ing], contact[ing], and/or mak[ing] sales” for 10 years to “[KNC] customers” and nine specifically named KNC suppliers. The trial court approved and entered a consent order reflecting the terms of the Settlement Agreement, thus ending the lawsuit.

Roughly a year after entry of the Settlement Agreement and consent order, Tutton allegedly formed a competing company and later violated the restrictive covenants in the Settlement Agreement. KNC sued Tutton again, this time in the North Carolina Business Court[1] (“Tutton II”), and Tutton challenged the Settlement Agreement as being unreasonable and unenforceable under the well-developed North Carolina case law on restrictive covenants between employers and employees. Indeed, North Carolina courts usually view five years as the outer limit of enforceable restrictive covenants between employer and employee, and even that period is enforceable only in “extreme conditions.” Hartman v. W.H. Odell & Assocs., 117 N.C. App. 307, 315, 450 S.E.2d 912, 918 (1994).

The Business Court rejected Tutton’s challenge and denied his early motion to dismiss KNC’s claim for breach of the Settlement Agreement. See KNC Techs., LLC v. Tutton, 2019 NCBC LEXIS 72 (N.C. Super. Ct. Oct. 9, 2019). Even though KNC and Tutton did have an employment relationship at one point, the Court declined to analyze the Settlement Agreement as a restrictive covenant between employer and employee. The Court noted there are other contexts in which restrictive covenants are routinely upheld (such as with the sale of a business, or between franchisors and franchisees), and the facts alleged “did not fit squarely under the analysis applied to restrictive covenants between employer and employee or buyer and seller, but instead call for a more situation-specific approach.” Id. at ¶ 29.

Under this “situation-specific approach,” the Court concluded the 10-year restriction in the Settlement Agreement was reasonable and enforceable. The facts supporting the Court’s conclusion were: (1) Tutton admittedly violated the original Non-Compete Agreement; (2) Tutton, while represented by counsel, settled Tutton I by freely agreeing to less onerous restrictions than a true covenant not to compete; and (3) the Settlement Agreement did “nothing more than protect KNC’s business interests, which Tutton [had] already demonstrated a propensity to ignore.” Id. at ¶ 31.

On April 8, 2021, on summary judgment after the parties conducted discovery, the Court continued to hold enforceable the 10-year restriction, at least for KNC’s suppliers. Tutton II, 2021 NCBC LEXIS 38, at ¶¶ 56-62. Although the 10-year supplier restriction was held enforceable, the language imposing the restriction itself was deemed ambiguous, and trial will be necessary to establish potential breach. Id. at ¶¶ 63-66. The Court did grant summary judgment to Tutton on the customer-focused restriction, because it prohibited Tutton from contacting too broad a universe of individuals and entities. Notably, the Court reiterated that the 10-year temporal scope of the customer restriction was reasonable under the specific facts before it. Id. at ¶ 47.

This case raises important considerations for employers when negotiating restrictive covenants outside the traditional employment context. Particularly where the employee is represented by counsel and the parties are negotiating settlement, courts may be more willing to enforce broader restrictions. This is also an important reminder that, even in the age of increased regulation and scrutiny, lengthy restrictive covenants may still be enforced.

Jackson Lewis attorneys in the Restrictive Covenants, Trade Secrets and Unfair Competition practice group are available to advise on these strategic considerations.

[1] The North Carolina Business Court is a special forum of the state trial division that only hears cases involving complex business disputes.

 

 

Two New Connecticut Bills Aim to Prohibit Physician Non-Competition Agreements

Connecticut lawmakers recently introduced two bills that seek to ban non-competition agreements for physicians. If implemented, this would be the second time in five years that Connecticut has legislated in the area of physician restrictive covenants.

In mid-2016, Connecticut enacted legislation that implemented a maximum one-year temporal limitation on physician non-competition agreements, as well as a geographic limitation of no greater than fifteen miles from the primary site where such physician practices. The law also set requirements as to how physician non-competes were to be executed, and restricted employers from enforcing such agreements when terminating physicians’ employment without cause and/or without offering to renew the physicians’ prior contract on the same or similar terms and conditions.

The two new bills, Senate Bill 99 and House Bill 5572, introduced on January 12 and January 24, 2021, respectively, propose to ban completely the use of non-compete clauses in physician contracts. Both bills have been referred to the Connecticut Legislature’s Joint Committee on Public Health. The specific details concerning the proposed restrictions have yet to be publicized, but Connecticut healthcare industry employers should continue to monitor developments in this area closely.

Nationwide, Connecticut appears to account for a disproportionate percentage of the proposed legislation in the area of restrictive covenant regulation in 2021. For example, three separate bills—Senate Bill 906, House Bill 6285, and House Bill 6379—each provide a complete overhaul of restrictive covenant law in Connecticut, in similar fashion (with some notable distinctions) to the proposal currently before the New Jersey General Assembly. In the area of home health care, competing bills have been introduced to either modify or eliminate existing limitations on various types of restrictive covenants in that industry.

Jackson Lewis attorneys are available to answer inquiries from employers concerning these and other proposed changes. We will continue to monitor developments in this area. Readers can subscribe to this blog to stay up to date on pending legislation and other updates as they arise.

New Jersey General Assembly to Vote on Renewed Bill Seeking to Curb Restrictive Covenants

New Jersey may be next up to join the growing number of states that significantly restrict the use of non-competition agreements in employment.  As we discussed back in December 2017, a bill proposed in New Jersey at the time, Senate Bill 3518, would “impose significant restrictions and limitations” on the use of restrictive covenants in the employment context.   Ultimately, SB 3518 died in committee, but a revival is underway.

On February 24, 2021, a renewed bill seeking to curb restrictive covenants, Assembly Bill 1650, passed through committee on a 6-3 vote, and is now heading to a full vote by the General Assembly.

The new bill is nearly identical to its 2017 predecessor.  Both aim to regulate the use of “restrictive covenants,” defined as “an agreement between an employer and an employee arising out of an existing or anticipated employment relationship, or an agreement between an employer and an employee with respect to severance pay, under which the employee or expected employee agrees not to engage in certain specified activities competitive with the employee’s employer after the employment relationship has ended.” (Emphasis added.)

It remains an open question whether provisions outside the parameters of traditional covenants not to compete (such as employee or customer non-solicitation provisions, or non-disclosure provisions) would fall within this statutory definition of “restrictive covenants.”  Other sections of the bill, however, suggest that traditional “non-competition” covenants are the only “restrictive covenants” at issue.  The bill contains an explicit presumption that “restrictive covenants” are necessary where an employer cannot adequately protect its interests through an “alternative agreement, including . . . an agreement not to solicit or hire employees of the employer; [or] an agreement not to solicit or transact business with customers, clients, referral sources, or vendors of the employer[.]”

As we previously discussed in detail, the bill, if made into law, would impose a host of new regulations on such “restrictive covenants,” including:

  1. A garden leave requirement, under which an employer must pay most former employees 100 percent of the wages and fringe benefits to which they would otherwise be entitled during the enforcement of a restrictive covenant. There is an exception to the garden leave requirement for employees terminated for “misconduct.” The term “misconduct” is a new concept in this newest iteration of the bill and is discussed in more detail below. Note that if the bill becomes law, New Jersey would become the first state in the country to require garden leave during the enforcement period for a restrictive covenant.  (As we previously observed, the Massachusetts Noncompetition Agreement Act, which shares many features with the New Jersey bill, does not actually require garden leave.)
  2. A prohibition on judicial modification of restrictive covenants that are found to be overly restrictive or otherwise in violation of the law.
  3. A limitation on the temporal scope of restrictive covenants to one year.
  4. A limitation on the geographic scope of restrictive covenants to the areas “in which the employee provided services or had a material presence or influence during the two years preceding” separation of employment. There is a qualification that the restrictive covenant “shall not prohibit an employee from seeking employment in other states,” but it’s unclear whether “seeking employment” is intended to be treated the same as engaging in “competition.”
  5. A prohibition on the enforcement of restrictive covenants for several broad categories of employees, such as:
    1. Employees classified as nonexempt under the Fair Labor Standards Act;
    2. Undergraduate or graduate students who intern or engage in short-term employment while they remain enrolled in school;
    3. Apprentices who meet the applicable federal or state apprenticeship qualifications;
    4. Seasonal or temporary employees;
    5. Independent contractors;
    6. Employees under the age of 18;
    7. Employees who have been terminated without a determination of misconduct, or have been laid off by the employer;
    8. “Low-wage” employees, defined as employees whose weekly wage is less than the state-wide average, as determined by the New Jersey Department of Labor and Workforce Development (which under last available data is $1,291.42 per week, equivalent to $67,153.84 per year); and
    9. Employees whose period of service with the employer is less than one year, making no distinction based on the reason for the separation or whether it was voluntary or involuntary.
  6. Procedural obligations on employers, such as:
    1. Disclosure of the restrictive covenant agreement in writing to prospective employees “by the earlier of a formal offer of employment, or 30 business days before the commencement of . . . employment.”
    2. Disclosure of the restrictive covenant agreement to existing employees at least 30 business days before the effective date.
    3. An express statement that the employee has the right to consult with counsel before signing a restrictive covenant agreement.
    4. A ten-day window after separation of employment where the employer must inform most employees if it intends to require compliance with the post-employment restrictions. As with the garden leave requirement, there is an exception discussed below.

Despite being nearly identical, there is one subtle, but material, distinction between the old bill and the new bill.

Under the old bill, restrictive covenants would not be enforceable at all against employees terminated without “good cause,” and if the employee were terminated with “good cause,” then neither the garden leave nor the post-separation ten-day “notice of intent” window would apply for the employer.

Under the new bill, the same carve-outs exist for both employees and employers, but the triggering event is termination with or without a determination of “misconduct,” as opposed to termination with or without “good cause.”

Termination for “good cause” is broader than termination for “misconduct” under the language of the bills.  The definition of “good cause,” for example, included poor work habits like inefficiency, working “belatedly and negligently,” or working “in violation of the standards of quality of the establishment.”  “Misconduct” is defined under the new bill as “conduct which is improper, intentional, connected with the individual’s work, within the individual’s control, not a good faith error of judgment or discretion, and is either a deliberate refusal, without good cause, to comply with the employer’s lawful and reasonable rules made known to the employee or a deliberate disregard of standards of behavior the employer has a reasonable right to expect, including reasonable safety standards and reasonable standards for a workplace free of drug and substance abuse.”

In short, all of the limitations on and requirements for restrictive covenants contained in the proposed statute would apply if the employee were terminated for narrowly defined “misconduct,” except the garden leave and “notice of intent” provisions.  No restrictive covenant would be enforceable against any employee terminated without a determination of “misconduct.” If an employee voluntarily resigns, then the restrictive covenants could be enforceable, with the garden leave and “notice of intent” requirements.

The bill would take effect immediately upon becoming law, but would not apply to any agreement in effect on or before the date of enactment.

We will continue to monitor the progress of Assembly Bill 1650 as it makes its way to the General Assembly floor.  In the meantime, New Jersey employers should consider taking proactive steps to protect their legitimate business interests through means that would not be in jeopardy, or be prepared to take prompt and necessary steps to comply if and when the bill were to become law.  Jackson Lewis attorneys are available to assist.

Employers’ Toolbox Series: Lessons on Ex Parte Seizure in Five Years of the DTSA

(This is part of the Restrictive Covenant Report “Employers’ Toolbox Series,” where we examine lesser-utilized methods of protecting confidential information, trade secrets, and other business interests.)

The Defend Trade Secrets Act (“DTSA”), 18 U.S.C. § 1836, et seq., is approaching its fifth anniversary after being signed into law by President Barack Obama on May 11, 2016.  To celebrate, we are highlighting some of the issues that have developed in five years of litigating the law’s most notorious feature: ex parte seizure orders.

As we wrote just before the DTSA was signed into law, the ex parte seizure provision has always been controversial.  Under the DTSA, an ex parte seizure order permits immediate confiscation of private devices like desktop computers, laptops, smartphones, or tablets without any advance notice to the device owner, and on the strength of the applicant’s evidence only.  Once granted, the order is served and executed by U.S. Marshalls or other law enforcement officers, similar to a criminal search warrant.

In the five years since the passage of the DTSA, a small but growing body of case law is developing on some important procedural and practical issues arising from ex parte seizure.

  1. Moving to Have the Ex Parte Seizure Application Filed Under Seal

The DTSA contains detailed instructions for obtaining an ex parte seizure order.  Because of the high evidentiary threshold needed for such extraordinary relief, applicants almost always will need to present documentary evidence along with the required affidavit or verified complaint.  Critically, the DTSA does not permit entry of an ex parte seizure order unless the court finds that the applicant “has not publicized the requested seizure.”  18 U.S.C. § 1836(b)(2)(A)(ii)(VIII).

The DTSA does not define the term “publicized.”  It is unclear whether filing seizure application materials on the public docket could constitute “publicizing” them.  Perhaps in an abundance of caution, many applicants simultaneously move to have the seizure application materials filed under seal.  Several courts have concluded that the applicant “has not publicized” the requested seizure where the application materials were filed under seal.  See, e.g., Shumway v. Wright, No. 4:19-cv-00058-DN-PK, 2019 U.S. Dist. LEXIS 148882 (D. Utah Aug. 26, 2019); Thoroughbred Ventures, LLC v. Disman, No. 4:18-cv-00318-ALM, ECF No. 6 (E.D. Tex. May 1, 2018).

However, applicants should not treat the motion to seal as a mere formality.  If the applicant fails to meet the legal requirements for filing under seal, that motion could be denied, and in turn could jeopardize the request for emergency relief.  See Corelogic Sols., LLC v. Geospan Corp., No. SACV 20-01500-CJC(KESx), 2020 U.S. Dist. LEXIS 246349, at *9 (C.D. Cal. Aug. 21, 2020) (denying motion to seal an application for a temporary restraining order where the applicant did not make a “document-by-document” showing of “good cause” to merit protection of alleged trade secret information from public disclosure).

  1. Seeking a TRO as a Backup to DTSA Seizure

Understandably, the DTSA sets a very high bar for ex parte seizure—higher, even, than the standard to obtain an ex parte temporary restraining order.  But these are not mutually exclusive remedies.

Even if a court denies the applicant’s motion for ex parte seizure under the DTSA, the court still can grant a motion for a temporary restraining order preventing the defendant from taking potentially harmful actions.  See Cochrane USA, Inc. v. Filiba, No. 18-341 (EGS), 2018 U.S. Dist. LEXIS 185726, at *9-10 (D.D.C. Mar. 9, 2018) (denying a motion for ex parte seizure under the DTSA because the applicant failed to establish “extraordinary circumstances” justifying seizure, but granting a motion for temporary restraining order preventing the defendants from “destroying, altering, modifying, forwarding, utilizing, disposing of, or in any other manner changing/altering or dismantling” the applicant’s data).

Temporary restraining orders are still powerful remedies that can be requested in the alternative to or in conjunction with ex parte seizure under the DTSA.  Indeed, even prior to the enactment of the DTSA, temporary restraining orders, including, if warranted, ex parte orders allowing for immediate seizure of electronic media by U.S. Marshalls or other law enforcement officers, were a valuable tool.  Although difficult to obtain and only applicable in limited circumstances, such orders remain an effective substitute for the DTSA’s more rigid seizure protocol.

Unsurprisingly, trade secret litigation has increased since the DTSA’s enactment. New issues relating to the controversial ex parte seizure provision will certainly crop up as more cases are filed. We will continue to monitor developments in this area of the law, and we will update the blog with new insights as they arise.

D.C. Mayor Signs Bill to Ban Non-Competes

The District of Columbia appears poised to join the growing number of nearby states regulating and limiting restrictive covenant agreements in the employment context.

Unanimously passed by the D.C. City Council on December 15, 2020 and signed by Mayor Muriel Bowser on January 11, 2021, the “The Ban on Non-Compete Agreements Amendment Act of 2020” goes further than recent laws enacted across the country.  It is a ban on virtually all non-compete agreements.

Specifically, the bill would prohibit employers from requiring or requesting that their employees not: (1) be employed by another person; (2) perform work or provide services for pay for another person; or (3) operate their own business.  Remarkably, the ban would potentially apply during employment, not just after an employee leaves.  How courts would reconcile the ban during employment with common law fiduciary duties and the duty of loyalty remains to be seen.

Now that the Mayor has signed the bill, it will be sent to Congress for review and will become law unless Congress passes a joint resolution disapproving it and the President signs that resolution within a thirty-day period.  The law will become applicable upon approval of a budget and financial plan that includes its fiscal effect. This is expected to take place later this year when the District of Columbia’s 2022 budget and financial plan is approved.

Our Practice Group members explore these issues and others in our article on the potential ramification of the bill and the procedural steps needed for it to become law.  We will continue to monitor the bill’s status and its impact, and we will provide updates on material developments.

New Indiana Law Governs Physician Non-Compete Agreements

In the midst of the COVID-19 pandemic, Indiana has enacted a new law governing non-compete agreements used with physicians.

Our Practice Group members in Indianapolis authored an article detailing the new law’s requirements.  As the article notes, the new law raises multiple unanswered questions.

And, while not as sweeping as other statutes, Indiana now joins the parade of states enacting new laws limiting the use of non-compete agreements.  We will continue to monitor all state law developments.

SCOTUS to Hear CFAA Case

It’s not often that a case in our practice area reaches the Supreme Court of the United States, so we are genuinely excited!

In Van Buren v. United States, No. 19-783, the U.S. Supreme Court will have a chance to resolve (finally) the circuit split regarding the scope of the Computer Fraud and Abuse Act.  Some circuits (the 2nd, 4th and 9th) take a narrow view of the CFAA, allowing claims against employees who lacked any authorization to access information stored on computers, but not allowing claims against employees who were permitted access and misused that access for allegedly improper purposes.  Other circuits (the 1st, 5th, 7th, and 11th) permit CFAA claims against employees for misusing information stored on the computer even though they otherwise were authorized to access such material.  We have posted about this circuit split previously.

Jackson Lewis’s Non-Competes and Protection Against Unfair Competition practice group, in conjunction our Privacy, Data and Cybersecurity practice group, published an article explaining the Van Buren case and its potential impact.

We currently have a nation of employees working remotely.  Regardless of the ultimate outcome at the Supreme Court, employers should consider reviewing and clarifying now their policies concerning which employees have access to what data.  We will monitor the Van Buren case and provide updates.

 

 

Virginia Bans Non-Competes for Low(er)-Wage Workers

Is anyone focusing on anything other than the COVID-19 Pandemic?  Apparently, the Virginia legislature and governor are undeterred, enacting a series of new laws.  Among them, Virginia has banned non-compete agreements for lower wage earners, becoming the most recent state to do so.  A summary of the key provisions is included in this article written by our Virginia colleagues Matt Nieman and Jason Ross: https://www.jacksonlewis.com/publication/virginia-enacts-wage-theft-non-compete-laws-amidst-flurry-new-employee-protections 

 

Texas Court Rejects Effort To Dismiss Non-Compete Lawsuit On Free Speech Grounds

Texas courts are increasingly encountering efforts to challenge restrictive covenant agreements on free speech grounds, where the restricted activity includes business-related communications. A recent Texas appellate court decision indicates that this strategy has its limits.

In Hieber v. Percheron Holdings, LLC, No. 14-19-00505-CV (Tex. App.—Houston [14th Dist.] Nov. 14, 2019), Percheron Holdings, LLC (“Percheron”) sued Hieber, a former sales executive, for violation of a non-compete and non-solicitation agreement, based on Hieber’s employment with a Percheron competitor and alleged communications with Percheron’s clients during industry meetings and social functions. Hieber responded by moving to dismiss the lawsuit pursuant to the Texas Citizens Participation Act (“TCPA” or the “Act”).

The TCPA does not strictly prohibit lawsuits arising out of a defendant’s free speech activities, but rather it imposes a heightened pleading standard in such cases. The purpose of the Act “is to encourage and safeguard the constitutional rights of persons to petition, speak freely, associate freely, and otherwise participate in government to the maximum extent permitted by law and, at the same time, protect the rights of a person to file meritorious lawsuits for demonstrable injury.”

Under the TCPA, a defendant may move for dismissal of a legal action that arises out of “a party’s exercise of the right of free speech, right to petition, or right of association,” if the plaintiff has not pleaded specific facts to support each element of the asserted causes of action. In response to such motion, the plaintiff must articulate the requisite factual basis, or else demonstrate that such basis already has been pleaded. Effectively, the TCPA elevates the required pleading standard for such actions from notice pleading to fact pleading. A plaintiff’s failure to meet the elevated pleading standard in response to such a motion carries the severe consequence of dismissal with prejudice.

Further, the TCPA sets forth a commercial-speech exemption, which provides that the Act “does not apply to a legal action brought against a person primarily engaged in the business of selling or leasing goods or services, if the statement or conduct arises out of the sale or lease of goods, services, or an insurance product, insurance services, or a commercial transaction in which the intended audience is an actual or potential buyer or customer.”

Hieber argued in his motion to dismiss that the activities Percheron characterized as solicitation of customers constituted the exercise of free speech under the TCPA. However, in defeating the motion, Percheron convinced the court that the speech at issue fell within the commercial-speech exemption. Specifically, Percheron established that Hieber was engaged in communications with actual or potential customers of LJA for the purpose of persuading them to engage his new employer as their service provider.

In his attempts to rebut Percheron’s argument, Hieber argued that he “did not sell anything” but was merely an employee of the seller. The court rejected that argument on the grounds that the commercial-speech exemption applies just as much to employees as to a business itself, and because the exemption does not require the defendant to be responsible for a completed transaction. The court explained, “even a proposed transaction will suffice.” The court also rejected Hieber’s argument that the conduct at issue, including his attendance at industry/charity events, did not implicate any efforts by him to sell services to LJA’s actual or potential customers. As the court noted, the entire purpose of those activities was to acquire additional business for LJA.

A review of published case law in Texas reveals approximately twenty cases in the past two years where a former employee moved to dismiss a non-compete or similar restrictive covenant lawsuit under the TCPA. While Percheron successfully invoked the TCPA’s commercial-speech exemption to sustain its claim arising from Hieber’s alleged solicitation of former customers, this exemption only covers customer communications, and may not relate to the majority of potential restrictive covenant violations (e.g., association with a competitor, disclosure of proprietary information to a competitor, solicitation of employees, etc.). As such, employers pursuing restrictive covenant litigation in Texas should first confer with experienced counsel as to whether the TCPA applies to their claims, and, if so, whether there is sufficient information about the alleged violations to establish the Act’s heightened pleading requirements. Employers are encouraged to contact a Jackson Lewis attorney for assistance in this process.

Massachusetts High Court Upholds Enforcement of Employee Non-Solicitation Covenant

Over the past few years, legislators and government agencies at both the state and federal levels have pushed reforms limiting the use of non-competes and other restrictive covenants by U.S. businesses. Some of those efforts have extended to covenants that restrict a party’s ability to solicit and/or hire employees who are not party to the agreements in question.

In the midst of these headwinds, a new decision from the Massachusetts Supreme Judicial Court, Automile Holdings, LLC v. McGovern, SJC-12740 (Mass. Jan. 14, 2020), stands out for its approval of an anti-raiding provision. Our article discussing the McGovern decision can be found here.

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