The Pennsylvania Supreme Court has ruled that a non-compete signed during the course of employment, without additional consideration, is not enforceable even though the agreement stated that the parties “intend to be legally bound.” Socko v. Mid-Atlantic Systems of CPA, Inc.
Douglas G. Smith, Melissa L. Evans and David E. Renner from our Pittsburgh office discuss the case on the Jackson Lewis website.
A recent decision from an Illinois Appellate Court suggests that employers with non-compete agreements “built to scare” may end up with an unenforceable contact and even the loss of confidential information under Illinois law. AssuredPartners, Inc. v. Schmitt (October 27, 2015 1st Dist.) Illinois Courts continue to carefully scrutinize contracts containing post-employment restrictions over concerns about over-reaching, especially restrictions that are seen as overbroad in geographic reach as well as attempts to keep an ex-employee completely out of an industry on a nationwide basis. In Assured Partners, the named plaintiff sought to prevent an insurance executive from working anywhere in the U.S. within the particular segment of the insurance industry he had worked all his life.
Defending the broad geographic scope of the agreement, the former employer apparently pointed out that the executive could work in the U.K., but neither the appellate court nor the trial court judge saw this as a meaningful option. Both courts also held that the restriction on any work involving professional liability insurance was overbroad considering the executive only worked in the area of legal liability insurance. And, not only did the Appellate Court find the non-compete clause overbroad and thus unenforceable, it went on to find that the non-solicitation clause was also overbroad because it attempted to prevent solicitation of the former employer’s prospects who were not yet customers, many of whom the executive had not himself had any contact with. Considering that the executive walked off with lists of contract expiration dates, as he did in this case, the court’s conclusion that even the confidentiality clause was overbroad because it would ban the former employee from using essentially anything he learned or observed while he was employed was especially notable.
The trial court and Appellate Court also declined to allow the employer to pull the cord on its reserve chute – application of a blue-pencil clause in the executive’s agreement. The trial court held that the agreement was “not a candidate for judicial reformation.” The Appellate Court agreed, stating, “[w]e decline to rescue a draftor from the risks of crafting a restrictive covenant that is patently overbroad” and noting that blue-penciling is only appropriate where the overreach was minor and in this case the agreement over-reached in three ways. Finally, the Appellate Court went one step further and denied the former employer’s motion to amend the complaint, cutting off the employer from any remedy.
This case reminds employers that:
A recent case from Florida’s Fifth District Court of Appeals underlines the importance for employers to provide a sufficient legitimate business interest to justify enforcement of a non-compete agreement. Where a former employee or contractor is interfering with client relationships, the employer must be careful to point out specific prospective or existing clients when enforcing a non-compete agreement.
In Evans v. Generic Solution Engineering, LLC, 2015 Fla. App. LEXIS 16175 (Fla. 5th DCA 2015) the appellate court reversed an order granting a temporary injunction against a former independent contractor who was subject to a non-competition agreement. The employer sought to prevent its former contractor from performing services for the employer’s former clients. The court held that an employer’s relationships with former clients are not legitimate business interests sufficient to enforce a restrictive covenant. While courts have previously acknowledged the distinction between former and existing client relationships, this appears to be the first decision in which an appellate court reversed a temporary injunction enforcing a non-compete based on the inadequacy of a business’ relationship with former clients.
Background
Defendants Evans and Chinn were former independent contractors performing work for Generic Solution Engineering, LLC d/b/a Tech Guys Who Get Marketing (“Tech Guys”). Only Chinn was subject to a non-compete provision in his independent contractor agreement. Chinn and Evans left Tech Guys to form their own company, X-Tech, which provides similar services to similar customers, including former Tech Guys customers RRI and E-data.
Following the typical path of non-compete litigation, Tech Guys filed suit and moved for a temporary injunction restraining Chinn and Evans from performing work for former clients RRI and E-data. The trial court granted Tech Guys’ motion as to Chinn and denied it as to Evans because Evans was not subject to a non-compete agreement.
Chinn appealed the order granting the temporary injunction against him and the appellate court reversed. The appellate court held that employers do not have a legitimate business interest in their relationships with former clients sufficient to support enforcement of a non-compete.
Relevant Law
Florida Statute § 542.335 allows for enforcement of restrictive covenants only where “the restraint [is] shown to be reasonably necessary to protect the ‘legitimate business interests’ justifying the restriction.” Evans at *2 (quoting Henao v. Prof’l Shoe Repair, Inc., 929 So.2d 723, 726 (Fla. 5th DCA 2006)). The Evans case acknowledges that “’the right to prohibit the direct solicitation of existing customers’ is a legitimate business interest” sufficient to support enforcement of a non-competition agreement. Id. (quoting Hilb Rogal & Hobbs of Fla., Inc. v. Grimmel, 48 So. 3d 957, 961 (Fla. 4th DCA 2010)).
The Court, however, also noted several prior cases distinguishing between an employer’s relationships with current or future clients as opposed to former clients. Id. (citing Envtl. Servs., Inc. v. Carter, 9 So.3d 1258, 1265 (Fla. 5th DCA 2009)(enforcing non-compete because of “substantial relationships with specific prospective or existing customers”); Ethan Allen, Inc. v. Georgetown Manor, Inc., 647 So.2d 812 (Fla.1994)(tortious interference not actionable where interference is based on relationship with past customers); see also Shields v. Paving Stone Company, Inc., 796 So. 2d 1267 (Fla. 4th DCA 2001).
Lessons
The takeaway for employers is that they must be careful to point to adequate legitimate business interests when seeking to enforce non-compete agreements. Employers must identify specific prospective or existing clients being solicited by former employees. Relying on a former employee’s interference with a former client will be insufficient to enforce a non-compete agreement.
In a detailed, 26-page published decision in the matter of Cardoni v Prosperity Bank, No. 14-20682 (5th Cir. Oct. 29, 2015) the Fifth Circuit Court of Appeals took a deep look at choice of law provisions in restrictive covenants. The Appellate Court started out by noting that in addition to their well-known disagreements over boundaries and football, Texas and Oklahoma do not see eye to eye on the enforceability of non-compete agreements. Texas generally allows them, Oklahoma does not.
The case arose after Texas-based Prosperity Bank acquired Oklahoma-based F&M Bank and Trust Company. Key employees were required to sign employment agreements containing non-compete, non-solicit, and non-disclosure provisions. Less than a year after the merger, four employees decided to leave and filed declaratory judgment actions in state court in Oklahoma seeking to invalidate the agreements under Oklahoma law. Prosperity filed suit in Texas seeking to enforce the agreements, citing the Texas choice of law and choice of venue provisions. After both cases were removed to Federal Court, they were consolidated in Houston based on the exclusive venue provision. While honoring the choice of venue provision, the District Court found that Oklahoma law applied to both the non-compete and non-solicit provisions in the agreement and they were unenforceable. The trial court also found that Texas law governed the non-disclosure provision, but there was not sufficient proof of a breach to support an injunction.
The Fifth Circuit opinion affirmed in part and reversed in part, noting the following:
In its decision, the Court of Appeals noted that although the U.S. Supreme Court has made it clear that courts should give effect to knowing and voluntary agreements between parties to arbitrate disputes, and recently ruled that forum selection clauses should be enforced in all but the most exceptional cases, public policy considerations still come into play with regard to choice of law provisions: “Unlike arbitration and forum selection clauses, which dictate where a dispute will be heard, choice-of-law provisions dictate the law that will decide the dispute, and thus create more tension with a state’s power to regulate conduct within its borders.” Thus, even though the choice of forum clause meant the dispute was heard in Texas, the public policy concerns of Oklahoma, where the employees resided, took precedence over the choice of law provisions in the contract that they signed.
The decision blows tumbleweeds in the way of multi-state employers who wish to utilize a “one size fits all” agreement in Oklahoma, even if the agreement contains a choice of law and exclusive choice of forum provision selecting a state which favors enforcement of non-compete agreements. Although many courts in other jurisdictions have relied on choice of law/choice of forum clauses to enforce certain restrictive covenants against employees residing in states with strong public policies against such restrictions (such as California), in this case the terms of the contract did not carry the day. Employers relying on a “one size fits all” strategy should proceed cautiously, and at least consider the possibility that the law of the state where the employee lived and worked may trump a choice of law provision to the contrary.
By: Richard J. Cino, David M. Walsh, and Eliza L. Lloyd
The absence of actual economic loss to an employer as a result of an employee’s breach of the duty of loyalty does not preclude the employer from being awarded the equitable remedy of disgorgement, a unanimous New Jersey Supreme Court has ruled. Kaye v. Rosefielde, No. A-93-13 (Sept. 22, 2015).
Defendant Alan Rosefielde, an attorney, was initially retained by plaintiff Bruce Kaye to act as outside counsel in connection with Kaye’s management of several timeshare business entities. Thereafter, Rosefielde was hired, at an annual salary of $500,000, as Chief Operating Officer of some of the timeshare businesses managed by Kaye.
The evidence showed that over the course of two years, Rosefielde committed serious misconduct by acting in his own interest for purely personal gain rather than in the interest of his employer. In addition to increasing his personal interest in a newly formed entity beyond the interest agreed to by Kaye, Rosefielde exposed his employer to potential liability on many occasions. For example, rather than pursue foreclosure proceedings against defaulting timeshare unit holders, Rosefielde arranged for the defaulting owners’ signatures to be forged on false quitclaim deeds. In addition, he misrepresented independent contractors’ employment statuses when applying for health insurance, causing the insurance company to issue policies to the independent contractors. The Supreme Court noted Rosefielde also put his employer at risk of liability for sexual harassment claims because he had made many inappropriate sexual advances toward two women.
Upon discovering Rosefielde’s misconduct, Kaye terminated his employment.
After determining that Rosefielde’s “egregious conduct” constituted a breach of his duty of loyalty, among other things, the trial court declined to order disgorgement of Rosefielde’s salary, reasoning his breach had not resulted in actual damages to his employer.
The Appellate Division affirmed this decision, commenting only “that the trial court’s findings of fact were grounded in the record and that its legal analysis was ‘unassailable.’”
The New Jersey Supreme Court ruled that, in an appropriate case, the remedy of disgorgement may be available to an employer, even in the absence of actual loss. It cited its earlier Cameco, Inc. v. Gedicke, 157 N.J. 504 (1999), as well as comments contained in the Restatement (Second) Agency, section 469, and Restatement (Third) Agency, section 8.01.
The Court explained, “[T]he equitable remedy of disgorgement is derived from a principle of contract law.” Indeed, compensation paid to an employee during periods in which he or she is disloyal is, effectively, unearned. Recognizing the broad discretion afforded to trial courts when crafting equitable remedies, the Court stated that it was for trial courts to determine the “appropriate” case in which to grant such relief.
Offering guidance to trial courts, the Court instructed that the following non-exclusive list of factors should be considered when determining whether disgorgement is an appropriate remedy:
Further, the Court stated that if the remedy of disgorgement is found to be appropriate, the breaching employee’s compensation should be apportioned such that only compensation received during periods in which the employee was acting in violation of his or her duty of loyalty would be subject to disgorgement.
Finally, the Court noted that if the trial court determined the employee had been disloyal during all pay periods, the employee’s entire salary may be subject to disgorgement.
In a 3-2 decision, the Utah Supreme Court has held that there is a presumption of harm for claims made under the Utah Uniform Trade Secrets Act, Utah Code § 13-24-1, et seq., and for claims for breach of a non-disclosure agreement when a former employee takes confidential information or trade secrets from her recent employer. InnoSys v. Mercer, 2015 UT 80 (Aug. 28, 2015).
Amanda Mercer, an engineer formerly employed by InnoSys, allegedly forwarded InnoSys’s confidential information to her Gmail account, copied a confidential business plan to a flash drive, and used some of that information as evidence in an unemployment hearing. The day after the hearing, Mercer claimed she deleted all of the emails and files.
InnoSys filed suit against Mercer asserting claims for misappropriation of trade secrets, breach of her non-disclosure agreement, and breach of fiduciary duty. Following rounds of discovery, Mercer prevailed on a summary judgment motion primarily on the grounds that InnoSys had not produced any evidence of actual or threatened harm in light of Mercer’s purported destruction of the information. Further, the trial court found that Mercer had not engaged in spoliation by purportedly deleting the files because she neither knew nor should have known that there was anticipated litigation. Finally, the trial court awarded sanctions against InnoSys.
The Utah Supreme Court reversed the trial court.
First, the Court concluded that the undisputed evidence shows Mercer had misappropriated the trade secrets:
(a) by disclosing them through emailing them to her Gmail account and disclosing them in the unemployment proceeding, and
(b) by unlawfully acquiring the business plan when she downloaded it.
In light of the prima facie case of misappropriation, the Court concluded there was a presumption of irreparable harm to InnoSys and the failure to quantify the harm was not fatal to InnoSys’s case. Mercer, theoretically, could rebut the presumption of harm, but the Court held there was no way she could meet her “formidable” burden in light of the evidence.
The Court further held that the same principles applied to establish damages under the breach of contract and breach of fiduciary duty claims. Accordingly, the Supreme Court also reversed the sanctions award.
This case provides helpful lessons for employers to consider in protecting trade secrets and other confidential information and succeeding in litigation. First, InnoSys had Mercer sign a non-disclosure agreement at the time she was hired. Second, in addition to the range of forensic investigation available to InnoSys at the time Mercer misappropriated its trade secrets in 2010, as described in the decision, advances in technology now may provide additional options. Counsel might recommend preventive forensic work that may identify the alleged misappropriation even earlier, possibly permitting the employer to seek emergency injunctive relief before many issues over confidential information arise. Third, there may be alternative ways to quantify damages in trade secret litigation – even where a former employee claims to have destroyed the information after the alleged misappropriation came to light.
Two recent cases from opposite coasts confirm that employees do not have an unfettered right to steal their employer’s documents notwithstanding the documents’ potential relevance to a whistleblower retaliation claim.
In West Hills Research and Development Inc. v. Wyles, Cal. Ct. App. 2d Dist. Case No. B255768 (July 17, 2015), when West Hills terminated Wyles, its former in-house counsel, he purloined financial and other company documents. Wyles contended that company officers had engaged in embezzlement, and that he took the documents to support a shareholder derivative suit challenging the wrongdoing. West Hills sued, contending Wyles took the documents to form a competing business and thereby misappropriated its trade secrets. Wyles moved to strike the lawsuit under California’s Anti-SLAPP (Strategic Lawsuit Against Public Policy) statute, contending his actions were protected because he took the documents for his intended lawsuit. The court of appeal held his actions were not protected by the Anti-SLAPP statute. The court noted Wyles took confidential information having nothing to do with his planned shareholder lawsuit, and that the gravamen of the company’s lawsuit was to challenge his taking and use of confidential information to form a competing business.
Perhaps a more dramatic case with a similar anti-theft holding is State v. Saavedra, 2015 N.J. Lexis 641 (2015). Saavedra sued the North Bergen Board of Education for discriminatory and retaliatory termination. During discovery, Saavedra produced hundreds of original and copied documents that she had taken from North Bergen during her employment. The documents included highly confidential student educational and medical records. When North Bergen reported the theft, Saavedra was indicted for official misconduct and theft. Saavedra moved to quash the indictment on the ground her actions were protected because she wanted the documents to support her lawsuit. The New Jersey Supreme Court held her activity was not protected and therefore the indictment was proper. The court reasoned that Saavedra had the right to obtain documents during discovery, and could obtain sanctions to the extent North Bergen failed to produce documents or destroyed them, but she did not have the right to simply take the documents in violation of the law. West Hills and Saavedra affirm the common sense principle that employers need not sit on their hands when employees steal their property, notwithstanding the employees’ claimed status as whistleblowers. At the same time, employers need to tread carefully in this circumstance, given the risk that an action taken against an employee who steals documents could itself give rise to a retaliation claim.
After surveying the law across the country, a federal judge has determined that Hawaii would likely follow the majority of states in holding that continued employment is adequate consideration for a non-compete under Hawaii law. A full analysis of the decision is posted on the Jackson Lewis website: Continued Employment Adequate Consideration for Non-Compete Imposed Mid-Employment, Hawaii Judge Rules
The Eight Circuit has concluded that the Arkansas Supreme Court would likely adopt the majority rule that a covenant not to compete can be assigned to the purchaser of a business. Stuart C. Irby Company, Inc. v. Tipton, No. 14-1970 and 14-2682 (8th Cir. Aug. 6, 2015) The appellate court reversed an across-the board win for defendants in this Arkansas non-compete dispute, disagreeing with the district court on almost every point.
The case concerned Tipton, a former branch manager for Treadway Electric Company, Inc., and Gilbert and Padgett, two employees who had reported to Tipton. All three signed one year non-competes with Treadway. Treadway then sold its assets to the Stuart C. Irby Company. Tipton, Gilbert and Padgett became employees for Irby and worked for another year or so. Tipton then resigned to work for a competitor, Wholesale Electric. Gilbert and Pagett quit the next day and also joined Wholesale Electric. Irby filed suit, alleging breach of fiduciary duty against Tipton for soliciting its employees to leave while still employed by Irby; civil conspiracy; breach of contract; and tortious interference. The district court granted summary judgment on all claims and awarded defendants in excess of $200,000 in attorneys’ fees.
The Court of Appeals held that Arkansas law would allow an assignment of a non-compete, and that the non-competes could have been assigned by Treadway to Irby, but remanded the matter for further review of the facts. The appellate court also rejected the conclusion of the trial court that the one year restricted period would have been triggered when the three individual defendants stopped being employees of Treadway and began working for Irby. The Court of Appeals found this conclusion “peculiar.” (The 8th Circuit’s rejection of this analysis is itself somewhat unusual as courts in other states have reached a similar conclusion under similar facts, where there is a sale of assets, not stock.)
The Eighth Circuit also concluded that there were issues of disputed fact as to whether Tipton breached his fiduciary duty under Arkansas law by soliciting employees before he quit. Because it reversed dismissal of fiduciary duty claim, it also reversed dismissal of a civil conspiracy claim. Because it reversed dismissal of the breach of contract claim, it also reversed dismissal of a tortious interference with contract claim against Wholesale Electric. Finally, because defendants were no longer the prevailing party, it reversed the award of attorneys’ fees.
The text of the non-compete agreements was not made part of the decision, so it is not clear if the contracts addressed the topic of assignability. In some states, non-competes are not assignable without the consent of the employee. In Treadway, the court seemed to focus only on whether the seller, Treadway, had actually assigned the contracts to the buyer, Irby. It was also not clear if the award of attorneys’ fees was based on the contract.
The decision offers several takeaways. First, assignability of restrictive covenants is often a source of confusion, and best addressed explicitly at the drafting stage, even if no merger or acquisition is on the horizon. Second, litigators in this area should not overlook potential common law claims for breach of duty of loyalty or fiduciary duty. Usually such claims involve pre-resignation solicitation of customers, but at least under Arkansas law, solicitation of subordinate employees may also trigger liability. Third, how a particular judge or appellate panel will rule on unfair competition claims is very unpredictable. In this case, defendants went from a run-the-table victory, and $200,000 in fees, to a seat either at the negotiating table or in the courtroom.
Since the much-discussed Fifield case from the Illinois appellate court two years ago, all that could be said with confidence was that, unless someone was employed for at least two years after signing a restrictive covenant agreement, its enforceability was highly questionable. Practitioners in Illinois have been recommending that employers provide consideration in addition to employment, such as a “sign on” bonus tied to the restrictions or any other consideration that would not be given but for the individual’s agreement to the restrictions. In the next breath, practitioners have been telling their clients that even the additional consideration might not be enough to bind employees employed for less than two years. Uncertainty is everyone’s enemy in this area, and there has been great uncertainty for the past two years. But that uncertainty recently has been reduced by the same appellate court’s ruling in McInnis v. OAG Motorcycle Ventures, Inc. decided June 25, 2015 by the Illinois Appellate Court for the First District, albeit by a 3-judge panel different from the panel that decided Fifield.
In simplified form, the salient facts are as follows: Following his resignation from OAG, McInnis filed an action for a declaration that his agreement not to compete with OAG and not to solicit its customers was unenforceable under Fifield because he had remained employed “only” 18 months after his execution of the noncompete agreement. OAG counterclaimed to enforce the restrictions against McInnis, who had begun work at a competitor.
The trial court held that there was inadequate consideration for the noncompete agreement because (1) McInnis had not been given any additional consideration for the agreement (i.e., something beyond his hire and subsequent employment for only 18 months) and, therefore, (2) Fifield’s two-years-of-continued-employment rule controlled.
On appeal, the appellate court discussed Fifield and related cases at some length, concluding that Fifield does not mean that two years’ subsequent employment was the only consideration that would bind an employee to a restrictive covenant agreement. The court made clear its view, which it claimed also is the view of other Illinois appellate courts, that the Fifield rule comes in to play when there otherwise is no additional consideration given to the individual for agreeing to the post-employment restrictions. And in McInnis, the appellate court held that the trial court properly concluded that no additional consideration existed. Thus, it affirmed the denial of enforcement of the agreement.
The dissent attacked the majority’s acceptance of Fifield in the first place. The dissent would reject Fifield’s holding as it applies to new hires, and instead believes a totality of the circumstances test should be applied to the question of the adequacy of consideration. Alas, unless and until the Illinois Supreme Court addresses this issue, however, Fifield remains a significant obstacle to enforcement of noncompete agreements, at least where the employer has not provided distinct additional consideration beyond mere employment.
McInnis provides authority to argue that providing consideration separate and distinct from employment (and the salary and benefits that everyone in that position receives) — that is, consideration that the employee would not have been given had he refused to sign the non-compete agreement— makes Fifield inapplicable to any enforcement action.