Tuesday, November 24, 2015

Illinois Revitalizes "Old" Rule Concerning Limits on Confidentiality Agreements

Attorneys in Illinois have assumed for many years that non-disclosure agreements do not need a time limit on them.

That assumption is now conclusively incorrect.

The genesis of the problem comes from the Illinois Trade Secrets Act, which provides as follows:

...a contractual or other duty to maintain secrecy or limit use of a trade secret shall not be deemed to be void or unenforceable solely for lack of durational or geographical limitation on the duty.

The ITSA passed the General Assembly in 1985, and after that point in time, a smattering of cases dealt with the reasonableness of non-disclosure covenants and seemed to endorse them without much analysis as to scope.

But in 1985, around the time the ITSA went into effect, a case called Cincinnati Tool Steel Co. v. Breed held that durational and geographic limitations are required for a confidentiality agreement. A few subsequent cases followed Cincinnati Tool Steel, but not many and the issue was rarely litigated.

(As a potentially interesting aside, "Cincinnati Tool Steel" was not some company based in Cincinnati, Ohio but simply took its name of the president, Ronald Cincinnati. Pardon me for being somewhat of an onomastic snob, but whenever I think of this case, I cannot help but be reminded of James Spader's portrayal of Robert California in The Office, a fantastically geographic-oriented surname.)

Two recent cases, though, have revitalized Cincinnati Tool Steel. In the Appellate Court of Illinois, the case of AssuredPartners, Inc. v. Schmitt (from October 26) held that an unlimited non-disclosure covenant, both in terms of its duration and in terms of the information that fell within the terms of the covenant, was unenforceable. In particular, the court warned that such a broad covenant drastically limited the employee's ability to work in the relevant industry because it prevented him from using any knowledge he gained while employed with AssuredPartners, despite his prior work experience in the industry and regardless of whether he gained that knowledge because of his employment.

The second case, Fleetwood Packaging v. Hein, comes from the Northern District of Illinois, where Judge Tharp invoked the rationale of Cincinnati Tool Steel to conclude a non-disclosure agreement that lacked a temporal and geographic scope was unenforceable. Responding to the argument concerning the ITSA clause cited above, Judge Tharp found that it only applied to contractual restrictions that limited the use of trade secrets - not confidential information.

The reasons for demanding limitations on non-disclosure covenants are sound and generally hinge on two policy rationales.

First, as AssuredPartners recognizes, the presence of a non-disclosure covenant that is unlimited in scope can have a drastic chilling effect and can raise the possibility that an employer will attempt to bootstrap what should be a narrow restriction into a much broader non-compete that the parties never signed. Just as problematically, the relatively undefined nature of confidential information (which by definition is at least partly subjective) can leave an employee twisting in the wind if she stays in the same industry as her prior employer (which most employees do).

Second, it is awfully difficult (if not impossible) for an employee to know what remains confidential after she has left. Much ephemeral business information can lose value quickly. If corporate strategies shift, then a strategic plan that is a few years old may be of no use to anyone. Only insiders should know what remains confidential. Those who no longer are providing services to a company have no reason to know whether certain information retains some confidentiality. Therefore, it makes sense to require some reasonable limit on scope so that an employee is not left uncertain as to what she can disclose about her past work.

Allowing unlimited agreements to protect trade secrets, while certainly a fine distinction, is consistent with public policy. The challenge, of course, is to parse viable trade secrets (which should be more specific and more obvious) from general confidential information  (which likely is categorical and less obvious).

Thursday, November 19, 2015

Pennsylvania Follows Trend in "Consideration" Cases

The subject of consideration is the new frontier of non-compete disputes.

Although Illinois is at the forefront of this burgeoning consideration debate, other states increasingly have begun exploring the concept of what exactly an at-will employee receives in exchange for agreeing to a non-compete agreement. This "exchange" is the fulcrum of consideration, a legal term that ensures the enforceability of a contract obligation.

Pennsylvania, like other state supreme courts, has waded into the arena, albeit with an arcane and interesting twist to the legal problem. Yesterday, the Supreme Court of Pennsylvania in Socko v. Mid-Atlantic Systems of CPA, Inc. held that an employee can challenge a restrictive covenant agreement signed after the start of employment on the grounds that it lacks consideration, even if the agreement contains specific language that the employee "intends to be legally bound."

Why does that intent-to-be-bound language matter?

Pennsylvania is the only state to adopt something called the "Uniform Written Obligations Act." Consider, for a second, whether a statute can be uniform if 1 out of 50 states has enacted it. The Act provides that a written promise:

shall not be invalid or unenforceable for lack of consideration if the writing also contains an additional express statement, in any form of language, that the signer intends to be legally bound.

The challenge for the Supreme Court of Pennsylvania was to harmonize this very old statute with the general common-law principle that says an employee who signs a restrictive covenant after the inception of employment must receive new consideration beyond employment itself. This rule generally requires an employer to provide something tangible such as a promotion, a bump in pay, or some severance benefit. Continued employment never suffices in Pennsylvania.

The Court, facing a somewhat daunting challenge, did its best to reach what it felt was the right result, consonant with years of legal decisions in the restrictive covenants area. It concluded that, despite the plain language of the Act, extending it to contracts in restraint of trade would be "unreasonable." The Court considered the "historic background regarding" non-competes, as well as their "unique treatment in the law." Therefore, even if non-compete contracts include the mandated "intends to be legally bound" language, an employee still can challenge the agreement on the grounds that it lacks consideration.

The main canon of statutory interpretation that the Court had going for it was the strict construction rule. That rule generally states a statute in derogation of the common law must be strictly construed. Applied to non-competes, the Court traced the history of these "unique" agreements and the special issues pertaining to consideration that the law had afforded them.

The case is perhaps not a model of how to resolve questions of statutory construction. Nevertheless, it continues a clear and definite trend. In the last several years, courts seem to be pivoting away from examining whether an employer has a legitimate business interest to protect through a non-compete and towards looking at whether there even is consideration at all. To be sure, questions of reasonableness and protectable interest are vitally important in cases like this. But the consideration issue is fundamental to the issue of contract formation in the first place and often results in a rapid disposition of the suit.

Tuesday, October 20, 2015

Lost Profits and No-Hire Clauses

A common feature of employment contracts these days is the no-hire clause. This is a form of a non-solicitation covenant and specifically precludes an employee from encouraging other employees to leave the firm.

I estimate that 9 out of 10 employee clients of mine are unconcerned with this type of covenant. They simply don't care to recruit fellow co-workers to join them at a new job. For the ten percent of clients that do care, they tend to be upper-level managers or lead a sales team. Their value to a new employer may depend on replicating that sales team.

The enforceability of no-hire clauses is not something that is widely litigated. One certainly can argue with exactly what kind of legitimate business interest the clauses protect. But for the most part, I've been content to assume that an employer at least can demonstrate some kind of an interest, even if it seems to vague and ephemeral.

The question of damages, though, presents a much more confounding problem. If one employee solicits another to leave - in violation of a covenant prohibiting that solicitation - what is the employee's monetary exposure?

A couple of possible damage theories immediately come to mind:

  1. The employer's cost to replace the wrongfully solicited employee. These costs might include recruitment expenses, headhunter fees, signing bonuses, and incremental pay differentials between the former and replacement employee.
  2. Liquidated damages, if provided for by contact. Some employment agreements attempt to define the agreed-upon damages for breach of a no-hire covenant. I have seen these clauses expressed as a percentage of the solicited employee's last-prevailing rate of pay.
  3. Lost profits. The conventional form of contract damages, this would measure the loss to the employer associated with the breach of the no-hire covenant.
But as to this last category, how would one prove that? Assume that the employee who was wrongfully solicited then began contacting or soliciting customers of the former employer. Is any lost income properly attributable to the no-hire violation? This would seem to be a step removed from the underlying breach, particularly if the employee who solicited the customer had no restrictive covenant agreement prohibiting that sales activity.

This is roughly the fact-pattern of Acadia Healthcare Co. v. Horizon Health Corp., 2015 Tex. App. LEXIS 7683 (Tex. Ct. App. July 23, 2015). To be sure, the case involved a great deal of facts that supported more serious charges of conversion, trade secret theft, and breach of contract against other employees. But the case is certainly crucial for how the plaintiff was unable to use expert testimony to render a lost-profits opinion arising from a no-hire breach.

The plaintiff's expert looked at two sets of facts and gave separate damages opinions on each. As to the first, he identified a specific prospect that a former Horizon employee solicited for Acadia (the new employer). The employee himself had signed no employment agreement, but his superiors solicited him to join Acadia in violation of their own no-hire covenants. The court found that the expert's opinion on lost profits concerning the solicited account was too speculative, in that the expert assumed that Horizon would have retained the account for 15 years. The expert's inability to identify specific information supporting a 15-year contract duration was fatal to this opinion.

The other fact concerned the solicited employee's "lost production," In essence, Horizon had claimed damages from the wrongful solicitation of this employee under the assumption that, but for the solicitation, he would have produced profit for Horizon into the future. The problem with Horizon's theory was that Horizon assumed the employee, who was at-will, would have remained with Horizon, would have been offered a new sales position, and would have accepted it. And the expert again assumed that the employee would have signed hypothetical contracts with 15-year contract terms.

Acadia Healthcare illustrates how difficult it is to prove damages in competition cases. As it relates to no-hire clauses, the damages analysis becomes attenuated because the recruitment usually precedes the proximate cause of any loss. And even assuming a plaintiff can tie those causes together, the assumptions underlying any future damages projection inherently become problematic and attenuated.

Monday, September 21, 2015

The Inevitable Disclosure Rule and Commercial Transactions

Claims for trade secrets misappropriation normally arise out two types of transactions: a fractured employment relationship or a failed business strategic transaction (such as a merger or joint venture).

One way to prove threatened misappropriation (and therefore secure injunctive relief) is to claim that improper use or disclosure of a secret is "inevitable." This inevitability theory is disfavored and not even viable in some jurisdictions. However, it continues to spur litigation and debate.

In the employment context, claims of inevitable disclosure normally must meet a certain standard, though the standard is necessarily flexible and case-specific:

  1. The old and new employer must be direct competitors.
  2. The employee's new position must overlap with the old one.
  3. The new employer must fail to take some reasonable step to guard against the employee's use or disclosure of trade secrets.
  4. The employee's departure conduct must suggest the possibility of misuse (e.g., misleading the employer as to plans, suspiciously accessing proprietary data).
If the inevitability theory works in employment cases, it does so because the employee's objectively perceived value to the new employer tends to derive from her prior work experience. Put another way, the employee normally does not bring some unrelated, free-standing value apart from this job history. So (again, in theory) it's at least plausible that even well-intentioned employees will disclose something that they shouldn't.

In a failed business transaction, this rationale is absent. Businesses may combine because of synergies that are unrelated to their status as market competitors. Therefore, it is dangerous to presume that erstwhile joint venture partners, for instance, will will have any incentive to incorporate the others' trade secrets.

The Appellate Court of Illinois' decision in Destiny Health, Inc. v. Cigna Corp., 2015 IL App (1st) 142530, notes this important distinction in applying the inevitable disclosure theory and rejecting it to a failed joint venture. Destiny Health discusses the leading case involving a failed acquisition and the attempted use of the inevitability theory, Omnitech Int'l v. Clorox Co., 11 F.3d 1316 (5th Cir. 1994). Both cases expound upon the difficulty in establishing trade secrets misappropriation through the inevitable disclosure theory.

Omnitech and Destiny Health both emphasize the danger associated with inferring trade secret misappropriation after a failed transaction. This leads to one of two perverse results: (1) if a company evaluates one potential target, and then declines to acquire it, the company effectively would be precluded from evaluating other targets; or (2) the company would have to evaluate potential targets without evaluating their trade secrets. 

Ultimately, I believe that contracts should set the parameters for the inevitable disclosure rule. In commercial transactions, a simple non-disclosure agreement (signed as a condition of evaluating a business transaction) should determine any future restrictions. If, as in Destiny Health, the agreement is silent on a party's ability to develop certain products, explore certain targets, or contracting with certain vendors, then the "inevitable disclosure" theory should be unavailable.

Similarly, in the employment context, I believe that the inevitable disclosure rule only should be applied to demonstrate the employer's protectable interest in enforcing a non-compete agreement. In other words, the employer should not have to wait for the ex-employee to disclose something before seeking enforcement. As long as the employer can show extensive access to company secrets, then this should support enforcement of a non-compete - assuming of course, the terms are reasonable and the agreement carries proper consideration.

The Destiny Health case illustrates the potential misuse and overapplication of the inevitable disclosure rule. Right now, it's operating as an uncontrolled extension of trade secrets law. The rule needs standards, but few courts seem willing to apply them with regularity.

Monday, August 17, 2015

Hawaii Goes Deep on Non-Compete Law

The mentions that the State of Hawaii gets on this blog are, predictably, few and far between. However, in the span of just a few weeks, we have two significant legislative and judicial updates.

The first concerns Act 158, which Governor David Ige signed into law in June. The law is limited in scope and is industry-specific. The main thrust of the law is that it bans enforcement of non-compete agreements for employees of technology businesses. A technology business is defined as one which derives more than half of its gross sales from "sales or licensing of products or services resulting from software development or information technology development." The law further defines those terms.

The law also prohibits the use of non-solicitation covenants, which are defined exclusively as those restrictions that prohibit an employee from soliciting a former co-worker. It does not include any restrictions on contacting, servicing, or soliciting customers or clients of a former employer, meaning Act 158 expressly leaves open the question of whether this type of restrictive covenant in a technology business is prohibited. By omitting it, it is likely that such covenants will continue to be scrutinized for reasonableness under the common law.

Act 158 took effect on July 1, but the law has prospective effect only. For an excellent summary of Act 158, read Robert Milligan's analysis here.

While Act 158 is decidedly pro-employee, a Hawaii federal district court rendered a decidedly pro-employer decision in a non-compete case. The question presented in The Standard Register Co. v. Keala, 2014 U.S. Dist. LEXIS 73695 (D. Haw. June 8, 2015), was whether continued employment constitutes sufficient consideration to enforce a non-compete against an at-will employee. This issue continues to divide courts across the country. In the past year or so, some courts (Wisconsin) have veered towards a pro-enforcement stance when this type of consideration is at issue. Others (Illinois and Kentucky) continue to lean pro-employee and require additional consideration beyond employment itself. And we await a ruling from Pennsylvania on this same issue.

The district court in Standard Register noted that the Supreme Court of Hawaii never had addressed the question, so it surveyed the majority and minority rules across the United States. In following the majority rule, the court also relied on the forthcoming Restatement of Employment Law, Section 8.06, which appears to endorse the majority position - that forbearance of the right to discharge is itself sufficient consideration. The Restatement goes on to criticize the middle-ground approach taken by Illinois courts (as well as a handful of others) which examine whether the employment continues for a substantial period of time.

Wednesday, August 5, 2015

A Federal Trade Secrets Statute Appears Inevitable, Questions and Concerns Remain

Last week, the Defend Trade Secrets Act of 2015 was introduced in both the House of Representatives and the United States Senate. The text of the proposed legislation appears below. This is a bipartisan, bicameral bill that likely will become law in 2015.

The structure of the DTSA is very familiar to practitioners and to those who follow trade secrets developments. Currently, trade secrets law is the only branch of intellectual property that is regulated by state law. Since 1979, the Uniform Trade Secrets Act has been part of our state-law landscape, and over the years almost every state has adopted some form of the UTSA. (The variations by state are minor and generally relate to ancillary topics like the statute of limitations and preemption. New York and Massachusetts remain holdouts for reasons that are unknown.)

If Congress passes the DTSA, then this state-law regulatory framework will change dramatically. To be sure, it is unlikely to disappear; litigants still may be bring a state-law claim for trade secrets theft. The draft of the DTSA does not contain a broad preemption clause, but eventually state cases would run off into the remote reaches of the court system. And federal courts would bear the burden of hearing trade secrets disputes.

The structure of the proposed DTSA builds upon existing law, but not in a way that is seamless. It would amend the rarely-used Economic Espionage Act, which is contained in title 18 of the United States Code. The EEA criminalizes trade secret theft, but contains no private civil enforcement mechanism. In 2013, there were only 25 prosecutions under the EEA. The case law, which would aid a federal court in a DTSA claim, is almost non-existent.

The DTSA, to that end, adopts the EEA's definition of a "trade secret," which differs at the edges from the UTSA's definition. On this score, under the EEA, a trade secret must meet a two-part standard. The owner of the claimed secret must take reasonable measures to keep the information. And, substantively, the information must derive independent economic value from not being generally known to "the public." Under the UTSA, the second part of the definition is slightly different. The information must derive economic value from not being generally known "to other persons who can obtain economic value from its disclosure or use." Conceivably, under the DTSA, a plaintiff could bring two claims for trade secrets theft under two different statutes with two different definitions accorded the central issue in the case. Some lawyer somewhere is going to have a field day with that. (I happen to know of a few of those lawyers, who shall remain nameless.)

Another source of potential controversy is the DTSA's proposed process for enabling plaintiffs to obtain an ex parte seizure order. This would allow a court to authorize a seizure of trade-secret instrumentalities, such as computer hard-drives, thumb-drives, and even cell phones where purloined data may exist. In contrast to other branches of intellectual property law, these instrumentalities may have an entirely lawful purpose. On the other hand, think of counterfeit goods or pirated CDs, where the products themselves are infringing.

The seizure order is modeled after something called an "Anton Piller Order," which is fantastically named and derives from English law. This type of seizure order has a quaint, colorful, and interesting history in and of itself. Commentators are concerned that plaintiffs may abuse the process of seizing trade secret instrumentalities on an emergency, ex parte basis. However, I do not see this as a real issue for two reasons. First, federal judges would be inclined against issuing such orders, and a plaintiff who proceeds without caution faces the possibility of sanctions later in the case. Second, courts already have the authority, either under Rule 65 or the inherent authority power, to allow for seizure of items on a basis at least very similar to what the DTSA proposes. In light of the concerns, though, I expect the DTSA, when it's passed, to water down the seizure order provision or eliminate it entirely.

One final point: I feel that with the adoption of the DTSA, most non-compete disputes will now end up in federal court as a result of the courts' ability to exercise supplemental jurisdiction over state-law claims. Since trade secrets often comprise the legitimate business interest supporting a non-compete claim, a plaintiff will have every incentive to load into a non-compete dispute a corresponding trade secret claim just to get into federal court. This will complicate otherwise straightforward disputes, increase litigation costs, and tax the federal judiciary. By my estimation, if we assume that trade secrets cases are as common as patent and trademark suits, then the passage of the DTSA will result in an addition 10 to 14 new cases per district court judge per year. If there is an ancillary impact because of the desire to get non-compete cases in federal court, then the number would be higher.

I remain opposed, but not in a hand-wringing, teeth-gnashing sort of way. Two years ago, I conducted a podcast along with Russell Beck and John Marsh discussing the pros and cons of a federal trade secret statute. A link to the post and the podcast itself can be found here.

Friday, July 31, 2015

Seventh Circuit Endorses Use of Blue-Pencil Rule for Non-Competes

More times than not, courts in non-compete disputes confront restrictive covenants that have problems. Sometimes the problems are severe and other times they are revealed through the unique facts of the case, rather than the face of the document.

Yesterday, I spoke at the Annual Meeting of the American Bar Association and gave an update on key issues in non-compete and trade secrets law. One of the issues I discussed was the partial enforcement rule - in other words, how courts handle problems of overbroad covenants in enforcement actions.

Interestingly, the day before my presentation, the Seventh Circuit issued its opinion in Turnell v. CentiMark Corp. (embedded below). That case discussed Pennsylvania law concerning partial enforcement of covenants following an appeal from a preliminary injunction. CentiMark is a leader in a certain type of commercial roofing material used on commercial and industrial buildings. Turnell ran the Chicago District and had multi-state responsibilities.

The district court found that, under Pennsylvania law, Turnell's agreement was overbroad. But, after an evidentiary hearing, it reduced the scope of the agreement and enforced the reasonable parts. In doing so, the court properly found instances of overbreadth that are fairly common: (a) the non-compete banned work in an industry similar to that in which CentiMark engaged, meaning it covered too many products; (b) the non-compete barred sales to even prospective, as opposed to actual, customers; and (c) the geographic scope was vague and reached territories where Turnell was not primarily working.

On appeal, Turnell did not challenge the terms of the injunction and argued the district court should not have wielded the fictional blue-pencil to rewrite the contract. But the Seventh Circuit found that Pennsylvania law allowed the court to use its discretion to fashion an injunction remedy.

During oral argument, the Court was sympathetic to the possible overuse of the blue-pencil rule. And Judge Kanne's clear, insightful opinion reflects the tension and perverse incentives that the rule sometimes creates. Interestingly, the Court stated that "to some extent overbreadth is unavoidable given the imprecision of our language. "Ultimately, however, the Court did not seem persuaded that the terms of Turnell's agreement with CentiMark reflected bad faith or an intentional overreach on the employer's part.

I noted at the ABA Annual Meeting that there are four approaches to partial enforcement of overbroad agreements:

1. The "no modification" or red-line rule, which holds that courts will not modify agreements. Put another way, the covenant must be enforceable as written. Virginia adopts this approach.

2. The strict blue-pencil rule, which provides that courts can excise or eliminate overbroad, severable portions of an agreement. But the court will not add terms or use discretionary powers to modify the covenant. Indiana adheres to the blue-pencil rule.

3. The equitable modification principle, which was at issue in Turnell. This approach trades predictability for flexibility, because a trial judge can in effect become a third-party to the contract and impose terms that appear nowhere in the contract. Ohio adheres to this rule, and so does Illinois, but only in a more cautionary sense (for it can implicate public policy concerns). For instance, had Turnell challenged the Pennsylvania choice-of-law clause, Illinois' public policy may have called on the district to apply more favorable law.

4. The mandatory modification rule, which requires courts to reform agreements if they're overbroad. Texas endorses this rule, but provides that if a court orders a reformation, damages are then not available.

The equitable modification rule is, in many respects, very problematic. And in other cases similar to Turnell, courts have refused any sort modification. The approach often leads to the "right" result from a policy perspective, but it has a damaging collateral effect divorced from the litigation. Attorneys often cannot advise clients as to expected litigation outcomes, because it is very difficult to predict how a court will apply the reformation concept. As a result, many employees forego challenging the agreement altogether because of unpredictability (and their lawyers' hedging).

In light of the Court's recent opinion in Instant Technology (see post below from July 15, 2015), it surprises me that the Court did not mention the importance of predictability and clarity in the law of non-competes. In the end, though, the Court was constrained by Pennsylvania law, which allowed the district court to exercise her discretion and reform Turnell's contract.

Wednesday, July 15, 2015

Seventh Circuit Smartly Avoids Fifield Issue, Disses Illinois Law

In the detritus of Illinois law following the Fifield v. Premier Dealers Services case, one federal case actually appeared to have the potential to reshape how state courts (not to mention an increasing number of lower federal courts) viewed the issue of non-compete consideration for at-will employees.

Instant Technology, LLC v. DiFazio (7th Circuit, Nos. 14-2132 & 14-2243) was one of the diversity cases where the court followed Fifield and endorsed the two-year, bright-line consideration rule, which holds that non-compete/non-solicit covenants are enforceable only if an at-will employee has been employed two years or more. (This, of course, assumes the only consideration offered was employment itself, not something more tangible.) Other diversity cases declined to follow Fifield on the grounds that it did not accurately state the law in Illinois. Those cases have said that if the Illinois Supreme Court were confronted with the issue, it would come out with a different rule than that set forth in Fifield.

Instant Technology was always somewhat of a flimsy candidate for a broad, doctrinal repudiation or endorsement of Fifield, since the case appeared to founder on whether the covenants in the IT staffing business supported a "legitimate business interest." The district court found not, and the Seventh Circuit held that this finding was supported by the evidence. And on that score, Judge Easterbrook's opinion in Instant Technology gave nary a mention of Fifield or the current debate over consideration.

However, at oral argument, the Court discussed Fifield at length. And Judge Easterbrook is not the kind to wilt away and blindly assume the appellate court got it right in Fifield. He would seem to have little trouble excoriating the state court rule if he felt the legal standard was groundless. But his opinion avoided the issue, so we have nothing authoritative from a case that at least held out the possibility of being a game-changer in the consideration debate.

But, not surprisingly, Judge Easterbrook used the opportunity to take a not-so-veiled shot at Illinois law, and in particular the "totality of the circumstances" test from Reliable Fire Equipment Co. v. Arredondo. That case changed the analytical framework for determining how an employer can establish a legitimate business interest to support a non-compete. It discarded the traditional approach - which looked at whether an employer had a near-permanent relationship with clients or whether it sought to protect confidential business information the employee subsequently tried to use - and set forth a rather malleable (cavernous?) test that considered the totality of the facts from the case.

In Instant Technology, the IT staffing firm disputed the district court's analysis and basically said the judge didn't consider "everything," without specifying what it exactly it was that the court missed.

Judge Easterbrook says:

"Making validity turn on 'the totality of the circumstances' - which can't be determined until litigation years after the events - makes it hard to predict which covenants are enforceable. If employers can't predict which covenants courts will enforce, they will not make investments that may depend on covenants' validity, and they will not pay employees higher wages for agreeing to bear potentially costly terms. Both employers and employees may be worse off as a result. Risk-averse employees who hope that their covenants will be unenforceable, but fear that they will be sustained, may linger in jobs they would be happier (and more productive) leaving. But our rule of decision comes from state law. Erie R.R. v. Tompkins, 304 U.S. 64 (1938). Reforming that law, or trying to undermine it, is beyond our remit."

This passage largely pivots off many of the questions Judge David Hamilton asked during oral argument in the case. Judge Hamilton was concerned about the blank-slate landscape of Illinois law (a term used by Instant Technology's counsel) and the lack of apparent predictability in an area that demands it. Predictability and certainty usually arrive in the form of bright-line rules, which (oddly enough) Fifield establishes. As for the broader question of reasonableness, the Seventh Circuit seems to be saying that Illinois employers got what they asked for: flexibility. The price? Often times, disappointment.

Wednesday, June 17, 2015

Florida's Non-Compete Law Is, Apparently, "Truly Obnoxious"

One of the most important issues in analyzing any non-compete agreement is choice of law. My experience is that at least 9 out of 10 contracts contain explicit choice-of-law clauses, which describe in the contract which state's law will govern enforcement.

A few years ago, I represented the prevailing defendants in Tradesman Int'l v. Black, 724 F.3d 1004 (7th Cir. 2013). Judge David Hamilton's concurring opinion in that case illustrates the importance of choice-of-law clauses and how predictability over which state's law applies is essential to litigation strategy. It is an extremely thoughtful and interesting opinion, and my post discussing it can be found here.

There are a number of red-flag states where choice-of-law issues are bound to come up. Certainly, if California has any kind of a nexus to the proceedings, then choice of law will be front and center. Other states, like Wisconsin, also pay particular attention to clauses that select another state's law. And Florida, by virtue of its pro-enforcement stance, is a third example.

On this score, Illinois courts will not enforce Florida choice-of-law clauses because they are contrary to our state's public policy. Recently, New York courts have followed this lead and have held that a Florida choice-of-law provision in an employment non-solicitation covenant is unenforceable and contrary to New York public policy.

The case is Brown & Brown, Inc. v. Johnson. The Court of Appeals of New York set forth the standard for invalidating a contractual choice-of-law clause: the foreign law must be "truly obnoxious." Now, that's a standard.

So what's the problem with Florida law, and why do some courts view its stance on non-competes as contrary to public policy. The New York court identified the following:

  1. The employee largely bears the burden of proof to show that enforcement is not necessary to protect an asserted business interest.
  2. Courts many not consider hardship to the employee from the covenant's enforcement.
  3. Courts may not use rules of contract construction that would require a court to construe a vague or unclear contract against the employer.
Overall, the New York court - like the courts in Illinois before it - were concerned with "Florida's nearly-exclusive focus on the employer's interests" in contrast with the traditional balancing test that governs enforcement.

Going back to my post from two years ago when I analyzed Judge Hamilton's concurring opinion in Tradesman, there still is no clear test that I can find to determine when a state's law contravenes another state's public policy. I raised three possibilities:

  1. The legislature has spoken on the issue and declared the state's public policy, much like California has done.
  2. A state's case law reflects a clear, uniform rule applicable without regard to the specific facts of the case. An example would be a court's refusal to partially enforce an overbroad agreement.
  3. The difference between the chosen state and the forum state would be outcome-determinative.
After reading Brown & Brown, I might add a fourth possibility: the chosen state's rules disproportionately favor the employer and undermine the foundation of the rule-of-reason analysis.

Friday, June 12, 2015

Mid-Year Legislative Update - Arkansas, New Mexico, and ... Jimmy John's?

This year, we have seen a slight uptick in proposed legislation concerning non-compete agreements. In previous posts, I've written about legislative efforts in Wisconsin, Washington, and elsewhere. However, while most bills stall out, a few gain momentum. And recently, we have two actual legislative enactments that will change existing law.


The first new law comes from Arkansas, where Gov. Asa Hutchinson signed Act 921. This new law allows a court to enforce reasonable aspects of a non-compete agreement. Previously, Arkansas courts would not allow a court to blue-pencil an agreement that would allow for partial enforcement. That is, an agreement with any overbroad sub-parts rendered the whole document unenforceable. A court's ability to sever offending provisions is weapon in an employer's enforcement arsenal and encourages overbroad drafting.

Act 921 also provides for a presumption that a covenant lasting two years or less is reasonable. Finally, Act 921 specifies an array of employer protectable interests, which include goodwill, confidential information, and training. (The list also identifies protectable interests as "methods" which I found odd.)

Act 921 takes effect on August, 6, 2015.

New Mexico

In April, New Mexico enacted Senate Bill 325, which limits the enforcement of non-competes for health care practitioners (which is defined to include physicians, dentists, podiatrists, and nurse anesthetists). The law is available here.

The law, however, contains a number of significant limitations. First, it does not apply to heath care practitioners who are shareholders or partners in a practice. Second, it does not prohibit a practice from binding a health care practitioner to a non-solicitation provision with regard to patients and employees of the practice (as long as the covenant is 1 year or less). And third, it does not preclude use of a liquidated damages provision. Therefore, we can expect to see physician employment contracts track the language of the statute and (in all likelihood) tie a breach of a non-solicitation covenant to some formula for liquidated damages.


Nationally, we have a new bill tied to enforcement of non-compete agreements and, of course, it arises out of the infamous Jimmy John's case. Illustrating once again that there is no limit to legislators' imagination when it comes to giving legislation creative and idiotic names, several Senate Democrats have backed the Mobility and Opportunity for Vulnerable Employees (MOVE) Act. A copy of the bill is available here.

The essence of the bill is that it would bar use of non-competes for low-wage workers, generally defined as those earning less than $15 per hour. A violation would result in a fine of up to $5,000 per employee subject to the non-compete, and the law would empower the Secretary of Labor to investigate complaints concerning the improper deployment of non-competes. The law also contains a posting requirement (the violation of which is punishable by a flat $5,000 fine) that would tell a low-wage employee of the ban on non-competes.

The bill also would require employers who propose to use a non-compete to disclose this to the employee before employment and "at the beginning of the process for hiring" the employee. While some states have examined this kind of notice requirement in recent years, this would mark a substantial change in the law. Best practices certainly call for up-front disclosure, but it is still very common for employees who leave a job and accept a new one to see a non-compete on the first day of work.