Wednesday, January 7, 2009
Arizona Case Highlights Problems With Overbroad Non-Competes (Nouveau Riche v. Tree)
A federal court's recent denial of a preliminary injunction motion illustrates perfectly a situation in which restrictive covenants will be ruled unenforceable.
Many experts in non-compete law recognize that the further West you go geographically, the less likely it is a non-compete agreement will be found enforceable. That said, Arizona's law concerning non-compete agreements is fairly middle-of-the-road, much like Illinois law in many respects. At issue in Nouveau Riche v. Tree were three common restrictive covenants - all of which were ruled to be unreasonable or inapplicable.
Because the restrictive covenants were so utterly one-sided, the court's opinion gives little mention of the underlying facts of the case. However, it appears that Nouveau Riche sells real estate investing products and educational materials. Disappointed "students" blog about the company and accuse it of being a "scam." Here, the plaintiffs were independent contractors and, thought it's not clear, were responsible for marketing Nouveau Riche's educational products to consumers (i.e., potential investors in short-sales and foreclosures).
The non-compete agreement prevented each of the defendants from working in any business competitive with Nouveau Riche for a period of one year, and the geographic territory extended to "all states in which the Company does at least 10% of the Company's business." It left undefined what types of activities were barred.
The district court had little trouble voiding the non-compete clause. In particular, the court noted that the flexible, shifting geographic term was incapable of definition, and that it could change every year - putting no one on notice of where he or she was prohibited from working. The court, in fact, called the non-compete clause "unfairly amorphous." Additionally, the court concluded that the activity restriction was far too broad. It purported to restrict the defendants from selling any products competitive with Nouveau Riche, going beyond those actually sold by the defendants.
The district court also found that the durational term of one year was too long, since the primary defendant's replacement had been found and trained effectively in less than four months. The court relied on Arizona case law holding that a duration term is reasonable only if it is no longer than necessary to put a new man on the job and to demonstrate his effectiveness.
Arizona adheres to a strict "blue-pencil" rule, meaning the court only can strike or delete overbroad terms. It cannot modify or rewrite the contract to make it reasonable, which is permissible in many jurisdictions including Alaska, Minnesota, Texas and Idaho. Here, there was nothing to blue-pencil; it was not as if the non-compete listed some states which could be crossed off to make the contract valid. Instead, the clause defined the geographic area by a percentage-of-total-business, which would require the court to interpret and identify specific states that were off-limits.
Secondary to the court's decision were the no-hire and non-disclosure clauses. Both were again held unreasonable. As to the no-hire clause, the defendants were nominally barred from soliciting any employee or contractor of the company even if they did not have any contact with them whatsoever. The court further noted that the clause would bar the defendants from soliciting them to join even a recreational club. Such absurd, overbroad language had no chance of being adjudicated favorably for Nouveau Riche. No-hire covenants are accorded much more deference in most jurisdictions, but they should be drafted to limit solicitation of key employees or at least those who have some connection to the departing employee. Because they are still technically restraints of trade, they must protect a legitimate business interest.
Finally, Nouveau Riche could not demonstrate a breach of the non-disclosure clause since it offered no evidence of what confidential information was even at issue.
This case is a perfect example of terrible contract drafting. An overbroad non-compete is often unenforceable in its entirety simply on the grounds that a court will find it failed to put the employee on clear notice of what was actually prohibited. That was the case here. Applying the contract language yielded an almost indefinite set of restraints on the defendants, going far beyond what was necessary to protect the plaintiff.
Even if Nouveau Riche could demonstrate a legitimate protectible interest to support the restraints - which appears doubtful - the agreements had no chance of standing up in an Arizona court.
Court: United States District Court for the District of Arizona
Opinion Date: 12/23/08
Cite: Nouveau Riche Corp. v. Tree, 2008 U.S. Dist. LEXIS 105577 (D. Ariz. Dec. 23, 2008)