Wednesday, July 28, 2010

Hurricane Lane's Lawsuit and the Relevance of Being "Malicious"

Football is huge in Tennessee.

When Lane Kiffin bolted UT for Southern California after a rather pedestrian 7-6 season in 2009, Volunteers fans were irate. Not because of Kiffin's remarkable pedigree - at best, he has an unimpressive record of mediocrity - but rather because he jumped ship from one blue-chip program to another.

So you would think Kiffin might be careful when wading into Tennessee. Not so.

Last week, the Tennessee Titans (really Tennessee Football, Inc.) filed suit against Kiffin claiming that he wrongfully induced their running backs coach, Kennedy Pola, to quit and assume a position with the USC football program.

Pola had a one-year contract with the Titans, and it contains an exclusivity or in-term non-compete clause. Simply put, Pola could not accept employment anywhere else during the term of his employment contract. A copy of the Complaint can be found here.

Much has been made in the news media of Kiffin's alleged "malicious" conduct. The only real relevance is that under Tennessee law, the Complaint must allege malice in order for a plaintiff - like the Titans - to recover treble (or, triple) compensatory damages. Tennessee law is somewhat unique in this regard. While contractual interference is a well-recognized tort, the availability of treble damages is a statutory remedy in Tennessee that is not particularly common.

All that said, it is clear that the lawsuit is trying to capitalize on Kiffin's infamy in the Volunteer State. It makes allegations about Kiffin's abrupt departure from UT and recruitment of other UT assistants (including his father) to join him at USC. It would be surprising if USC and Kiffin allowed the case to progress very far, particularly given that he is set to embark on his first season at USC in just a month or so.

Interestingly, the Titans did not sue Pola, the coach who left to join Kiffin. It is possible the Titans did not want to send a message to other potential coaches around the league that they are willing to sue ex-employees and who might be deterred from joining the Titans in the future.

Had the Titans elected to sue Pola and prevent him from assuming his position with USC, it almost certainly could have done so. There are many cases involving athletes where injunctive relief has been granted to prevent a player from terminating his services while the contract is in force and jumping ship to a rival. The most famous of these cases involved Rick Barry, who tried to get out of his NBA contract with the then-San Francisco Warriors in favor of playing in the now-defunct ABA with the Oakland Oaks. Barry, the first player to switch from the NBA to the ABA (in the same geographic market, no less), was ordered to sit out a year before joining the Oaks.

Thursday, July 22, 2010

Failure to Separate Covenants Invalidates Non-Solicitation Agreement (MJM Investigations v. Sjostedt)

If you're drafting non-compete agreements in a blue-pencil state like North Carolina, you have to be careful.

Proving once again that the consequences for improper drafting can be severe, the Court of Appeals in North Carolina invalidated a client non-solicitation clause due in part to overbreadth but also due to the strict application of the state's blue-pencil law.

As regular followers of this blog know, there is a sharp distinction between states which will modify covenants to make them reasonable and states which adhere to a mechanical blue-pencil approach. North Carolina falls in the latter category. (It is this scribe's humble opinion that the more equitable approach - favored in states like Illinois and Ohio - leads to less litigation and incents employees to comply with at least some restriction that an objective person would deem reasonable. That is not to say this approach does not have a chilling or deterrent effect, which it clearly does.)

This means that a court may not add or change terms of a covenant, but instead only can sever or strike out offending provisions. The covenant at issue concerned an employee's agreement not to compete and not solicit clients in a specialized, niche field related to insurance coverage. Specifically, the plaintiff assisted insurance carriers in evaluating claims made related to services provided by contractors of the federal government for work overseas.

The defendant, a consultant, terminated his agreement with the plaintiff and apparently began competing directly in the same claims processing field with the plaintiff's clients. He argued that the restrictive covenants were invalid and lost in the trial court as to the less cumbersome client non-solicitation obligation. The court struck the two-year non-compete as invalid on the grounds it was overbroad.

On appeal, the defendant obtained further relief as he successfully convinced the Court of Appeals that the client non-solicitation also could not be enforced. He won on a couple of grounds:

(1) The two-year time limit was contained only in the non-compete restriction, and since it was struck as overbroad, the non-solicitation clause had no time limit whatsoever. This is a perfect illustration of the rigidity of the blue-pencil rule, because a court in an equitable modification state could easily apply the two-year time limit to the non-solicitation clause in its discretion.

(2) The definition of "client" and "prospect client" was not defined in the agreement. In North Carolina, as in many states, a client limitation cannot extend beyond relationships the employee made while employed with his former firm. In this case, the court had ample precedent to hold the terms "client" and particularly "prospect client" were too vague to be enforced. This ruling provides a lesson for practitioners: if you're going to use defined terms in a non-compete agreement, use them to define which clients are off-limits so that an employee cannot argue vagueness. That argument often wins.


Court: Court of Appeals of North Carolina
Opinion Date: 7/20/10
Cite: MJM Investigations, Inc. v. Sjostedt, 2010 N.C. App. LEXIS 1280 (N.C. Ct. App. July 20, 2010)
Favors: Employee
Law: North Carolina

Wednesday, July 21, 2010

Employer Must Watch For Broad Use of Employee Indemnification and Advancement Rights (James River Mgmt. v. Kehoe)

Imagine a very common scenario where a corporate officer or employee steals valuable corporate data, deletes or compromises electronic information on his way out the door, solicits customers to leave prior to his termination of employment...and then says his employer must pay for the legal defense of is almost certain to be contentious litigation.

Is this such a far-fetched scenario?

Not really, and it all has to do with the concept of advancement and indemnification. Corporate laws across the United States provide that companies may indemnify officers, directors and employees for litigation costs and judgments incurred due to the fact of their affiliation with the company.

Advancement is a little bit different but related - it concerns the right receive legal fees prior to the time litigation is terminated and decided. In essence, it means the right to have someone else pay your attorney on a regular basis.

In many corporations, the rights to advancement and indemnification are mandatory under governing bylaws. This seems counterintuitive, but is used to attract key personnel as corporate officers and directors. An employee may even have such rights spelled out in an employment agreement.

Most of us are familiar with corporate executives being indemnified in breach of fiduciary duty cases, such as shareholder derivative actions, or even criminal suits for insider trading. But the same concepts apply in unfair competition law. Believe it or not, there are cases holding that a corporation suing a departed executive must advance legal expenses to that executive during trade secrets or fiduciary duty litigation - theories which fit the facts described in the first paragraph of this post. The reason is that advancement rights - particularly under Delaware law - are broadly interpreted.

As one court interpreting Delaware law recently stated: "The line between actions taken in a personal vis-a-vis corporate capacity is not drawn according to whether the director or officer acted detrimentally to the interest of the corporation, but instead on whether there is a nexus or causal connection between any of the underlying proceedings and one's corporate capacity without regard to one's motivation for engaging in that conduct."

In the context of trade secrets theft, an employee can claim that such conduct occurred as a result of his prior employment and that it arises directly out of his rule as a corporate fiduciary. Can the same be said of a non-compete violation? Probably not. The courts clearly hold that contractual obligations in a non-compete agreement are the product of an arms-length transaction, entered into by the employee in his personal - not corporate - capacity.

The lesson for counsel is this: don't forget about advancement and indemnity rights. The source of those rights is the governing state's corporation or limited liability company law, the bylaws or operating agreement, and any agreement the employee may have signed during his or her employment.

If the employee has advancement rights which are contested, then a court must decide those rights in a summary proceeding. The rights to advancement may be conditioned, however, on an employee's undertaking to repay such costs and fees to the corporation if his actions were not taken in good faith (or whatever the bylaws say on this). For a defendant who is in a precarious spot but wants to fight until the end, advancement only gets him or her so far. It is effectively an interest-free loan.

At the very least, though, it may give the company suing the ex-employee a strong incentive to work out an early resolution to the case.


Court: United States District Court for the Eastern District of Virginia
Opinion Date: 12/8/09
Cite: James River Mgmt. Co., Inc. v. Kehoe, 674 F. Supp. 2d 745 (E.D. Va. 2009)
Favors: Employee
Law: Delaware

Tuesday, July 20, 2010

Wholesale Insurance Broker Dispute Highlights Potential for Reputational Injury (Allison v. CRC)

Crain's had an excellent article yesterday about the dispute concerning Patrick Ryan's re-emergence in the wholesale insurance brokerage industry. Ryan, the founder of AON Corporation, is one of the most high-profile business and philanthropic figures in the area. He invested a substantial amount of money - $275 million - to create and fund Ryan Specialty Group, a wholesale insurance brokerage.

The controversial aspect of Ryan's maneuver was his plan to outfit RSG: he engaged in a mass recruitment effort that resulted in the defection of more than 100 employees from rival CRC Insurance Services, an Alabama-based broker. Wholesale brokers like CRC and RSG compete to provide insurance proposals to retail brokers. Those retail brokers deal directly with prospective insureds. It can be a fragmented, specialized market, but the gist is that a wholesale broker's key relationships often are with retail brokers - not end-user insureds.

Not all retail brokers were happy with Ryan's plan to ramp up RSG's business through the hiring of CRC's employees. In the insurance industry, non-compete arrangements and client relationships are critical corporate assets. Certain retail brokers saw Ryan's move as less than respectful of those assets. It is not a stretch to think CRC has been decimated in its ability to service clients. The Crain's article contains some illuminating quotes.

Last month, Judge Zagel in Chicago denied CRC's motion to preliminarily enjoin its ex-employees from violating the non-competition/non-solicitation obligations in their employment contracts. What was interesting about Judge Zagel's opinion is the degree to which he analyzed the balance of harms arising out of CRC's injunction request. He assumed the agreements were valid - a ruling that is not a final judgment on those contracts - but spent the bulk of his opinion assessing the harm to the employees if he were to enjoin them from working for RSG, and the harm to CRC if he were to deny the motion.

Ultimately, after struggling with the issue, Judge Zagel found that the harm to the ex-CRC employees - potentially losing their jobs for two years - outweighed corresponding harm to CRC itself. The court found that an injunction would not stem the tide of lost business, holding essentially that there was no guarantee that CRC's clients would come rushing back if the employees were barred from working with RSG.


Court: United States District Court for the Northern District of Illinois
Opinion Date: 6/21/10
Cite: Allison v. CRC Insurance Services, Inc., 2010 U.S. Dist. LEXIS 61015 (N.D. Ill. June 21, 2010)
Favors: Employee
Law: Illinois

Friday, July 16, 2010

Restrictive Covenants Tied to Stock Option Grant Subject to Lower Scrutiny (The Selmer Co. v. Rinn)

Traditionally, courts will analyze restrictive covenants under two tiers of scrutiny. Those covenants incidental to the sale of a business are subject to a common law rule of reason, while those tied to employment are governed by a stricter standard of scrutiny requiring the courts to examine certain other factors (which vary state-by-state).

But not all employment-related covenants merit strict scrutiny. For instance, an employment contract given to the seller of a business who stays on to assist the buyer likely will be judged under the rule of reason since it was given in connection with the underlying transaction. And even some higher level executives will have their covenants examined with a less exacting standard of review in some states given their pervasive exposure to confidential information.

Another example is one I have written about before: covenants extended in the context of a stock option grant. The law is not uniform on this, but the prevailing sentiment is that covenants which are part of a stock option award agreement will be adjudicated under the less stringent rule of reason rather than the traditional employment standard.

The Wisconsin Court of Appeals held as such in a recent case and articulated the reason behind why courts traditionally are not as likely to invalidate such covenants:

"...[U]nlike typical restrictive covenants, upon which a prospective employee's position may depend, there were no consequences attached to [the employee]'s refusal to accept the agreement. The circuit court found [the employee] was not pressured to sign the stock option agreement, nor was his employment conditioned upon his doing so. Indeed, the circuit court found [the employee]'s refusal would not have affected his employment in any way." In fact, the evidence in the Wisconsin court's case revealed the employee quadrupled his investment in company stock by accepting the agreement's benefits.

The Wisconsin court obviously reached the right result, as covenants executed in exchange for participation in an incentive program are not compulsory and are intended to align the employee's goals with the long-term best interest of the company. In fact, that case did not even deal with a traditional non-compete agreement, but rather applied only if the employee solicited firm clients or disclosed confidential information of the employer.

It is somewhat of a mistake to call the two tests used by courts as the "employment test" and the "sale of business" test. They are not limited to such confining topics. It is more appropriate to say generally that covenants that are part of an adhesive agreement are subject to strict scrutiny, while those which are the product of a bargained-for-exchange are governed by a rule of reason.

Covenants in the latter group almost certainly include those in a franchise agreement, operating or shareholder agreement, settlement agreement, or incentive plan award agreement. It might even include covenants tied to long-term employment contracts for high-level executives, though the law on this is not particularly well-developed. The former group normally will be found in most employment or independent contractor agreements.


Court: Court of Appeals of Wisconsin, District Three
Opinion Date: 7/13/10
Cite: The Selmer Co. v. Rinn, 789 N.W.2d 621 (Wisc. Ct. App. 2010)
Favors: Employer
Law: Wisconsin

Tuesday, July 13, 2010

Revised Federal Pleading Standard Heightens Plaintiff's Duty to State Claim (US Bank v. Parker)

Lawyers are accustomed to lax pleading standards available to them in federal court. While discovery and pre-trial obligations are far more exacting, getting a claim to survive the initial pleading stage has never been perceived as that difficult.

However, after the recent Supreme Court decisions in Twombly and Iqbal, that perception is changing.

Those decisions held that simply reciting bare elements of a cause of action and surrounding them with mere labels and conclusions would not allow a plaintiff to survive a motion to dismiss a complaint. Instead, the complaint had to plead enough facts to make a claim factually plausible.

This standard can impact non-compete cases, particularly when the plaintiff may have a reasonable suspicion that a departed employee is violating a post-employment obligation but little in the way of actual evidence.

In a recent case out of Missouri, a federal district court held that Twombly and Iqbal require allegations beyond those qualified as "upon information and belief." The court in US Bank v. Parker found that the plaintiff's sole allegations of breach were all made upon information and belief and contained no facts that would render them plausible.

The case highlights the problem employers often face when deciding whether to pursue a claim for unfair competition: the information gap. For employees who have left no paper (or digital) trail of their post-competitive plans, an employer must have some means to discover wrongdoing. Particularly when there is only a non-disclosure or non-solicit covenant at issue, the employer will need evidence, not just belief, that documents have been taken or are missing, or that protected accounts have been solicited.


Court: United States District Court for the Eastern District of Missouri
Opinion Date: 7/9/10
Cite: US Bank Nat'l Ass'n v. Parker, 2010 U.S. Dist. LEXIS 68324 (E.D. Mo. July 9, 2010)
Favors: Employee
Law: Federal Rules of Civil Procedure

Monday, July 12, 2010

Poignant Lyrics and Lessons From the LeBron Fiasco

You take the pieces of the dreams that you have
cause you don't like the way they seem to be going
You cut them up and spread them out on the floor
You're full of hope as you begin rearranging
Put it all back together
but anyway you look at things and try
The lovers are losing

-- "The Lovers Are Losing" (Keane, 2009)

What do the lyrics from a (great) song by British alt-rock group Keane and the ridiculous LeBron James fiasco of last week have to do with non-compete law?

Well, it all has to do with hope, expectations and loyalty.

When an employee departs from one firm and jumps ship to a competitor, the motivations for doing so are almost always noble and altruistic - at least from that employee's perspective. She may be trying to raise her pay, service her clients better, or provide for long-term security. No shame, that. Along the way, she may make mistakes, but it is rare that such mistakes are the product of anything more than negligence.

However, from the perspective of the jilted employer, the feelings are always more personal. Perhaps it has to do with the training and investment made in employees, the lack of respect an employer has for its competitor, or an inflated sense of the employer's importance.

Witness the comments from Cleveland Cavaliers majority owner Dan Gilbert after LeBron James left to take his talents to South Beach:

"This shocking act of disloyalty from our home grown chosen one sends the exact opposite of the lesson we would want our children to learn. And who we would want them to grow up to become."

Gilbert peppered his open letter to Cavs fans with other inflammatory screed, calling James' move a "cowardly betrayal" and describing his decision (or perhaps the presentation of it) as "heartless and callous."

Clearly, Gilbert felt like he, his fellow owners, co-workers and fans were personally scorned. As over-the-top as his letter was, this is not at all unlike what occurs during litigation between competitors. Under the pressure to save clients or protect proprietary information, employers have to make fast decisions - and sometimes the decisions made in the heat of the moment are emotional and not particularly well-considered.

Gilbert spoke of "disloyalty", which is a word often invoked against employees when they leave to compete. LeBron, for all his self-indulgence, was not disloyal - at least from a lawyer's perspective. He didn't breach any contract, demand to be traded, or renege on a promise.

But competitives decisions - like the Decision - frequently inflame passions and evoke feelings that Gilbert expressed so inartfully.

I have written before about cease-and-desist letters gone haywire. Letters that employers would like to claw back. There are a small number of cases where those letters, clearly not thought out at all, actually result in substantial liability for interference or defamation.

Emotions run high - understandably so - when employees leave to compete. Often times, lawsuits are not thought out particularly well. We see this often when filing a complaint seems like the right thing to do, but it ends up alienating the very customers who have to testify in court. This is a hidden cost of litigation that usually is considered after the first shot has been fired.

This is just a guess, but I highly doubt LeBron James thought of the poignant lyrics Tom Chaplin wrote when he decided to ponder his basketball future. What seemed like the right decision may still turn out to be just that. Those hard feelings that Dan Gilbert has probably will subside over time and other emotions will settle in.

This evolution of emotion is extremely common in unfair competition suits, and employees who find themselves making the jump across the street will have to deal with the confrontation and discomfort that we all saw on TV last week. Individuals who are sales-driven, type-A personalities tend to do better in dealing with litigation and the confrontation that comes with it.

But it is not for everyone. It may be very difficult to deal with inflammatory rhetoric that is tossed around in non-compete or fiduciary litigation, and it can be so distracting that the employee who is sued simply is unable to perform the very skills that made her a valued asset to begin with.

The comforting thought for most of us, though, is that we don't have to go to work and get booed - like LeBron certainly will.

Thursday, July 8, 2010

Liquidated Damages Clauses in the Professional Services Context and General Drafting Considerations (Palekar v. Batra)

Liquidated damages clauses are common in restrictive covenant agreements, particularly in those for accountants, physicians and other professionals. One reason for their prevalence is the view some courts and legislatures have taken with regard to restraining professionals' ability to compete. It is highly disfavored and impacts the public interest to a much greater degree than ordinary sales businesses, so by substituting a liquidated damages clause for an actual prohibition on competition, employers can mitigate compelling arguments against enforcement.

Delaware is no exception. It has a statute in place that prohibits any agreements restricting the right of a physician to practice medicine in a particular locale. However, it does not prohibit agreements that put a price on such competition. Courts in Delaware have held that a liquidated damages clause in a physician's contract which may discourage competition, but which does not prevent it, are consistent with the statute.

Of course, the clause itself must still be legally compliant. The standards of enforceability are fairly uniform from state to state. As the Superior Court of Delaware recently noted, however, liquidated damages clauses are presumptively valid and the burden rests on the party challenging it to show it is unenforceable. (This is not true everywhere - some states flip the burden of proof).

Drafting liquidated damages clauses requires attorneys to take into account a number of different considerations:

(1) It is important to have a number of recitals to show that the parties intend to fix damages ahead of time in the event of a breach.
(2) Those recitals should include an acknowledgment that the parties agree damages in the event of breach would be difficult to calculate.
(3) The clause cannot, in most jurisdictions, allow for the simultaneous recovery of actual damages - or else it is not a true liquidation at all.
(4) The liquidated damages clause must provide some clear or readily ascertainable amount accruing on breach. If the amount cannot be determined, it won't be enforced.
(5) If the clause applies to multiple covenants, attorneys ought to consider whether the clause makes any sense at all by applying hypotheticals. For instance, it would seem unreasonable to apply the same damages to a breach of a major covenant (i.e., a client non-solicitation covenant) as it would to a relatively minor one.

My experience has shown that courts are often receptive to liquidated damages clauses in non-compete arrangements, particularly if the agreement is well-drafted, contains proper recitals and appears to be designed to compensate the employer rather than to punish the employee. In addition, if the clause is a proxy for an actual restriction, then courts seem more inclined to view them as enforceable.

On the other hand, I have also had success in invalidating covenants that were hopelessly vague, cumulative of other remedies, and which appeared designed to forfeit previously-earned benefits. It is a very difficult area of the law and demands that attorneys have an intimate understanding of the law governing the agreement.


Court: Superior Court of Delaware, New Castle
Opinion Date: 5/18/10
Cite: Bhaskar S. Palekar, M.D., P.A. v. Batra, 2010 Del. Super. LEXIS 257 (Del. Super. Ct. May 18, 2010)
Favors: Employer
Law: Delaware