Tuesday, November 23, 2010

Boring Case On Venue Dispute Leads Us Into the Holidays (Rihani v. Team Express Distributing, Inc.)

I'm not working tomorrow, and I really don't feel like working today. No, it isn't because I can't wait to listen to the new Kanye West album. It has been a very busy few months, and there is no better way to unwind than to transition right into the suffocating crush of holiday expectations.

But enough sarcasm. I still have to contribute to this blog.

Struggling to find an appropriate topic to talk about today, I was reviewing some of my colleagues' recent posts for inspiration. Rob Radcliffe wrote recently about how it is important when assessing a non-compete agreement to get a proper framework for analysis and lay of the land. He points to venue, waiver of jury trials, and arbitration as three factors any lawyer must consider when examining a non-compete agreement. In Rob's view, these provisions "define the playing field."

It got me thinking that I haven't really spent any time looking at contractual provisions over venue. My readers probably are thanking me for that, but I did stumble across an interesting case from Maryland earlier this year that addressed sort of an interesting contract interpretation question.

The clause in Rihani v. Team Express Distributing provided that "venue for all actions arising out of or in any way related to this Agreement shall be irrevocably set in Howard County, Maryland." The plaintiff filed suit in federal court. Problem: there is no federal court in Howard County, Maryland. The defendant moved to dismiss, contending that the only reasonable interpretation of the forum selection clause means that the action had to be filed in state court.

The court agreed and found that "when [the venue clause] prohibits venue outside a geographic boundary, it must be interpreted to prohibit venue in any court that sits outside that geographic boundary." Interestingly, courts are split on this issue. Some courts reason that under near-identical language, a federal court may have jurisdiction because it is the court with venue over a particular county. I'm not sure after reading this case if I became more educated or more confused.

The bottom line is this: attorneys drafting agreements for their employer clients may want to revisit provisions like the one above. Venue clauses are one area where I see a wide range of contract language, and I can see how disputes like this arise. It probably is a better practice to reserve the option of pursuing a case in either federal or state court located within a certain geographic region. In many cases, federal court is clearly a better option.


Court: United States District Court for the District of Maryland
Opinion Date: 4/30/10
Cite: Rihani v. Team Express Distributing, LLC, 711 F. Supp. 2d 557 (D. Md. 2010)
Favors: N/A
Law: Federal

Wednesday, November 17, 2010

Consideration Rule Not Applicable to Independent Contractors (Schmit Towing v. Frovik)

I've written before about the independent consideration rule for "afterthought" covenants - that is, those non-competes that are entered into after the start of employment. States vary on their rules relative to consideration, with some demanding valuable consideration (such as a bonus) beyond mere continuation of employment.

Minnesota is one of those states that seems to be fairly exacting when assessing the adequacy of consideration, noting the inherent lack of bargaining power that employees have when presented with such covenants. I wrote last month about an extension of this independent consideration rule that illustrates how careful employers and their attorneys must be.

In an unpublished opinion, the Court of Appeals of Minnesota held that the independent consideration rule does not apply, however, outside the employment relationship and specifically not to independent contractors. In Schmit Towing v. Frovik, the defendant operated a business towing vehicles and received work from the plaintiff pursuant to a subcontractor agreement. The first agreement contained no non-compete clause. But the second contract, which took effect the same day the first one ended, prohibited the defendant from providing towing services to a competitor.

The Court of Appeals reversed the grant of summary judgment and refused to extend the independent consideration rule outside the employee-employer relationship, holding that to do so would be an extension of the law - a matter reserved only for the Supreme Court and the legislature. The court did not address any other issue surrounding the covenant.


Court: Court of Appeals of Minnesota
Opinion Date: 11/9/10
Cite: Schmit Towing, Inc. v. Frovik, 2010 Minn. App. Unpub. LEXIS 1101 (Minn. Ct. App. Nov. 9, 2010)
Favors: Employer
Law: Minnesota

Monday, November 15, 2010

Defendant's Gains From Breach of Non-Compete Not A Proper Measure of Damages (Phelps v. Wystrach)

The Court of Appeals of Arizona found recently that in the sale of business context, the purchaser could not rely upon the seller's gains from the breach of a non-compete agreement to establish damages.

The factual matrix in Phelps v. Wystrach is a common one. Wystrach sold her veterinary practice to Phelps and in turn gave Phelps a 5-year, 40-mile non-compete. That covenant, apparently, also included a separate covenant that Wystrach would not solicit the practice's former clients. It is not clear if this covenant contained any time or territory limit.

Following the closing of the practice's sale, Wystrach serviced the veterinary business of her former largest client, a breeder and trainer of show horses in Tucson. The owner of the horse farm testified she would not have worked with Phelps even if Wystrach had been unavailable. This is a classic third-party refusal to deal defense, which the court noted was irrelevant to the issue of whether Wystrach breached the non-compete agreement.

The issue of damages was a different matter, however.

The court found that evidence of Wystrach monetary gains from working with the horse farm was not a proper basis upon which to award Phelps damages arising out of the non-compete agreement. The holding is similar to TruGreen Cos., LLC v. Mower Bros, Inc., which I discussed a few years back that held under Utah law unjust enrichment is not a basis for awarding damages for a non-compete claim.

The concept of unjust enrichment damages in a sale of business context seems materially different than in a normal employee case. In a business sale, a purchaser is specifically paying the seller to avoid soliciting or working with customers of her former firm. Any breach would logically compromise the value of what was paid for the business. Employment cases, obviously, lack this key damages metric.

This highlights the need for sellers to include liquidated damages clauses in the purchase agreement. A predetermined damage formula can avoid the problems of proving lost profits and obtaining only chimerical relief at trial, like the buyer did in Phelps.


Court: Court of Appeals of Arizona, Division Two
Opinion Date: 10/29/10
Cite: J.A. Phelps v. Wystrach, 2010 Ariz. App. LEXIS 201 (Ariz. Ct. App. Oct. 29, 2010)
Favors: N/A
Law: Arizona

Thursday, November 11, 2010

Federal Court In Maine Holds Involuntary Termination Can Be Considered In Enforcement of Non-Compete (OfficeMax v. County Qwick Print)

Having a federal court judge in Maine draft an opinion which discusses and analyzes, in some detail, a law review article is not all that common.

And it's certainly not very common when the author of that law review article happens to be, um, me, and when I have no involvement representing a party in the case. In a way, it's kind of like watching your own funeral.

But on with it.

I wrote an article for the DePaul Business & Commercial Law Journal about 8 years ago that canvassed the law on the enforceability of non-competes in involuntary discharge cases. The law was, and remains, a bit scattered, with courts coming down in four general categories:

(1) The non-compete is per se invalid;
(2) There is a presumption against enforceability;
(3) The circumstances of termination are a factor to consider in an overal balancing analysis; and
(4) The termination is not even a factor a court can consider.

A federal court in Maine, in OfficeMax Inc v. County Qwick Print, acknowledged no decision in that state had considered the impact of involuntary termination on a non-compete. After summarizing my law review article, it determined that "the safer approach is to consider the circumstances of [the defendant]'s termination as a factor in balancing the relative equities between the parties." In so deciding, the court exercised some restraint by not attempting to create a new rule of substantive law for the state of Maine. Put differently, the court examined this factor under its procedural injunction rules rather than as a question of state substantive law.

This is an understandably cautious approach, but consistent with what I suggested courts adopt as far as considering the impact of termination. In my article, I recommended that the most sound analysis was option (3), the balancing inquiry. Stated another way, courts should scrutinize under the rubric of "reasonableness" how an employee's tenure ended. This would not bind courts to bright-line rules and would allow for some needed flexibility, rather than having the case turn into a collateral after-the-fact job performance inquiry, something totally ill-suited to emergency, expedited proceedings.

In this regard, I still believe that how employment ended is highly relevant to the question of reasonableness of a post-employment restraint. It is at least as important of whether third-parties or the public will encounter some hardship through enforcement.

Anecdotally, I know judges are sympathetic to employees who have been terminated for reasons other than cause and are more troubled by sudden, abrupt resignations that leave an employer in the lurch with a key account or at an important juncture of a project. Though courts may not voice every single factor that comes into play in their decision, I think it's reasonable to assume that a terminated employee stands a better chance of prevailing in a close case.


Court: United States District Court for the District of Maine
Opinion Date: 11/8/10
Cite: OfficeMax Inc. v. County Qwick Print, Inc., 2010 U.S. Dist. LEXIS 119070 (D. Me. Nov. 8, 2010)
Favors: Employer
Law: Maine

Monday, November 8, 2010

The Continuing Futility of the "They Forced Me to Sign" Defense (Ayco Co. v. Feldman)

I cannot tell you how many times a client calls me and feels as though he or she has a strong defense to a non-compete claim because of duress - "the company forced me to sign it."

This defense of duress or coercion is by and large unavailable. Here are the three biggest rationales (or some variant) that I hear for a client who thinks duress is the ticket to avoiding the impact of a non-compete clause:

(1) I was a long-time employee, and all of a sudden my new manager made me sign a non-compete agreement. It blew me away!

(2) If I didn't sign it, I was told I would be fired.

(3) I am the sole breadwinner in my house and needed to keep my job.

Let me address each factual scenario.

First, this is an issue of consideration - not duress. In many states, the concept of "continued employment" is enough to make a non-compete enforceable. In some states, though, it is not. In those states that frown upon so-called afterthought covenants, your argument is lack of consideration - not duress.

Second, the threat of lawful termination cannot possibly constitute duress. Generally, an employer can fire an at-will employee for any reason as long as it is not illegal (like termination on the basis of race or gender). Refusing to sign a non-compete agreement is perfectly acceptable. But, with very rare exceptions, so is an employer's decision to terminate on this basis.

Third, this is an issue of hardship. In many states (like Iowa), courts consider whether the covenant places an "undue hardship" on an employee in determining whether the restriction is valid. (Note: Some states forbid this factor to be taken into account. Yes, I'm looking at you, Florida, Section 542.335(1)(g)(1) of your annotated statutes.) An employee often times can make a convincing argument that a covenant will work an undue hardship on his career, particularly in cases where the extent of that covenant goes beyond what is necessary to protect an employer's interests.

Many employment agreements provide for contractual acknowledgments that the employee read the contract and had an opportunity to consult with counsel. This certainly is not required, but it is good practice.


Court: United States District Court for the Northern District of New York
Opinion Date: 10/22/10
Cite: The Ayco Co., L.P. v. Feldman, 2010 U.S. Dist. LEXIS 112872 (N.D.N.Y. Oct. 22, 2010)
Favors: Employer
Law: New York

Thursday, November 4, 2010

Court Rejects "Inevitable Disclosure" Claim Arising Out of Failed Transaction (Texarkana Beh. Assoc. v. Universal Health)

Courts still struggle to uphold the "inevitable disclosure" doctrine.

There's no easy way to say it. The idea of enjoining a party based on the theory that disclosure (really, use) of trade secrets is inevitable is a difficult one to grasp. Courts are called upon to make inferences and assumptions that are tough to make when the end result is a restraint on trade.

Inevitable disclosure is a theory of misappropriation. It is not based on actual use or even an identifiable threat to use a particular secret. Rather, it revolves around the idea that a party, even one who tries in good faith, cannot help but use certain secrets for an unfair competitive advantage.

A dispute arising out of a failed acquisition illustrates the struggle that courts have. The case is notable in that it does not follow the usual factual matrix of an employee leaving to join a competitor. Rather, it concerned a dispute between two nationwide healthcare management companies that operate behavioral health centers following a failed acquisition.

The two companies, Texarkana Behavioral and Universal Health Services, were direct competitors, and UHS tried to buy Texarkana in 2004. Negotiations broke down that year. Two years later, UHS bought property in Fayetteville to build a health care facility. Texarkana appropached UHS and inquired whether it was interested in buying Texarkana's facility in Fayetteville. The parties entered into a confidentiality agreement, shared business information and discussed an acquisition, but negotiations again broke down.

UHS then moved forward with constructing its own facility in Fayetteville. Texarkana sued, claiming trade secrets theft under the inevitable disclosure doctrine. The court noted that Texarkana likely had not identified its trade secrets well enough, but assumed for summary judgment purposes that it did. The court held, however, that Texarkana established nothing to demonstrate that it was inevitable UHS would disclose anything secret to Texarkana.

Three facts were central to the court's holding. First, one of Texarkana's key executives (a former UHS employee) stated that he felt as though he could perform his duties at TBA without using anything confidential to UHS. Second, UHS never manifested any intent to use anything proprietary to Texarkana. Third, and most importantly (in my mind), the confidentiality agreements contained no provisions that restricted what UHS could construct or operate around Fayetteville.

The inevitable disclosure doctrine, as applied in the commercial context, can be particularly difficult to justify. In an arms' length transaction such as the one entered into between Texarkana and UHS, the parties could have bargained for a limited non-compete as a condition to exchanging sensitive information. Clearly, Texarkana had to know in 2007 that UHS would have constructed a health facility if the deal did not go through. Texarkana did not obtain any sort of activity covenant from UHS, however.

Courts rightly should be concerned about applying the inevitable disclosure doctrine when sophisticated entities (particularly those with a history of failed negotiations) enter into a contract for a potential acquisition, are aware of the consequences of not closing the deal, and don't include some type of a non-compete. Allowing a party like Texarkana to use the inevitable disclosure doctrine in this circumstance would have vitiated those negotiations and allowed it to create non-compete provision when none was ever anticipated. Both parties had to know the potential risks if the deal did not close.


Court: United States District Court for the Western District of Arkansas
Opinion Date: 10/26/10
Cite: Texarkana Behavioral Assocs., L.C. v. Universal Health Svcs., Inc., 2010 U.S. Dist. LEXIS 114112 (W.D. Ark. Oct. 26, 2010)
Favors: N/A
Law: Arkansas

Wednesday, November 3, 2010

Georgia Voters Approve Constitutional Amendment

Yesterday, Georgia voters overwhelmingly approved a constitutional amendment that has the practical impact of enabling courts to more readily enforce non-competition agreements. The voters approved the measure with 67% in favor of the amendment.

Previously, the Georgia legislature passed a law codifying the new statutory requirements for non-compete agreements. Because of the way Georgia's constitution was written, however, an amendment was needed to enable the law to take effect. The new law will be effective as soon as the Secretary of State certifies the election results.

The law does not contain any retroactivity provision, so existing contracts will be analyzed under the law as it exists prior to the amendment. This has happened several times before following legislative action, as courts in Florida and Michigan, for instance, had to assess covenants under different standards depending on when the contract at issue was signed.

More on the substance of the Georgia law to follow later in the week (or next), but there are a few notable changes, the most significant of which is that courts will be allowed to blue-pencil employment non-compete contracts. One can certainly expect Georgia employment law attorneys to be busy rewriting non-compete agreements for their clients.