cases, commentary and news related to restrictive covenants
Wednesday, June 22, 2011
Illinois Courts Still Struggling Over "Continued Employment" As Consideration
If you could chart out all the cases in Illinois that discuss the "continued employment" rule, you can reach only one conclusion.
The law is a muddled, hopeless mess.
Two recent decisions just weeks apart confirm that this area of the law is in need of clarification. By now, the concept should be familiar to anyone who reads this blog. For at-will employees, continued employment can provide sufficient consideration for signing a non-compete agreement. This arises when an employer determines an existing at-will employee needs to be bound by a restrictive covenant.
Courts in Illinois, as they are apt to do, have grafted onto this principle a rule that the continued employment must be for a "substantial period." They have not formulated any bright-line rule as to what that means. Some cases suggest it's two years, while others say a shorter period of time. And then other courts say you need to look at other factors beyond just the length of the continued employment. The most important of those factors would be the method of termination - involuntary or a resignation.
The rationale for this factor is obvious. As Judge Castillo recently stated, the "substantial period" rule "protects employees from employers who hire workers, have them sign post-employment covenants, then fire them soon thereafter." He even called the method of termination a "critical distinction in determining that one year's employment was sufficient consideration when the employee quit.
However, the Illinois Appellate Courts may be more employee-friendly. A recent ruling by the Fifth District in Diederich Ins. Agency, LLC v. Smith found that three months' continued employment was not sufficient consideration even though the employee resigned voluntarily to compete. The more significant aspect of the case, though, addressed a novel issue I have not seen an Illinois court examine. The employee, an insurance agent, had signed a 2-year covenant at the start of employment. Less than a year later, the employer modified it to reduce the scope to 1-year. Nothing was provided to the employee for this second agreement, which was clearly more narrow in scope.
The court found that the modification was a new agreement which needed fresh consideration, not supplied by continued employment. This is a curious result (to put it mildly), since the employer's generosity in reducing the scope of the non-compete agreement resulted in a windfall for the employee.
The court's ruling results in kind of a perverse incentive to keep overbroad agreements in place at the risk of running into a consideration problem. Courts should be encouraging employers to do what the agency in Diederich Ins. Agency did and pare back covenants when business circumstances call for it. Arguably, this type of reasoning could extend to modifications of covenants when an employer, for instance, takes out a geographic territory it no longer services or a list of "restricted clients" that may have been identified with specificity.
Court: United States District Court for the Northern District of Illinois
Opinion Date: 5/23/11
Cite: LKQ Corp. v. Thrasher, 2011 U.S. Dist. LEXIS 54852 (N.D. Ill. May 23, 2011)
Court: Appellate Court of Illinois, Fifth District
Opinion Date: 6/7/11
Cite: Diederich Ins. Agency, LLC v. Smith, 2011 Ill. App. LEXIS 599 (Ill. App. Ct. 5th Dist. June 7, 2011)
Tuesday, June 14, 2011
Supreme Court of Maine Upholds $100,000 Liquidated Damages Clause Against Physicians (Sisters of Charity Health v. Farrago)
Liquidated damages clauses are kind of like the Miami Heat.
They look powerful, but it's hard to tell whether they will ever come through. Courts frequently find such clauses unenforceable. In the non-compete context, they are quite common and can take a variety of different forms. A common type of clause is one that puts a flat-fee price on competition or solicitation of customers.
I am not crazy about flat-fee clauses, because they have been struck down on many occasions as arbitrary. But not always. The Supreme Court of Maine just upheld such a clause in three physicians' employment contracts, set at $100,000 for a non-competition violation. The evidence the court used to uphold the reasonableness of the clause was fairly compelling: over 1,300 patients requested a transfer of their medical records when the doctors left for another institution. At an annual gross revenue per patient level, the (arguable) actual damages far exceeded the liquidated sum.
Keep in mind there really is no downside to using a liquidated damages clause in a contract. Even if they are unenforceable, the fallback position is actual damages - which is where you'd be without including the clause in the first place. I still believe that some formula based on the number of clients lost, rather than a flat fee for breach itself, has a better chance of being validated by a court. But as the Maine case shows, the decisions on these types of provisions come out both ways with no real distinguishing factors.
Court: Supreme Judicial Court of Maine
Opinion Date: May 26, 2011
Cite: Sisters of Charity Health System, Inc. v. Farrago, 2011 Me. LEXIS 62 (Maine May 26, 2011)
Saturday, June 4, 2011
Supreme Court of Colorado: Continued Employment Does Constitute Sufficient Consideration for Non-Compete (Lucht's Concrete Plumbing v. Horner)
Colorado was one of a handful of states - along with South Carolina, Washington and a few others - which held that continued employment was not sufficient consideration for an at-will employee's agreement to a non-competition covenant. I have written often on this subject before. The issue arises in a fairly common fact pattern. If an employer requires an existing at-will employee to sign a non-compete under threat of termination, is this ability to fire enough legal "consideration" to form a valid non-compete contract?
Colorado has now decided "yes."
In Lucht's Concrete Plumbing, Inc. v. Horner, the Supreme Court of Colorado joined the majority of states and held that continued employment does provide sufficient consideration to form a valid non-compete agreement. This reverses last year's appellate decision, a summary of which can be found here.
The Court quite simply held that since an employer may terminate an at-will employee at any time, its agreement not to discharge the employee once he or she signs a non-compete agreement is legal consideration to form a contract which is not illusory. The Court alluded to, but did not really discuss, the problematic situation of involuntary termination shortly after signing. Courts have recognized that there may be a consideration problem if the employer extracts a non-compete agreement from an existing at-will employee and then terminates him or her shortly thereafter. The Supreme Court of Colorado seemed to suggest this was not so much a consideration issue, but would bear on the agreement's overall reasonableness.
Court: Supreme Court of Colorado
Opinion Date: 5/31/11
Cite: Lucht's Concrete Plumbing, Inc. v. Horner, 2011 Colo. LEXIS 436 (Col. May 31, 2011)
Wednesday, June 1, 2011
Expedited Discovery In Non-Compete Cases Is Not Guaranteed
By now, most of my readers know that non-compete disputes often arise very quickly. The preferred - and in most cases - only true remedy is injunctive relief preventing certain competitive activity from occurring.
Employers seeking to enforce non-compete agreements by way of injunctive relief almost always seek expedited discovery. In emergency injunction proceedings, expedited discovery frequently is necessary for an employer to be able to prove its case at the time of hearing. Remember that in many non-compete disputes, an employer knows only a fraction of what competitive activity has occurred, or which is about to occur.
Expedited discovery is just what it sounds like: production of documents and deposition testimony on a truncated schedule, sometimes in a matter of days - not weeks. This is a marked, even drastic, departure from a typical discovery schedule. In non-injunction cases where damages are sought, discovery can take the better part of a year. In complex litigation, it often exceeds two years.
But there is no guarantee a court will even order expedited discovery. To be sure, an employer must establish why it needs such discovery and why courts should depart from the typical (and lengthy) discovery protocol. In the federal system, courts use one of two standards for evaluating a request to expedite discovery.
The first standard is the minority rule and is called the "preliminary injunction" standard. Specifically, the party seeking expedited discovery has to show that irreparable injury would result without resort to a quick discovery process. It also must show some likelihood of success on the merits, which typically is accomplished through a detailed initial complaint and injunction moving papers. Finally, an employer will need to show that the burden to the responding employee in producing information is outweighed by the harm to the requesting party from not obtaining such discovery.
Parties who state convincing cases for expedited discovery, in fact, often establish in their moving papers as much of the case as they ultimately can prove on their own. It is not uncommon to see detailed affidavits from likely witnesses, along with supporting business documents like e-mails or customer contracts. A prepared employer will tell the court it has done what it can and needs expedited discovery to fill in the gaps, which it cannot be expected to know from firsthand knowledge.
The second standard is more prevalent and is generally known as the "good cause" standard. A court will evaluate whether an employer has demonstrated good cause to depart from the normal discovery schedule. The test is certainly more flexible. Under either test, however, an employer (or enforcing party) needs to demonstrate some specific reason why expedited discovery is sought. In non-compete cases, this reason often is evidence that an employee is soliciting or servicing a specific group of customers or using sensitive business information unfairly.
There are two pitfalls I often see when parties move for expedited discovery.
First, employers often do not narrowly tailor their discovery requests to the issues likely to be at issue during an injunction hearing. If the discovery proposed to be served is too broad, a court almost certainly will deny expedited discovery - or in some cases, indicate which requests for information need to be answered on an expedited basis.
Second, employers sometimes don't make a specific showing of an emergency at all. Vague complaints that sweep too broadly or do not identify for the court why injunctive relief should issue often doom expedited discovery motions. For employers seeking to obtain expedited discovery, it's critical to introduce affidavits early on in the case to demonstrate some likelihood of actually getting injunctive relief.
If a judge sees the potential for a fishing expedition, with only vague conclusory allegations, he or she will deny a request for early, expedited discovery. No judge wants to be burdened with repeated emergency motions for a case that is crawling out of the gate.
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