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.

No comments:

Post a Comment