Tuesday, October 20, 2015

Lost Profits and No-Hire Clauses

A common feature of employment contracts these days is the no-hire clause. This is a form of a non-solicitation covenant and specifically precludes an employee from encouraging other employees to leave the firm.

I estimate that 9 out of 10 employee clients of mine are unconcerned with this type of covenant. They simply don't care to recruit fellow co-workers to join them at a new job. For the ten percent of clients that do care, they tend to be upper-level managers or lead a sales team. Their value to a new employer may depend on replicating that sales team.

The enforceability of no-hire clauses is not something that is widely litigated. One certainly can argue with exactly what kind of legitimate business interest the clauses protect. But for the most part, I've been content to assume that an employer at least can demonstrate some kind of an interest, even if it seems to vague and ephemeral.

The question of damages, though, presents a much more confounding problem. If one employee solicits another to leave - in violation of a covenant prohibiting that solicitation - what is the employee's monetary exposure?

A couple of possible damage theories immediately come to mind:

  1. The employer's cost to replace the wrongfully solicited employee. These costs might include recruitment expenses, headhunter fees, signing bonuses, and incremental pay differentials between the former and replacement employee.
  2. Liquidated damages, if provided for by contact. Some employment agreements attempt to define the agreed-upon damages for breach of a no-hire covenant. I have seen these clauses expressed as a percentage of the solicited employee's last-prevailing rate of pay.
  3. Lost profits. The conventional form of contract damages, this would measure the loss to the employer associated with the breach of the no-hire covenant.
But as to this last category, how would one prove that? Assume that the employee who was wrongfully solicited then began contacting or soliciting customers of the former employer. Is any lost income properly attributable to the no-hire violation? This would seem to be a step removed from the underlying breach, particularly if the employee who solicited the customer had no restrictive covenant agreement prohibiting that sales activity.

This is roughly the fact-pattern of Acadia Healthcare Co. v. Horizon Health Corp., 2015 Tex. App. LEXIS 7683 (Tex. Ct. App. July 23, 2015). To be sure, the case involved a great deal of facts that supported more serious charges of conversion, trade secret theft, and breach of contract against other employees. But the case is certainly crucial for how the plaintiff was unable to use expert testimony to render a lost-profits opinion arising from a no-hire breach.

The plaintiff's expert looked at two sets of facts and gave separate damages opinions on each. As to the first, he identified a specific prospect that a former Horizon employee solicited for Acadia (the new employer). The employee himself had signed no employment agreement, but his superiors solicited him to join Acadia in violation of their own no-hire covenants. The court found that the expert's opinion on lost profits concerning the solicited account was too speculative, in that the expert assumed that Horizon would have retained the account for 15 years. The expert's inability to identify specific information supporting a 15-year contract duration was fatal to this opinion.

The other fact concerned the solicited employee's "lost production," In essence, Horizon had claimed damages from the wrongful solicitation of this employee under the assumption that, but for the solicitation, he would have produced profit for Horizon into the future. The problem with Horizon's theory was that Horizon assumed the employee, who was at-will, would have remained with Horizon, would have been offered a new sales position, and would have accepted it. And the expert again assumed that the employee would have signed hypothetical contracts with 15-year contract terms.

Acadia Healthcare illustrates how difficult it is to prove damages in competition cases. As it relates to no-hire clauses, the damages analysis becomes attenuated because the recruitment usually precedes the proximate cause of any loss. And even assuming a plaintiff can tie those causes together, the assumptions underlying any future damages projection inherently become problematic and attenuated.

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