I've been uncharacteristically quiet about the subject of restrictive covenants, consumed (somewhat mercifully) by other cases in other areas of the law.
But the flow of non-compete decisions does not stop for those who venture astray, and so it appears I have some catchin' up to do.
I'll start with my home State (for now) of Illinois, where we have high taxes and a high output of non-compete cases. The federal district courts in Illinois churn out a lot of interesting non-compete cases. Those decisions, too, tend to be influential. For instance, most Illinois courts have decided to break from appellate case law on the employee at-will consideration rule that has generated some buzz (and some appellate work for yours truly).
Non-Competition Covenants and Motions to Dismiss
One example of this independence from the federal bench is the case of Medix Staffing Solutions Inc. v. Dumrauf. Judge Sara Ellis granted a motion to dismiss a non-compete claim that Medix brought again a former Director of Business Operations. The decision was notable - and fairly bold - since Illinois courts have suggested that enforceability and overbreadth questions generally are unsuitable for motions to dismiss. True, you see these teed up more often at summary judgment or even through preliminary injunction rulings. But infrequently, the propriety of a motion to dismiss in the context of non-competes appears in the case law.
The court in Dumrauf found that the employer's non-compete was extreme and facially unenforceable when it barred the employee from working within 50 miles of any Medix office for any business that competed with Medix or that offered a product or service in competition with Medix. Of central concern to the court was the non-compete's prohibition on Dumrauf's work in any capacity for a competing enterprise. The case demonstrates the importance of drafting non-competition agreements with a reasonable scope limitation that is roughly commensurate with the type of job the employee performed at the company (or perhaps one that, if not comparable, would threaten the same type of legitimate business interest).
Judge Ellis lastly declined to modify, or blue-pencil, the non-compete, as is typical of most (but not all) Illinois courts. The deciding factor is usually how close the employer came to being reasonable. But here, the non-compete failed terribly so Judge Ellis said no to rewriting it.
Non-Solicitation Covenants and Motions for Summary Judgment
The employer didn't fare a whole lot better in Call One, Inc. v. Anzine, but the case does show that blue-penciling is not always a pipe dream.
The non-solicitation covenant in Anzine had all the hallmarks of a crapshow. It was (a) not limited to the employee's particular accounts, and (b) included something called "prospective" customers, which unhelpfully covered accounts the company solicited or "had plans to solicit."
Judge Matthew Kennelly found the covenant unenforceable, noting along the way that Illinois precedents in the non-compete field are of "less than usual value." This could mean either that the cases are too fact-specific to be helpful in a subsequent case, or that Illinois state appellate courts are not helpful as a general proposition. Or both.
But Judge Kennelly looked to a reformation clause in the underlying agreement, which contemplated that a court could make an invalid clause valid. Many changes skim over that clause for reasons that are obvious. As a result, he fixed some (but in my opinion not all) of the problems in the non-solicitation clause, such that Anzine was still barred from soliciting company customers (and active prospects as of the date she was terminated) and customers for which she had sales responsibility.
One other observation on this case. Anzine sent a couple of work spreadsheets to her personal email account, but Judge Kennelly found that no jury could find that this rose to the level of "misappropriation" of a trade secret. The self-emailing phenomenon is not new, but in and of itself it is no panacea for a trade secrets claim. Here, Anzine appeared to have plausible reasons for what she did, and the e-mailing didn't occur under suspicious circumstances (like, for instance, a forwarding of documents after notice and before departure). The court's discussion of this is worth a read for practitioners who've dealt with this set of facts before.
Non-Competition Covenants, Non-Solicitation Covenants, and Motions to Dismiss (Redux)
And on the opposite end of the spectrum (somewhat), we have American Transport Group v. Power. There, the court denied the defendant's motion to dismiss a restrictive covenants claim even when problems with those covenants were clearly apparent. The theme running through this case was nearly the opposite of Dumrauf, as Judge Virginia Kendall repeatedly noted that the employer must have the opportunity to develop the record on the question of reasonableness.
The non-compete precluded a freight broker's salesman from working for any competitor for three months, regardless of geographic location. I have a lot to say about the freight brokerage business, but that's beyond the scope of this. It is true, however, that geography seems to matter very little for sales people who work the phones contacting shippers (that is, customers) and arranging carriers. So I wasn't terribly bothered by the three-month clause or the lack of a geographical limit, as much as I am bothered by the use of non-competes in this industry entirely.
The non-solicitation clause though was a problem, and I think Judge Kendall should have found it unenforceable. It barred Power, for one year, from soliciting or diverting any customer or carrier of his employer. The court provided little analysis here, but I am uncertain how ATG ever could restrict the employee's use of a carrier (in effect, a supplier) when freight brokers all deal with the same carriers. Seems gratuitous.
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So what lessons did we learn today? Judges reach different holdings on similar facts. Companies still have a lot to learn when drafting agreements. Lawyers will keep getting business because this stuff ain't going away. And your author can't take a month off again, because the cases keep piling up.
Showing posts with label Blue-Pencil. Show all posts
Showing posts with label Blue-Pencil. Show all posts
Tuesday, July 10, 2018
Tuesday, May 29, 2018
Justice Thomas and Questions About Severability
A lot can be said about Justice Clarence Thomas. Some of it bad, but much of it quite good. For those who assert he is one of the worst Supreme Court justices of all time, take that for what it is good. Toxic political commentary and sheer uninformed drivel.
The best of Justice Thomas comes out in the now-familiar lone-wolf opinion, whether concurring or dissenting. His unique views span a wide range of the legal landscape, from the Eighth Amendment to the collateral-order doctrine to qualified immunity. Whether you agree with those views or not, they spark discussion and offer an idiosyncratic viewpoint that often makes a great deal of sense.
He expressed another one of these views again last week in Murphy v. NCCA on the issue of severability, which comes up in the Court's constitutional jurisprudence from time to time.
Put simply, the severability doctrine arises when the Court strikes at least part of a statute as unconstitutional. The question then becomes whether the Court should "sever and excise" the offending parts while saving the remainder.
Justice Thomas would like to reexamine that doctrine and has doubts that it is an appropriate part of constitutional analysis for two reasons: (1) it does not follow statutory interpretation principles, because by definition it requires courts to determine what a legislature would have done had the unconstitutional parts of the statute never been enacted at all; and (2) it requires courts to render an advisory opinion on issues the parties aren't fighting over.
***
You may be asking: what the hell does this have to do with non-compete agreements, which is after all sort of the point of this blog.
The connection, however loose or attenuated, is that non-compete law has its own severability principle and it's not all that dissimilar from what Justice Thomas discussed.
In Illinois, the general rule on contract severability is this: a court may enforce the valid parts of an agreement "in favor of a party who did not engage in serious misconduct if the performance as to which the agreement is unenforceable is not an essential part of the agreed exchange." That framework generally parrots the Restatement (Second) of Contracts, Section 184. And to further clarify the rule, whether an unenforceable term is an "essential part" of the contract depends on the relative importance of the term in light of the entire agreement between the parties.
The black-letter formulation of this rule thus invokes some of the concerns Justice Thomas outlined in his Murphy concurrence. Assume the following very realistic hypothetical scenario:
The best of Justice Thomas comes out in the now-familiar lone-wolf opinion, whether concurring or dissenting. His unique views span a wide range of the legal landscape, from the Eighth Amendment to the collateral-order doctrine to qualified immunity. Whether you agree with those views or not, they spark discussion and offer an idiosyncratic viewpoint that often makes a great deal of sense.
He expressed another one of these views again last week in Murphy v. NCCA on the issue of severability, which comes up in the Court's constitutional jurisprudence from time to time.
Put simply, the severability doctrine arises when the Court strikes at least part of a statute as unconstitutional. The question then becomes whether the Court should "sever and excise" the offending parts while saving the remainder.
Justice Thomas would like to reexamine that doctrine and has doubts that it is an appropriate part of constitutional analysis for two reasons: (1) it does not follow statutory interpretation principles, because by definition it requires courts to determine what a legislature would have done had the unconstitutional parts of the statute never been enacted at all; and (2) it requires courts to render an advisory opinion on issues the parties aren't fighting over.
***
You may be asking: what the hell does this have to do with non-compete agreements, which is after all sort of the point of this blog.
The connection, however loose or attenuated, is that non-compete law has its own severability principle and it's not all that dissimilar from what Justice Thomas discussed.
In Illinois, the general rule on contract severability is this: a court may enforce the valid parts of an agreement "in favor of a party who did not engage in serious misconduct if the performance as to which the agreement is unenforceable is not an essential part of the agreed exchange." That framework generally parrots the Restatement (Second) of Contracts, Section 184. And to further clarify the rule, whether an unenforceable term is an "essential part" of the contract depends on the relative importance of the term in light of the entire agreement between the parties.
The black-letter formulation of this rule thus invokes some of the concerns Justice Thomas outlined in his Murphy concurrence. Assume the following very realistic hypothetical scenario:
- Employee signs agreement containing broad non-compete clause and narrow non-solicitation of customers clause.
- Employer focuses its case on customer solicitation, but appears to agree that employee can work for competitor despite the nominal presence of the non-compete in the contract.
- Employer is generally successful in showing actual solicitation and that the circumstances render the non-solicitation enforceable.
- Employee proves that the facts make the non-compete gratuitously overbroad.
In such a circumstance, what do we make of the severability rule? It is clear in my hypothetical that part of the agreement is unenforceable, but does that doom the non-solicitation covenant? Under Illinois law, the employee may have a winning argument if circumstances show that the non-compete was integral to the overall contract formation. For instance, she could show the following:
- Employer insisted that it be included, despite the employee's objections to the broader non-compete.
- The contract recitals suggest all provisions of the agreement work in unison, are all needed to protect confidential information, or are each integral to the contract.
- The Employer threatened to enforce the non-compete in an early cease-and-desist letter.
At least if we apply Justice Thomas' reasoning, the severability principle may be a big distraction if the employer isn't attempting to enforce it in court. In other words, the defendant would be addressing a counterfactual: yes, your Honor, but if Employer did try to enforce it, it would lose. Depending on the facts, though, Justice Thomas' stated concerns over an advisory opinion may be overstated.
The prevailing law on severability then diverges a bit from Justice Thomas' analysis and focuses less on whether the employer would have entered into the agreement with the employee if it had known the non-compete wouldn't have been enforceable and instead more on whether the offending non-compete covenant was an essential part of contract formation. On this score, the analysis does not seem to raise the judicial power concerns Justice Thomas discusses in Murphy and rather focuses on the circumstances at signing.
The arguments for and against severability are not easy to resolve. Justice Thomas' opinion, though, clarifies in a very straightforward way the tension surrounding them.
Friday, June 30, 2017
The Reading List (2017, No. 22): The "Not Precedent Opinions Can Be Interesting" Edition
Non-Compete and Trade Secrets News for the week ended June 30, 2017
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LinkedIn "Solicitations"
From the Appellate Court of Illinois this week, we got treated to a non-precedential Rule 23 order that addresses a fertile area of non-compete litigation. What effect should courts make of LinkedIn invitations to a former employee's co-workers and do those invitations amount to improper "solicitation"?
The court in Bankers Life and Casualty Co. v. American Senior Benefits LLC, 2017 IL App (1st) 160687-U, says no. Justice Simon's order gives a nice summary of similar cases from various jurisdictions and notes that the issue of "solicitation" really turns on the content of the social media post, communication, or invitation to connect. In this particular case, the LinkedIn e-mails were "generic" and mentioned nothing about either the employee's past or current employer. Nor did the e-mails invite former co-workers to leave their job or view an employment opportunity posting.
UPDATED (Aug. 8, 2017): The Appellate Court has now published the Bankers Life opinion, apparently agreeing that it sets forth a new rule of law or helps clarify an existing one. The link to the published opinion can be found here.
The Defend Trade Secrets Act and "Inevitable Disclosure"
John Marsh of Bailey Cavalieri has a very insightful post on the Third Circuit's non-precedential order in Fres-Co Systems USA, Inc. v. Hawkins. The case was a typical one in the non-compete field. Sales executive with influence over key accounts bolts for a competitor and then gets sued.
After the district court entered a preliminary injunction in favor of the employer, the Third Circuit reversed and remanded for it to consider the injunction standard more fully. As John notes, however, some of the language in the Third Circuit's order was a little loose (at best) concerning the threat of "irreparable harm" posed by the employee's move to a competitor. In particular, some of the order's reasoning implicitly suggests "inevitable disclosure" may be grounds for enjoining conduct under the Defend Trade Secrets Act. But it never comes right out and says that.
I think there's a danger of reading too much into this non-precedential order. For starters, the court lumped together its irreparable harm analysis for all the substantive legal claims, appearing never to appreciate the limits on injunctive relief under the DTSA. (The court never cites or quotes the limitation at all.) It could have instructed the district court to reconsider the irreparable harm factor in light of the DTSA, but failed to do so. Opportunity missed. That said, the plaintiff moved as well under the Pennsylvania Uniform Trade Secrets Act, which does not contain any DTSA-like limits on injunctive relief. And to be sure, the employee's non-compete would provide a separate grounds on which to analyze irreparable harm.
The Hawkins order is available here.
Trade Secrets Damages
Quantlab Financial prevailed in the Fifth Circuit Court of Appeals, which upheld a jury verdict of $11.2 million stemming from a claim of trade-secrets misappropriation. The case arose before the financial crisis and concerned the then-nascent business of high-frequency trading. The facts sounded a familiar refrain, with the evidence demonstrating large-scale copying and appropriation of trading technology source code and improper computer access by insiders.
The Fifth Circuit's unpublished disposition is located here.
Nevada Changes Non-Compete Statute
Last year, the Nevada Supreme Court in the case of Golden Road Motor Inn v. Islam held that courts could not modify overbroad non-competes, a decision I analyzed at some length. The analysis endures; the rule doesn't. Effective June 3, 2017, Nevada has a new non-compete statute that requires courts to modify overbroad non-competition covenants - a wholesale abrogation of Golden Road Motor Inn. The new law seems to strike a more employee-friendly balance, however, in that it specifically provides that a covenant cannot restrict a former employee if a customer "voluntarily chose to leave and seek services from the former employee." That's a gaping carve-out, sure to invite fact disputes about whether the customer voluntarily left. In other words, Nevada places customer choice above any countervailing employer interest.
Russell Beck's Fair Competition Law blog has an analysis of the new law here.
The Non-Compete PR Crisis
The firm Butzel Long released a Client Alert (really, a white paper) that deconstructed a number of problematic non-compete cases involving low-wage or mid-tier employees. This terrific publication addresses the Jimmy John's, Amazon.com, and Goldfish Swim School cases and offers practical guidance about how these companies could have avoided the nightmare public-relations fallout. I highly recommend this release for any practitioner who works in the non-compete and trade secrets field.
Non-Compete Crackdown in Australia?
The Guardian reports on concerns that the use of non-competes is stifling innovation in Australia, noting the concentration of market power in select industries. The report notes the same general concerns that reform advocates in the United States have, with the most compelling concern being the declining number of start-ups. This concern is all the more acute as the large technology companies continue to expand their reach into non-traditional markets - Amazon's pending acquisition of Whole Foods simply the latest example.
Uber's "Reason to Know" of Trade-Secret Theft
Android Headlines reports that members of Uber's board saw evidence of trade-secret theft concerning Anthony Levandowski's alleged appropriation of LiDAR technology from Google/Waymo. Uber was required to file an accounting with the court disclosing the names of people who may have had access to the files at the heart of Waymo's case. Uber has resisted disclosing a critical due diligence report authored by a firm before it acquired Levandowski's start-up, which likely will color Waymo's theory that Uber had "reason to know" that Levandowski was using Waymo's materials on behalf of Uber. That "reason to know" standard is crucial if Waymo is going to hold Uber liable. This discovery dispute appears to be the make-or-break moment in the biggest trade-secret action of the past several years.
***
I will be taking a few weeks off from updating this blog. See you in mid-July!
***
LinkedIn "Solicitations"
From the Appellate Court of Illinois this week, we got treated to a non-precedential Rule 23 order that addresses a fertile area of non-compete litigation. What effect should courts make of LinkedIn invitations to a former employee's co-workers and do those invitations amount to improper "solicitation"?
The court in Bankers Life and Casualty Co. v. American Senior Benefits LLC, 2017 IL App (1st) 160687-U, says no. Justice Simon's order gives a nice summary of similar cases from various jurisdictions and notes that the issue of "solicitation" really turns on the content of the social media post, communication, or invitation to connect. In this particular case, the LinkedIn e-mails were "generic" and mentioned nothing about either the employee's past or current employer. Nor did the e-mails invite former co-workers to leave their job or view an employment opportunity posting.
UPDATED (Aug. 8, 2017): The Appellate Court has now published the Bankers Life opinion, apparently agreeing that it sets forth a new rule of law or helps clarify an existing one. The link to the published opinion can be found here.
The Defend Trade Secrets Act and "Inevitable Disclosure"
John Marsh of Bailey Cavalieri has a very insightful post on the Third Circuit's non-precedential order in Fres-Co Systems USA, Inc. v. Hawkins. The case was a typical one in the non-compete field. Sales executive with influence over key accounts bolts for a competitor and then gets sued.
After the district court entered a preliminary injunction in favor of the employer, the Third Circuit reversed and remanded for it to consider the injunction standard more fully. As John notes, however, some of the language in the Third Circuit's order was a little loose (at best) concerning the threat of "irreparable harm" posed by the employee's move to a competitor. In particular, some of the order's reasoning implicitly suggests "inevitable disclosure" may be grounds for enjoining conduct under the Defend Trade Secrets Act. But it never comes right out and says that.
I think there's a danger of reading too much into this non-precedential order. For starters, the court lumped together its irreparable harm analysis for all the substantive legal claims, appearing never to appreciate the limits on injunctive relief under the DTSA. (The court never cites or quotes the limitation at all.) It could have instructed the district court to reconsider the irreparable harm factor in light of the DTSA, but failed to do so. Opportunity missed. That said, the plaintiff moved as well under the Pennsylvania Uniform Trade Secrets Act, which does not contain any DTSA-like limits on injunctive relief. And to be sure, the employee's non-compete would provide a separate grounds on which to analyze irreparable harm.
The Hawkins order is available here.
Trade Secrets Damages
Quantlab Financial prevailed in the Fifth Circuit Court of Appeals, which upheld a jury verdict of $11.2 million stemming from a claim of trade-secrets misappropriation. The case arose before the financial crisis and concerned the then-nascent business of high-frequency trading. The facts sounded a familiar refrain, with the evidence demonstrating large-scale copying and appropriation of trading technology source code and improper computer access by insiders.
The Fifth Circuit's unpublished disposition is located here.
Nevada Changes Non-Compete Statute
Last year, the Nevada Supreme Court in the case of Golden Road Motor Inn v. Islam held that courts could not modify overbroad non-competes, a decision I analyzed at some length. The analysis endures; the rule doesn't. Effective June 3, 2017, Nevada has a new non-compete statute that requires courts to modify overbroad non-competition covenants - a wholesale abrogation of Golden Road Motor Inn. The new law seems to strike a more employee-friendly balance, however, in that it specifically provides that a covenant cannot restrict a former employee if a customer "voluntarily chose to leave and seek services from the former employee." That's a gaping carve-out, sure to invite fact disputes about whether the customer voluntarily left. In other words, Nevada places customer choice above any countervailing employer interest.
Russell Beck's Fair Competition Law blog has an analysis of the new law here.
The Non-Compete PR Crisis
The firm Butzel Long released a Client Alert (really, a white paper) that deconstructed a number of problematic non-compete cases involving low-wage or mid-tier employees. This terrific publication addresses the Jimmy John's, Amazon.com, and Goldfish Swim School cases and offers practical guidance about how these companies could have avoided the nightmare public-relations fallout. I highly recommend this release for any practitioner who works in the non-compete and trade secrets field.
Non-Compete Crackdown in Australia?
The Guardian reports on concerns that the use of non-competes is stifling innovation in Australia, noting the concentration of market power in select industries. The report notes the same general concerns that reform advocates in the United States have, with the most compelling concern being the declining number of start-ups. This concern is all the more acute as the large technology companies continue to expand their reach into non-traditional markets - Amazon's pending acquisition of Whole Foods simply the latest example.
Uber's "Reason to Know" of Trade-Secret Theft
Android Headlines reports that members of Uber's board saw evidence of trade-secret theft concerning Anthony Levandowski's alleged appropriation of LiDAR technology from Google/Waymo. Uber was required to file an accounting with the court disclosing the names of people who may have had access to the files at the heart of Waymo's case. Uber has resisted disclosing a critical due diligence report authored by a firm before it acquired Levandowski's start-up, which likely will color Waymo's theory that Uber had "reason to know" that Levandowski was using Waymo's materials on behalf of Uber. That "reason to know" standard is crucial if Waymo is going to hold Uber liable. This discovery dispute appears to be the make-or-break moment in the biggest trade-secret action of the past several years.
***
I will be taking a few weeks off from updating this blog. See you in mid-July!
Friday, March 10, 2017
The Reading List (2017, No. 10): South Carolina Interprets Stealth Confidentiality Agreement
Non-Compete and Trade Secrets News for the week ended March 10, 2017
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South Carolina Non-Competes
The Court of Appeals of South Carolina issued a very interesting and important ruling on the oft-overlooked interplay between non-disclosure and non-competition covenants. The case is Fay v. Total Quality Logistics, LLC, No. 2014-1828.
In Fay, the Court of Appeals determined that an indefinite non-disclosure agreement operated as a stealth non-competition restriction, because it provided that if the ex-employee entered into a similar business as his employer and worked in a similar type of position, he would "necessarily and inevitably" use the employer's confidential information to perform his job. In other words, the agreement attempted to graft the devilish "inevitable disclosure" doctrine into a non-disclosure/non-competition covenant. Bad move. This contractual language in effect prohibited the employee ever from competing with his former employer. Under South Carolina's strict "blue-pencil" rule, the court couldn't modify the contract to add in a reasonable time limit. As such, it was unenforceable.
The concurring opinion offered the same conclusion, but first looked to Ohio law because that's what the parties agreed to apply to the contract. But even under Ohio law (which is more friendly), the indefinite non-disclosure agreement would be unenforceable. Fay represents yet another case in an emerging area: an employee's challenge of a broad non-disclosure agreement and arguing it operates as a stealth non-compete. You can read the opinion of the Court of Appeals by clicking here.
Proposed Amendments to CFAA
The Computer Fraud and Abuse Act has been amended many times since it first appeared on the scene in 1986. In reality, it needs to be rewritten or broken up into several different laws. But it's back on the legislative docket, at least if one Congressman has his way.
Rep. Tom Graves (R. GA) has proposed the Active Cyber Defense Certainty Act. The bill would allow victims of cyber-attacks to engage in limited defensive measures to identify and stop attackers. In essence, it's a bill that enables "hacking back" and formalizes that concept as a defense to prosecution for unlawful computer access. The text of the bill is available here.
The theory of hack-backs have generated a lot of debate among scholars in recent years, with some arguing that, even if legal, it could have dramatic unintended consequences in ensnaring innocent third-parties. It is often difficult to trace the source of a hack.
***
In other news, a great deal of news is floating around about Waymo, LLC v. Uber Techs., Inc., the trade secrets case involving Google's self-driving technology. News reports first surfaced a few weeks ago about the claim that featured, at its core, the departure of Waymo manager Anthony Levandowski and the supposed downloading of nearly 14,000 confidential Waymo files. Waymo appears to have suspected misappropriation based on the erroneous e-mail transmission of a circuit board drawing, intended for Uber but delivered instead to Waymo. A copy of the Complaint, which features a claim under the Defend Trade Secrets Act, is available here. The "Introduction" sets forth the big-picture story and is a great example of persuasive legal writing.
***
For those interested in the ex parte seizure order procedure available under the DTSA, this link contains the first ever federal court seizure order carried out. The case is Mission Capital Advisors LLC v. Romaka, No. 1:16-cv-5878 (S.D.N.Y.). The collateral costs of obtaining such an order are fairly high. Of note, the defendant in this case never was represented by counsel during the litigation.
***
Finally, the U.S. Attorney's Office in the Middle District of Louisiana released a statement on February 16 that confirms the sentence of Brian Johnson for violating Section (a)(5)(A) of the CFAA. Johnson's guilty plea stemmed from his installation of malicious code on Georgia-Pacific's information technology system after G-P terminated his employment. The code resulted in significant damage to G-P's operations. Johnson will serve a 3-year prison term and must pay more than $1 million in restitution.
***
South Carolina Non-Competes
The Court of Appeals of South Carolina issued a very interesting and important ruling on the oft-overlooked interplay between non-disclosure and non-competition covenants. The case is Fay v. Total Quality Logistics, LLC, No. 2014-1828.
In Fay, the Court of Appeals determined that an indefinite non-disclosure agreement operated as a stealth non-competition restriction, because it provided that if the ex-employee entered into a similar business as his employer and worked in a similar type of position, he would "necessarily and inevitably" use the employer's confidential information to perform his job. In other words, the agreement attempted to graft the devilish "inevitable disclosure" doctrine into a non-disclosure/non-competition covenant. Bad move. This contractual language in effect prohibited the employee ever from competing with his former employer. Under South Carolina's strict "blue-pencil" rule, the court couldn't modify the contract to add in a reasonable time limit. As such, it was unenforceable.
The concurring opinion offered the same conclusion, but first looked to Ohio law because that's what the parties agreed to apply to the contract. But even under Ohio law (which is more friendly), the indefinite non-disclosure agreement would be unenforceable. Fay represents yet another case in an emerging area: an employee's challenge of a broad non-disclosure agreement and arguing it operates as a stealth non-compete. You can read the opinion of the Court of Appeals by clicking here.
Proposed Amendments to CFAA
The Computer Fraud and Abuse Act has been amended many times since it first appeared on the scene in 1986. In reality, it needs to be rewritten or broken up into several different laws. But it's back on the legislative docket, at least if one Congressman has his way.
Rep. Tom Graves (R. GA) has proposed the Active Cyber Defense Certainty Act. The bill would allow victims of cyber-attacks to engage in limited defensive measures to identify and stop attackers. In essence, it's a bill that enables "hacking back" and formalizes that concept as a defense to prosecution for unlawful computer access. The text of the bill is available here.
The theory of hack-backs have generated a lot of debate among scholars in recent years, with some arguing that, even if legal, it could have dramatic unintended consequences in ensnaring innocent third-parties. It is often difficult to trace the source of a hack.
***
In other news, a great deal of news is floating around about Waymo, LLC v. Uber Techs., Inc., the trade secrets case involving Google's self-driving technology. News reports first surfaced a few weeks ago about the claim that featured, at its core, the departure of Waymo manager Anthony Levandowski and the supposed downloading of nearly 14,000 confidential Waymo files. Waymo appears to have suspected misappropriation based on the erroneous e-mail transmission of a circuit board drawing, intended for Uber but delivered instead to Waymo. A copy of the Complaint, which features a claim under the Defend Trade Secrets Act, is available here. The "Introduction" sets forth the big-picture story and is a great example of persuasive legal writing.
***
For those interested in the ex parte seizure order procedure available under the DTSA, this link contains the first ever federal court seizure order carried out. The case is Mission Capital Advisors LLC v. Romaka, No. 1:16-cv-5878 (S.D.N.Y.). The collateral costs of obtaining such an order are fairly high. Of note, the defendant in this case never was represented by counsel during the litigation.
***
Finally, the U.S. Attorney's Office in the Middle District of Louisiana released a statement on February 16 that confirms the sentence of Brian Johnson for violating Section (a)(5)(A) of the CFAA. Johnson's guilty plea stemmed from his installation of malicious code on Georgia-Pacific's information technology system after G-P terminated his employment. The code resulted in significant damage to G-P's operations. Johnson will serve a 3-year prison term and must pay more than $1 million in restitution.
Tuesday, February 28, 2017
Georgia Ruling Illustrates Difficulty with Relying on Blue-Pencil Rule
One of the issues I see most frequently when litigating non-compete disputes involves what's known as the blue-pencil rule. The rule actually has a few separate iterations to it, but for the layperson it's the idea that a court might be able to revise or narrow an overbroad agreement and still enforce it (or at least part of it).
(I wrote a state-by-state guide to the blue-pencil rule more than 8 years ago. It may not be entirely accurate now, as I don't routinely update old posts. It remains one of my most viewed pages, with nearly 40,000 unique viewers having read it (i.e., clicked through to it)).
Advising clients about how courts may deploy the blue-pencil rule is a challenge because in many places - including Illinois -its use is discretionary. This makes rendering predictions somewhat challenging, particularly since very few non-compete scenarios are alike.
There's also a separate problem. My experience is the rule is somewhat judge-specific. By that I mean, different judges apply the rule with different philosophies in mind. Many (most?) don't like to insert themselves in the contract drafting process. Others see themselves as arbiters of equity, charged with a more activist role to do "what's right" under the circumstances. Unless you have direct experience on the precise issue with the same judge, that makes predictive counseling an enormous chore.
***
The reason I write on, and revisit, this topic now is due to two separate events. First, from Georgia, we encountered LifeBrite Laboratories, LLC v. Cooksey, No. 1:15-cv-4309. In that case, the district court evaluated the blue-pencil rule in Georgia in light of the 2011 change to Georgia law. Previously, courts had not allowed any sort of blue-penciling. If a covenant was overbroad, the entire thing failed. Georgia's new law gave courts the ability "to modify a covenant that is otherwise void." But the court noted that the new law did not define the term "modify."
It had a choice. Did the term mean to remove offending language or make substantive changes of the court's own accord? The court, having relied on Georgia's common law before the statutory change, chose the former and not the latter. I would guess this came as a surprise to Georgia lawyers, many of whom likely assumed "modify" granted the court broader discretion. I don't think we've heard the last on this subject. LifeBrite isn't controlling in Georgia state courts.
***
I also write because of an appeal I have pending in Illinois. At least one district of the Appellate Court of Illinois has explained its law of severability in terms of non-compete agreements. I happen to have the very issue pending before the same district, so we'll see if the court expounds on its prior case law. The law of severability states that even if some part of a contract is unenforceable, a court may enforce the rest of the agreement "in favor of a party who did not engage in serious misconduct if the performance as to which the agreement is unenforceable is not an essential part of the agreed exchange."
The italicized language has been held to ruin an entire non-compete when one clause is unenforceable. That means, for instance, that an overbroad customer non-solicitation covenant could imperil an otherwise enforceable non-disclosure agreement. Or vice versa. And given the crackdown in Illinois on overbroad non-disclosure agreements, I expect the law of severability may rear its head time and again.
***
As a quick primer, recall that there are several permutations to blue-penciling and severability. The terms are important:
1. Blue-penciling. This doctrine is what the Georgia court in LifeBrite endorsed. A court can remove offending language and save the balance of the covenant. That would mean, for instance, deleting a particular county in which the employee never worked but which is part of the restriction.
2. Equitable modification/Reformation. This is a broader doctrine, which allows courts to rewrite an overbroad agreement. It is less technical and interjects the court in the drafing process.
3. Red-penciling. This is a very strict, pro-employee doctrine. If the covenant is overbroad, the court will strike it and not change it in any respect. Nevada is a red-pencil state, as we found out last year.
4. Severability. As discussed above, this doctrine means a court can strike an entire restrictive covenant but save the rest of the agreement. In Illinois, I think it's at best an open question now how the law of severability applies to restrictive covenants. Probably case-by-case, depending on the language of the agreement.
5. Step-Down Clauses. A step-down clause provides that if a court determines one covenant is unenforceable, then a different term or restriction applies. For instance, a step-down clause may say that "if the court determines an 18-month non-solicitation restriction is overbroad, then the parties expressly agree to a 6-month covenant in its place." This, in theory, eliminates the court's job in rewriting a contract. I wrote once on this topic. Notably, the district court in LifeBrite stated it would have enforced a step-down clause providing an alternative provision to the overbroad clause that rendered the agreement unenforceable. (See FN 78 at page 21).
(I wrote a state-by-state guide to the blue-pencil rule more than 8 years ago. It may not be entirely accurate now, as I don't routinely update old posts. It remains one of my most viewed pages, with nearly 40,000 unique viewers having read it (i.e., clicked through to it)).
Advising clients about how courts may deploy the blue-pencil rule is a challenge because in many places - including Illinois -its use is discretionary. This makes rendering predictions somewhat challenging, particularly since very few non-compete scenarios are alike.
There's also a separate problem. My experience is the rule is somewhat judge-specific. By that I mean, different judges apply the rule with different philosophies in mind. Many (most?) don't like to insert themselves in the contract drafting process. Others see themselves as arbiters of equity, charged with a more activist role to do "what's right" under the circumstances. Unless you have direct experience on the precise issue with the same judge, that makes predictive counseling an enormous chore.
***
The reason I write on, and revisit, this topic now is due to two separate events. First, from Georgia, we encountered LifeBrite Laboratories, LLC v. Cooksey, No. 1:15-cv-4309. In that case, the district court evaluated the blue-pencil rule in Georgia in light of the 2011 change to Georgia law. Previously, courts had not allowed any sort of blue-penciling. If a covenant was overbroad, the entire thing failed. Georgia's new law gave courts the ability "to modify a covenant that is otherwise void." But the court noted that the new law did not define the term "modify."
It had a choice. Did the term mean to remove offending language or make substantive changes of the court's own accord? The court, having relied on Georgia's common law before the statutory change, chose the former and not the latter. I would guess this came as a surprise to Georgia lawyers, many of whom likely assumed "modify" granted the court broader discretion. I don't think we've heard the last on this subject. LifeBrite isn't controlling in Georgia state courts.
***
I also write because of an appeal I have pending in Illinois. At least one district of the Appellate Court of Illinois has explained its law of severability in terms of non-compete agreements. I happen to have the very issue pending before the same district, so we'll see if the court expounds on its prior case law. The law of severability states that even if some part of a contract is unenforceable, a court may enforce the rest of the agreement "in favor of a party who did not engage in serious misconduct if the performance as to which the agreement is unenforceable is not an essential part of the agreed exchange."
The italicized language has been held to ruin an entire non-compete when one clause is unenforceable. That means, for instance, that an overbroad customer non-solicitation covenant could imperil an otherwise enforceable non-disclosure agreement. Or vice versa. And given the crackdown in Illinois on overbroad non-disclosure agreements, I expect the law of severability may rear its head time and again.
***
As a quick primer, recall that there are several permutations to blue-penciling and severability. The terms are important:
1. Blue-penciling. This doctrine is what the Georgia court in LifeBrite endorsed. A court can remove offending language and save the balance of the covenant. That would mean, for instance, deleting a particular county in which the employee never worked but which is part of the restriction.
2. Equitable modification/Reformation. This is a broader doctrine, which allows courts to rewrite an overbroad agreement. It is less technical and interjects the court in the drafing process.
3. Red-penciling. This is a very strict, pro-employee doctrine. If the covenant is overbroad, the court will strike it and not change it in any respect. Nevada is a red-pencil state, as we found out last year.
4. Severability. As discussed above, this doctrine means a court can strike an entire restrictive covenant but save the rest of the agreement. In Illinois, I think it's at best an open question now how the law of severability applies to restrictive covenants. Probably case-by-case, depending on the language of the agreement.
5. Step-Down Clauses. A step-down clause provides that if a court determines one covenant is unenforceable, then a different term or restriction applies. For instance, a step-down clause may say that "if the court determines an 18-month non-solicitation restriction is overbroad, then the parties expressly agree to a 6-month covenant in its place." This, in theory, eliminates the court's job in rewriting a contract. I wrote once on this topic. Notably, the district court in LifeBrite stated it would have enforced a step-down clause providing an alternative provision to the overbroad clause that rendered the agreement unenforceable. (See FN 78 at page 21).
Friday, February 10, 2017
The Reading List (2017, No. 6): Surprise Result on Blue-Penciling Rule in Georgia
Non-Compete and Trade Secrets News for the week ended February 10, 2017
***
Georgia Blue-Penciling of Restrictive Covenants
Last December, a federal district court in Georgia limited courts' ability to modify overbroad restrictive covenants. More on this significant case in my end-of-the-month column, but LifeBrite Labs. v. Cooksey, No. 1:15-cv-4309, merits a brief mention this week.
The court held that Georgia's relatively new state statute concerning non-competes, which permits courts to "modify a covenant that is otherwise void and unenforceable," allowed it only to excise language that rendered the agreement overbroad. In other words, courts could not rewrite the contract, or supply it with any new terms, as part of its statutory ability to modify agreements. The court relied principally on Georgia's existing case law in the sale-of-business context and the rule that it must construe statutes in derogation of the common-law narrowly. Put simply, "modify" means blue-penciling. The opinion and order, with its very insightful analysis, is available here.
(FordHarrison also comments on this case in its Non-Compete News.)
Military Contractor Trade Secrets
The Eleventh Circuit Court of Appeals has reversed a summary judgment of a trade-secrets claim between military contractors, Advantor Systems of Florida and DRS Technical Services, Inc. The disputed technology involved intrusion detection systems that Advantor originally sold certain United States Air Force bases. When the Air Force elected to consolidate its security systems across all AF bases, Advantor was left out in the cold. DRS won the contract and dumped Advantor as a potential sub-contractor during negotiations. The parties had signed a transactional confidentiality agreement and a one-year "no direct hire" agreement that precluded either from directly soliciting the other's employees.
The ruling is rather lengthy (53 pages) and since it's unpublished, it does not merit an extended discussion. However, it is worth reading the passage where the court of appeals reverses summary judgment on the trade-secrets claim based on the Air Force's disclosure of technical manuals and drawings to DRS. Those manuals were necessary for DRS' continued service of Advantor equipment previously sold to the AF (recall that Advantor used to supply systems to several, but not all, AF bases). The analysis discusses a rarely litigated question concerning the term "misappropriation": whether the defendant (DRS) had "reason to know" that a third-party (AF) had some limitation on its ability to disseminate information obtained in confidence (from Advantor).
A copy of the Eleventh Circuit's unpublished opinion is available here.
Choice-of-Law Clauses
California courts have continued a trend of invalidating choice-of-law clauses with regard to employee restrictive covenants. The general principle is that courts will enforce such clauses unless the contractually chosen law is "contrary to the fundamental policy of the forum state." In Stryker Sales Corp. v. Zimmer Biomet, No. 1:16-cv-01670, a California federal district court found a public-policy rift between Michigan and California law concerning non-competes. No surprise there. Michigan is a fairly typical state when it comes to non-compete law, employing a reasonableness test to restrictive covenants. But California bars them almost entirely, which led the court to invalidate the choice-of-law clause in Stryker Sales.
This case illustrates why obtaining the proper forum, and enforcing forum selection clauses, is so crucial to non-competes directed at parties with some California connection. The original action was brought in Michigan, but venue wasn't proper there. A copy of the decision is available here.
Restoration Hardware Trade Secrets Suit
Multiple outlets have reported on a trade-secrets suit between Restoration Hardware and Crate and Barrel. The Complaint, filed in California state court, alleges that Crate and Barrel CEO and former Restoration Hardware employee Doug Diemoz tried to hire other RH executives in violation of a no-hire agreement. According to the Chicago Tribune, Diemoz is alleged to have used Gmail to communicate with RH employees, stating in one such e-mail "that damn non solicitation!" Diemoz' supposed recruitment allegedly ties into another employee's downloading of confidential information about RH's food and beverage operations in Chicago.
The crux of the trade-secret allegation is a little odd. RH seems to be claiming that Crate and Barrel is attempting to replicate its "model" of providing food-and-beverage services in conjunction with its other retail offerings. I suppose that something about the roll-out of those operations could be secret, but it seems like an allegation primed for a reverse-engineering defense. RH's pilot program was launched at the Three Arts Club in Chicago. Before its conversion (it was badly rundown), I lived at the Three Arts Club for a summer in my early 20s and consumed an untold number of alcoholic beverages - not the coffee drinks RH is now peddling to its shoppers.
***
In other news, Holland & Hart reports on a $5.175 million trade-secrets verdict it obtained in Utah on behalf of Hydro Engineering, Inc. against Riveer Environmental. The case stemmed from Riveer's hiring of a key salesperson who had a non-compete with Hydro. The verdict summary illustrates, once again, that e-mail communications among the defendant's employees were central to the plaintiff's proofs.
***
Georgia Blue-Penciling of Restrictive Covenants
Last December, a federal district court in Georgia limited courts' ability to modify overbroad restrictive covenants. More on this significant case in my end-of-the-month column, but LifeBrite Labs. v. Cooksey, No. 1:15-cv-4309, merits a brief mention this week.
The court held that Georgia's relatively new state statute concerning non-competes, which permits courts to "modify a covenant that is otherwise void and unenforceable," allowed it only to excise language that rendered the agreement overbroad. In other words, courts could not rewrite the contract, or supply it with any new terms, as part of its statutory ability to modify agreements. The court relied principally on Georgia's existing case law in the sale-of-business context and the rule that it must construe statutes in derogation of the common-law narrowly. Put simply, "modify" means blue-penciling. The opinion and order, with its very insightful analysis, is available here.
(FordHarrison also comments on this case in its Non-Compete News.)
Military Contractor Trade Secrets
The Eleventh Circuit Court of Appeals has reversed a summary judgment of a trade-secrets claim between military contractors, Advantor Systems of Florida and DRS Technical Services, Inc. The disputed technology involved intrusion detection systems that Advantor originally sold certain United States Air Force bases. When the Air Force elected to consolidate its security systems across all AF bases, Advantor was left out in the cold. DRS won the contract and dumped Advantor as a potential sub-contractor during negotiations. The parties had signed a transactional confidentiality agreement and a one-year "no direct hire" agreement that precluded either from directly soliciting the other's employees.
The ruling is rather lengthy (53 pages) and since it's unpublished, it does not merit an extended discussion. However, it is worth reading the passage where the court of appeals reverses summary judgment on the trade-secrets claim based on the Air Force's disclosure of technical manuals and drawings to DRS. Those manuals were necessary for DRS' continued service of Advantor equipment previously sold to the AF (recall that Advantor used to supply systems to several, but not all, AF bases). The analysis discusses a rarely litigated question concerning the term "misappropriation": whether the defendant (DRS) had "reason to know" that a third-party (AF) had some limitation on its ability to disseminate information obtained in confidence (from Advantor).
A copy of the Eleventh Circuit's unpublished opinion is available here.
Choice-of-Law Clauses
California courts have continued a trend of invalidating choice-of-law clauses with regard to employee restrictive covenants. The general principle is that courts will enforce such clauses unless the contractually chosen law is "contrary to the fundamental policy of the forum state." In Stryker Sales Corp. v. Zimmer Biomet, No. 1:16-cv-01670, a California federal district court found a public-policy rift between Michigan and California law concerning non-competes. No surprise there. Michigan is a fairly typical state when it comes to non-compete law, employing a reasonableness test to restrictive covenants. But California bars them almost entirely, which led the court to invalidate the choice-of-law clause in Stryker Sales.
This case illustrates why obtaining the proper forum, and enforcing forum selection clauses, is so crucial to non-competes directed at parties with some California connection. The original action was brought in Michigan, but venue wasn't proper there. A copy of the decision is available here.
Restoration Hardware Trade Secrets Suit
Multiple outlets have reported on a trade-secrets suit between Restoration Hardware and Crate and Barrel. The Complaint, filed in California state court, alleges that Crate and Barrel CEO and former Restoration Hardware employee Doug Diemoz tried to hire other RH executives in violation of a no-hire agreement. According to the Chicago Tribune, Diemoz is alleged to have used Gmail to communicate with RH employees, stating in one such e-mail "that damn non solicitation!" Diemoz' supposed recruitment allegedly ties into another employee's downloading of confidential information about RH's food and beverage operations in Chicago.
The crux of the trade-secret allegation is a little odd. RH seems to be claiming that Crate and Barrel is attempting to replicate its "model" of providing food-and-beverage services in conjunction with its other retail offerings. I suppose that something about the roll-out of those operations could be secret, but it seems like an allegation primed for a reverse-engineering defense. RH's pilot program was launched at the Three Arts Club in Chicago. Before its conversion (it was badly rundown), I lived at the Three Arts Club for a summer in my early 20s and consumed an untold number of alcoholic beverages - not the coffee drinks RH is now peddling to its shoppers.
***
In other news, Holland & Hart reports on a $5.175 million trade-secrets verdict it obtained in Utah on behalf of Hydro Engineering, Inc. against Riveer Environmental. The case stemmed from Riveer's hiring of a key salesperson who had a non-compete with Hydro. The verdict summary illustrates, once again, that e-mail communications among the defendant's employees were central to the plaintiff's proofs.
Thursday, July 28, 2016
Supreme Court of Nevada Rejects Blue-Pencil Doctrine
Non-compete law continues to evolve at the state level, both in terms of targeted legislation and judicial refinement of common-law principles. For the most part, the decided trend is for lawmakers and judges to pare back the use of broad non-competes and to make specific public-policy based exceptions (or create categorical limits), as in the case of covenants impacting emerging technology workers and health-care providers.
I have often remarked, both here and in presentations to colleagues, that if we're going to get serious about the proper use of non-compete agreements then we ought to hone in on two very specific concepts: ensuring the adequacy of consideration (preferably at the outset of a lawsuit) and discarding the notion that courts should be reforming overbroad contracts that are carelessly and gratuitously written.
This month, the Supreme Court of Nevada rejected the blue-pencil doctrine and held that courts may not rewrite a non-compete agreement to make it reasonable. The case is Golden Road Motor Inn, Inc. v. Islam, 132 Nev. Adv. Rep. 49 (a link to the docket page is available here). Briefly stated, the case involved a casino manager who signed a one-year, post-termination covenant (apparently well after she started working for Atlantis Casino Resort) that broadly prohibited her from working in any gaming business within 150 miles of her employer. The effect of the restriction rendered her unemployable in Nevada's largest casino market.
The Court, in a 4-3 opinion, rejected the blue-pencil doctrine as inconsistent with Nevada law on reformation of contracts. In a passage that is sure to be cited in future cases, the majority rejected the dissent's endorsement of the blue-pencil rule where appropriate and said:
"Our exercise of judicial restraint when confronted with the urge to pick up the pencil is sound public policy. Restraint avoids the possibility of trampling the parties' contractual intent...Even assuming only minimal infringement on the parties' intent, as the dissent suggests, a trespass at all is indefensible, as our use of the pencil should not lead us to the place of drafting. Our place is in interpreting. Moreover, although the transgression may be minimal here, setting a precedent that establishes the judiciary's willingness to partake in drafting would simply be inappropriate public policy as it conflicts with the impartiality that is required of the bench, irrespective of some jurisdictions' willingness to overreach."
Apart from these public policy principles, the Court defaulted its legal analysis to general principles on contract reformation. Generally, courts can reform contracts if one shows mutual mistake by clear and convincing evidence. That is an awfully tough showing, reserved for cases where a writing does not reflect what the parties intended. The blue-pencil rule has nothing to do with conforming a contract to the parties' mutually-held intent, but rather fashions a judicial rewrite of an agreement after-the-fact under the guise of fairness.
The Court then parsed reformation further, focusing on procedure. That discussion is crucial for lawyers to understand. What the Court in Golden Road Motor Inn was saying is that courts often reform or blue-pencil non-competes in the context of awarding preliminary injunctions. It didn't endorse that approach, to be sure. But once a case reaches final judgment on the merits, the employer must demonstrate the agreement is reasonable on its face and not plead for judicial reformation.
It is interesting to see the Court make this nuanced distinction. The thinking apparently is that an injunction is in fact equitable in nature and courts have the ability to fashion appropriate relief at an emergency hearing, subject of course to the possibility that the court later may find the agreement is unreasonable. But at a preliminary stage, a court does not make ultimate fact determinations and so is not ruling definitively on enforceability. Conceivably, a court could say it is likely the agreement is reasonable but that the injunction requested seeks too much. Therefore, we'll just blue-pencil for now.
That may be what happens in practice, but I don't think so. To be certain, the cases don't read this way. And therein lies the problem. The blue-pencil rule has become a crutch, used to deter fair competition and used to bless poor drafting and (in many cases) an intent to restrain trade for no valid reason.
On this score, the Golden Road Motor Inn dissent's argument that the blue-pencil rule "also favors the employee by appropriately limiting the restriction" is pure nonsense. My experience is that employees sure as hell don't feel that way. The next employee who comes into my office and is excited by an overbroad agreement and the potential for judicial modification (after expensive litigation) will be the first.
I have often remarked, both here and in presentations to colleagues, that if we're going to get serious about the proper use of non-compete agreements then we ought to hone in on two very specific concepts: ensuring the adequacy of consideration (preferably at the outset of a lawsuit) and discarding the notion that courts should be reforming overbroad contracts that are carelessly and gratuitously written.
This month, the Supreme Court of Nevada rejected the blue-pencil doctrine and held that courts may not rewrite a non-compete agreement to make it reasonable. The case is Golden Road Motor Inn, Inc. v. Islam, 132 Nev. Adv. Rep. 49 (a link to the docket page is available here). Briefly stated, the case involved a casino manager who signed a one-year, post-termination covenant (apparently well after she started working for Atlantis Casino Resort) that broadly prohibited her from working in any gaming business within 150 miles of her employer. The effect of the restriction rendered her unemployable in Nevada's largest casino market.
The Court, in a 4-3 opinion, rejected the blue-pencil doctrine as inconsistent with Nevada law on reformation of contracts. In a passage that is sure to be cited in future cases, the majority rejected the dissent's endorsement of the blue-pencil rule where appropriate and said:
"Our exercise of judicial restraint when confronted with the urge to pick up the pencil is sound public policy. Restraint avoids the possibility of trampling the parties' contractual intent...Even assuming only minimal infringement on the parties' intent, as the dissent suggests, a trespass at all is indefensible, as our use of the pencil should not lead us to the place of drafting. Our place is in interpreting. Moreover, although the transgression may be minimal here, setting a precedent that establishes the judiciary's willingness to partake in drafting would simply be inappropriate public policy as it conflicts with the impartiality that is required of the bench, irrespective of some jurisdictions' willingness to overreach."
Apart from these public policy principles, the Court defaulted its legal analysis to general principles on contract reformation. Generally, courts can reform contracts if one shows mutual mistake by clear and convincing evidence. That is an awfully tough showing, reserved for cases where a writing does not reflect what the parties intended. The blue-pencil rule has nothing to do with conforming a contract to the parties' mutually-held intent, but rather fashions a judicial rewrite of an agreement after-the-fact under the guise of fairness.
The Court then parsed reformation further, focusing on procedure. That discussion is crucial for lawyers to understand. What the Court in Golden Road Motor Inn was saying is that courts often reform or blue-pencil non-competes in the context of awarding preliminary injunctions. It didn't endorse that approach, to be sure. But once a case reaches final judgment on the merits, the employer must demonstrate the agreement is reasonable on its face and not plead for judicial reformation.
It is interesting to see the Court make this nuanced distinction. The thinking apparently is that an injunction is in fact equitable in nature and courts have the ability to fashion appropriate relief at an emergency hearing, subject of course to the possibility that the court later may find the agreement is unreasonable. But at a preliminary stage, a court does not make ultimate fact determinations and so is not ruling definitively on enforceability. Conceivably, a court could say it is likely the agreement is reasonable but that the injunction requested seeks too much. Therefore, we'll just blue-pencil for now.
That may be what happens in practice, but I don't think so. To be certain, the cases don't read this way. And therein lies the problem. The blue-pencil rule has become a crutch, used to deter fair competition and used to bless poor drafting and (in many cases) an intent to restrain trade for no valid reason.
On this score, the Golden Road Motor Inn dissent's argument that the blue-pencil rule "also favors the employee by appropriately limiting the restriction" is pure nonsense. My experience is that employees sure as hell don't feel that way. The next employee who comes into my office and is excited by an overbroad agreement and the potential for judicial modification (after expensive litigation) will be the first.
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.
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.
Tuesday, November 19, 2013
Georgia Court of Appeals Discusses Anti-Severability Rules
One of the defining characteristics of a state's non-compete law is its application of the blue-pencil rule. Although several variations of the rule exist, states generally fall into one of two camps: those that readily modify overbroad covenants to make them reasonable, and those that generally frown on modification or blue-penciling.
Georgia historically has been one of the states that enforces only those agreements that are reasonable as written. That is to say, courts cannot modify overbroad agreements to make them enforceable. In essence, Georgia judges will decline to force the parties to accept a contract they could have, but didn't, make.
Georgia law continues to evolve, and a new statute governs contracts entered into after May of 2011. However, it doesn't impact contracts signed before the effective date, and courts will continue to apply the old common law for many years to come.
The Court of Appeals discussed at length the state's anti-severability rule in Lapolla Industries, Inc. v. Hess. As the Court described, the anti-severability rule applies to the following types of restrictive covenants:
- covenants restricting employment or competition generally in a relevant market;
- covenants restricting the solicitation of business from actual or potential customers; and
- covenants restricting the acceptance of business from actual or potential customers.
(There was another type of restrictive covenant at issue in Hess, which I still don't understand after reading it several times and which the Court of Appeals intelligently glided over. Lapolla (the ex-employer) had a non-solicitation covenant that prohibited the employee from soliciting or accepting business from a business competitive with or similar to Lapolla. In other words, the employee could not vend any kind of product or service to a Lapolla competitor. Silly.)
However, the anti-severability rule does not apply to covenants that either:
- restrict solicitation or hiring of certain employees or independent contractors; and
- restrict disclosure of trade secrets or confidential information.
Like many states, Georgia historically has frowned upon so-called market-based restraints, which contain broad prohibitions on working for a competitor in any capacity. Georgia's case law, however, also has applied strict scrutiny to lesser restrictive customer-based restraints, such that a number of appellate decisions strike down clauses that many other states would deem enforceable. For instance, Georgia courts have frowned upon customer-based restraints that prevent an employee from accepting, instead of soliciting, a customer's business. This distinction never has made much sense to me, since it's virtually impossible without the aid of legal process to determine who solicited whom.
The Court also discusses at length in Hess Georgia's reluctance to enforce choice of forum and choice of law clauses in contracts when application of a foreign state's law would lead to a result contrary to Georgia's public policy. In keeping with one of my sacrosanct rules to limit discussion of venue and jurisdiction disputes to an absolute minimum, I will say no more regarding this subject.
Thursday, August 15, 2013
More from Tradesmen Int'l v. Black: Analyzing Judge Hamilton's Concurring Opinion
When construction staffing industry titan Tradesmen International lost its appeal in the Seventh Circuit, it suffered more than just a defeat in a particular lawsuit that (in my opinion) it had no expectation of winning.
In the course of its analysis, the Court of Appeals made it perfectly clear that Tradesmen's non-compete was unenforceable under Ohio law. As Judge Tinder noted in his opinion, the non-compete had a nationwide reach and extended to all Tradesmen customers and prospects throughout the country even though the individual defendants worked solely in Indiana. Consequently, the agreement went far beyond what was necessary to protect Tradesmen's business interests.
To me, one of the more interesting aspects of the Seventh Circuit's ruling was Judge David Hamilton's concurring opinion and his discussion of the blue-pencil rule, which generally deals with a court's willingness to strike overbroad portions of a non-compete.
That Judge Hamilton wrote separately in this case is not surprising. During oral argument, it was clear to me he was troubled by the scope of Tradesmen's agreement and what precisely it was trying to protect. Though he is the newest member of the Seventh Circuit, Judge Hamilton quickly has become known as an active questioner during argument. And this case provided him the opportunity to live up to that reputation. Judge Hamilton has made it known in interviews that he has a great interest in the law of non-compete agreements and trade secrets.
Although he agreed with the majority opinion, Judge Hamilton wrote about the intersection of choice-of-law clauses and the blue-pencil rule. In Tradesmen, the individual non-compete agreements all contained Ohio choice-of-law provisions. The choice isn't unreasonable, since Tradesmen is an Ohio-based company with a nationwide footprint. Businesses certainly have an interest in seeing that its contracts are interpreted under a uniform set of rules. But the case potentially posed a significant choice-of-law issue because the individual defendants were Indiana citizens, and the litigation took place in Illinois.
Judge Hamilton, though, is troubled (and has been in the past) by courts' willingness to enforce choice-of-law clauses when another state has a greater interest in the case and the chosen state's law embraces an employer-friendly blue-pencil rule. As he wrote, even though most states assess non-competes under a general rule of reason framework, "even a gentle tap on that fragile surface of similarity shows important differences from state to state."
According to Judge Hamilton, courts should "not discount too quickly the force of ... public policy" that certain states have adopted when refusing to enforce overbroad non-compete agreements. In his mind, a state's unwillingness to rewrite or pare back non-compete agreements can be a strong enough public policy to invalidate a choice-of-law clause.
As an example, Indiana courts - like many others - subscribes to a strict blue-pencil rule. This means a court will not rewrite an overbroad contract, but will sever offending clauses from the rest of the agreement. States like Ohio, and to a lesser degree Illinois, have different policies (nuanced though they may be) that allow for courts to modify agreements or enforce them to the extent they are reasonable.
Is this a strong enough difference in public policy to invalidate a choice-of-law clause?
Judge Hamilton thinks it might be for a very pragmatic reason: an employer like Tradesmen can draft an obviously unenforceable contract and throw it to the courts to enforce a reasonable contract the parties could have signed instead. A state's unwillingness to adopt a liberal rule allowing for partial enforcement may signal a broader public policy that the state "protect[s] employees from overly broad coveants." The employer-friendly rule impacts employees who may not have the ability to obtain firm guidance on what type of competitive activity is prohibited legally, even with the sound advice of counsel.
Judge Hamilton addressed this same public policy issue in a lengthy opinion when he sat as a district court judge in the Southern District of Indiana. The case was Dearborn v. Everett J. Prescott, Inc., 486 F. Supp. 2d 802 (S.D. Ind. 2007), and the case had strong similarities to some of the issues in the Tradesmen suit concerning choice-of-law. Though his opinion in Dearborn was thoughtful and extremely thorough, I didn't entirely agree with everything Judge Hamilton wrote in that case. Still, his reasoning has great appeal, for it recognizes the critical role the blue-pencil rule plays in non-compete suits. Judge Hamilton's concurrence in Tradesmen rings many of the same alarm bells he struck in Dearborn concerning choice-of-law.
Divining when a state's public policy is so strong as to override a contractual choice-of-law clause is no easy task. To me, courts could look at this one of three ways:
(1) Has the legislature enacted a clear statement of public policy? This is the easy analysis, because legislatures typically bear the laboring oar of setting forth public policy choices. As a result, states that have strong legislative enactments on non-competes - California, North Dakota, and Oklahoma on the employee side; Florida on the employer side - present obvious examples of when parties will have to confront critical choice-of-law issues.
(2) Have courts expressed a consistent, widely applied rule that clearly expresses a public policy choice? This becomes more nuanced because non-compete cases are so fact-specific. But, taking the blue-pencil rule as an example, if a state's case law shows a uniform pattern where courts are unwilling to rewrite or modify overbroad covenants, this may rise to the level of a public policy sufficient to invalidate a choice-of-law clause. Illinois, for instance, has suggested in recent years that despite its black-letter principle of allowing modification of overbroad non-competes, public policy considerations may not allow a court to do the work an employer should have done when drafting contracts.
(3) Could the difference in state law change the outcome? This approach would take a broader view of public policy, and to me it's not the proper analysis. For instance, in some (but not all) states, "continued employment" is sufficient consideration to enforce a non-compete signed after the start of employment. Certain states seem to have broader pronouncements that a non-compete cannot extend to "prospective" customers. To be sure, these are significant differences depending on the facts of the case, and they well may be dispositive in litigation. But they are really at the edges of a state's public policy as to enforcement. Courts long have recognized that mere differences in a state's law don't rise to the level of a strong public policy.
Judge Hamilton seems to subscribe to the second approach, and he views a state's willingness to rewrite non-competes as a strong enough choice to implicate public policy concerns. Ultimately, this may signal the Seventh Circuit's willingness to examine choice-of-law issues more carefully and retreate from prior decisions where the court seemingly has deferred to a choice-of-law clause as long as it has some connection to the dispute.
In Tradesmen, I didn't make an issue out of choice-of-law for the simple reason that Tradesmen never could point to any evidence my clients breached any agreement. The issue was, to be frank, moot and not worth spending a nickel of legal fees over. Had my clients decided to challenge the enforceability of the contracts, then certainly choice-of-law would have been a more significant legal issue to consider.
In the course of its analysis, the Court of Appeals made it perfectly clear that Tradesmen's non-compete was unenforceable under Ohio law. As Judge Tinder noted in his opinion, the non-compete had a nationwide reach and extended to all Tradesmen customers and prospects throughout the country even though the individual defendants worked solely in Indiana. Consequently, the agreement went far beyond what was necessary to protect Tradesmen's business interests.
To me, one of the more interesting aspects of the Seventh Circuit's ruling was Judge David Hamilton's concurring opinion and his discussion of the blue-pencil rule, which generally deals with a court's willingness to strike overbroad portions of a non-compete.That Judge Hamilton wrote separately in this case is not surprising. During oral argument, it was clear to me he was troubled by the scope of Tradesmen's agreement and what precisely it was trying to protect. Though he is the newest member of the Seventh Circuit, Judge Hamilton quickly has become known as an active questioner during argument. And this case provided him the opportunity to live up to that reputation. Judge Hamilton has made it known in interviews that he has a great interest in the law of non-compete agreements and trade secrets.
Although he agreed with the majority opinion, Judge Hamilton wrote about the intersection of choice-of-law clauses and the blue-pencil rule. In Tradesmen, the individual non-compete agreements all contained Ohio choice-of-law provisions. The choice isn't unreasonable, since Tradesmen is an Ohio-based company with a nationwide footprint. Businesses certainly have an interest in seeing that its contracts are interpreted under a uniform set of rules. But the case potentially posed a significant choice-of-law issue because the individual defendants were Indiana citizens, and the litigation took place in Illinois.
Judge Hamilton, though, is troubled (and has been in the past) by courts' willingness to enforce choice-of-law clauses when another state has a greater interest in the case and the chosen state's law embraces an employer-friendly blue-pencil rule. As he wrote, even though most states assess non-competes under a general rule of reason framework, "even a gentle tap on that fragile surface of similarity shows important differences from state to state."
According to Judge Hamilton, courts should "not discount too quickly the force of ... public policy" that certain states have adopted when refusing to enforce overbroad non-compete agreements. In his mind, a state's unwillingness to rewrite or pare back non-compete agreements can be a strong enough public policy to invalidate a choice-of-law clause.
As an example, Indiana courts - like many others - subscribes to a strict blue-pencil rule. This means a court will not rewrite an overbroad contract, but will sever offending clauses from the rest of the agreement. States like Ohio, and to a lesser degree Illinois, have different policies (nuanced though they may be) that allow for courts to modify agreements or enforce them to the extent they are reasonable.
Is this a strong enough difference in public policy to invalidate a choice-of-law clause?
Judge Hamilton thinks it might be for a very pragmatic reason: an employer like Tradesmen can draft an obviously unenforceable contract and throw it to the courts to enforce a reasonable contract the parties could have signed instead. A state's unwillingness to adopt a liberal rule allowing for partial enforcement may signal a broader public policy that the state "protect[s] employees from overly broad coveants." The employer-friendly rule impacts employees who may not have the ability to obtain firm guidance on what type of competitive activity is prohibited legally, even with the sound advice of counsel.
Judge Hamilton addressed this same public policy issue in a lengthy opinion when he sat as a district court judge in the Southern District of Indiana. The case was Dearborn v. Everett J. Prescott, Inc., 486 F. Supp. 2d 802 (S.D. Ind. 2007), and the case had strong similarities to some of the issues in the Tradesmen suit concerning choice-of-law. Though his opinion in Dearborn was thoughtful and extremely thorough, I didn't entirely agree with everything Judge Hamilton wrote in that case. Still, his reasoning has great appeal, for it recognizes the critical role the blue-pencil rule plays in non-compete suits. Judge Hamilton's concurrence in Tradesmen rings many of the same alarm bells he struck in Dearborn concerning choice-of-law.
Divining when a state's public policy is so strong as to override a contractual choice-of-law clause is no easy task. To me, courts could look at this one of three ways:
(1) Has the legislature enacted a clear statement of public policy? This is the easy analysis, because legislatures typically bear the laboring oar of setting forth public policy choices. As a result, states that have strong legislative enactments on non-competes - California, North Dakota, and Oklahoma on the employee side; Florida on the employer side - present obvious examples of when parties will have to confront critical choice-of-law issues.
(2) Have courts expressed a consistent, widely applied rule that clearly expresses a public policy choice? This becomes more nuanced because non-compete cases are so fact-specific. But, taking the blue-pencil rule as an example, if a state's case law shows a uniform pattern where courts are unwilling to rewrite or modify overbroad covenants, this may rise to the level of a public policy sufficient to invalidate a choice-of-law clause. Illinois, for instance, has suggested in recent years that despite its black-letter principle of allowing modification of overbroad non-competes, public policy considerations may not allow a court to do the work an employer should have done when drafting contracts.
(3) Could the difference in state law change the outcome? This approach would take a broader view of public policy, and to me it's not the proper analysis. For instance, in some (but not all) states, "continued employment" is sufficient consideration to enforce a non-compete signed after the start of employment. Certain states seem to have broader pronouncements that a non-compete cannot extend to "prospective" customers. To be sure, these are significant differences depending on the facts of the case, and they well may be dispositive in litigation. But they are really at the edges of a state's public policy as to enforcement. Courts long have recognized that mere differences in a state's law don't rise to the level of a strong public policy.
Judge Hamilton seems to subscribe to the second approach, and he views a state's willingness to rewrite non-competes as a strong enough choice to implicate public policy concerns. Ultimately, this may signal the Seventh Circuit's willingness to examine choice-of-law issues more carefully and retreate from prior decisions where the court seemingly has deferred to a choice-of-law clause as long as it has some connection to the dispute.
In Tradesmen, I didn't make an issue out of choice-of-law for the simple reason that Tradesmen never could point to any evidence my clients breached any agreement. The issue was, to be frank, moot and not worth spending a nickel of legal fees over. Had my clients decided to challenge the enforceability of the contracts, then certainly choice-of-law would have been a more significant legal issue to consider.
Monday, May 13, 2013
You Can't Reverse Blue-Pencil a Non-Compete
By now, I hope readers of this blog would be aware that the title of this post simply reinforces the obvious.For background, the "blue-pencil" rule is intended to allow a court to enforce the reasonable parts of non-competition agreements, while deleting those portions that render the covenant overbroad. Its cousin, the "equitable modification" rule gives a little more discretion to a trial court judge, such that he or she can make substantive changes to the clause (as opposed to deletions) when narrowing it up.
What neither rule allows is expansion of the covenant to include a broader range of competitive activity. Lawyers and clients need to understand, though, that judges are generalists and aren't as accustomed to examining this issues with the kind of depth that nerds like me are. So they make mistakes.
A perfect illustration comes from the Appellate Court of Illinois, which issued an opinion this week that addressed this reverse blue-penciling issue. The non-solicitation covenant at issue in that case was similar to what many provide: the employee (a physician) could not "solicit, divert or take away business or patronage" of the medical practice for three years following termination of employment.
The case, which is embedded below, is yet another primer on "How Not to Leave Your Employer" and follows the same basic fact pattern as I've written about on prior occasions. The trial court in Chicago issued a preliminary injunction which enforced the agreement and restrained the defendants (including one not bound to any non-compete) from "treating any current or former patients of" the medical practice.
This is more extensive than the terms of the non-solicitation covenant because "treating" is broader than the operative triggering language in the contract - "solicit, divert or take away." The Appellate Court held such an expansion of the terms was improper given the relatively clear language of the contract.
Counsel drafting non-solicitation covenants should always consider whether the terms are broad enough to include "passive" solicitation (that is, a client approaches the ex-employee) as opposed to mere "active" solicitation (affirmative efforts to lure clients away). Because it is almost impossible for an employer to assess objectively the difference between the two (it only knows the client has left), there are few business reasons why a non-solicitation covenant should be drafted to exclude passive solicitation.
Friday, December 28, 2012
The Year In Illinois Non-Competes Fittingly Concludes With Another Rule 23 Order
In short, the court can issue non-precedential Rule 23 orders, which constitute judgments rather than opinions. And they're not to be cited as precedent in future cases.
I have no problem with the concept of Rule 23 orders. They're meant to reduce the court's burden to crank out opinions that can later be cited back to them by lawyers as precedential and binding within an appellate district.
But in truth, they should be limited to two classes of cases: (1) review of criminal convictions; and (2) review of civil cases where there is a highly deferential standard of review. For instance, appellate review over a jury verdict under a manifest weight of the evidence standard is an ideal case for a limited, non-precedential opinion. Cases like that almost never announce some rule that future courts will point to as precedential.
But the non-compete cases that have come before the Appellate Court do not fall within these categories and address important issues of law, or interpretations of law, in the wake of the Supreme Court's Reliable Fire case late last year. My September post describes some of these rulings.
And so, with 2012 coming to a close, it seems only appropriate that our appellate court has done it again - issuing a Rule 23 order on a fairly significant question in a non-compete case.
The case of Saddlers Row, LLC v. Dainton (opinion contained below) arose out of a fairly common set of facts. The employee had a two-year, 75-mile general non-compete agreement, which he breached by going to work for a direct competitor a mere seven miles from his prior place of work. The employer acknowledged that customer relationships, not trade secrets, were the protectable interest. But the evidence showed that most of its customers were located within 40 miles of the employer's place of business - and that 75 miles stretched further than was necessary to protect the vast majority of its customer base.
The circuit court refused to impose an order of preliminary injunctive relief, finding the 75-mile scope overbroad. It then refused to blue-pencil the agreement and pare back the geographic scope by 25 or so miles.
The appellate court agreed that the geographic scope was unreasonable, but held that the circuit court abused its discretion by refusing to modify the covenant to make it enforceable.
The court looked at two critical factors in determining that circuit court should have modified the covenant:
1. The covenant's geographic scope, while overbroad, was close to reasonable. Since most of the employer's customers were within 40 miles or so of its place of business, a 75-mile restriction was hardly a major overreach. In fact, since the employer had customers out of state (apparently, very few), any line-drawing would be arbitrary. Put another way, the employer clearly made a good-faith effort at trying to draw a reasonable restriction.
2. The employee directly competed in close proximity to the employer. The court emphasized that this was not a case where the employee tried, in good faith, to compete in an area outside the employer's sweet spot, such that any competition would be minimal. This was an "in-your-face" breach. And because equitable considerations are paramount in any blue-penciling analysis, the appellate court deemed it important that the employee knew he was in blatant breach of the covenant.
The decision is obviously pro-employer, and it's rare to find cases like this where an appellate court finds that a refusal to blue-pencil is an abuse of the trial court's discretion. Off-hand, I can't think of many in Illinois like this. This demonstrates why the case should never have been a Rule 23 order. The court emphasized very specific considerations that come into play when determining whether blue-penciling is appropriate.
Of further interest is the court's omission of any analysis concerning why a customer non-solicitation covenant wasn't the proper type of contract to use in this case. When an employer is not trying to protect trade secrets, its need for a general non-compete is diminished. And in Saddlers Row, the employer admitted it wasn't trying to protect trade secrets. Its interest was in securing customers, and the more appropriate fit for that type of protectable interest would appear to be a common non-solicitation covenant. But this was not even discussed.
Saddlers Row v. Dainton
Saturday, December 1, 2012
Georgia Case Demonstrates Importance of Addressing Choice of Venue and Law Clauses
Non-compete contracts entered into before the ratification of a constitutional amendment in 2011 are governed by the common law, and that body of law remains exceedingly treacherous for companies enforcing covenants.
A recent Georgia appellate case illustrates why procedural choice of venue and choice of law rules are vitally important.
The case of Carson v. Obor Holding Co., LLC yields a fairly common fact-pattern. Carson wore two hats for Obor Digital, a company that supplies staffing and software services in the defense industry. He was a member of the holding company (the defendant in the case) and an employee of the operating entity (not a defendant). He resigned in April of 2011, claiming "constructive discharge" by virtue of a reduction in his commissions. He then immediately filed suit in Georgia state court seeking an injunction against enforcement of the restrictive covenants contained in the Holding Company operating agreement.
The trial court dismissed his case, finding a Florida choice-of-forum clause was valid. That contract also required application of Florida law. Florida, in direct contrast to Georgia, is an exceedingly friendly enforcement state.
The Court of Appeals of Georgia reversed and held that the forum selection clause was invalid. It is important to note that courts won't invalidate forum selection clauses simply because one state's law (here, Georgia) is more favorable to employees than another state's (here, Florida). Rather, the difference has to implicate some fundamental public policy.
Florida tends to pose special problems with choice-of-forum and choice-of-law clauses if the suit is brought in another state. This is so for two primary reasons. First, Florida has a mandatory blue-pencil rule, requiring courts to modify overbroad covenants to the extent necessary for protection of the enforcing party. Georgia (pre-2011) is the exact opposite, essentially adopting an all-or-nothing policy. Second, Florida disallows a court from considering any employee hardships - economic or otherwise - that may result from enforcement. Georgia requires courts to consider such hardships in the balancing analysis. (Illinois adopted a similar rationale a few years back to invalidate Florida choice-of-law provisions in non-compete cases pending in Illinois courts.)
Turning to the substance of the covenants, Obor Holding's operating agreement had the following deficiencies in the restrictive covenants:
(1) The non-disclosure covenant did not define "confidential information," and it barred use of confidential information in perpetuity. Georgia law holds this is invalid if the non-disclosure for non-trade secret information is unlimited. (This is ridiculous, but maybe more on this in another post.)
(2) The non-solicitation covenant was not limited either (a) to a discrete class of customers, or (b) territorially. It also barred Carson from accepting business from a customer. Georgia cases hold that non-solicitation covenants that bar this so-called "passive solicitation" are invalid. (Again, stupid. How can an enforcing party know who contacted whom?)
(3) The non-compete covenant was invalid because it applied throughout the country and had no discernible territory limitation and because it had no activity scope tied to it. That is, it barred any affiliation with a competitor, not just some particular competitive conduct.
Because of the fundamental difference in how Georgia and Florida courts view non-competes, the Court of Appeals found that the operating agreement covenants violated Georgia public policy and that a Florida court would enforce them (at least to some extent). That means that, in Georgia, the choice-of-venue clause was invalid. A Georgia court had to hear the case and had to apply Georgia law. IIt must be nice to be a Georgia non-compete lawyer. No shortage of cases. And plenty of contract rewrites given the change in the law in 2011.
Other states that will pose similar procedural problems like this are Wisconsin, Oklahoma, North Dakota, and California. States that are viewed as more employee-friendly may not have robust public policy considerations that require courts to override choice-of-forum and choice-of-law clauses.
--
Court: Court of Appeals of Georgia
Opinion Date: 11/20/12
Cite: Carson v. Obor Holding Co., LLC, 2012 Ga. App. LEXIS 971 (Ga. Ct. App. Nov. 20, 2012)
Favors: Employee
Law: Georgia
Friday, April 13, 2012
End of the Week Discussion
I thought I'd take after Russell Beck and John Marsh and provide a longer summary of some cases, articles, and blog posts I read the past week or so.
Mind you, a lot of this information gathering occurred at 3 a.m. holding a screaming baby, so if what I write doesn't make sense, forgive me.
Recent Cases
United Rentals, Inc. v. Frey, 2012 U.S. Dist. LEXIS 40009 (D. Conn. Mar. 23, 2012). A district court granted an employee's motion for summary judgment on the issue of damages. The case followed a familiar pattern, as the employee violated the non-compete provision by contacting customers within the Restricted Area (as defined in the contract). However, the agreement tried to establish damages by placing a constructive trust on whatever the employee earned as a result of the breach. This was contrary to Connecticut law, which mandates that an employer demonstrate what it would have earned absent the breach.
Fail-Safe, LLC v. A.O. Smith Corp., No. 11-1354 (7th Cir. Mar. 29, 2012). The Seventh Circuit affirmed entry of summary judgment on a trade secrets case, one of the few it has had recently. The case involved an effort between two companies to develop a certain type of technology relating to pool drain entrapment prevention technology (which is a long way of describing way to keep people from getting stuck in a pool...). The case describes the failure of the plaintiff to take any steps to protect what it believed was confidential business information in its technology development discussions with the defendant. Of particular importance to the Seventh Circuit was the lack of any confidential relationship between the two companies (they weren't fiduciaries, partners, or anything really...except two independent entities), the failure to designate or mark documents confidential, and the apparent willingness to disclose information without a confidentiality agreement in place. This wasn't a close case.
United Factory Furniture Corp. v. Alterwitz, 2012 U.S. Dist. LEXIS 48795 (D. Nev. Apr. 6, 2012). This case approved of a mirror imaging protocol over the defendants' computers. The case, which does not deal with a non-compete agreement, generally involved an employee's alleged misuse of company information and improper access to a server. The court balanced the interests in preserving potentially relevant evidence and individual privacy considerations, concluding that the appointment of a third-party neutral expert to image and collect hard-drives was the appropriate way to satisfy the competing interests at stake.
Recent Blog Posts and Articles of Interest
I provided a couple of links yesterday to the U.S. v. Nosal commentary, one from John Marsh and another from Robert Milligan at Seyfarth.
For other commentary on this case, see a Reuters article here. Also the Privacy and Security Law Blog, here.
Hat-tip to Rob Radcliff for his link to this article concerning Synthes' continued pursuit of ex-sales reps for non-compete violations. The sales rep is fighting back with an interesting anti-trust counterclaim, arguing (I think) that Sythes is misusing the legal process to restrain trade.
Really good discussion from Fisher & Phillips on the blue-pencil rule. I happen to think an overuse of the blue-pencil rule smacks of judicial activism, forcing parties to agree ex post to contracts other than the ones they've signed. Vice-Chancellor Travis Laster issued an excellent decision last year concerning this, expressing his rather dim view of judicial modification of non-competes.
Speaking of judicial activism, the Chicago Tribune editorial page published an Op-Ed by Geoffrey Stone on judicial activism, specifically with reference to the Affordable Care Act. This has nothing to do with non-competes, of course, and I'm not sure there is a single thing I agree with in this editorial. Still, it's interesting - in the same way listening to Newt Gingrich can be interesting.
Mind you, a lot of this information gathering occurred at 3 a.m. holding a screaming baby, so if what I write doesn't make sense, forgive me.
Recent Cases
United Rentals, Inc. v. Frey, 2012 U.S. Dist. LEXIS 40009 (D. Conn. Mar. 23, 2012). A district court granted an employee's motion for summary judgment on the issue of damages. The case followed a familiar pattern, as the employee violated the non-compete provision by contacting customers within the Restricted Area (as defined in the contract). However, the agreement tried to establish damages by placing a constructive trust on whatever the employee earned as a result of the breach. This was contrary to Connecticut law, which mandates that an employer demonstrate what it would have earned absent the breach.
Fail-Safe, LLC v. A.O. Smith Corp., No. 11-1354 (7th Cir. Mar. 29, 2012). The Seventh Circuit affirmed entry of summary judgment on a trade secrets case, one of the few it has had recently. The case involved an effort between two companies to develop a certain type of technology relating to pool drain entrapment prevention technology (which is a long way of describing way to keep people from getting stuck in a pool...). The case describes the failure of the plaintiff to take any steps to protect what it believed was confidential business information in its technology development discussions with the defendant. Of particular importance to the Seventh Circuit was the lack of any confidential relationship between the two companies (they weren't fiduciaries, partners, or anything really...except two independent entities), the failure to designate or mark documents confidential, and the apparent willingness to disclose information without a confidentiality agreement in place. This wasn't a close case.
United Factory Furniture Corp. v. Alterwitz, 2012 U.S. Dist. LEXIS 48795 (D. Nev. Apr. 6, 2012). This case approved of a mirror imaging protocol over the defendants' computers. The case, which does not deal with a non-compete agreement, generally involved an employee's alleged misuse of company information and improper access to a server. The court balanced the interests in preserving potentially relevant evidence and individual privacy considerations, concluding that the appointment of a third-party neutral expert to image and collect hard-drives was the appropriate way to satisfy the competing interests at stake.
Recent Blog Posts and Articles of Interest
I provided a couple of links yesterday to the U.S. v. Nosal commentary, one from John Marsh and another from Robert Milligan at Seyfarth.
For other commentary on this case, see a Reuters article here. Also the Privacy and Security Law Blog, here.
Hat-tip to Rob Radcliff for his link to this article concerning Synthes' continued pursuit of ex-sales reps for non-compete violations. The sales rep is fighting back with an interesting anti-trust counterclaim, arguing (I think) that Sythes is misusing the legal process to restrain trade.
Really good discussion from Fisher & Phillips on the blue-pencil rule. I happen to think an overuse of the blue-pencil rule smacks of judicial activism, forcing parties to agree ex post to contracts other than the ones they've signed. Vice-Chancellor Travis Laster issued an excellent decision last year concerning this, expressing his rather dim view of judicial modification of non-competes.
Speaking of judicial activism, the Chicago Tribune editorial page published an Op-Ed by Geoffrey Stone on judicial activism, specifically with reference to the Affordable Care Act. This has nothing to do with non-competes, of course, and I'm not sure there is a single thing I agree with in this editorial. Still, it's interesting - in the same way listening to Newt Gingrich can be interesting.
Tuesday, September 27, 2011
Step-Down Clauses May Be Important In Blue-Pencil States (Team IA, Inc. v. Lucas)
Step-down clauses are not something I often see in non-compete agreements.
The basic premise is fairly easy to grasp. A step-down clause provides alternative restrictions if a court finds that one (that is, the more restrictive one) is too broad to be enforced. When would such a clause be appropriate to use? If your jurisdictions is a true blue-pencil state.
The blue-pencil rule provides that, though certain overbroad clauses can be stricken without invalidating an entire contract, a non-compete clause cannot be rewritten by a court to make it reasonable. That means that a restriction - usually a territorial one - runs the risk of being held overbroad, unenforceable and not salvageable.
A step-down clause is a creative way to avoid the sometimes strict impact of the blue-pencil rule. A recent South Carolina case, which upheld a step-down clause, illustrates how it can work in the context of a non-compete lawsuit. The employee's territorial restriction was nationwide, but also provided that in the event it was held overbroad, could be limited to four southeastern states.
The court struck down the nationwide restriction as overbroad but concluded the step-down clause, with a much narrower geographic territory, was valid and enforceable.
In equitable modification states (which allow for reasonable alterations to a non-compete to make them reasonable), using a step-down clause is not as critical. Still, it may provide the court an easy alternative. Many judges are hesitant to modify parties' contracts and may view a reasonable step-down clause as upholding the parties' bargain.
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Court: Court of Appeals of South Carolina
Opinion Date: 9/14/11
Cite: Team IA, Inc. v. Lucas, 2011 S.C. App. LEXIS 267 (S.C. Ct. App. Sept. 14, 2011)
Favors: Employer
Law: South Carolina
Friday, April 22, 2011
Be Careful When Drafting Geographic Restriction in Louisiana (In re Gulf Fleet Holdings, Inc.)
Louisiana is one of those special drafting states. Attorneys must proceed with great care when drafting the scope of a non-compete restriction by virtue of a strictly applied statute. Section 23:921(C) of the Louisiana Statutes provides that for a non-compete to be enforceable specific parishes or municipalities must be identified. Even if an employer conducts business throughout the state, a blanket prohibition on competing in Louisiana will be invalid.
It is settled law in Louisiana that an employer cannot enforce a non-compete in a parish where it does not conduct business. For employers that want to restrict post-employment activities, therefore, it is essential to be consistent and include in the non-compete agreement only those parishes where it can show demonstrable business activity.
If an employer chooses to be overinclusive and list, for instance, all parishes in Louisiana, this would not necessarily be fatal or render the covenant overbroad. Several courts, including a recent adversary proceeding in bankruptcy, have allowed an employer to engage in this practice and have blue-penciled the listed parishes where the employer does not engage in business.
Another twist, however: the operative agreement must contain a clause allowing for such severing of the covenant. Finally, if the covenant applies outside Louisiana, the restrictions must also list out the prohibited territories by county. So for instance, if an employer chooses to restrict business in neighboring Texas, it too must list each Texas county it considers off-limits.
Louisiana courts place a strange emphasis on over-technical drafting. It can certainly be argued that the practice of blue-penciling specific parishes or counties creates an incentive for an employer to be overinclusive and overbroad, knowing full well courts can strike specific locations without rendering the entire agreement unenforceable.
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Court: United States Bankruptcy Court for the Western District of Louisiana
Cite: In re Gulf Fleet Holdings, Inc., 2011 Bankr. LEXIS 1396 (W.D. La. Mar. 31, 2011)
Opinion Date: 3/31/11
Favors: Employer
Law: Louisiana
Wednesday, April 13, 2011
Court Considers Hypotheticals In Determining Overbreadth of CVS Non-Compete Agreement (Saban v. Caremark Rx, LLC)
I have written often on the important of good, clear drafting.
At a seminar I presented last week, a circuit court judge agreed with my observation on the blue-pencil rule. She stated that in 23 years, she has not modified an overbroad covenant. Courts simply do not warm to the idea of subjecting the parties to a contract to which they did not agree.
A recent case involving a former key employee of Caremark illustrates the danger of poor drafting that yields potentially absurd results. The one-year non-compete in the case of Joel Saban provided Saban could not work "in any capacity" for a business engaged in "Competition." The biggest problem for CVS was its definition of "Competition", which included for instance any retail business with plans to include a pharmacy as a "component of its business.
Saban, however, was not a CVS pharmacist or retail employee. He was, essentially, a key business-to-business guy who negotiated drug price discounts in the pharmacy benefits management side of Caremark. Utilizing hypotheticals about what the covenant would prohibit yielded "canyon-like" overbreadth in terms of potential restrictions. Caremark objected to the use of such hypotheticals, contending it was inconsistent with ascertaining the parties' intent at the time of contracting.
The court had little trouble rejecting this argument. The use of hypotheticals to demonstrate overbreadth is part and parcel of a non-compete defense on the issue of reasonableness. This all goes back to the concept of notice and basic fairness. If the terms of the covenant are not sufficiently clear to advise an employee of what conduct is prohibited, then an employee's burden to comply is too high.
Hypotheticals are most relevant to illustrate cases on the edge - where the employee believes he is complying, but the employer says he isn't. But they are still relevant even in claims where indisputably direct, vigorous competition exists. This is so because the employee challenging the covenant may have sought legal advice on whether to compete based on the reasonableness of the covenant's language.
The larger point here is that overbroad covenants do not get a free pass if the actual facts show true and substantial competition. Any employer deploying a covenant must run through a series of hypotheticals to see if the terms capture too much business activity or that commensurate with the interest it is trying to protect.
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Court: United States District Court for the Northern District of Illinois
Opinion Date: 4/11/11
Cite: Saban v. Caremark Rx, LLC, 2011 U.S. Dist. LEXIS 38847 (N.D. Ill. Apr. 11, 2011)
Favors: Employee
Law: Rhode Island
Monday, April 4, 2011
"Reasonableness" of Non-Compete Must Be Examined In Totality (Delaware Elevator, Inc. v. Williams)
As readers know, a non-compete's enforceability depends on whether it is reasonable under the law. The idea of reasonableness is multi-layered. In most states, a court must consider time, territory, activity limits, impact on the employee, and impact on the public.
Vice Chancellor Travis Laster of the Delaware Court of Chancery wrote one of the best, most well-reasoned opinions I have seen on a non-compete case the past several years. He weaved in and out of timeless legal doctrines and contemporary economic choices that employers and employees make. He also excoriated the blue-pencil doctrine as a boondoggle that encourages poor draftsmanship.
But the most important part of the case centers on how courts should assess reasonableness. Laster favors a cohesive approach where a court examines time, territory and other restrictions of a covenant to determine how they work in combination. In short, Laster states: "All else equal, a longer restrictive covenant will be more reasonable if geographically tempered, and a restrictive covenant covering a broad area will be more reasonable if temporally tailored." He is one of the few judges who emphasize this point.
Laster likely is aware of how lawyers play the reasonableness game. Parse out one term of the agreement, cite a case that holds it is reasonable, and move on to the next point. This is fundamentally the wrong approach. A court needs to examine how the factors operate together, not in a vacuum.
Laster is relatively new to the Court of Chancery, having ascended to the position in 2009. Already, he is viewed as energetic, smart, and willing to challenge lawyers. Any case by Judge Laster is already persuasive precedent.
An excellent article on Judge Laster can be found here
Court: Court of Chancery of Delaware, New Castle
Opinion Date: 3/16/11
Cite: Delaware Elevator, Inc. v. John J. Williams, 2011 Del. Ch. LEXIS 47 (Del. Ct. Ch. Mar. 16, 2011)
Favors: Neutral
Law: Maryland
Tuesday, March 15, 2011
One-Way Fee Shifting Clauses and Public Policy
Fee-shifting clauses are fairly common in non-compete agreements.
While most fee-shifting provisions in negotiated commercial contracts are mutual, employment non-compete agreements frequently contain one-way clauses. Under this scheme, employers often retain the right to obtain fees if they prevail in a dispute against an ex-employee. (Not suprisingly, I have yet to see a clause that allows only the employee to obtain his or her fees in a successful defense.)
One question I often hear from my employee clients is whether such a one-way provision is even enforceable.
At least a couple of theories are available.
First, some states may have statutes of general applicability that automatically construe one-way fee shifting provisions into mutual ones. California, Montana, and Washington are examples.
Second, a judge may be receptive to an unconscionability defense. For prevailing employees, this argument doesn't appear to give them a right to recover their fees. However, it may be a viable route to avoid fee-shifting in the event of a loss. An appellate court judge in Ohio in 1992 was open to this unconscionability defense, but since the parties did not raise it before the court, the issue was never decided.
Third, the rule of equitable modification may give a prevailing employee grounds to seek fees under a one-way fee-shifting clause. In those states that adopt equitable modification, rather than a strict blue-pencil rule, courts retain the ability to modify overbroad covenants to make them reasonable.
Can this rule be extended to allow a court to modify a fee-shifting clause? I don't know if there is any case that has ever ruled on this issue, but I think the argument has some intuitive appeal. In my mind, a lot would depend on the breadth of the restrictions, the parties' bargaining power, and the governing state's policy on reformation of covenants.
Because non-compete agreements implicate public policy unlike other commercial contracts, a higher degree of scrutiny of one-way fee provisions logically should apply. Whether a court actually will be open to this argument is something I have not yet seen.
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