Debts Incurred for Violating Non-Competition Provision Usually Are Dischargeable (In re: O'Connor)

In most competition cases, a defendant's obligation to satisfy a monetary judgment entered against him or her may be impacted by the decision to file for bankruptcy.

As a general matter, contract debts are dischargeable. So, if an employee is found liable for breach of a non-compete contract and found to owe lost profits or liquidated damages to the ex-employer, he may be able to avail himself of bankruptcy law and avoid the obligation. It is likely in such a factual matrix that the debt would be discharged.

There are a few notable exceptions, however. If a damages judgment is rendered on a breach of fiduciary duty claim (which often is added to a non-compete case, depending on the pre-termination conduct), that would not be dischargeable as long as the trust relationship existed prior to the act creating the debt. Note that in some jurisdictions (e.g., New Hampshire) ordinary employees do not automatically owe a fiduciary duty to their employers. The test is usually whether the employee was in a supervisory or managerial capacity, but these are rare exceptions.

Another provision of the bankruptcy code provides for non-dischargeability in the event of a willful or malicious injury. No matter how much an employee intends to violate a non-compete, however, the question of malice in a contract claim is meaningless. There is nothing inherently wrong with breaching a contract, as long as the non-breaching party is made whole.

There is one interesting other exception to the non-dischargeability rule: a judgment of damages following a finding of contempt will not be dischargeable. Say, for instance, that a defendant breaches a non-compete agreement and is enjoined by order of the court (or, even by agreement) from further violating his or her contract. If that defendant subsequently competes in a way that violates the court order, any damages arising from the contempt proceeding are non-dischargeable under Section 523(a)(6). This rule applies to both temporary and permanent injunctions.

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Court: United States Bankruptcy Court for the Western District of Louisiana
Opinion Date: 9/30/10
Cite: In re O'Connor, 2010 Bankr. LEXIS 3475 (W.D. La. Sept. 30, 2010)
Favors: Employee
Law: Federal

Contempt Sanctions May Allow for Double Recovery (Mitchells Salon & Day Spa v. Bustle)

It is a truism most non-compete agreements get resolved well short of trial. To be sure, the settlement options available to parties in non-compete disputes are much more robust, since even the most vigorously fought, emotional contests don't necessarily result in large monetary exposure. Conduct restrictions, in myriad forms, are always potential settlement options. And usually better ones at that.

Given the frequent disparity in resources between the parties, a negotiated resolution sometimes results not just in a settlement agreement but also an actual agreed court order outlining what the ex-employee cannot do in the marketplace. From the employer's perspective, the specter of a court order is much more powerful given the potential for contempt sanctions if the ex-employee gets an irresistable itch to compete. On the other hand, documenting a restriction in a private settlement agreement means the ex-employer would need to sue for a violation on a separate contract claim.

The sanctions for violating a court order can be significant. A recent Ohio appellate case illustrates this. In a dispute between a high-end beauty salon and a hair stylist, the latter agreed to incorporate his non-solicitation covenant into a court order. He soon began violating the order and directly provided stylist services to many of his former clients.

The court's penalty upon a finding of contempt was disgorgement of the profits the stylist earned and extension of the covenant for an additional 11 months so that the salon obtained the benefit of its bargain. Arguably, this constitutes a double-recovery. The stylist also was ordered to pay the salon's legal fees in excess of $15,000 and private investigator fees of more than $52,000. Courts have much wider discretion to impose penalties for civil contempt. It should go without saying that parties have a much greater interest in complying with a court order than a private contract, but the Ohio case illustrates how sweeping those penalties can be.

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Court: Court of Appeals of Ohio, First Appellate District
Opinion Date: 4/30/10
Cite: Mitchells Salon & Day Spa, Inc. v. Bustle, 187 Ohio App. 3d 336 (Ohio Ct. App. 1st Dist. 2010)
Favors: Employer
Law: Ohio

Ohio Decision Demonstrates Vagueness Problem With Trade Secrets Injunctions (Chornyak & Assoc. v. Nadler)

A recent decision out of the Ohio appellate courts demonstrates a common, amateurish mistake many attorneys make in trade secrets litigation.

On appeal, a company in the financial services industry contended the trial court improperly refused to hold its ex-employee in contempt of court for violating a permanent injunction order entered in November 2005. That order restrained defendant from "directly or indirectly, ... disclosing, using, transferring or destroying any Chornyak & Associates, Ltd. trade secret(s) as that term is defined in [Ohio Code Section] 1333.61 in any form whatsoever including originals, copies, other reproductions, derivatives, or computerized information, in any form whatsoever."

The plaintiff filed a contempt citation when its expert determined that the defendant had uploaded and used one Word document and two Excel spreadsheets generated during the course of his employment with Chornyak and which had been in his home office stored on a floppy disk. Eventually, the appellate court affirmed the trial court's determination that none of the documents constituted trade secrets of the former employer, and it upheld the trial court's denial of the contempt citation.

The more central question, though, is why the court even addressed the status of the documents as trade secrets in the first place. The underlying injunction order was patently void.

Illinois law on this issue is particularly exacting, mandating that a party seeking an order of injunctive relief spell out with reasonable specificity the exact trade secrets that are the subject of the restraint. In state court, Tseutaki v. Novicky, 158 Ill. App. 3d 505 (1st Dist. 1983), sets forth the standard, while in federal courts the landmark decision from American Can v. Mansukhani, 742 F. 2d 314 (7th Cir. 1984), delineates the law to be followed.

At bottom, a reasonable person with no legal training must be able to ascertain what documents or categories of information are subject to an order punishable by contempt. Simply incorporating the terms "trade secrets or confidential information of the Plaintiff" is too vague and not enforceable by contempt sanctions.

Poor drafting and lack of judicial oversight of such orders does no one any good. The plaintiff will not be able to rely on the order in the event the defendant uses its information, and the defendant will have to test its conduct through contempt proceedings. Great care must be taken with the drafting of injunction orders. And if the plaintiff is concerned about disclosing its trade secrets in a court order, it can always make reference to an attached schedule kept under seal in the court file.

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Court: Court of Appeals of Ohio, Tenth Appellate District
Opinion Date: 12/18/08
Cite: Chornyak & Assoc., Ltd. v. Nadler, 2008 Ohio App. LEXIS 5569 (Ohio App. Ct. Dec. 18, 2008)
Favors: Employee
Law: Ohio