Choice-of-law and -forum clauses are not only some of the most important issues in non-compete agreements, but they also are some of the most complex.
To step back, the clauses are just what they sound like. If you have a restrictive covenant agreement, look to the back and you'll find what many normal people call "boilerplate" terms. A choice-of-law clause says what State's law will govern the agreement. And a choice-of-forum clause will tell you where the case can, or even must, be heard.
These clauses take on added importance for employees who work for larger enterprises, because often the employee's place of citizenship will differ from the corporate nerve center. A valued sales employee may have selling responsibility only on the west coast, but her company may be situated in New York or Florida. This is extremely common, and employees often don't quite know what to do when their place of residence is different than the law governing their agreements.
Red-flag States, such as California and Oklahoma, pose special problems because of clear public policy concerns that deal with non-compete law. In those States (and others), many restrictive covenants enforceable in States like Texas or Florida won't be reasonable at all. What to do, then, when a citizen of one of these States has an agreement governed by a State's law that embraces non-competes?
Let's walk through how to assess this.
Step 1: Determine the employee's place of citizenship. This should be easy, but we've seen cases where employees move in order to take a new job in a State that is somewhat hostile to non-competes. Can this move aid the employee, or is it irrelevant?
Step 2: Find out if the employee's home State poses special enforcement problems. Those States are California, Oklahoma, North Dakota, Louisiana, and Wisconsin. There may be others, too, but for certain an employee's citizenship in one of these States should cause counsel to engage in a deep enforceability analysis.
Step 3: Ascertain whether suit in State or Federal court is likely. If there is a possibility of a suit in Federal court, then the Supreme Court's case of Atlantic Marine in 2013 will be important to consider. But, that is only if the contract contains a choice-of-forum clause.
Step 4: Review State choice-of-law rules. Most States adopt the analysis from Section 187 of the Restatement (Second) of Conflicts of Laws. If the parties select a State's law to apply, it will be given effect unless one of two conditions is met: (a) the selected State has no substantial relationship to the parties or the transaction; or (b) application of the chosen State's law would be contrary to the public policy of a State that has a materially greater interest and whose law would apply absent the choice-of-law clause.
Step 5: Apply the choice-of-law rules. Often, the first exception noted above won't apply, unless you encounter the totally bonkers situation where an employer gratuitously picks the most authoritarian State even though that State has nothing to do with the employment relationship. Or, perhaps, the employer picks Delaware when the only connection to Delaware is that the company chose to be incorporated there. That may fall within exception (a).
More likely, you'll need to do a deep dive on exception (b), which often applies when an employee has little connection to the forum State. Again, consider my example where an employee sells only in Oklahoma and has no job responsibilities in New York where the company home is. Very common fact pattern.
Step 6: Assuming you have a scenario involving exception (b), consider the nature of the public-policy at stake. Do you have a California problem, where non-competes are totally off-limits? Or do you have a State with marginal deviations to the general rule of reason, like a Nebraska which does not allow overbroad non-competes to be enforced? Sometimes these small deviations can be outcome-determinative in a particular dispute, but is that enough to qualify as a "public policy"? Debatable, to be sure.
Step 7: See if some other limiting condition applies. That is, does a State have a particular rule about choice-of-law or -forum clauses that applies to employees? Some States do by statute.
There are a few recent illustrations that involve some or all of these steps. The first comes from the redundantly-named Supreme Judicial Court of Massachusetts in a case called Oxford Global Resources, LLC v. Hernandez, in which the SJC held that a Massachusetts court would not enforce choice-of-law and -forum clauses that both selected Massachusetts against a former employee residing in California. Of particular note, that employee had job responsibilities only in California. The deciding factor was California's strong public policy that I have discussed often, which bars non-competes for employees.
Conversely, the Delaware Court of Chancery addressed a slightly different question in NuVasive, Inc. v. Miles. There, an employee in California entered into an employment contract that specified Delaware law and venue. But that agreement was entered into after California amended its Labor Code, Section 925. That section was generally intended to deepen the public policy interest against non-competes by preventing circumvention of California law through choice-of-law clauses. But Section 925 also carved out contracts where the employee's counsel negotiates the choice-of-law provision. As the Delaware court found, that carve-out balanced an overriding public policy interest in favor of free competition with a countervailing interest in the freedom to contract. As such, the choice-of-law clause was valid.
These issues are extremely important, and sometimes the case law can be confusing. That is more so with venue clauses than with choice-of-law provisions. But an employee and counsel must be attuned to the importance of both when it appears they can have an impact on the agreement.
Showing posts with label Delaware. Show all posts
Showing posts with label Delaware. Show all posts
Monday, November 19, 2018
Monday, July 16, 2018
Back from Hiatus (Part II): State Law Updates
Last week, I discussed three examples of Illinois courts analyzing similar non-compete issues in very different ways, a post that amply illustrates how difficult it is for lawyers to predict outcomes for clients. It also reminded me of a famous Abraham Lincoln quote: "Discourage litigation. Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser - in fees, expenses, and waste of time. As a peacemaker the lawyer has a superior opportunity of being a good man. There will still be business enough."
But to be sure, many people ignore Lincoln and litigate anyway - often with profoundly silly reasons motivating them.
So because we have litigation, we have legal developments and I therefore have a blog that continues to chug along. And you continue to read, meaning I must update you with some new rulings over the past several months.
California:
The infamous, long-running case involving ex-Korn/Ferry International executive David Nosal may have reached its end, with the Supreme Court declining a cert petition and the District Court now having finally decided on the scope of Nosal's restitution to KFI. United States v. Nosal is the most notable case under the Computer Fraud and Abuse Act, which generally criminalizes unauthorized access to protected computers. Nosal had its roots as a garden-variety trade secret case, but it was a criminal prosecution and tested the CFAA's limits.
Ultimately, Nosal secured some victories along the way. But still he will serve a year in prison and pay restitution to KFI. As to the scope of restitution, KFI sought about $1,000,000 in legal fees incurred to assist the Department of Justice investigation. After the Ninth Circuit weighed in KFI, will have to settle for less: $164,000. Still a heavy price to pay for Nosal, who probably deserved a civil suit but definitely does not deserve to spend a year in prison.
Connecticut:
The case of Datto, Inc. v. Falk discussed whether a forfeiture-for-competition clause was reasonable and enforceable. A minority of jurisdictions apply the same, or at least a similar, non-compete standard to these clauses, which (as one might expect) enable an employer to clawback certain benefits if an employee leaves to compete.
Forfeiture clauses range in scope, frequently calling for the forfeiture of unvested stock options but sometimes also calling for the employee to pay back income earned from the exercise of a grant within a certain period before the end of employment. Datto involved a dispute as to whether the cancellation of certain stock options were void because Falk (an ex-Chief Revenue Officer) accepted a position with a competitor.
The court was bound to apply Delaware law on the question of reasonableness, and that law in my view is somewhat confusing. Precedent, in effect, equated true non-competes with forfeiture clauses, finding they accomplished the same results. That's not necessarily true. A forfeiture clause may incent future performance, while a non-compete unquestionably tries to protect a separate economic interest beyond employee loyalty.
Datto illustrates the confusion in its analysis, though the district court judge admittedly was bound by controlling law. He noted, for instance, that the forfeiture clause was reasonable because "[t]his is not a case of an employee who is barred altogether from working for the competition anywhere in the world."
In my opinion, courts ought to use varying levels of scrutiny when examining restraints, similar to the current First Amendment jurisprudence. Specifically, I think that for employment-based non-competes, courts should use the strict scrutiny test (which by and large, they say they do), and for sale-of-business non-competes, they should examine them under a rational basis inquiry.
For mid-tier restrictions, like franchise non-competes and forfeiture clauses like that in Datto, I would use intermediate scrutiny. That test would require courts to determine whether the restrictive means used (e.g., the scope of the event triggering the forfeiture) are substantially related to the interest the restraint is designed to protect. This test, though it may not be perfect, would at least provide courts with a flexible, coherent way to analyze less problematic covenants that lack adhesive properties.
New York:
The New York Court of Appeals answered a significant question of damages related to trade secrets claims in the case of E.J. Brooks v. Cambridge Security Seals. The Court held that a plaintiff's damages cannot be measured by the costs the defendant avoided due to unlawful activity.
If a principal goal of trade secret law is to encourage innovation, then a cost-avoidance theory of damages seems to be a logical means to further that goal. Stated another way, if the misappropriation shortens a product-development cycle and enables X to bring a product to market more efficiently, then X is unjustly enriched by not incurring research-and-development expenses.
In the Court's view, cost-avoidance is inconsistent with a compensatory theory of damages. And under New York law, only the plaintiff's losses count. Cost-avoidance theory resembles unjust enrichment, but because New York has not adopted some variation of the Uniform Trade Secrets Act -- which specifically allows for unjust enrichment-type damages -- the theory is not viable.
The holding, predictably, spurred a long and persuasive dissent. It summarized the pragmatism and utility of cost-avoidance damages, noting that they are "generally much simpler than, and less subject to challenge than, lost-profit damages, which makes them an attractive alternative for plaintiffs who are willing to forego a potentially larger recovery in favor of a smaller, more certain one." (The assumption of a "smaller" recovery reasonably invokes the principle that a developer does not spend X to recover X. Normally, a rational economic actor would spend X to recover some multiple of X.)
A link to E.J. Brooks is available here. I emphasize again that I view this as a distinctly New York rule of law, and not one likely to be adopted across jurisdictions that have embraced a more flexible approach to damages.
South Carolina:
But to be sure, many people ignore Lincoln and litigate anyway - often with profoundly silly reasons motivating them.
So because we have litigation, we have legal developments and I therefore have a blog that continues to chug along. And you continue to read, meaning I must update you with some new rulings over the past several months.
California:
The infamous, long-running case involving ex-Korn/Ferry International executive David Nosal may have reached its end, with the Supreme Court declining a cert petition and the District Court now having finally decided on the scope of Nosal's restitution to KFI. United States v. Nosal is the most notable case under the Computer Fraud and Abuse Act, which generally criminalizes unauthorized access to protected computers. Nosal had its roots as a garden-variety trade secret case, but it was a criminal prosecution and tested the CFAA's limits.
Ultimately, Nosal secured some victories along the way. But still he will serve a year in prison and pay restitution to KFI. As to the scope of restitution, KFI sought about $1,000,000 in legal fees incurred to assist the Department of Justice investigation. After the Ninth Circuit weighed in KFI, will have to settle for less: $164,000. Still a heavy price to pay for Nosal, who probably deserved a civil suit but definitely does not deserve to spend a year in prison.
Connecticut:
The case of Datto, Inc. v. Falk discussed whether a forfeiture-for-competition clause was reasonable and enforceable. A minority of jurisdictions apply the same, or at least a similar, non-compete standard to these clauses, which (as one might expect) enable an employer to clawback certain benefits if an employee leaves to compete.
Forfeiture clauses range in scope, frequently calling for the forfeiture of unvested stock options but sometimes also calling for the employee to pay back income earned from the exercise of a grant within a certain period before the end of employment. Datto involved a dispute as to whether the cancellation of certain stock options were void because Falk (an ex-Chief Revenue Officer) accepted a position with a competitor.
The court was bound to apply Delaware law on the question of reasonableness, and that law in my view is somewhat confusing. Precedent, in effect, equated true non-competes with forfeiture clauses, finding they accomplished the same results. That's not necessarily true. A forfeiture clause may incent future performance, while a non-compete unquestionably tries to protect a separate economic interest beyond employee loyalty.
Datto illustrates the confusion in its analysis, though the district court judge admittedly was bound by controlling law. He noted, for instance, that the forfeiture clause was reasonable because "[t]his is not a case of an employee who is barred altogether from working for the competition anywhere in the world."
In my opinion, courts ought to use varying levels of scrutiny when examining restraints, similar to the current First Amendment jurisprudence. Specifically, I think that for employment-based non-competes, courts should use the strict scrutiny test (which by and large, they say they do), and for sale-of-business non-competes, they should examine them under a rational basis inquiry.
For mid-tier restrictions, like franchise non-competes and forfeiture clauses like that in Datto, I would use intermediate scrutiny. That test would require courts to determine whether the restrictive means used (e.g., the scope of the event triggering the forfeiture) are substantially related to the interest the restraint is designed to protect. This test, though it may not be perfect, would at least provide courts with a flexible, coherent way to analyze less problematic covenants that lack adhesive properties.
New York:
The New York Court of Appeals answered a significant question of damages related to trade secrets claims in the case of E.J. Brooks v. Cambridge Security Seals. The Court held that a plaintiff's damages cannot be measured by the costs the defendant avoided due to unlawful activity.
If a principal goal of trade secret law is to encourage innovation, then a cost-avoidance theory of damages seems to be a logical means to further that goal. Stated another way, if the misappropriation shortens a product-development cycle and enables X to bring a product to market more efficiently, then X is unjustly enriched by not incurring research-and-development expenses.
In the Court's view, cost-avoidance is inconsistent with a compensatory theory of damages. And under New York law, only the plaintiff's losses count. Cost-avoidance theory resembles unjust enrichment, but because New York has not adopted some variation of the Uniform Trade Secrets Act -- which specifically allows for unjust enrichment-type damages -- the theory is not viable.
The holding, predictably, spurred a long and persuasive dissent. It summarized the pragmatism and utility of cost-avoidance damages, noting that they are "generally much simpler than, and less subject to challenge than, lost-profit damages, which makes them an attractive alternative for plaintiffs who are willing to forego a potentially larger recovery in favor of a smaller, more certain one." (The assumption of a "smaller" recovery reasonably invokes the principle that a developer does not spend X to recover X. Normally, a rational economic actor would spend X to recover some multiple of X.)
A link to E.J. Brooks is available here. I emphasize again that I view this as a distinctly New York rule of law, and not one likely to be adopted across jurisdictions that have embraced a more flexible approach to damages.
South Carolina:
In Hartsock v. Goodyear Dunlop Tires North America, Ltd., the Supreme Court of South Carolina recognized an evidentiary privilege for trade secrets, but held the privilege was "qualified." That means it is different than, say, an attorney-client privilege or one barring self-incrimination. By "qualified," the Court held that a party seeking the disclosure of trade-secret material must show a "substantial need" for it that is relevant to the specific issues involved in the litigation. If a proponent makes that showing, the trade-secret holder still can gain the benefit of a protective order over the compelled disclosure.
The decision is, to be certain, a weird one. This is not really a privilege rule, but rather a rule of discovery that calls upon courts to make a balancing decision. If anything, this rule will create confusion where none should exist.
Texas:
Everything is bigger in Texas, including damages and attorneys' fee judgments. In the long-running case of Quantlab Technologies v. Godlevsky, a federal district court awarded the plaintiff its attorneys' fees in a trade secrets suit for what the court called defense behavior that was "so acrimonious, vexatious, and indefensible that...[it] exceeds any that this judge has seen in his nineteen years on the bench." The case involved stolen technology in the high-frequency trading industry, and the court at various times had sanctioned the defendants for destroying or failing to preserve evidence.
The price for that behavior was a fee judgment of $3,220,205 against each individual defendant.
The plaintiff didn't fare so well in GE Betz v. Moffitt-Johnston. There, the Fifth Circuit held that under Texas law, a company failed prove than ex-employee breached a customer non-solicitation covenant. The employee succeeded despite "highly suspicious" computer activity, including the mass download of data to an external device. But the company couldn't prove that any contacts with customers amounted to solicitation of business, rendering the contract claim unsupportable.
The Fifth Circuit did, however, vacate a large fee award for the ex-employee. Texas law allows an employee sued on a non-compete violation to obtain fees if the employer knows the agreement is overbroad and sues to enforce the agreement to an extent greater than necessary to protect the employer's interests. That's a hard standard to meet, absent some damaging admission or a truly terrible agreement. And the employee here didn't do so.
The price for that behavior was a fee judgment of $3,220,205 against each individual defendant.
The plaintiff didn't fare so well in GE Betz v. Moffitt-Johnston. There, the Fifth Circuit held that under Texas law, a company failed prove than ex-employee breached a customer non-solicitation covenant. The employee succeeded despite "highly suspicious" computer activity, including the mass download of data to an external device. But the company couldn't prove that any contacts with customers amounted to solicitation of business, rendering the contract claim unsupportable.
The Fifth Circuit did, however, vacate a large fee award for the ex-employee. Texas law allows an employee sued on a non-compete violation to obtain fees if the employer knows the agreement is overbroad and sues to enforce the agreement to an extent greater than necessary to protect the employer's interests. That's a hard standard to meet, absent some damaging admission or a truly terrible agreement. And the employee here didn't do so.
Thursday, September 25, 2014
Advancement Rights Percolate Beneath Delaware Trade Secrets Lawsuits
Assume you represent a company and suspect a departed executive is competing unfairly by using the company's trade secret information. Further assume you have a case with, at least at first blush, a strong set of facts and a motivated client which wants to move quickly. But like most trade secrets cases, the suit is going to cost a lot of money and take a great deal of discovery to resolve.
How do you feel about advising your client that it may need to pay the ex-employee's legal fees as the case proceeds?
This is the reality of trade secrets lawsuits, particularly against former officers and directors of Delaware corporations. Delaware has a broad public policy that encourages individuals to serve in officer and director roles. To entice that service, Delaware corporate law allows, and virtually all company bylaws adopt, broad advancement rights.
So what is "advancement"?
The concept simply refers to a corporation's obligation to front (or, advance) legal expenses that an officer or director incurs by reason of her service to the company. Unlike indemnification, advancement means that an officer or director may have a right to receive regular payments to defray legal expense as the proceeding develops over time.
Importantly, this advancement right even can apply when the officer or director sits in an adversarial position to the company, as the officer or director would in a trade secrets misappropriation case. I have highlighted above the phrase "by reason of" because it is central to many disputes over whether an individual is properly entitled to advancement of legal fees.
Delaware courts have provided a helpful definition for this key phrase: it simply means there must be a "causal connection" between the underlying proceedings and one's official corporate capacity. See Homestore, Inc. v. Tafeen, 888 A.2d 204, 214 (Del. 2005).
There are a growing number of cases that apply the official capacity test to trade secrets cases. The courts finding advancement rights in these cases reason that where a claim is based on misuse of confidential information learned in an individual's official corporate capacity, that claim is one that qualifies as being brought "by reason of" her service to the company. There are several cases that address this, and most look at the nature of the allegations found in the underlying complaint. An example for practitioners comes from Pontone v. Milso Indus. Corp., 2014 Del. Ch. LEXIS 152 (Aug. 22, 2014), a fairly common dispute between a company and a former officer, who competed after his non-compete agreement ended. The core allegation dealt with the officer's purported misuse of trade secrets to lure away customers and employees of the former employer.
The overarching rationale that allows for advancement is that a corporate officer would not have had access to confidential information but for her service to the company. This, courts reason, provides the essential link between the challenged conduct and the official capacity needed to meet the "by reason of" language that virtually all Delaware corporations have in their bylaws.
The advancement rights that are likely available may be limited to officers and directors, as opposed to employees. But it is essential to parse carefully the language of the state's enabling statute and the corporate charter and bylaws to see who qualifies for advancement and what the precise conditions are for receiving advancement. Though many states will follow Delaware case law, there is variation among the statutory provisions and a high likelihood that a non-Delaware entity will not provide for broad advancement rights.
So for those attorneys who are filing trade secrets cases, it is essential to evaluate the potential for advancing your adversary's costs along the way. In effect, this could double your client's litigation expense.
How do you feel about advising your client that it may need to pay the ex-employee's legal fees as the case proceeds?
This is the reality of trade secrets lawsuits, particularly against former officers and directors of Delaware corporations. Delaware has a broad public policy that encourages individuals to serve in officer and director roles. To entice that service, Delaware corporate law allows, and virtually all company bylaws adopt, broad advancement rights.
So what is "advancement"?
The concept simply refers to a corporation's obligation to front (or, advance) legal expenses that an officer or director incurs by reason of her service to the company. Unlike indemnification, advancement means that an officer or director may have a right to receive regular payments to defray legal expense as the proceeding develops over time.
Importantly, this advancement right even can apply when the officer or director sits in an adversarial position to the company, as the officer or director would in a trade secrets misappropriation case. I have highlighted above the phrase "by reason of" because it is central to many disputes over whether an individual is properly entitled to advancement of legal fees.
Delaware courts have provided a helpful definition for this key phrase: it simply means there must be a "causal connection" between the underlying proceedings and one's official corporate capacity. See Homestore, Inc. v. Tafeen, 888 A.2d 204, 214 (Del. 2005).
There are a growing number of cases that apply the official capacity test to trade secrets cases. The courts finding advancement rights in these cases reason that where a claim is based on misuse of confidential information learned in an individual's official corporate capacity, that claim is one that qualifies as being brought "by reason of" her service to the company. There are several cases that address this, and most look at the nature of the allegations found in the underlying complaint. An example for practitioners comes from Pontone v. Milso Indus. Corp., 2014 Del. Ch. LEXIS 152 (Aug. 22, 2014), a fairly common dispute between a company and a former officer, who competed after his non-compete agreement ended. The core allegation dealt with the officer's purported misuse of trade secrets to lure away customers and employees of the former employer.
The overarching rationale that allows for advancement is that a corporate officer would not have had access to confidential information but for her service to the company. This, courts reason, provides the essential link between the challenged conduct and the official capacity needed to meet the "by reason of" language that virtually all Delaware corporations have in their bylaws.
The advancement rights that are likely available may be limited to officers and directors, as opposed to employees. But it is essential to parse carefully the language of the state's enabling statute and the corporate charter and bylaws to see who qualifies for advancement and what the precise conditions are for receiving advancement. Though many states will follow Delaware case law, there is variation among the statutory provisions and a high likelihood that a non-Delaware entity will not provide for broad advancement rights.
So for those attorneys who are filing trade secrets cases, it is essential to evaluate the potential for advancing your adversary's costs along the way. In effect, this could double your client's litigation expense.
Friday, October 5, 2012
Case Law Update: The Remedies and Civil Procedure Edition
This is a much overdue case law update, so it's a little lengthy. But on the upside, it touches on a number of different subjects from around the country.
Lost Profits
A federal district court in Indiana excluded significant parts of an expert's lost profits testimony in the hotly contested case of CDW, LLC v. NETech Corp. The case arose out of an allegation that NETech lifted out CDW's Indianapolis branch office and suffered millions in losses in "advanced technology" revenue. On a Daubert motion, the district court excluded a financial expert's "yardstick" methodology for predicting what CDW's Indianapolis branch would have earned but for the alleged wrongful conduct by the ex-employees. The ruling effectively excluded opinions that would have established lost profits of over $17,000,000. The district court allowed an alternative formulation of lost profits in a much lower amount to go to the jury.
Equitable Extension
The extension of non-competes past their expiration date (as measured from the date of termination of employment) is one of the most controversial, hotly contested remedies in litigation. As a federal district court in Idaho noted a few weeks ago, judges normally impose this remedy - when it's available - after a jury finding of breach or after a favorable ruling on summary judgment for the enforcing party. But in unusual cases, like that in MWI Veterinary Supply Co. v. Wotton, 2012 U.S. Dist. LEXIS 131784 (D. Idaho Sept. 14, 2012), the court can issue an extension remedy at a TRO or preliminary injunction phase. That finding was important in the Wotton case since the court had to find extension was appropriate to determine likelihood of success on the merits of the case. The non-compete, which arose out of the sale of a business, expired by the time the court addressed the preliminary injunction motion.
Temporary Restraining Orders
An Ohio court refused to grant a temporary restraining order against a departed sales executive in Chart Industries, Inc. v. Spagnoletti, 2012 U.S. Dist. LEXIS 140102 (N.D. Ohio Sept. 28, 2012), because the non-competition covenant contained no geographic or job-scope limitations. Though careful to note that such covenants were not per se unenforceable, the court stated it was important that the employer did not ask the court to impose any sort of limitation on the covenant at the TRO stage that would make it reasonable. The case demonstrates the continued difficulty courts have enforcing non-competes that contain no limiting language whatsoever. Delaware law applied.
Necessary and Indispensable Parties
In non-compete cases, the plaintiff sometimes will elect to forego suing the new employer and will proceed simply against the employee. There are a number of strategic and substantive reasons why this may be the case. The ruling in OneCommand, Inc. v. Beroth, 2012 U.S. Dist. LEXIS 122587 (S.D. Ohio Aug. 29, 2012), shows that a new employer is not a necessary party who must be part of the litigation under Federal Rule of Civil Procedure 19. Even if the plaintiff has potential claims against a new employer (for interference, trade secrets theft and the like), it is not necessary to make that company a party to a breach of contract suit with the employee.
Jury Trial Waivers
The right to a jury trial can be waived by contract if the waiver is knowing and voluntary. Generally, such waivers are strictly construed, however. One question that frequently arises is how far the contractual waiver extends to non-contract claims, like trade secrets misappropriation. A Delaware court concluded that a jury waiver provision in an asset purchase agreement encompassed related tort claims of trade secrets theft, conversion, and common-law unfair competition - reasoning that the "arising out of" language in the agreement was sufficiently broad to include torts intrinsically related to the contract action. The case is Coface Collections North Am., Inc. v. Newton, 2012 U.S. Dist. LEXIS 124342 (D. Del. Aug. 31, 2012).
Attorneys' Fees
Non-compete litigation can sometimes perpetuate itself solely because of fees that are incurred. An illustration of this problem comes from the case of Cumulus Broadcasting v. Okesson, 2012 U.S. Dist. LEXIS 124836 (D. Conn. Sept. 4, 2012). After the parties settled, they left it to the district judge to award attorneys' fees under a provision of the employment agreement that enabled the plaintiff to recover fees enforcing the non-compete.
The court, seemingly none-too-pleased (particularly since it was not allowed to see the terms of the parties' settlement agreement (?)), significantly pared back what the plaintiff thought it was owed. It essentially limited its fees to those incurred to obtain a preliminary injunction. And even that apparently gave the plaintiff only a small slice of what it wanted. The court ripped about $10,000 in fees off what it cost to take the matter to hearing.
The fee award was $80,317 (inclusive of some $21,000 in costs) - about 1/4 of what the plaintiff incurred and claimed it was entitled to. If nothing else, the case highlights for clients what a preliminary injunction can cost. And it further shows that weak non-compete cases can cost a lot more than the value of the benefit received.
Lost Profits
A federal district court in Indiana excluded significant parts of an expert's lost profits testimony in the hotly contested case of CDW, LLC v. NETech Corp. The case arose out of an allegation that NETech lifted out CDW's Indianapolis branch office and suffered millions in losses in "advanced technology" revenue. On a Daubert motion, the district court excluded a financial expert's "yardstick" methodology for predicting what CDW's Indianapolis branch would have earned but for the alleged wrongful conduct by the ex-employees. The ruling effectively excluded opinions that would have established lost profits of over $17,000,000. The district court allowed an alternative formulation of lost profits in a much lower amount to go to the jury.
Equitable Extension
The extension of non-competes past their expiration date (as measured from the date of termination of employment) is one of the most controversial, hotly contested remedies in litigation. As a federal district court in Idaho noted a few weeks ago, judges normally impose this remedy - when it's available - after a jury finding of breach or after a favorable ruling on summary judgment for the enforcing party. But in unusual cases, like that in MWI Veterinary Supply Co. v. Wotton, 2012 U.S. Dist. LEXIS 131784 (D. Idaho Sept. 14, 2012), the court can issue an extension remedy at a TRO or preliminary injunction phase. That finding was important in the Wotton case since the court had to find extension was appropriate to determine likelihood of success on the merits of the case. The non-compete, which arose out of the sale of a business, expired by the time the court addressed the preliminary injunction motion.
Temporary Restraining Orders
An Ohio court refused to grant a temporary restraining order against a departed sales executive in Chart Industries, Inc. v. Spagnoletti, 2012 U.S. Dist. LEXIS 140102 (N.D. Ohio Sept. 28, 2012), because the non-competition covenant contained no geographic or job-scope limitations. Though careful to note that such covenants were not per se unenforceable, the court stated it was important that the employer did not ask the court to impose any sort of limitation on the covenant at the TRO stage that would make it reasonable. The case demonstrates the continued difficulty courts have enforcing non-competes that contain no limiting language whatsoever. Delaware law applied.
Necessary and Indispensable Parties
In non-compete cases, the plaintiff sometimes will elect to forego suing the new employer and will proceed simply against the employee. There are a number of strategic and substantive reasons why this may be the case. The ruling in OneCommand, Inc. v. Beroth, 2012 U.S. Dist. LEXIS 122587 (S.D. Ohio Aug. 29, 2012), shows that a new employer is not a necessary party who must be part of the litigation under Federal Rule of Civil Procedure 19. Even if the plaintiff has potential claims against a new employer (for interference, trade secrets theft and the like), it is not necessary to make that company a party to a breach of contract suit with the employee.
Jury Trial Waivers
The right to a jury trial can be waived by contract if the waiver is knowing and voluntary. Generally, such waivers are strictly construed, however. One question that frequently arises is how far the contractual waiver extends to non-contract claims, like trade secrets misappropriation. A Delaware court concluded that a jury waiver provision in an asset purchase agreement encompassed related tort claims of trade secrets theft, conversion, and common-law unfair competition - reasoning that the "arising out of" language in the agreement was sufficiently broad to include torts intrinsically related to the contract action. The case is Coface Collections North Am., Inc. v. Newton, 2012 U.S. Dist. LEXIS 124342 (D. Del. Aug. 31, 2012).
Attorneys' Fees
Non-compete litigation can sometimes perpetuate itself solely because of fees that are incurred. An illustration of this problem comes from the case of Cumulus Broadcasting v. Okesson, 2012 U.S. Dist. LEXIS 124836 (D. Conn. Sept. 4, 2012). After the parties settled, they left it to the district judge to award attorneys' fees under a provision of the employment agreement that enabled the plaintiff to recover fees enforcing the non-compete.
The court, seemingly none-too-pleased (particularly since it was not allowed to see the terms of the parties' settlement agreement (?)), significantly pared back what the plaintiff thought it was owed. It essentially limited its fees to those incurred to obtain a preliminary injunction. And even that apparently gave the plaintiff only a small slice of what it wanted. The court ripped about $10,000 in fees off what it cost to take the matter to hearing.
The fee award was $80,317 (inclusive of some $21,000 in costs) - about 1/4 of what the plaintiff incurred and claimed it was entitled to. If nothing else, the case highlights for clients what a preliminary injunction can cost. And it further shows that weak non-compete cases can cost a lot more than the value of the benefit received.
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
Monday, December 27, 2010
Wal-Mart/CVS Dispute Over Mullany Illustrates Problems of Hiring the "Senior Big Dog"
The Delaware Non-Compete Law Blog has a couple of excellent posts on the recent decision by Judge Travis Laster enjoining CVS Caremark from hiring Hank Mullany, a former senior executive with Wal-Mart Stores, Inc.
At the time of his departure, Mullany was the Executive Vice-President and President of Wal-Mart North, a position that reported directly to Wal-Mart's CEO. Mullany oversaw store operations, real estate and supply chain functions for 19 states, stretching from Illinois all the way to eastern seaboard states from Maine to North Carolina.
Mullany gave notice of his resignation in October, about 10 months after his promotion to President of Wal-Mart North. Wal-Mart later found out that CVS intended to hire Mullany. According to Wal-Mart's Complaint, CVS and Wal-Mart compete in the retail pharmacy market and other associated markets, such as beauty aids, consumables and groceries. Mullany's non-compete agreement with Wal-Mart prohibited him from working with any general or specialty retail store with a gross revenue threshold of $5 billion.
Vice-Chancellor Laster found that, in signing the non-compete agreement, Mullany knew exactly what he was signing and that the covenant appeared reasonable under Delaware law. It is true that one does not necessarily think of CVS and Wal-Mart as direct competitors, but in the retail space, with whom wouldn't Wal-Mart compete at least in some respect?
In his decision, Vice-Chancellor Laster specifically noted that if non-compete agreements should apply to anyone it is to "senior big dog executives." Though it is relatively uncommon for a state's non-compete test to hone in on the position or pay grade of the employee, it is not a stretch by any means to think that courts consider an employee's level of sophistication and business acumen to be a significant factor when determining to what extent the covenant should be enforced.
This relates, most often, to the protectable interest of "confidential information." Wal-Mart's Complaint was replete with references to the types of information and business strategies Mullany was able to access while at Wal-Mart. Those allegations portrayed a convincing story of how Mullany could use that information to run CVS' operations and take on Wal-Mart directly, particular in the pharmacy and prescription drug market. In competitive transitions like the one Mullany sought to make, a non-disclosure agreement is of limited use because compliance is hard to monitor. It is much easier to determine whether an executive employee is working for a competitor, and nearly impossible for outsiders to determine exactly what information he or she is using to perform day-to-day duties.
Wednesday, December 1, 2010
In Non-Compete Cases, Judges Determine Which Facts Are Important (FBK Partners v. Thomas)
Clients never like to hear my standard advice that each non-compete case turns on its own facts, and that no two cases are alike. But it is true. Lawyers can advise their clients as to the general rules of law and analyze a set of facts based on those rules. However, absent a dispute over solely a legal issue (which is rare), it is nearly impossible to look at two non-compete cases the same way.
Reading cases and explaining them here is helpful so that clients (a) know a bite about the law, and (b) see how outcomes similar to theirs may be decided. It is also helpful to see what facts judges cling to. I've said before, and I'll say it again, that judges' perceptions of facts often are colored by one simple, overriding theme: which party is wearing the "white hat"? But even taking that principle as a truism, it is still interesting to see which particular facts judges examine when ruling on a case.
Take the recent case of FBK Partners v. Thomas, a garden-variety non-compete dispute in Kentucky federal court. The employee, Thomas, had discussed leaving FBK to join a start-up, and apparently started moonlighting with the start-up prior to his last day at FBK. Aside from that, the facts of the case weren't all that different than a typical non-compete dispute.
The case isn't particularly notable for announcing a new rule of law or applying a rule in a curious way. However, it is notable for a couple of key facts that seemed to sway the judge's decision. Here are three such facts that caused me to do a double-take:
(1) The court rejected the employee's argument that the employer breached his employment agreement by modifying his duties. No real surprise that the argument is rejected. But the court's justification for it? Read this:
"There is evidence in the record that he knew the non-compete was valid when he began considering working for [the start-up]. Why else would he have provided [his new employer] with a copy of the non-compete?"
I don't understand this point at all. Employees are supposed to provide a copy of their non-compete to a new employer, and doing so should not amount to an admission that the non-compete is valid.
(2) The first point makes even less sense when you consider what the court said about the non-compete's reasonableness. The geographic scope of the non-compete included the entire United States and Mexico. However, Thomas worked for FBK in two states and in Mexico. At a minimum, Thomas had a good argument the geographic scope was unreasonable (which may have been why he showed a copy to his new employer). In enforcing the non-compete, the court did not modify the agreement to encompass a narrower geographic scope. The court's rationale was based in part on Thomas' failure to argue for a modification, but look at what else the court said:
"Furthermore, this Court is not inclined to modify an agreement that the parties entered into with full knowledge and adequate consideration."
This makes no sense. If a contract has no consideration, it isn't valid, so refusing to modify it on the basis that it has consideration is non-sensical. The fact that an employee signed an agreement with "full knowledge" of its terms has never been a proper rationale for applying the modification rule. It doesn't even make sense.
(3) The third fact is the most curious, though it didn't appear to sway the outcome at all. In assessing Thomas' potential breaches of the non-compete, the court said as follows:
"Thomas likely committed breach as early as December of 2008 by traveling to Kentucky to meet with [the new employer] and view [its] site in contravention of the agreement's prohibition on 'seeking employment' with a competitor."
This is the first time I have ever seen a court make such a statement. I don't think it is all that significant, because it would be nearly impossible for an employer to prove any damages associated with such a breach. However, if the employment contract contains a clause like this, interviewing, or seeking employment, with a competitor may allow an employer to terminate a contract for "cause" and avoid paying severance.
--
Court: United States District Court for the Eastern District of Kentucky
Opinion Date: 11/23/10
Cite: FBK Partners, Inc. v. Thomas, 2010 U.S. Dist. LEXIS 124579 (E.D. Ky. Nov. 23, 2010)
Favors: Employer
Law: Delaware
Reading cases and explaining them here is helpful so that clients (a) know a bite about the law, and (b) see how outcomes similar to theirs may be decided. It is also helpful to see what facts judges cling to. I've said before, and I'll say it again, that judges' perceptions of facts often are colored by one simple, overriding theme: which party is wearing the "white hat"? But even taking that principle as a truism, it is still interesting to see which particular facts judges examine when ruling on a case.
Take the recent case of FBK Partners v. Thomas, a garden-variety non-compete dispute in Kentucky federal court. The employee, Thomas, had discussed leaving FBK to join a start-up, and apparently started moonlighting with the start-up prior to his last day at FBK. Aside from that, the facts of the case weren't all that different than a typical non-compete dispute.
The case isn't particularly notable for announcing a new rule of law or applying a rule in a curious way. However, it is notable for a couple of key facts that seemed to sway the judge's decision. Here are three such facts that caused me to do a double-take:
(1) The court rejected the employee's argument that the employer breached his employment agreement by modifying his duties. No real surprise that the argument is rejected. But the court's justification for it? Read this:
"There is evidence in the record that he knew the non-compete was valid when he began considering working for [the start-up]. Why else would he have provided [his new employer] with a copy of the non-compete?"
I don't understand this point at all. Employees are supposed to provide a copy of their non-compete to a new employer, and doing so should not amount to an admission that the non-compete is valid.
(2) The first point makes even less sense when you consider what the court said about the non-compete's reasonableness. The geographic scope of the non-compete included the entire United States and Mexico. However, Thomas worked for FBK in two states and in Mexico. At a minimum, Thomas had a good argument the geographic scope was unreasonable (which may have been why he showed a copy to his new employer). In enforcing the non-compete, the court did not modify the agreement to encompass a narrower geographic scope. The court's rationale was based in part on Thomas' failure to argue for a modification, but look at what else the court said:
"Furthermore, this Court is not inclined to modify an agreement that the parties entered into with full knowledge and adequate consideration."
This makes no sense. If a contract has no consideration, it isn't valid, so refusing to modify it on the basis that it has consideration is non-sensical. The fact that an employee signed an agreement with "full knowledge" of its terms has never been a proper rationale for applying the modification rule. It doesn't even make sense.
(3) The third fact is the most curious, though it didn't appear to sway the outcome at all. In assessing Thomas' potential breaches of the non-compete, the court said as follows:
"Thomas likely committed breach as early as December of 2008 by traveling to Kentucky to meet with [the new employer] and view [its] site in contravention of the agreement's prohibition on 'seeking employment' with a competitor."
This is the first time I have ever seen a court make such a statement. I don't think it is all that significant, because it would be nearly impossible for an employer to prove any damages associated with such a breach. However, if the employment contract contains a clause like this, interviewing, or seeking employment, with a competitor may allow an employer to terminate a contract for "cause" and avoid paying severance.
--
Court: United States District Court for the Eastern District of Kentucky
Opinion Date: 11/23/10
Cite: FBK Partners, Inc. v. Thomas, 2010 U.S. Dist. LEXIS 124579 (E.D. Ky. Nov. 23, 2010)
Favors: Employer
Law: Delaware
Wednesday, July 21, 2010
Employer Must Watch For Broad Use of Employee Indemnification and Advancement Rights (James River Mgmt. v. Kehoe)
Imagine a very common scenario where a corporate officer or employee steals valuable corporate data, deletes or compromises electronic information on his way out the door, solicits customers to leave prior to his termination of employment...and then says his employer must pay for the legal defense of is almost certain to be contentious litigation.
Is this such a far-fetched scenario?
Not really, and it all has to do with the concept of advancement and indemnification. Corporate laws across the United States provide that companies may indemnify officers, directors and employees for litigation costs and judgments incurred due to the fact of their affiliation with the company.
Advancement is a little bit different but related - it concerns the right receive legal fees prior to the time litigation is terminated and decided. In essence, it means the right to have someone else pay your attorney on a regular basis.
In many corporations, the rights to advancement and indemnification are mandatory under governing bylaws. This seems counterintuitive, but is used to attract key personnel as corporate officers and directors. An employee may even have such rights spelled out in an employment agreement.
Most of us are familiar with corporate executives being indemnified in breach of fiduciary duty cases, such as shareholder derivative actions, or even criminal suits for insider trading. But the same concepts apply in unfair competition law. Believe it or not, there are cases holding that a corporation suing a departed executive must advance legal expenses to that executive during trade secrets or fiduciary duty litigation - theories which fit the facts described in the first paragraph of this post. The reason is that advancement rights - particularly under Delaware law - are broadly interpreted.
As one court interpreting Delaware law recently stated: "The line between actions taken in a personal vis-a-vis corporate capacity is not drawn according to whether the director or officer acted detrimentally to the interest of the corporation, but instead on whether there is a nexus or causal connection between any of the underlying proceedings and one's corporate capacity without regard to one's motivation for engaging in that conduct."
In the context of trade secrets theft, an employee can claim that such conduct occurred as a result of his prior employment and that it arises directly out of his rule as a corporate fiduciary. Can the same be said of a non-compete violation? Probably not. The courts clearly hold that contractual obligations in a non-compete agreement are the product of an arms-length transaction, entered into by the employee in his personal - not corporate - capacity.
The lesson for counsel is this: don't forget about advancement and indemnity rights. The source of those rights is the governing state's corporation or limited liability company law, the bylaws or operating agreement, and any agreement the employee may have signed during his or her employment.
If the employee has advancement rights which are contested, then a court must decide those rights in a summary proceeding. The rights to advancement may be conditioned, however, on an employee's undertaking to repay such costs and fees to the corporation if his actions were not taken in good faith (or whatever the bylaws say on this). For a defendant who is in a precarious spot but wants to fight until the end, advancement only gets him or her so far. It is effectively an interest-free loan.
At the very least, though, it may give the company suing the ex-employee a strong incentive to work out an early resolution to the case.
--
Court: United States District Court for the Eastern District of Virginia
Opinion Date: 12/8/09
Cite: James River Mgmt. Co., Inc. v. Kehoe, 674 F. Supp. 2d 745 (E.D. Va. 2009)
Favors: Employee
Law: Delaware
Is this such a far-fetched scenario?
Not really, and it all has to do with the concept of advancement and indemnification. Corporate laws across the United States provide that companies may indemnify officers, directors and employees for litigation costs and judgments incurred due to the fact of their affiliation with the company.
Advancement is a little bit different but related - it concerns the right receive legal fees prior to the time litigation is terminated and decided. In essence, it means the right to have someone else pay your attorney on a regular basis.
In many corporations, the rights to advancement and indemnification are mandatory under governing bylaws. This seems counterintuitive, but is used to attract key personnel as corporate officers and directors. An employee may even have such rights spelled out in an employment agreement.
Most of us are familiar with corporate executives being indemnified in breach of fiduciary duty cases, such as shareholder derivative actions, or even criminal suits for insider trading. But the same concepts apply in unfair competition law. Believe it or not, there are cases holding that a corporation suing a departed executive must advance legal expenses to that executive during trade secrets or fiduciary duty litigation - theories which fit the facts described in the first paragraph of this post. The reason is that advancement rights - particularly under Delaware law - are broadly interpreted.
As one court interpreting Delaware law recently stated: "The line between actions taken in a personal vis-a-vis corporate capacity is not drawn according to whether the director or officer acted detrimentally to the interest of the corporation, but instead on whether there is a nexus or causal connection between any of the underlying proceedings and one's corporate capacity without regard to one's motivation for engaging in that conduct."
In the context of trade secrets theft, an employee can claim that such conduct occurred as a result of his prior employment and that it arises directly out of his rule as a corporate fiduciary. Can the same be said of a non-compete violation? Probably not. The courts clearly hold that contractual obligations in a non-compete agreement are the product of an arms-length transaction, entered into by the employee in his personal - not corporate - capacity.
The lesson for counsel is this: don't forget about advancement and indemnity rights. The source of those rights is the governing state's corporation or limited liability company law, the bylaws or operating agreement, and any agreement the employee may have signed during his or her employment.
If the employee has advancement rights which are contested, then a court must decide those rights in a summary proceeding. The rights to advancement may be conditioned, however, on an employee's undertaking to repay such costs and fees to the corporation if his actions were not taken in good faith (or whatever the bylaws say on this). For a defendant who is in a precarious spot but wants to fight until the end, advancement only gets him or her so far. It is effectively an interest-free loan.
At the very least, though, it may give the company suing the ex-employee a strong incentive to work out an early resolution to the case.
--
Court: United States District Court for the Eastern District of Virginia
Opinion Date: 12/8/09
Cite: James River Mgmt. Co., Inc. v. Kehoe, 674 F. Supp. 2d 745 (E.D. Va. 2009)
Favors: Employee
Law: Delaware
Thursday, July 8, 2010
Liquidated Damages Clauses in the Professional Services Context and General Drafting Considerations (Palekar v. Batra)
Liquidated damages clauses are common in restrictive covenant agreements, particularly in those for accountants, physicians and other professionals. One reason for their prevalence is the view some courts and legislatures have taken with regard to restraining professionals' ability to compete. It is highly disfavored and impacts the public interest to a much greater degree than ordinary sales businesses, so by substituting a liquidated damages clause for an actual prohibition on competition, employers can mitigate compelling arguments against enforcement.
Delaware is no exception. It has a statute in place that prohibits any agreements restricting the right of a physician to practice medicine in a particular locale. However, it does not prohibit agreements that put a price on such competition. Courts in Delaware have held that a liquidated damages clause in a physician's contract which may discourage competition, but which does not prevent it, are consistent with the statute.
Of course, the clause itself must still be legally compliant. The standards of enforceability are fairly uniform from state to state. As the Superior Court of Delaware recently noted, however, liquidated damages clauses are presumptively valid and the burden rests on the party challenging it to show it is unenforceable. (This is not true everywhere - some states flip the burden of proof).
Drafting liquidated damages clauses requires attorneys to take into account a number of different considerations:
(1) It is important to have a number of recitals to show that the parties intend to fix damages ahead of time in the event of a breach.
(2) Those recitals should include an acknowledgment that the parties agree damages in the event of breach would be difficult to calculate.
(3) The clause cannot, in most jurisdictions, allow for the simultaneous recovery of actual damages - or else it is not a true liquidation at all.
(4) The liquidated damages clause must provide some clear or readily ascertainable amount accruing on breach. If the amount cannot be determined, it won't be enforced.
(5) If the clause applies to multiple covenants, attorneys ought to consider whether the clause makes any sense at all by applying hypotheticals. For instance, it would seem unreasonable to apply the same damages to a breach of a major covenant (i.e., a client non-solicitation covenant) as it would to a relatively minor one.
My experience has shown that courts are often receptive to liquidated damages clauses in non-compete arrangements, particularly if the agreement is well-drafted, contains proper recitals and appears to be designed to compensate the employer rather than to punish the employee. In addition, if the clause is a proxy for an actual restriction, then courts seem more inclined to view them as enforceable.
On the other hand, I have also had success in invalidating covenants that were hopelessly vague, cumulative of other remedies, and which appeared designed to forfeit previously-earned benefits. It is a very difficult area of the law and demands that attorneys have an intimate understanding of the law governing the agreement.
--
Court: Superior Court of Delaware, New Castle
Opinion Date: 5/18/10
Cite: Bhaskar S. Palekar, M.D., P.A. v. Batra, 2010 Del. Super. LEXIS 257 (Del. Super. Ct. May 18, 2010)
Favors: Employer
Law: Delaware
Delaware is no exception. It has a statute in place that prohibits any agreements restricting the right of a physician to practice medicine in a particular locale. However, it does not prohibit agreements that put a price on such competition. Courts in Delaware have held that a liquidated damages clause in a physician's contract which may discourage competition, but which does not prevent it, are consistent with the statute.
Of course, the clause itself must still be legally compliant. The standards of enforceability are fairly uniform from state to state. As the Superior Court of Delaware recently noted, however, liquidated damages clauses are presumptively valid and the burden rests on the party challenging it to show it is unenforceable. (This is not true everywhere - some states flip the burden of proof).
Drafting liquidated damages clauses requires attorneys to take into account a number of different considerations:
(1) It is important to have a number of recitals to show that the parties intend to fix damages ahead of time in the event of a breach.
(2) Those recitals should include an acknowledgment that the parties agree damages in the event of breach would be difficult to calculate.
(3) The clause cannot, in most jurisdictions, allow for the simultaneous recovery of actual damages - or else it is not a true liquidation at all.
(4) The liquidated damages clause must provide some clear or readily ascertainable amount accruing on breach. If the amount cannot be determined, it won't be enforced.
(5) If the clause applies to multiple covenants, attorneys ought to consider whether the clause makes any sense at all by applying hypotheticals. For instance, it would seem unreasonable to apply the same damages to a breach of a major covenant (i.e., a client non-solicitation covenant) as it would to a relatively minor one.
My experience has shown that courts are often receptive to liquidated damages clauses in non-compete arrangements, particularly if the agreement is well-drafted, contains proper recitals and appears to be designed to compensate the employer rather than to punish the employee. In addition, if the clause is a proxy for an actual restriction, then courts seem more inclined to view them as enforceable.
On the other hand, I have also had success in invalidating covenants that were hopelessly vague, cumulative of other remedies, and which appeared designed to forfeit previously-earned benefits. It is a very difficult area of the law and demands that attorneys have an intimate understanding of the law governing the agreement.
--
Court: Superior Court of Delaware, New Castle
Opinion Date: 5/18/10
Cite: Bhaskar S. Palekar, M.D., P.A. v. Batra, 2010 Del. Super. LEXIS 257 (Del. Super. Ct. May 18, 2010)
Favors: Employer
Law: Delaware
Tuesday, January 19, 2010
Liquidated Damages Provision Upheld In LLC Non-Compete Dispute (Mattern & Associates v. Seidel)
A federal district judge in Delaware has upheld enforcement of a $150,000 liquidated damages clause ancillary to a non-compete clause. The restrictive covenant was contained in an operating agreement for Mattern & Associates, a consulting firm that provided technology services to law firms. The defendant, John Seidel, was a 3% member of the LLC and left in 2005 to seek a sales position with Konica Minolta Business Solutions.
At trial, a jury found in favor of M&A and against Seidel on all claims, the most significant of which was Seidel's breach of contract and application of the liquidated damages provision. The Operating Agreement, which was governed by Pennsylvania law, applied the $150,000 sum only to the non-compete covenant, not other types of restrictions. Under Pennsylvania law, this is vitally important. Though Pennsylvania is like many states when it comes to analyzing the enforceability of liquidated damages provisions, it takes a much closer look at them in the context of non-compete arrangements. In particular, an employer must demonstrate that the "sum fixed as security for the performance (of the non-compete) must not be overbroad in that it applies to a number of stipulations of widely different importance." M&A smartly limited the application of the liquidated damages provision to the most significant restriction.
The prophylactic rule articulated in Mattern & Associates requires employers to draft liquidated damages provisions carefully. Many employment contracts contain an array of restrictions, ranging from the onerous (a business non-compete) to the trivial (a non-disparagement clause). When a liquidated damages clause applies across the board to sweeping restraints and less exacting activity restrictions, it reeks of arbitrariness. An employer is vulnerable to a facial attack on the clause as a transparent penalty that bears no connection to a likely breach.
--
Court: United States District Court for the District of Delaware
Opinion Date: 1/14/10
Cite: Mattern & Associates, LLC v. Seidel, 2010 U.S. Dist. LEXIS 3199 (D. Del. Jan. 14, 2010)
Favors: Employer
Law: Pennsylvania
At trial, a jury found in favor of M&A and against Seidel on all claims, the most significant of which was Seidel's breach of contract and application of the liquidated damages provision. The Operating Agreement, which was governed by Pennsylvania law, applied the $150,000 sum only to the non-compete covenant, not other types of restrictions. Under Pennsylvania law, this is vitally important. Though Pennsylvania is like many states when it comes to analyzing the enforceability of liquidated damages provisions, it takes a much closer look at them in the context of non-compete arrangements. In particular, an employer must demonstrate that the "sum fixed as security for the performance (of the non-compete) must not be overbroad in that it applies to a number of stipulations of widely different importance." M&A smartly limited the application of the liquidated damages provision to the most significant restriction.
The prophylactic rule articulated in Mattern & Associates requires employers to draft liquidated damages provisions carefully. Many employment contracts contain an array of restrictions, ranging from the onerous (a business non-compete) to the trivial (a non-disparagement clause). When a liquidated damages clause applies across the board to sweeping restraints and less exacting activity restrictions, it reeks of arbitrariness. An employer is vulnerable to a facial attack on the clause as a transparent penalty that bears no connection to a likely breach.
--
Court: United States District Court for the District of Delaware
Opinion Date: 1/14/10
Cite: Mattern & Associates, LLC v. Seidel, 2010 U.S. Dist. LEXIS 3199 (D. Del. Jan. 14, 2010)
Favors: Employer
Law: Pennsylvania
Tuesday, December 29, 2009
Legal Precedent Thin on Whether Employee Can Seek Injunctive Relief Preventing Enforcement of Invalid Non-Compete (Frank v. Wesco Distribution)
At least ninety percent of all non-compete disputes start with an employer filing a lawsuit and seeking some form of injunctive relief to prevent a further breach of contract. It is the rare case where an employee initiates a claim against an ex-employer, where the preferred remedy is a declaration that the non-compete is invalid.
The employee-side claim can arise in a number of situations. Perhaps an employee's non-compete concerns a forfeiture-for-competition covenant, in which the employee needs to determine the validity of an agreement before risking forfeiture of stock options or deferred compensation. In some cases, a non-compete term could be lengthy enough that the litigation won't run its course by the time a non-compete expires. And in other cases, the employee may use the litigation as leverage to effectuate a settlement on less restrictive terms. But in all of these cases, the relief available to an employee is fairly narrow and does not pose any immediate problem for the defending employer.
I recently litigated a case where I represented an employee who filed a declaratory judgment claim seeking to have his non-compete invalidated on grounds of overbreadth. After four lengthy months, we prevailed and my client was able to take the job that - mercifully- had not been filled while the litigation was pending. For (mostly) tactical reasons, though, we initially aimed for another remedy - a preliminary injunction prohibiting the employer from attempting to enforce the non-compete agreement or interfere with any prospective job opportunities through threats of enforcement.
The trial judge denied my emergency petition, not on the grounds that such relief was automatically unavailable but rather on practicality. He did not feel the injunction, if granted, would cause the prospective employer to hire my client. My personal view on this is that the judge may have been correct; I'm still not sure. The issue, though, is not easily resolved.
We as lawyers are not guided by much in the way of precedent on this issue. I have located only four reported decisions approving of an injunction in the scenario I have just described: Brenneman v. NVR, Inc., 2007 U.S. Dist. LEXIS 12761 (S.D. Ohio Feb. 9, 2007), Bryan v. Hall Chemical Co., 993 F. 2d 831 (11th Cir. 1993) (Georgia), Caras v. The American Original Corp., 1987 Del. Ch. LEXIS 467 (Del. Ch. July 31, 1987), and a recent appeal (cite below) in New York, Frank v. Wesco Distribution, Inc. Because so few disputes arise in this procedural posture, I don't expect we'll see cases like Wesco Distribution all that often. But attorneys representing employees should be aware of them nonetheless.
As a practical tip, however, I would recommend that any lawyer seeking preliminary injunctive relief like this clearly define what he or she wants the court to do. Simply asking the court to bar an employer from "enforcing" a non-compete probably is too broad of a request and almost sounds like it is asking for a court to enjoin a future court proceeding (perhaps in a different venue or in a different court system). The better practice, it seems, is to request (in addition to this) that the court prohibit the ex-employer from interfering with a specific job opportunity or from representing to third-parties that an employee is barred from working on account of a non-compete agreement.
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Court: Supreme Court of New York, Appellate Division, First Department
Opinion Date: 12/22/09
Cite: Frank v. Wesco Distribution, Inc., 892 N.Y.S.2d 348 (N.Y. App. Div. 1st Dep't 2009)
Favors: Employee
Law: New York
The employee-side claim can arise in a number of situations. Perhaps an employee's non-compete concerns a forfeiture-for-competition covenant, in which the employee needs to determine the validity of an agreement before risking forfeiture of stock options or deferred compensation. In some cases, a non-compete term could be lengthy enough that the litigation won't run its course by the time a non-compete expires. And in other cases, the employee may use the litigation as leverage to effectuate a settlement on less restrictive terms. But in all of these cases, the relief available to an employee is fairly narrow and does not pose any immediate problem for the defending employer.
I recently litigated a case where I represented an employee who filed a declaratory judgment claim seeking to have his non-compete invalidated on grounds of overbreadth. After four lengthy months, we prevailed and my client was able to take the job that - mercifully- had not been filled while the litigation was pending. For (mostly) tactical reasons, though, we initially aimed for another remedy - a preliminary injunction prohibiting the employer from attempting to enforce the non-compete agreement or interfere with any prospective job opportunities through threats of enforcement.
The trial judge denied my emergency petition, not on the grounds that such relief was automatically unavailable but rather on practicality. He did not feel the injunction, if granted, would cause the prospective employer to hire my client. My personal view on this is that the judge may have been correct; I'm still not sure. The issue, though, is not easily resolved.
We as lawyers are not guided by much in the way of precedent on this issue. I have located only four reported decisions approving of an injunction in the scenario I have just described: Brenneman v. NVR, Inc., 2007 U.S. Dist. LEXIS 12761 (S.D. Ohio Feb. 9, 2007), Bryan v. Hall Chemical Co., 993 F. 2d 831 (11th Cir. 1993) (Georgia), Caras v. The American Original Corp., 1987 Del. Ch. LEXIS 467 (Del. Ch. July 31, 1987), and a recent appeal (cite below) in New York, Frank v. Wesco Distribution, Inc. Because so few disputes arise in this procedural posture, I don't expect we'll see cases like Wesco Distribution all that often. But attorneys representing employees should be aware of them nonetheless.
As a practical tip, however, I would recommend that any lawyer seeking preliminary injunctive relief like this clearly define what he or she wants the court to do. Simply asking the court to bar an employer from "enforcing" a non-compete probably is too broad of a request and almost sounds like it is asking for a court to enjoin a future court proceeding (perhaps in a different venue or in a different court system). The better practice, it seems, is to request (in addition to this) that the court prohibit the ex-employer from interfering with a specific job opportunity or from representing to third-parties that an employee is barred from working on account of a non-compete agreement.
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Court: Supreme Court of New York, Appellate Division, First Department
Opinion Date: 12/22/09
Cite: Frank v. Wesco Distribution, Inc., 892 N.Y.S.2d 348 (N.Y. App. Div. 1st Dep't 2009)
Favors: Employee
Law: New York
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