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:

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 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.

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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.

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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.

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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 Appellate Court: Physicians' Liquidated Damages Clauses Enforceable

I have written frequently on this blog concerning the subject of liquidated damages. A pre-determined formula or amount of damages is particularly appropriate for non-compete disputes for three primary reasons.

First, proving lost profits can be difficult and requires a company to develop a sustainable, sensible damages model (in my experience, too many plaintiffs never think about this until it's too late).

Second, it eliminates the transaction costs associated with proving lost profits. This requires company time and effort, and often the retention of an expert in the field.

And third, liquidated damages helps solve the time-tested riddle of whether pursuing non-compete litigation is an economically viable outcome for a company. By pre-setting damages, a plaintiff can eliminate some inherent risk and uncertainty surrounding a traditional damages presentation.

Of course, there's a downside. Liquidated damages clauses aren't easy to uphold and are frequently struck down by courts as penalties.

The Court of Appeals of South Carolina just upheld a liquidated damages provision in a physician shareholder agreement that was unlike any I've ever seen. It had several components:

If the physician violated a 20-mile non-compete tied to his or her interventional cardiology practice, then the physician:

(1) forfeited $60,000 in deferred compensation (the payment meant to provide fresh consideration for the new contract);

(2) owed 100 % of the physician's prior year's income with the medical practice;

(3) was divested of a defined share of accounts receivable owed the medical practice; and

(4) was divested of earned but unpaid salary.

If the physician paid the amounts, then he or she was free to compete.

The amounts subject to the liquidated damages clause, as might be expected for the profession, were several hundred thousand dollars per physician. But the Court of Appeals upheld the contract, reasoning that the economic impact from competing in violation of the contract was inherently difficult to calculate and further reasoning that the formulas were tied to what the practice could have expected to receive had the physicians complied with the terms of the agreement.

The kicker for the Court of Appeals seemed to be the impetus behind the non-compete in the first place. The medical practice took out a $5 million loan to finance construction of a new medical office. After the physicians left to compete, the office was not fiscally sustainable - and closed.

The lesson to be learned for corporate counsel is that it is worth considering a robust liquidated damages clause and - more importantly - developing a rationale for why the formula approximates lost profits upon competition. Well thought-out clauses can add a great deal of value to actual or threatened litigation and mitigate the risk associated with developing a damages model.

The case is Baugh v. Columbia Heart Clinic, P.A., 2013 S.C. App. LEXIS 5 (S.C. Ct. App. Jan. 16, 2013).

Preliminary Injunction Order Cannot Be Used As Substantive Evidence at Trial

This one completely baffles me.

Lawyers have to make judgment calls at trial over evidence all the time. Just as important as deciding what to introduce by way of oral testimony or documentary evidence is deciding what to leave out - even if it may be marginally helpful.

In a South Carolina competition dispute, the plaintiffs tried to introduce for a jury the temporary injunction order that the judge entered at the start of the case. And the court agreed to admit it and let the jury review an 11-page order the judge signed after the case was filed.

The case arose out of a business divorce in the PEO industry. PEO stands for professional employer organization, and it is common now for firms to, in effect, outsource their human resources departments. When a shareholder of Allegro failed in his efforts to buy out the majority owner, he left to start his own PEO firm. Lawsuit follows. Injunction entered. Trial ensues.

But why would the grant of an injunction ever be something the jury should see? And how did this happen?

Those questions aren't answered by the Court of Appeals' decision, except for the following:

"It is hard for this court to determine an instance where admission of a preliminary injunction order into the trial record would not be highly prejudicial."

Truth.

It's not hard to see the prejudice. Injunctions are misunderstood. It takes a lot of effort, at least in this lawyer's experience, to explain to a client what a preliminary injunction is, and how that piece fits into the total litigation puzzle. Clients who prevail on an injunction motion think they've "won the case." Not so. They're surprised they may have to testify again. Injunctions are decided on truncated records. In some courts, the judge may not hear live evidence. And by their very nature, only part of the evidentiary record is developed.

Even if an aggressive plaintiff's lawyer wanted to trumpet its injunction order before a jury (which is something I can't come to terms with), a judge should know better. The court should have known its findings on a temporary injunction order would greatly influence a jury.

This was a basic mistake that never should have happened. And the plaintiff now has to retry its case at great cost. As I tell my clients, always expect the unexpected in competition disputes.

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Court: Court of Appeals of South Carolina
Opinion Date: 7/11/12
Citation: Allegro, Inc. v. Scully, 2012 S.C. App. LEXIS 334 (S.C. Ct. App. July 11, 2012)
Favors: Employee
Law: South Carolina

Supreme Court of South Carolina Addresses Validity of Invention Assignment Clause

Cases addressing invention assignment clauses are few and far between. But 2012 has produced two state supreme court decisions in this area of intellectual property law. Earlier this year, Wyoming addressed the matter, and now South Carolina has.

I have discussed this subject infrequently, but assignment clauses often intersect non-compete law. In essence, they provide that any inventions (patentable or not) that an employee develops in association with her employer are the property of the employer. The only real controversial element of these clauses is the holdover or trailer aspect of them - which are found, I'd say, in about half the contracts I've seen. Those holdover clauses bear some passing resemblance to a post-termination non-compete, as they require an employee to assign inventions if they are developed within a period of time - usually 6 months or a year - after termination.

The purpose of holdover clauses is fairly obvious. Assume an employee in product development is working on a rollout of new smart phone technology, whose planned launch is several months away. If she leaves and starts development of a product based on that same technology, an assignment clause without a trailer may not capture this invention. The holdover clause creates a disincentive for an employee to delay or hide work on a technological development, because presumably the employee knows the trailer clause won't allow her to lie in the weeds and exploit it after termination. One can also look at a holdover clause as an extension of an employee's duty of loyalty, in effect providing a remedy in contract for improperly exploiting valuable commercial information after departure.

The Supreme Court of South Carolina in Milliken & Co. v. Morin held that holdover clauses were not restraints of trade subject to the traditional three-part rule of reason. More importantly, they are not strictly construed against the employer. Still, because there is potential for overreaching and for holdover clauses to restrict some competition, courts will assess whether they're reasonable. It's difficult to distinguish between a more lax test of reasonableness (applicable to clauses like an invention assignment holdovers and even non-disclosure covenants) and a three-part rule of reason (applicable to non-competes). In fact, the test that the Court in Morin established sounds almost identical to the non-compete test.

Practically speaking, courts will simply check to see what the economic impact of the holdover clause is on the marketplace. If it looks and acts like a more expansive non-compete, such as a term that is too long (say 5 years) or a clause that is too vague so as to not put someone on notice of its scope, then a court more likely will apply a strict scrutiny test. If the clause looks commercially reasonable and designed to protect an employer's inventions, then a simple reasonableness check almost certainly will uphold the covenant.

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Court: Supreme Court of South Carolina
Opinion Date: 8/1/12
Cite: Milliken & Co v. Morin, No. 27154
Favors: Employer
Law: South Carolina

Fourth Circuit Adopts Reasoning From U.S. v. Nosal in Limiting CFAA Application

In my opinion, the civil remedy provisions of the CFAA - outside those applicable to hackers - are totally useless.

The Act is nothing more than a jurisdictional hook to get into federal court, where a host of state law claims are the real focus of a case. In a case where there is diversity of citizenship, the Act is uber-useless.

The Fourth Circuit in WEC Carolina Energy Solutions LLC v. Miller, 2012 U.S. App. LEXIS 15441 (4th Cir. July 26, 2012), affirmed the dismissal of a CFAA complaint arising out of an allegation that an ex-employee improperly downloaded confidential business information and used that information to make a presentation on behalf of a competitor following termination of employment.

The court agreed with the Ninth Circuit's narrow view of "without authorization" in United States v. Nosal and disagreed with the Seventh Circuit's expansive application of the CFAA under common-law agency principles in Int'l Airport Centers, LLC v. Citrin. Readers may recall that Nosal was written by Judge Kozinski and Citrin, the "cessation-of-agency" theory, was the work of Judge Posner.

The Fourth Circuit did not extend liability to so-called use-policy violations. In other words, if an employee obtains or access information from a protected computer to which he or she is not entitled to retrieve in the first place, then the CFAA would provide a remedy under the plain text of the statute. Conversely, misusing information to which the employee had a right to access falls outside the Act's scope.

Because the CFAA is both a criminal and civil statute, the Fourth Circuit relied on the rule of lenity to chose an interpretation of the statute that would not result in criminal sanctions. The court indicated its holding would "disappoint employers hoping for a means to rein in rogue employees," but it also noted that other legal remedies exist. Indeed, these types of disputes are fundamentally the province of state contract and tort law. Just as much of trade secret law is in fact duplicative of common law remedies, so too is the CFAA. WEC Carolina - the plaintiff - has a state court complaint pending against the same defendants in the federal case, a case that has nine other claims for relief.

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

Supreme Court of South Carolina Holds Trial Court Cannot Rewrite Territorial Restriction (Poynter Investments v. Century Builders of Piedmont)

South Carolina is a state with a fairly strict blue-pencil rule, meaning that drafting is at a premium. Because judges cannot rewrite parties' agreements for them, a non-compete will stand or fall on its own, with courts able to strike only certain terms to avoid overbreadth problems.

The Supreme Court of South Carolina issued another ruling illustrating the narrow scope of its blue-pencil rule in a sale-of-business non-compete. The trial court determined that the seller of a business should be enjoined from violating the covenant, but issued a ruling which modified the geographical scope of the contract beyond what South Carolina courts permit.

The non-compete at issue contained a step-down clause (a topic on which I recently wrote), first providing that it would extend to an area of 75 miles from the principal place of business. If that were unenforceable, the covenant would be limited to Greenville County and any county that borders it. If that were unenforceable, the covenant then would be limited to just Greenville County.

The court went with the last step-down clause and enforced the covenant only in Greenville County. Its error was apparently trying to craft some compromise among the various step-down provisions. The court held the seller was enjoined from competing within Greenville County and an area within 15 miles from the principal place of business.

The latter part of the order, the 15-mile restraint, was an addition to the non-compete's geographic term. While it may not seem unfair or unreasonable, the court's modification of the covenant went beyond what South Carolina courts permit. In a state that employs the equitable modification rule, the result likely would have survived appellate scrutiny.

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Court: Supreme Court of South Carolina
Opinion Date: 5/24/10
Cite: Poynter Investments, Inc. v. Century Builders of Piedmont, Inc., 694 S.E.2d 15 (S.C. 2010)
Favors: Employee
Law: South Carolina

Non-Compete In Shareholder Agreement Found Unenforceable (Lampman v. DeWolff, Boberg & Assoc.)

In many jurisdictions, non-compete agreements contained within a shareholder's agreement are evaluated under a much less stringent rule-of-reason analysis. The idea here is that those who have an equity stake in a venture need to secure the loyalty of those similarly situated to themselves. It goes without saying there is a much lower likelihood that a shareholder-employee will be tricked into making a desperate decision only to be shackled later on under circumstances that seem manifestly unfair.

But in Lampman v. DeWolff, Boberg & Associates, the Fourth Circuit (applying South Carolina law) did not give any deference to a non-compete covenant contained in a shareholder's agreement and found that its overbroad provisions rendered it unenforceable as a matter of law.

Lampman was an employee and shareholder of DBA performing management consulting services. Along with others, he signed a shareholder's agreement in 2004. That agreement contained a restrictive covenant which provided that a shareholder could not directly or indirectly engage in "Competition" with DBA for a period of three years. The definition of "Competition" ultimately was critical to the court's ruling:

"Competition shall mean...serving in any capacity, job or function...for any Person that analyzes, designs, modifies, and implements management systems to improve productivity, quality, service and capacity levels that generates quantifiable financial savings, and where such services are competitive with or similar to those that such Shareholder rendered during his employment with [DBA]." The covenant also contained a non-exclusive list of competitors to whom the covenant specifically applied.

Along with the lack of any geographic restriction, the italicized phrases gave the court grounds to strike the covenant as unreasonable under South Carolina law. By virtue of that state's strict blue-pencil doctrine, modification was not possible. The court gave an example of where the covenant would bar Lampman from performing consulting services outside any geographic area where DBA served clients. This in and of itself probably doomed the agreement.

Secondarily, though, the court noted where the covenant prevented Lampman from working for many entities that do not compete in the same marketplace as DBA. In particular, the use of "indirect" competition and the bar on providing "similar" services yielded absurd results. For instance, Lampman could not go work as an employee at Ford Motor if he was charged with analyzing its management operating systems and developing a model for internal cost savings. This example, the court found, highlighted how the covenant went far beyond preventing direct competition with DBA.

It was not clear from the opinion whether DBA sought to prevent Lampman's employment or merely recoup dividends paid to him after his departure but prior to the time his shares were redeemed pursuant to the shareholder's agreement. But that is not material.

Practitioners in states like South Carolina must be scrupulous in examining the language of non-compete covenants in all types of agreements for any indicia of overbreadth. It is best to use hypotheticals and examples to determine whether any non-competitive activity is inadvertently included within the restriction. And using phrases such as "directly or indirectly" or "similar to" or "in any capacity" almost always invites a challenge from an aggrieved employee on grounds of overbreadth.

Finally, the court in Lampman never discussed whether a less stringent standard of reasonableness should have applied because the covenant was contained in a shareholder's agreement. Had it done so, the outcome may have been different.

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Court: United States Court of Appeals for the Fourth Circuit
Opinion Date: 3/23/09
Cite: Lampman v. DeWolff, Boberg & Associates, Inc., 2009 U.S. App. LEXIS 6046 (4th Cir. Mar. 23, 2009)
Favors: Employee
Law: South Carolina

Strict Construction Rule Prevents Enforcement of Non-Compete Agreement in Washington Case (Fluke Corp. v. Milwaukee Electric Tool)

Employers should always be aware that non-compete agreements will be strictly construed against it as the party in charge of drafting the contract; presumptions regarding ambiguities almost always devolve in favor of an employee. It is here where lawyers need to be particularly scrupulous in drafting agreements that reflect the intentions of the employer and guard against potential loopholes.

A recent Washington appellate case illustrates what happens when the precise contract language renders a non-compete totally ineffectual, such that traditional notions of reasonableness and protectable interests never even get addressed.

Fluke Corp. v. Milwaukee Electric Tool involves a dispute over the termination of Jonathan Morrow, who left Fluke to begin work for Milwaukee Electric in its Test and Measurement Field. But Morrow was initially hired by Jacobs Chuck Manufacturing, a subsidiary of Danaher Corporation. Fluke was a separate subsidiary of Danaher.

Morrow's two-year, broad non-compete restriction was contained in a contract with Jacbos Chuck; Fluke was not a party to it and the definition of "Company" in the preamble to the agreement referenced only Jacobs Chuck as a division of Danaher.

The non-compete clause broadened the definition of Company to include any affiliate of Danaher, but the expanded definition of Company was limited just to the non-compete term. Morrow was transferred to Fluke after he signed the non-compete contract, and he never signed a new agreement with Fluke.

Fluke balked when Morrow quit to join a competitor. Reversing the trial court's order of injunctive relief, the appellate court held that the unambiguous contract language rendered the non-compete unenforceable by Fluke against Morrow.

The reasoning: Morrow's transfer to another subsidiary - Fluke - constituted a termination of the employment agreement. It was critical that other contract provisions not at issue stated that a transfer of Morrow to another affiliate of Danaher would not constitute a termination of the agreement. However, by limiting the effect of transfer to just a few paragraphs, the fact the non-compete section was silent on this issue meant Morrow's transfer to Fluke was a termination for purposes of the non-compete covenant.

Finally, the agreement did not provide for automatic assignment to a subsidiary in the case of a transfer. Had it, the outcome may have been different - or at least the court would have been forced to address the substance of the non-compete.

The decision is an example of how employers must be careful in analyzing when the non-compete purports to operate, either in terms of an inter-company transfer, a termination or an assignment following an acquisition. It is critical that terms in one paragraph match up with another so that employees cannot argue that the strict construction rule releases them from any post-employment obligations.

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Court: Court of Appeals of Washington, Division One
Opinion Date: 2/17/09
Cite: Fluke Corp. v. Milwaukee Electric Tool Corp., 2009 Wash. App. LEXIS 364 (Wash. Ct. App. Feb. 17, 2009)
Favors: Employee
Law: South Carolina