Louisiana Court: No-Hire Covenants Do Not Fall Within Non-Compete Statute (CDI v. Hough)

Though frequently a target of derision, the Louisiana courts actually have churned out some interesting non-compete decisions of late. The latest construed a fairly typical no-hire clause, a covenant generally barring employees from soliciting co-workers for a period of time after termination. Courts have been all over the map with respect to these types of covenants. One example is Missouri, where an appellate court held that such covenants were invalid as a matter of law because they did not support a recognized business interest, namely that of maintaining a stable workforce. The legislature acted expeditiously to overturn that decision. Illinois, by way of example, is all over the board on these types of covenants.

In CDI v. Hough, the Court of Appeal had occasion to apply a no-hire clause to an amended statute of general applicability governing non-compete agreements. The employee contended it was an invalid restraint under the statute; the employer felt the statute was not applicable by its terms to a no-hire clause.

The employer came out ahead and was able to enforce the covenant.

Louisiana's statute generally prohibits contracts "by which anyone is restrained from exercising a lawful profession, trade or business of any kind." There are exceptions for reasonable non-competes, but those aren't relevant here. The italicized language is the key to analyzing a no-hire.

According to the court, a no-hire clause does not prevent anyone from exercising a lawful profession. It merely places a restriction on who that individual can solicit to join him. Though the dissent disagreed, the wording of the statute seemingly does not apply at all to no-hire clauses, which are generally the least troubling type of employment covenant (according to most courts, at least).

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Court: Court of Appeal of Louisiana, First Circuit
Opinion Date: 3/27/09
Cite: CDI Corp. v. Hough, 2009 La. App. LEXIS 457 (La. Ct. App. Mar. 27, 2009)
Favors: Employer
Law: Louisiana

Will Statutory Amendments Apply Retroactively to Non-Compete Agreements? It Depends. (Hixson Autoplex v. Lewis)

As of this writing, 16 states have statutes of general applicability concerning non-compete agreements. Several other states have much more limited statutory provisions which address, among other things, no-hire covenants (Missouri), non-disclosure agreements (Washington), and profession-specific non-competes (Delaware, Illinois, New York, Massachusetts, and others).

Legislation in this area is increasing, particularly as the economy flattens and employees conduct business across state lines. Idaho and Oregon have enacted major changes to non-compete law by statute in the last year or two, while Georgia is on the cusp of major reform. Though a bill was filed in the Illinois House of Representatives concerning non-compete agreements, that legislation did not make it past a first reading and the deadline has passed for it to be introduced and called for a vote during Regular Session.

Given the expectation that legislative activity will only proliferate in this field of law, a logical question is whether a statute should be applied prospectively or retroactively. Even then, the question arises as to what prospective application means to a contract that is intended to apply at a future point in time.

The Court of Appeal of Louisiana had occasion to consider this question in Hixson Autoplex of Alexandria v. Lewis. In that case, the employee, a car salesman, signed an industry non-compete with his dealership in 2005. A year later, the Louisiana legislature carved out car salesmen from the statute permitting narrowly tailored non-competes. (Parenthetically, this appears to be the only state granting a non-compete exemption to car salesmen. It is unknown why this lobby has enough influence in Louisiana to get such a law passed). In 2008, Lewis was terminated and accepted employment with another dealership in a prohibited territory under his contract.

The court held that the change to the non-compete law substantive, not procedural, and as a default rule, substantive changes in the law apply prospectively only. The dissent rightfully points out that the relevant inquiry could be considered the time of termination, not the time the contract was entered into. After all, the covenant only takes effect upon termination, and the sina qua non of a covenant is to protect the employer after the employee is gone. By the time Lewis was fired, the statute had been changed. Neither side had anything to gain by the contract prior to this date.

Generally speaking, a legislature's expressed intent will govern. A statute may very well provide that it is intended to apply to agreements entered into on or before a date certain, and that type of clause will govern. Absent such an expression, the substantive change in the law applies prospectively. But Hixson Autoplex, and in particular the dissent, notes the inquiry regarding prospective application of a statutory amendment is not as simple in non-competes as it is in other business transactions.

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Court: Court of Appeal of Louisiana, Third Circuit
Opinion Date: 4/1/09
Cite: Hixson Autoplex of Alexandria, Inc. v. Lewis, 2009 La. App. LEXIS 509 (La. Ct. App. Apr. 1, 2009)
Favors: Employer
Law: Louisiana

Wisconsin Court Approves 2-Year "Look-Back" Provision In Customer Non-Compete (Techworks v. Wille)

The old rules pertaining to non-compete agreements always focused on geographic territory as an indispensable element of reasonableness. Along with a time restriction, courts frequently scrutinized whether a geographic boundary was reasonably tailored to protect an employer.

However, customer-based restrictions can serve as legitimate proxies for a geographic term, and courts appear to consider them as much more favorable (and fair) substitutes. When drafting customer non-compete clauses, attorneys still must be careful to make them reasonable. A sweeping restriction barring an employee from contacting or working with any customer (past, present or future) is sure to be struck down as overbroad.

In many states, courts will require some nexus between the employee and the customer, often times by requiring that the non-compete only extend to those customers with whom the employee had substantial contact during the course of his or her employment. A commonly-disputed type of customer non-compete, though, involves a "look-back" provision. This type of provision was at issue in the recent Wisconsin case of Techworks, LLC v. Wille.

Generally speaking, a look-back covenant bars an employee from contacting customers with whom he dealt during a certain period of time prior to the end of his employment. Companies generally draft look-back provisions in one of two ways.

The first, and more problematic, provides that an employee cannot work with any customer with whom he developed a relationship during the course of his employment. For long-term employees, this could include customers who have not done business with the company in many years. In that type of case, the covenant really protects no legitimate business interest, but rather competition per se. Needless to say, those are tough to justify for employers.

The second, which was at issue in Techworks, involves a specific look-back period of time. In the employee's covenant, the look-back period was two years, such that the covenant barred him from working with any customer with whom he dealt as an employee two years before his departure. The Court of Appeals of Wisconsin, in a surprising decision, found this reasonable. Wisconsin is a notoriously pro-employee state on non-compete agreements.

A dissenting opinion noted that the three customers at issue had actually ceased doing business with the ex-employer several months prior to the defendant's resignation. This raised the issue of what possible legitimate interest the employer had to protect by enforcing the covenant. Still, the majority glossed over the fact and entered summary judgment on the validity of the covenant. The issue of breach was reserved for trial.

Despite the holding, employers must be careful in arbitrarily selecting look-back dates. They must be able to articulate why the time-frame was chosen and what interest is being protected. For instance, evidence demonstrating that other customers frequently come back after a period of time may help establish reasonableness, but it is easy to see an argument like that offered by the dissent in Techworks prevailing in another court.

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Court: Court of Appeals of Wisconsin, District One
Opinion Date: 3/31/09
Cite: Techworks, LLC v. Wille, 770 N.W.2d 727 (Wis. Ct. App. 2009)
Favors: Employer
Law: Wisconsin

Arizona Follows Majority Rule on Assignment of Restrictive Covenants (Sogeti USA v. Scariano)

One of the most common defenses raised by employees who try to break a non-compete is based on standing. Frequently, this arises when an employee signs a non-compete with one employer, who is later acquired by a successor entity. If the employer departs and competes, the successor entity will often try to enforce an agreement it never signed. Many times, the non-compete is silent as to whether the rights, duties and obligations are assignable to the successor.

In Sogeti USA v. Scariano, a federal district court addressed this issue as one of first impression under Arizona law. The court followed the majority of jurisdictions which hold that assignments of non-compete agreements are permissible even if: (a) the contract is silent regarding assignment; and (b) there has been no affirmative consent to the assignment by the employee.

Other jurisdictions following this rule include Illinois, New Jersey, and Kansas. States which hold otherwise, and require an assignability clause or consent by the employee, include Pennsylvania and Nevada. In these minority of states, courts focus on the "personal services" element to the contract and the employer's ability to write an assignment clause into the contract.

A couple of important caveats should be mentioned. First, an employee may impliedly consent to the assignment if he knows of it and continues in his employment for a significant period of time. Second, the rules on assignment are different if the business transaction is a merger rather than an acquisition. Business corporation statutes, not contract law, will govern the contractual obligations of the merged entity.

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Court: United States District Court for the District of Arizona
Opinion Date: 3/27/09
Cite: Sogeti USA, LLC v. Scariano, 2009 U.S. Dist. LEXIS 25658 (D. Ariz. Mar. 27, 2009)
Favors: Employer
Law: Arizona

Senate Bill 2149 Still Without Vote on Third Reading

As previously reported, Senate Bill 2149 proposes significant procedural amendments to the Illinois Trade Secrets Act. Today is the last day for the State Senate to take up a vote on the Third Reading of a bill. In legislative parlance, each bill requires three readings (the third calls for passage of a bill), but since the Senate elected not to go in session today, the deadline has passed for bills to be voted on during this regular session.

SB 2149 was placed on the calendar for third reading over a week ago but it did not come up for a vote last evening when the Senate adjourned at nearly 10:00 p.m. The chief sponsor of the bill has requested of the Senate President an extension of time to call for a third reading of SB 2149 so it still is possible the bill will be presented for a full vote during this regular session of the General Assembly. The Senate is back in session on April 21.

Pallmeyer's Opinion Portends Fight Over Key Issue Regarding Illinois Non-Competes (Giffney Perret v. Matthews)

Judge Rebecca Pallmeyer's recent opinion in Giffney Perret v. Matthews serves as a primer on Illinois non-compete law. As has become the custom, the opinion focuses on whether the language of a restrictive covenant was too broad (it was), whether it should be modified (it wasn't), and whether the employer could satisfy the rigorous "legitimate business interest" test (it did...sort of). The case is a crisp read through all the rules and standards non-compete lawyers must consider when advising their clients about the enforceability of a basic employment non-compete.

But the real nub of the opinion, for me at least, sits in Footnote 16, and it's a point I've been waiting for a court to address.

The problem in Illinois is that there is a gaping disconnect between the types of legitimate business interests a non-compete can protect and the breadth of restrictions sanctioned by courts. As most lawyers have become accustomed to, non-competes can only be used to protect the following business interests:

(1) "near-permanent" customer relationships the employee would not have developed but for his or her association with the employer; and

(2) access to confidential business information the employee has tried to use for his or her benefit following the termination of employment.

To be sure, other states recognize a wider range of protectable interests (e.g., goodwill, ordinary customer relationships, special training), but Illinois is rigorous in requiring the employer to meet one of the two cited above. Even the customer relationships test is exacting - it requires an employer to prove those relationships are "near-permanent", and courts have two different tests interpreting what this even means.

Judge Pallmeyer starts to hint in Footnote 16 at a bigger problem with the business interest test. In the context of the case, the court found that the plaintiff (Giffney Perret) had no protectable interest in its customer relationships. Its printing business was primarily engaged in ordinary sales, and the relationships with its clients were somewhat fleeting; it put printing jobs out to bid with competitors such that customers multi-sourced with regularity. In Illinois, this ordinary sales type of business won't cut it as far as the near-permanency test goes.

But read what Pallmeyer says about this:

"Moreover, even looking past the unreasonable terms in the non-solicitation clause, [Plaintiff's] covenant did not need a non-solicitation privision in order to protect any legitimate business interest established here. Because the covenant has a non-disclosure clause to protect [its] interest in confidential information, a non-solicitation provision was really only necessary if it were to protect relationships with near-permanent customers. As discussed above, [Plaintiff] had no protectable interest in near-permanent customers, so the non-solicitation provision as a whole was not 'necessary to protect the promisee.'"

Under this reasoning, it is hard to imagine how industry non-compete agreements (barring employment, not just solicitation of customers) would be valid in Illinois against employees. Put another way, if the interest an employer is limited to protecting through a covenant extends only to near-permanent customers or confidential information, then a general industry non-compete is by definition overbroad. Only activity restraints against solicitation of customers and disclosure of confidential information should be enforced.

Will we see anything more from courts on this point? It's hard to say, since the rules are well-established and there are a litany of cases enforcing industry-wide bans on employment with a competitor. But counsel should be aware of this opinion if a general non-compete is at issue. Arguably, the presence of a non-solicitation and non-disclosure clause makes the non-compete duplicative and not tied to any protectable business interest.

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Court: United States District Court of Illinois
Opinion Date: 3/24/09
Cite: Giffney Perret, Inc. v. Matthews, 2009 U.S. Dist. LEXIS 23531 (N.D. Ill. Mar. 24, 2009)
Favors: Employee
Law: Illinois

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

Illinois Trade Secrets Amendments Face Vote In State Senate As Early As Today

I have previously written about Senate Bill 2149, which proposes important procedural changes to the Illinois Trade Secrets Act. The changes concern an initial disclosure of the trade secrets by the plaintiff, along the lines of Federal Rule 26(a)(1), and detailed attorneys' fee shifting provisions.

SB 2149 has been placed on the Senate calendar order for what is called a "third reading." Under General Assembly rules, a bill must be placed on the calendar three times before a legislative chamber can pass it. The first reading introduces the bill, while the second reading allows for floor amendments. (No floor amendments were made to the bill.) It is the third reading when the bill is actually voted on. This bill is going to get a thumbs-up or thumbs-down; it won't die in the Rules Committee.

Illinois Court Goes Bananas Over Unlimited Non-Compete Agreement (Del Monte Fresh Produce v. Chiquita Brands)

Illinois courts have been fairly uniform on the rule-of-reason as applied to industry non-compete agreements. While there is a legitimate debate brewing over whether (or, perhaps to what extent) an employer must show a protectable interest in support of a non-compete, patently unreasonable and overbroad covenants continue to be struck down.

Consider the case of Kim Kinnavy, a former district sales manager with Del Monte who was in charge of customers with banana supply contracts. Kinnavy signed a one-year non-compete contract barring her from working industry-wide for a wide range of businesses involved in the supply or brokerage of fresh vegetables or fruit.

As Judge Hibbler noted, "the Non-Compete prohibits Kinnavy from 'being connected in any manner with' an entity that brought fruit, vegetables, or other produce from Del Monte. Under these terms, Kinnavy could not work as a cashier at a Piggly-Wiggly that bought produce from Del Monte." This example highlights a problem I frequently see in analyzing non-competes: employers give too little thought to drafting the contract so that it contains reasonable parameters on the type of employment that is off-limits.

The fundamental problem here is with notice: if a non-compete is a blanket, industry-wide ban, the employee has no idea what he or she is entitled to do and is therefore discouraged from seeking a job with any competitor, even if that job bears no rational nexus to the job he or she has just left. The court also noted the worldwide ban on employment for one-year and deemed it fundamentally unreasonable, citing a litany of Illinois cases construing and rejecting as unreasonable similar covenants.

Given the breadth of the restrictions, the court declined to modify or blue-pencil the covenant to make it more reasonable. Of primary concern to Illinois courts is the language of the contract. Courts simply won't employ the blue-pencil rule if the employer misses by a wide margin. Here, the covenant failed on two grounds of reasonableness - geographic reach and scope of activity - and the court was not inclined to rewrite the contract for the employer.

The court declined to use the modification rule based on the express language of the contract. Even though the non-compete contained a severability clause, the court found that the non-compete was an "essential feature of the contract at issue" and that the severability rule could not apply. In particular, the contract specifically stated "each of the above provisions is essential to the Company and the Company would not furnish the Employee the consideration set forth in this Policy [of Trade Secret and Non-Competition] absent the Employee's agreement to abide by and be bound by each of the above provisions..." In any case where an employer seeks to invoke the blue-pencil doctrine, the reasoning employed in Judge Hibbler's ruling should be examined carefully.

Finally, for the third time in the last two years, the court struck down a Florida choice-of-law clause as contrary to Illinois public policy. I previously wrote about this issue in another post.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 3/19/09
Cite: Del Monte Fresh Produce, N.A., Inc. v. Chiquita Brands Int'l, Inc., 616 F. Supp. 2d 805 (N.D. Ill. 2009)
Favors: Employee
Law: Illinois

Michigan Courts Continue Favorable Policy Towards Enforcement of Non-Compete Agreements (Kelly Services v. Marzullo)

Prior to 1985, Michigan was one of the most employee-friendly states when it came to non-compete agreements. With one very narrow exception, such covenants were void under state statute. Since then, however, the repeal of Michigan's old law and the enactment of a new statutory scheme has made Michigan one of the most-employer friendly venues with respect to non-competes.

Michigan's broad policy favoring non-compete agreements was on display in Kelly Services v. Marzullo, a case in the ever-litigious employment staffing services industry. Marzullo was a high-level executive for Kelly Services, working in its Dallas, Texas office as Regional Manager/Vice-President. In June of 2007, Marzullo signed a new restrictive covenant agreement, which was governed by Michigan law. In addition to a non-solicitation and non-disclosure clause, the contract contained a one-year industry non-compete covenant which barred Marzullo from working in the employee staffing business in any state in which he had responsibility during the three years prior to his termination. From the facts, it appears Texas would be the only state included within the industry non-compete.

After his resignation, Marzullo went to work for Roth Staffing Companies, and he stated that he would be responsible for West Coast operations. At the time he left, Marzullo indicated he would not have responsibility for clients in Dallas and mentioned he would have to relocate. Aided by a LinkedIn profile indicating otherwise, Kelly Services determined Marzullo was not only still living in Dallas after his resignation but was responsible for Roth's Dallas territory.

At the preliminary injunction hearing, Kelly Services conceded Marzullo had not yet solicited any of his old accounts in violation of the contract, nor had it discovered misappropriation of confidential information. Marzullo, however much he tried to downplay the extent of his work in Texas, was in violation of the industry non-compete.

Under Michigan's pro-employer law, this was enough to warrant an injunction in Kelly Services' favor. Marzullo's defense was based mainly on the choice-of-law clause; had he been able to apply Texas law (which he wasn't), Marzullo stood a chance of prevailing on a technical consideration argument, but the court even seemed dubious that contention would enable Marzullo to escape the one-year covenant.

Employers in Michigan have a significant upper hand when litigating non-compete agreements, and they are able to prevail even if less-restrictive activity covenants would otherwise protect an employer.

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Court: United States District Court for the Eastern District of Michigan
Opinion Date: 11/20/08
Cite: Kelly Services, Inc. v. Marzullo, 2008 U.S. Dist. LEXIS 107793 (E.D. Mich. Nov. 20, 2008)
Favors: Employer
Law: Michigan