Supreme Court of Illinois Grants Leave to Appeal in Reliable Fire Equipment

Today the Supreme Court of Illinois granted an employer's leave to appeal in Reliable Fire Equipment v. Arredondo, the Second District case last year which added new confusion to non-compete law in Illinois.

Following Reliable Fire Equipment, the five appellate courts in Illinois were left to apply three different "protectable interest" tests. The Court had little choice but to resolve this conflict among the appellate districts.

The case represents the Court's first true opportunity to enunciate a standard by which employment-based non-compete agreements will be judged. I believe the Court will adopt some variant of the traditional test widely used across many jurisdictions, which allows enforcement of non-compete agreements if: (a) the covenant is reasonable and not greater than is required for the protection of the employer; (b) the covenant does not impose an undue hardship on the employee; and (c) the covenant is not injurious to the public interest.

Element (a) is almost always an issue in litigation and encompasses traditional hot-button issues like a covenant that is too long, too extensive in geographic reach, or too broad in scope. It also would require a court to analyze the breadth of the covenant in relation to the interest an employer seeks to protect.

Also, it is element (a) where Illinois courts have gotten lost on a detour for the last, oh, 70 years or so. The Court is unlikely to issue an opinion in Reliable Fire Equipment until early 2012.

Hair Stylists Subject to Enforceable Non-Compete Agreement (Jon Scott Salon v. Garcia)

Clients mistakenly believe that non-competes are limited to a narrow range of "sophisticated" industries. In fact, non-compete agreements are common in a wide range of disciplines, from so-called professions (accounting services) to business-to-business relationships (wholesale insurance brokerage) to retail services (personal training).

I presented at a seminar a few weeks back, and a judge remarked to me that his experience with non-compete cases "usually involved hair stylists." Though he was joking, it's not unheard of to see such cases. Stylists develop a personal connection with their clients and provide a service that is hard to replicate. Many personal services providers have sales employees or technicians who develop intimate relationships with clients and who get to know their clients very well. It is this kind of interest a business can protect legitimately through a non-compete agreement.

Employers ought to consider using the least restrictive means possible to prevent competition by personal services providers. A customer non-solicitation agreement for a hair stylist, for instance, would narrowly match the restriction with the protected interest. A stylist presents a risk only if she takes her clients. She is unlikely, for instance, to develop some proprietary program or process that has independent value.

Don't be surprised, though, when courts misapply the law if the non-compete defendant is a retail service provider like a stylist. A lot of judges who don't hear but a few non-compete disputes a year think covenants should be limited to a narrow set of circumstances - the high-paid CEO, the rainmaking insurance producer, or the partner at an accounting firm. A recent Texas judge misapplied the law and dismissed a proceeding against a stylist, holding that because she was an "at-will" employee, she could not be restrained by a non-compete at all.

This was a ruling that was contrary to existing precedent. The mistake may have been made due to courts' hostility to non-compete agreements, particularly as to employees who line Main St. USA. Non-compete litigation always has a cost; mistakes made by courts are one of those costs that are hard to predict.

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Court: Court of Appeals of Texas, Fifth District
Opinion Date: 5/19/11
Cite: Jon Scott Salon, Inc. v. Garcia, 2011 Tex. App. LEXIS 3790 (Tex. Ct. App. May 19, 2011)
Favors: Employer
Law: Texas

Non-Compete In Post-Employment Settlement Agreement Judged With Less Scrutiny (McClain & Co. v. Carucci)

Not all non-competition covenants are judged with the same degree of scrutiny.

On the pro-enforcement side is the "sale-of-business" covenant, under which the restrictions normally are examined only for their reasonableness as to time, territory and scope. On the anti-enforcement side is the traditional employment-based covenant, which usually requires an enforcing party to show not only that the covenant is reasonable, but also tied to a legitimate business interest. The burdens on an employee's ability to earn a living, and the public interest are usually considered as well under an exacting "reasonableness" analysis.

The history of covenants not to compete is quite interesting (to me), and many would argue that the old justifications and presumptions that courts used long ago do not apply in a more modern economy. Sale-of-business covenants were the first types of covenants to be enforced by courts, and for the most part, they pose few enforcement problems. Employment covenants are a different story.

In the past on this blog, I have been critical of the sale-of-business nomenclature, because it is underinclusive and suggests to courts, lawyers, and (most importantly) clients that the test only applies to a covenant signed in connection with a business sale. Sounds logical.

But it's not right.

In point of fact, courts analyze a wide range of covenants under this more relaxed standard. Among these are covenants in franchise agreements and shareholder agreements. Last week, a Virginia court - in a matter of first impression - added another type of agreement to this list: settlement agreements.

This makes sense. Many settlement agreements are the product of arms-length negotiations and pose few problems in terms of being adhesive. That is not always the case, though. For many terminated employees, a severance agreement may not be negotiable at all and may be presented as a take-it-or-leave-it offer. A lot depends on the employee's position within the company, and pre-existing contracts he or she has which may impact the terms of any release.

In McClain & Co., Inc. v. Carucci, the employer and employee reached a post-employment settlement agreement after Carucci apparently embezzled nearly $300,000. The agreement called for him to pay the employer $250,000, grant it a 30-month non-compete, and exchange releases. The court examined the few other cases on point and concluded that the "sale-of-business" test applied to the settlement agreement, at least in Carucci's case.

The court did not lay down a per se rule on this, nor should it have. A court when confronting a non-compete in a release agreement likely will examine a number of factors, including the degree to which it was negotiated, the benefits the employee received (such as garden-leave), the circumstances of the employee's termination, and other unique circumstances.

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Court: United States District Court for the Western District of Virginia

Opinion Date: 5/4/11

Cite: McClain & Co., Inc. v. Carucci, 2011 U.S. Dist. LEXIS 48404 (W.D. Va. May 4, 2011)

Favors: Employer

Law: Virginia

Flat-Fee Liquidated Damages Award Upheld in Staffing Dispute (ProTherapy Assocs. v. AFS of Bastian)

Staffing agreements almost always have some sort of non-compete or (more commonly) non-solicitation covenant. Courts recognize that without such protections staffing companies could become an involuntary employment agency for their clients.

In recognition of this, many agreements don't prohibit solicitation but rather tie a monetary price to it. These arrangements are called "liquidated damages" clauses, and they basically set a pre-determined formula for solicitation or hiring of an employee. Liquidated damages clauses can be enforceable, but several procedural requirements must be met. Most commonly, the damages must not be readily ascertainable at the time of contracting. Additionally, the formula or pre-determined sum must not be grossly disproportionate to damages that might be expected to result from a breach.

A recent dispute in the skilled nursing staffing industry upheld a clause that provided for $10,000 per wrongfully solicited or hired employee. The case followed a familiar storyline. The staffing company was terminated in favor of a replacement. The nursing homes used the replacement company to hire the workers the homes could not themselves hire without paying the liquidated damages.

The court found the $10,000 sum to be reasonable and enforceable. The plaintiff introduced evidence showing that the replacement cost of skilled nurses was relatively close to the $10,000 figure and that nurses frequently received signing bonuses of $10,000. Employers who choose to utilize liquidated damages clauses should be prepared to justify them with actual figures showing why the preset number was reasonable and proportionate to likely harm. The number need not be perfect, but also it can't just be random and certainly can't be punitive.

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Court: United States District Court for the Western District of Virginia
Opinion Date: 5/3/11
Cite: ProTherapy Associates, LLC v. AFS of Bastian, Inc., 2011 U.S. Dist. LEXIS 47161 (W.D. Va. May 3, 2011)
Favors: N/A
Law: Florida

Ninth Circuit Extends Application of Computer Fraud and Abuse Act (U.S. v. Nosal)

The Computer Fraud and Abuse Act's role in competition cases has decreased over the past few years. This is due in large part to the interpretation of the "damage" or "loss" element that an employer must show as part of a claim. It also is due, however, to courts' restrictive interpretation of an employee' improper access of a protected computer.

The Ninth Circuit was on the leading edge of the statutory interpretation issues, taking a fairly pro-employee stance in LVRC Holdings, LLC v. Brekka. In a recent decision, the court of appeals softened its stance a bit and issued a pro-employer ruling on the CFAA's scope and application.

The criminal case of United States v. Nosal puts front and center an employer's access or use restrictions. In particular, an employer's policies, most often expressed in a non-disclosure agreement, which place a restriction on the ability of an employee to use or access sensitive company data will determine the CFAA's applicability. For instance, if an employer requires all employees to agree that a CRM database can only be accessed or used for any internal client or business purposes, the use of that database for improper competitive purposes could result now in an employee "exceeding his authorized access" of the system. This would be shown, for instance, by converting a report to Excel and e-mailing it to a personal account or a co-conspirator.

An employer who does not put an employee on notice that such conduct is prohibited most likely will not be able to state a CFAA claim. Keep in mind that a CFAA claim is both civil and criminal, and it still requires an employer to demonstrate a minimum loss in the amount of $5,000. It is not an easy claim to prove. The Ninth Circuit has opened a slight window for employers in that circuit to use carefully worded policies and agreements as a basis for an "exceeds authorized access."

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Court: United States Court of Appeals for the Ninth Circuit

Opinion Date: 4/28/2011

Cite: United States v. Nosal, 2011 U.S. App. LEXIS 8660 (9th Cir. Apr. 28, 2011)

Favors: Employer

Law: Federal

Clean Departure Key To Minimizing Liability

I met with a new client yesterday who presented a non-compete problem that I see everyday:

(1) Client has an exciting new job opportunity.

(2) Client has an agreement with significant enforceability problems.

(3) Client and potential new employer have taken steps to avoid direct competition and to ensure ex-employer's interests are still protected.

But still, the new job arguably falls within the terms of the non-compete agreement. This is where the method of departure can tip the balance from a high-risk case to one that contains relatively low risk of liability.

What are the keys to a clean departure?

(1) Return all employer information, whether stored electronically or in paper. This may require the employee to work with the IT department to make sure a home computer is scanned and cleaned properly. Employees should not assume that an undisclosed, mass deletion of data is acceptable.

(2) Be honest and forthright in an exit interview. If you mislead your employer about your post-termination plans, that leads to the inference that you are hiding something.

(3) Make your last 30 days of employment your absolute best. Don't mail it in with customers, vendors, or co-workers. You don't want your employer arguing that as you prepared to leave to a work for the competition, you went in the tank with the company's five biggest clients.

(4) Work out an agreement with the new employer that protects your ex-employer. Some clients express surprise at this, but it is essential. Your new contract should require you not to use any confidential information of any ex-employer and should prevent you from bringing anything proprietary onto the new employer's premises. Ideally, it should restrict your work activities so that there is some separation of duties between your new job and previous job. This could, for instance, limit your work with a category of customers or a particular product until a non-compete period has passed.

(5) Comply with the notice and resignation provisions in your current employment agreement. This may require 30 days' notice or impose a transition obligation. Don't ignore these terms.

These are illustrative steps for an employee (and a new employer) to consider. If an employee finds himself or herself embroiled in a lawsuit, a judge ruling on an injunction motion will give careful weight to the departure and will likely consider the factors above in determining what hardship may befall a company if its non-compete is not enforced. My experience is that a court also will more carefully look at the terms of the covenant and try to find some overbreadth if the employee has acted responsibly and done his or her best to make a smooth transition.

Be Careful When Drafting Geographic Restriction in Louisiana (In re Gulf Fleet Holdings, Inc.)

Louisiana is one of those special drafting states. Attorneys must proceed with great care when drafting the scope of a non-compete restriction by virtue of a strictly applied statute. Section 23:921(C) of the Louisiana Statutes provides that for a non-compete to be enforceable specific parishes or municipalities must be identified. Even if an employer conducts business throughout the state, a blanket prohibition on competing in Louisiana will be invalid.

It is settled law in Louisiana that an employer cannot enforce a non-compete in a parish where it does not conduct business. For employers that want to restrict post-employment activities, therefore, it is essential to be consistent and include in the non-compete agreement only those parishes where it can show demonstrable business activity.

If an employer chooses to be overinclusive and list, for instance, all parishes in Louisiana, this would not necessarily be fatal or render the covenant overbroad. Several courts, including a recent adversary proceeding in bankruptcy, have allowed an employer to engage in this practice and have blue-penciled the listed parishes where the employer does not engage in business.

Another twist, however: the operative agreement must contain a clause allowing for such severing of the covenant. Finally, if the covenant applies outside Louisiana, the restrictions must also list out the prohibited territories by county. So for instance, if an employer chooses to restrict business in neighboring Texas, it too must list each Texas county it considers off-limits.

Louisiana courts place a strange emphasis on over-technical drafting. It can certainly be argued that the practice of blue-penciling specific parishes or counties creates an incentive for an employer to be overinclusive and overbroad, knowing full well courts can strike specific locations without rendering the entire agreement unenforceable.

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Court: United States Bankruptcy Court for the Western District of Louisiana
Cite: In re Gulf Fleet Holdings, Inc., 2011 Bankr. LEXIS 1396 (W.D. La. Mar. 31, 2011)
Opinion Date: 3/31/11
Favors: Employer
Law: Louisiana

What Provisions Does the Employer Need In Its Non-Compete Agreeement?

A common theme in non-compete disputes is poor drafting. This is why I always tell my employer clients that putting a binding, enforceable non-compete agreement in place requires more than just pushing the print button on a prior form.

In reality it takes a minimum of four hours to consult with a client, put a form contract together, and then follow-up to make edits and finalize it for actual use. Even this is an austere budget, but it may be doable in some cases.

I normally advise employers not to throw in the kitchen sink. But here are the key terms I generally will include in most non-compete agreements, aside from (obviously) the covenants themselves which are always different and always specifically tailored to the employee.

1. Tolling - This clause ensures the covenant terms runs from the date of breach, not the date employment ends. Not all states imply a tolling right. It may be essential for the contract to spell it out.

2. Liquidated Damages - This may not be for every situation, but ordinary lost profits are tough to prove in competition cases. A liquidated (or pre-determined) damages clause sets the formula (e.g., two times annualized commissions per solicited client) and leads to a more ready assessment of what the case may be worth on the financial side. I had a client in last week who asked whether liquidated damages are "cheaper" to prove, and the answer generally is yes.

3. Invention Assignment - This provision is most appropriate for creative employees and those who develop products, ideas, source code, and the like. Some states, like Illinois, have carve-outs that may need to be included in the contract.

4. Attorneys' Fees - Everyone is familiar with the idea, and it is generally a good idea to make sure a fee-shifting clause is mutual. Otherwise, it may not be enforced.

5. Definitions - This depends on the agreement, of course. A definitions section serves a few purposes. It usually means you have a more readable agreement, but also it clarifies the nature of the restrictions and allows an employer to address business-specific matters that may arise. An employer should consider definitions for key terms like the following:

Solicit

Restricted Territory

Restricted Customer

Business of the Company

Competition

6. The Playing Field - Venue, choice of law, arbitration, and jury trial waiver. The first two are essential for employers operating in several states.

Keep in mind this list is not exhaustive, and it certainly does not cover the prototype executive employment agreement, which itself will contain detailed terms on compensation, benefits, severance, and termination.

Court Considers Hypotheticals In Determining Overbreadth of CVS Non-Compete Agreement (Saban v. Caremark Rx, LLC)

I have written often on the important of good, clear drafting.

At a seminar I presented last week, a circuit court judge agreed with my observation on the blue-pencil rule. She stated that in 23 years, she has not modified an overbroad covenant. Courts simply do not warm to the idea of subjecting the parties to a contract to which they did not agree.

A recent case involving a former key employee of Caremark illustrates the danger of poor drafting that yields potentially absurd results. The one-year non-compete in the case of Joel Saban provided Saban could not work "in any capacity" for a business engaged in "Competition." The biggest problem for CVS was its definition of "Competition", which included for instance any retail business with plans to include a pharmacy as a "component of its business.

Saban, however, was not a CVS pharmacist or retail employee. He was, essentially, a key business-to-business guy who negotiated drug price discounts in the pharmacy benefits management side of Caremark. Utilizing hypotheticals about what the covenant would prohibit yielded "canyon-like" overbreadth in terms of potential restrictions. Caremark objected to the use of such hypotheticals, contending it was inconsistent with ascertaining the parties' intent at the time of contracting.

The court had little trouble rejecting this argument. The use of hypotheticals to demonstrate overbreadth is part and parcel of a non-compete defense on the issue of reasonableness. This all goes back to the concept of notice and basic fairness. If the terms of the covenant are not sufficiently clear to advise an employee of what conduct is prohibited, then an employee's burden to comply is too high.

Hypotheticals are most relevant to illustrate cases on the edge - where the employee believes he is complying, but the employer says he isn't. But they are still relevant even in claims where indisputably direct, vigorous competition exists. This is so because the employee challenging the covenant may have sought legal advice on whether to compete based on the reasonableness of the covenant's language.

The larger point here is that overbroad covenants do not get a free pass if the actual facts show true and substantial competition. Any employer deploying a covenant must run through a series of hypotheticals to see if the terms capture too much business activity or that commensurate with the interest it is trying to protect.

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Court: United States District Court for the Northern District of Illinois

Opinion Date: 4/11/11

Cite: Saban v. Caremark Rx, LLC, 2011 U.S. Dist. LEXIS 38847 (N.D. Ill. Apr. 11, 2011)

Favors: Employee

Law: Rhode Island

"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

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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