Trading Secrets : Trade Secrets Lawyers & Attorneys : Seyfarth Shaw Law Firm : Computer Fraud, Confidentiality Agreements, Corporate Espionage

Yesterday, Georgia's House Judiciary Committee passed House Resolution 178 , which would enable the non-compete legislation enacted last year.    The Resolution and the following constitutional amendment are necessary because of prior court rulings stating that the Georgia's legislature lacks the authority to act in this area.   The Daily Report  indicated that the Resolution would be carried in the Georgia Senate by Sen. William S. Cowsert, R-Athens.  If passed by both the House and the Senate, then on the general election ballot in November 2010, Georgia's voters would have an opportunity to approve the proposed constitutional language. 

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In the December 2009 edition of the Georgia Bar Journal, Michael Elkon, Erin McPhail Wetty and I published an article about Georgia's HB 173:  "Georgia Gets Competitive."   The article discusses some of the most troublesome areas of Georgia's current law on non-competes and then how HB 173 proposes to address those areas. 

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When we last wrote about IBM’s efforts to enjoin David Johnson, its former Vice President of Corporate Development, from joining Dell, Judge Stephen Robinson of the Southern District of New York had denied IBM’s second motion for preliminary injunction and the Second Circuit Court of Appeals was preparing to hold oral argument on the matter. The Court of Appeals has now issued a brief order upholding Judge Robinson’s decisions. After setting forth that it would review the District Court’s denials of the motions for preliminary injunction under the deferential abuse of discretion standard, the Court of Appeals upheld the denial of the first motion for preliminary injunction. In so doing, it cited to the trial court’s finding that Johnson was “extremely credible” and that IBM’s witness “lacked familiarity with documents bearing on the controversy.” The Court of Appeals also rejected IBM’s attacks on the trial court’s order denying the second preliminary injunction, finding that the trial court was correct when it held that it could not address the second motion because it concerned the same facts as the first motion, which was at that time before the Second Circuit.

The matter now returns to the trial court. In the last actions taken in the trial court prior to the resolution of the appeal, Johnson had moved to dismiss two counts of IBM’s Amended Complaint. The trial court had also denied Johnson’s request to stay discovery, instead directing the parties to agree on a scheduling order. The case will now proceed on those two fronts.

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As mentioned in a previous blog entry, the U.S. Court of Appeals for the Ninth Circuit held in Comedy Club, Inc. v. Improv West Associates, 553 F.3d 1277 (9th Cir. 2009), that an in-term (during the term of the contract/relationship) covenant not to compete governed by California law was enforceable to the extent that it did not foreclose competition in a substantial share of a business, trade, or market. 

The Court overturned an arbitrator’s ruling that permitted a nationwide in-term covenant not to compete as a “manifest disregard of the law.” The Court relied on an apparent variant of the Ninth Circuit’s “narrow restraint” doctrine and older California state law authority to support a watered-down version of the covenant not to compete. 

As detailed in a recent article on Comedy Club authored by Robert Milligan and Jim McNairy and published in Business Law News ("BLN") Comedy Club is a significant decision because (1) the Court’s ruling relied in part on the so-called “narrow restraint” exception to California’s statutory prohibition against covenants not to compete, even after the California Supreme Court had just expressly rejected the narrow restraint exception in Edwards v. Arthur Andersen, 44 Cal. 4th 937 (2008); and (2) arbitration decisions are notoriously difficult to overturn, but the Ninth Circuit had little trouble doing so in Comedy Club.

As Robert and Jim explain in the BLN article, in light of Comedy Club, in-term covenants not to compete may be enforceable in the franchise context in California “to protect trademarks, trade names, and goodwill of a licensor” if they are narrowly tailored and do not foreclose a party from engaging in its business or trade in a substantial section of the market.

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In Pittman v. Coosa Med. Group PC, the Georgia Court of Appeals upheld a trial court's decision to grant an interlocutory injunction enforcing a non-compete provision that prevented Dr. H. Harris Pittman from practicing neurosurgery within a 30-mile radius of CMG’s principal office in Rome, Georgia. 

The non-compete provision is contained in an employment contract that Pittman signed with CMG in 1999. Pittman resigned from CMG on January 1, 2009, and started working for Redmond Neurosurgery, LLC that same day. Redmond’s office is located approximately five miles from CMG’s. CMG initiated a legal action against Pittman roughly one month after Pittman joined Redmond.

Pittman made three arguments on appeal in an attempt to convince the Court of Appeals that the trial court erred in enforcing the non-compete. The first argument is that CMG has no legitimate interest in enforcing the non-compete because Pitttman’s specialty – neurosurgery – and CMG’s line of business – neurology – are complementary, rather than competitive. The Court of Appeals rejected this argument, citing the testimony of CMG President, Dr. William Naguszewski, that Pittman’s decision to start working in the same geographic area led to “all sorts of questions get[ting] raised” about the practice and therefore impaired the reputations of CMG’s physicians. Naguszewski also testified that Pittman’s presence in the market would make it hard for CMG to recruit a replacement neurosurgeon, especially since Pittman testified that he intended to recruit neurosurgeons himself.

Pittman’s second argument was that CMG released him from the agreement. The record reflected that Pittman and CMG did indeed have negotiations regarding Pittman moving his practice, but the parties did not finalize a deal, so the Court of Appeals concluded that there was no meeting of the minds on an agreement to terminate the non-compete provision.

Finally, Pittman argued that CMG consented in his violation of the non-compete provision by referring patients to him at Redmond. However, Naguszewski testified that CMG’s physicians did so because the welfare of their patients trumped the contractual dispute. The Court of Appeals upheld the trial court’s finding that CMG’s physicians made these referrals based on their independent medical judgment and not in assent to Pittman’s competitive acts. Thus, the Court of Appeals upheld the trial court’s decision. 

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By Kate Perrelli and Erik Weibust

On October 7, 2009, the Massachusetts Legislature’s Joint Committee on Labor and Workforce Development held a hearing on a non-compete bill, House No. 1799, sponsored by Representatives Will Brownsberger and Lori Ehrlich. Representatives Brownsberger and Ehrlich had each previously sponsored their own independent bills – Brownsberger’s based on California’s statute that bans non-compete agreements altogether, and Ehrlich’s based on Oregon’s statute that permits non-compete agreements with certain restrictions. The two Representatives have spent a considerable amount of time and energy over the past few months crafting a compromise bill, relying on input from proponents and opponents of non-compete agreements, including industry leaders, employees, trade associations, and attorneys. Several of these people testified before the committee about the need for predictability in the area of restrictive covenants -- for both employers and employees -- and the need to balance the interest of employer’s in protecting their confidential information, trade secrets, and goodwill, with those of employees in being able to switch jobs freely. Although this compromise bill in some respects codifies Massachusetts common law, there are four provisions in particular that warrant further review and refinement:

• The bill prohibits enforcement of non-compete agreements against employees who make less than $75,000 per year. One concern with this provision is that start-up companies often pay their employees lower salaries until they are able to obtain greater financing, yet provide them with as much, if not more, confidential information and trade secrets than higher paid employees at other companies. The bill ignores this scenario. In addition, there is no method in the bill for determining whether companies that pay hourly wages to their employees, such as staffing agencies, are subject to the law, as it is difficult to determine whether an employee will make more than $75,000 in a given year when they begin their employment, which is when they would be required to execute a non-compete agreement. The bill makes no exception or accommodation for these types of companies or others that would be adversely impacted by the $75,000 minimum.
   
• The bill limits non-compete agreements to one year, with the exception of a garden leave clause provision, pursuant to which the employer would pay the employee to sit on the sidelines for the term of the restriction. Courts in the Commonwealth often enforce as reasonable two-year non-compete agreements, and in some limited instances, for longer. A one year limitation may be insufficient in many situations. 
   
• Attorneys’ fees are mandatory for successful defendant-employees, yet they are merely permissive for successful plaintiff-employers, and are to be awarded only in the latter situation if the employer can show that the employee acted with bad faith, a very subjective standard. Moreover, an employee also receives attorneys’ fees if he or she files a declaratory judgment action challenging his or her non-compete agreement, provided that two days before doing so, the employee provides the former employer with specific measures that the employee would take to protect the employer’s confidential business interests, which measures are substantially adopted by a court as part of a hearing on preliminary injunctive relief. Again, this provision may place undue pressure on a start-up to accept an employee’s proposal to avoid incurring legal fees.   
   
• The bill rejects the inevitable disclosure doctrine, under which it is presumed that an employee who had access to a significant amount of confidential information and trade secrets will disclose that information, even if unintentionally, to his or her new employer. This doctrine plays the important role of acting as a backstop to non-compete agreements, or as the only protection where no non-compete agreement is executed, and is necessary to further protect employers against disclosure by such employees. Complete obliteration of this doctrine will affect certain industries more dramatically than others.

Kudos to the legislators, and the group that they enlisted to fashion this compromise bill.  Massachusetts has stepped back, at least for the time being, from the precipice of following California’s legislature’s path in banning non-competes altogether, and instead, has taken a big step forward to provide more clarity to a very complex, fact-specific area of Massachusetts law. There are steps left to be taken, but the current debate is healthy and productive.

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Earlier this week, Starbucks Corp. sued a former executive in the U.S. District Court for the Western District of Washington, seeking enforcement of a noncompetition agreement. (Starbucks Corp. v. Paul Twohig, Civil Action No. 09-01404 (W.D. Wash.))

Former Division Senior Vice President Paul Twohig left Starbucks in March 2009, and, according to news reports, purportedly accepted a position with Dunkin' Donuts as its Brand Operations Officer.  According to the complaint, Twohig executed a noncompetition agreement in 2004, promising that he would not participate in the management, operation, or control of any direct competitors for 18 months after leaving Starbucks.

Starbucks alleges that, as Division Senior Vice President, Twohig controlled all aspects of Starbucks' retail operations in the Southeast, including developing the brand and creating business plans. And, Starbucks contends that after leaving the company in March, Twohig contacted Starbucks in August to ask whether it would release him from his noncompetition agreement, so that he could accept a position with Dunkin' Donuts. Starbucks declined to release Twohig from the contract.

Starbucks is seeking preliminary and permanent injunctive relief, damages and fees.

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Katherine (Kate) Perrelli (a Seyfarth Shaw partner in Boston) recently published an op-ed, “Is Banning Non-Competes the Answer for Massachusetts?" in the September 21, 2009 issue of Massachusetts Lawyers Weekly. In her article, Kate discusses two bills addressing non-competition agreements that are currently pending in the Massachusetts legislature; one bill would enforce reasonably tailored non-competes, while the other would ban them altogether.  A full copy of the article is available here. Kate outlines the supporting arguments of both critics and proponents of non-competition agreements. She explains that those criticizing non-competes claim that restrictive covenants limit employee mobility and industry innovation and should be banned altogether. Proponents of non-competes argue that banning them will hurt employers by negatively impacting employer research productivity and the employer’s ability to protect intellectual property. Kate contends that “reasonable and narrowly tailored non-competes, combined with non-solicitation and non-disclosure agreements, best balance the freedom and interests of the employee against the employer’s interest in protecting intellectual capital.” Kate notes that “while encouraging the free flow of employees and ideas in our economy is appealing, the Legislature should listen carefully to Massachusetts’ business leaders and examine relevant research closely before embracing an all outright ban. Such action may in the end have harmful effects on startups, current employers and the Massachusetts’ economy generally.” She further notes that “banning non-competes in Massachusetts would be a dramatic sea change for companies currently and considering, doing business here.”  A copy of joint proposed legislation is available here.  A hearing is scheduled for tomorrow, October 7, 2009, where debate will be heard on the competing bills.

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In a landmark decision just issued, the Illinois Appellate Court, Fourth District, ruled that an ex-employer seeking to enforce a covenant-not-to-compete against former sales personnel need only show that the time-and-territory restrictions are reasonable and need not prove, in addition, that there is a sufficient legitimate-business-interest in enforcement. 

In Sunbelt Rentals, Inc. v. Ehlers, No. 4-09-0290 (9/23/09), the appellate tribunal agreed with the trial judge that the defendants’ conduct amounted to breach of a reasonable contract and affirmed the entry of a preliminary injunction prohibiting the defendants from violating the covenant. The appellate court held for the first time that the plaintiff’s business interest – that is, a showing not only that the time-and-territory restrictions were reasonable but also that the ex-employer had a “near permanent relationship” with customers and/or that information it provided to ex-employees was confidential – is irrelevant. In the process, the court overruled a number of its own prior decisions and criticized the reasoning of virtually every previous Illinois intermediate appellate decision in point. 

Interestingly, the primary basis for this dramatic shift is the absence of any mention of the legitimate-business-interest test in a 2006 Illinois Supreme Court opinion (Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85) enforcing a restrictive covenant. (For entertainment, read the Sunbelt court’s explanation for affirming the circuit court judge notwithstanding that judge’s indisputable violation of the principle “that a trial court is not free to ignore binding precedent from the appellate court in its own district.”) 

Note that the time to seek rehearing of the Sunbeltdecision, or a petition for leave to appeal to the Illinois Supreme Court, has not yet expired.

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A recent trial court decision from Superior Court Judge Tommy Hankinson of the Griffin Judicial Circuit illustrates one of the many difficulties of enforcing a non-compete provision in Georgia. Specifically, the case – Turner v. Peachtree Fayette Women’s Specialists, LLC, Civil Action File No. 2009V-0746, slip op. (2009) – illustrates that when an employer drafts the geographic scope of a non-compete provision, it had better be sure that the signing employee is going to work in all of the specified areas.

The Plaintiff, Dr. Heather Turner, starting working for Defendant Peachtree Fayette Women’s Specialists (“PFWS”) in October 2006. At the outset of her employment, Dr. Turner signed a non-compete provision that prevented her from providing obstetrical and gynecological services for a two-year period after the end of her employment in the following territory: (1) the area within a five-mile radius of PFWS’s office; (2) Piedmont Fayette Hospital in Fayetteville; and (3) Piedmont Hospital in Atlanta. The case turned on the last of the three areas.

Dr. Turner announced her intention to resign on March 16, 2009, and then filed a declaratory judgment action on April 28, 2009, arguing that the non-compete provision was unenforceable. PFWS counterclaimed for a declaratory judgment, injunctive relief, and attorneys’ fees. After conducting an evidentiary hearing, Judge Hankinson found that Dr. Turner never worked or treated patients at Piedmont Hospital in Atlanta, although she did have staff privileges there. Other PFWS physicians treated patients at Piedmont Hospital earlier in Dr. Turner’s employment with PFWS, but they were not doing so and had not renewed their staff privileges there by the time that Dr. Turner resigned. 

The Court concluded that Dr. Turner did not perform work throughout the territory covered by the non-compete provision and that, as a result, the provision was unenforceable. The Court rejected PFWS’s argument that it received referrals from Piedmont Hospital in Atlanta, noting that Dr. Turner had no relationships there from which to obtain referrals. Because Georgia does not permit blue-penciling or modification of unenforceable provisions, the Court’s conclusion leaves Dr. Turner completely free of the non-compete restriction. PFWS has filed a notice of appeal, so the Georgia Court of Appeals will have an opportunity to opine on the case.

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On July 30, 2009, the Eleventh Circuit reversed a district court decision granting over $1.6 million in damages to a former employer, but upheld an injunction against the former employee, enforcing a non-compete agreement. In Proudfoot Consulting Co. v. Gordon, No. 09-14075, Judge Trager issued an opinion finding that a non-compete agreement that prevented a former Project Director from competing in North America and any other territory to which the employee had been assigned during his employment for six months following his employment was enforceable under Florida law.

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When we last wrote about IBM’s efforts to enjoin David Johnson, its former Vice President of Corporate Development, from joining Dell, Judge Stephen Robinson of the Southern District of New York had denied IBM’s Motion for Preliminary Injunction following a June 22, 2009 preliminary injunction hearing, and IBM had filed an interlocutory appeal. On June 24, 2009, IBM filed an amended complaint, alleging that Johnson violated the terms of IBM’s equity based compensation programs, as well as his fiduciary duties. Two days later (and on the same date that the court issued its decision denying IBM’s first motion for preliminary injunction), IBM filed a request to move a second time for a preliminary injunction based on information developed during the expedited discovery process. The court denied this request.

Two weeks later, IBM filed a second motion for preliminary injunction. In that July 10, 2009 motion, IBM set forth that Johnson should be enjoined pursuant to his "legal duties to protect IBM trade secrets and confidential information" and his "duties to IBM pursuant to a confidentiality agreement that he signed when he joined IBM, the provisions of his various IBM equity grants and IBM’s internal Business Conduct Guidelines." On July 23, 2009, the Court held a pre-motion conference at which IBM conceded that its second motion for preliminary injunction was not based on information obtained during the expedited discovery process.

On July 30, 2009, Judge Robinson denied IBM’s second motion for preliminary injunction in rather strong terms. The court stated that it would not allow IBM to "litigate this matter through piecemeal, seriatim motions requesting the same relief." In fact, the court used the term "piecemeal, seriatim motions" three separate times in its decision as it held that IBM should have asserted all its bases for injunctive relief at the first opportunity. The court went on to refer to IBM’s method of proceeding as "vexatious" and representing a "great disservice to the interests of Mr. Johnson and of the Court in the orderly conduct of this litigation." The court also held that IBM’s second motion would require the court to reconsider certain aspects of its ruling on the first motion for preliminary injunction, a ruling that is before the Second Circuit Court of Appeals.

IBM immediately appealed the decision denying its second motion for preliminary injunction and filed a petition for writ of mandamus on August 7, 2009. The Second Circuit Court of Appeals has consolidated IBM’s appeals and has scheduled oral argument for September 9, 2009. Also, Johnson moved to dismiss IBM’s claims set forth in its amended complaint and to stay discovery. That motion is fully briefed and is before Judge Robinson.

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In the wake of its ultimately successful efforts to obtain an injunction against former executive Mark Papermaster following Papermaster’s move to Apple, IBM recently sought to enjoin David Johnson from joining Dell. Johnson, who was IBM’s Vice President of Corporate Development, recently joined Dell as its Senior Vice President of Strategy.  After conducting a preliminary injunction hearing, Judge Stephen Robinson of the U.S. District Court for the Southern District of New York denied IBM’s motion for preliminary injunction. 

Judge Robinson issued his ruling on June 26, 2009, 22 days after Judge Karas of the Southern District issued an order authorizing expedited discovery and permitting Johnson to work for Dell, subject to a restriction that he could not advise it regarding Dell or IBM strategy. Judge Karas had also required Johnson to supply his counsel with a daily log of his activities at Dell with “reasonable specificity,” including the amount of time spent on the activities and the persons involved. The log was to be made available to IBM’s counsel on request, if ordered by the Court.

Judge Robinson’s primary reason for denying IBM’s motion was a rather basic one: he found it unlikely that IBM could show that Johnson agreed to the non-compete provision upon which IBM based its claim. Johnson worked for IBM for 27 years, the last nine of which he directed IBM’s mergers, acquisitions, and divestitures strategy. In 2005, IBM asked Johnson to sign a non-competition agreement as part of a company-wide effort to have senior executives do so. Johnson was reluctant to sign the agreement without researching his future with the company, so he took the creative step of signing the agreement on the signature line for IBM. When IBM learned of Johnson’s tactic, it sent him a blank agreement to execute. IBM’s human resources department followed up with a number of calls and e-mails to ask Johnson to sign the agreement on the employee line. IBM did not execute the version of the agreement that Johnson signed on the IBM line, nor did it retain an original copy of the agreement. IBM also provided Johnson with annual equity award for 2005-08, despite the fact that entitlement to such awards in 2005 and 2006 was dependent on executing the non-compete agreement.

The Court found that IBM faced a “daunting, if not insurmountable, task” in establishing that Johnson signed his non-compete agreement. It stated that Johnson’s conduct in not agreeing to the non-compete document by signing on IBM’s signature line was ambiguous, thus exposing him to the risk that IBM would misunderstand his intent not to assent. However, when IBM asked Johnson to re-sign the agreement and he refused to do so, his statement of his intentions became unambiguous. IBM’s subsequent efforts to induce Johnson to sign, as well as its general counsel’s raised eyebrows when Johnson disclosed the HR department’s efforts indicated that IBM did not believe that Johnson had executed the agreement. The Court further found that IBM’s 2005 and 2006 equity awards to Johnson were not concurrent with his “signing” of his non-compete agreement. Finally, the Court rejected IBM’s argument that Johnson had intended to mislead it, concluding that Johnson instead intended to buy himself more time to clarify his position at IBM. Of no small import was the Court’s conclusion that Jonson was “an extremely credible and reasonable witness.”

The Court also addressed IBM’s claims regarding the hardship that it would suffer without injunctive relief. In that section, the Court shifted its focus from whether Johnson signed his non-compete agreement to whether Johnson possessed (and presumably would inevitably disclose) IBM trade secrets. The Court addressed IBM v. Papermaster directly. It cited the technical knowledge that Papermaster possessed regarding IBM microprocessors and concluded that Johnson’s business knowledge was, in comparison, not clearly proprietary to IBM. Ultimately, the Court concluded that the balance of equities tipped away from IBM because Johnson’s skill-set would erode if he were enjoined from working in the industry, as would his relationships with a “large personal network” of investment bankers, consulting groups, and chief information officers. Thus, Judge Robinson denied IBM’s motion for preliminary injunction and vacated Judge Karas’s June 4, 2009 order.

IBM appealed Judge Robinson’s decision immediately. On June 29, 2009, the Second Circuit Court of Appeals reinstated Judge Karas’s order placing restrictions on Johnson’s work for Dell and establishing reporting requirements. The Court of Appeals intends to hear IBM’s appeal on an expedited basis.

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In Atlanta Bread Co. Int’l, Inc. v. Lupton-Smith, S08G1815, 2009 WL 1834215 (Ga. Jun. 29, 2009), the Georgia Supreme Court today confirmed that in-term restrictive covenants are subject to the same strict scrutiny standard applied to post-term covenants and the same reasonableness standards of time, territory, and scope. 

The question presented in Atlanta Bread Company was whether the in-term non-compete covenant in a franchise agreement between Atlanta Bread Company and Sean Lupton-Smith is enforceable under Georgia law. The covenant at issue states as follows:

During the term of this Agreement, neither [Lupton-Smith] nor any Principal Shareholder, for so long as such Principal Shareholder owns an Interest in [Lupton-Smith], may, without prior written consent of Franchisor, directly or indirectly engage in, or acquire any financial or beneficial interest in (including any interest in corporations, partnerships, trusts, unincorporated associations or joint ventures), advise, help, guarantee loans or make loans to, any bakery/deli business whose method of operation is similar to that employed by store units within the System.

During the term of the franchise agreements, Lupton-Smith opened and began operating a P.J.’s Coffee & Lounge in Atlanta, Georgia. Atlanta Bread Company sent a notice terminating the franchise agreement and litigation ensued. The trial court and Court of Appeals both found that the in-term non-compete provision was unenforceable under Georgia law because it failed to “meet[] the reasonableness standards promulgated in Georgia.” 

The Supreme Court rejected Atlanta Bread Company’s argument that the provision is a loyalty provision rather than a non-compete provision, noting that

[a] plain reading of the clause shows that it prohibits the franchisee from engaging in a certain type of business during the term of the parties’ agreement and, thus, it is a partial restraint of trade designed to lessen competition. Such restraints, no matter the nomenclature assigned to them, are disfavored in this state as a matter of public policy.

The Court rejected any contention that a franchise relationship should be treated differently, confirming that the court has held time and again” that franchise agreements and employment agreements are subject to the same strict scrutiny (meaning, among other things, that it cannot be blue-penciled). This analysis removes any doubt that the Court’s analysis in Atlanta Bread Company also will apply to in-term restrictive covenants in an employment agreement. 

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Seyfarth's Michael Elkon recently authored an article on Georgia's new non-compete law and its potential effects on technology companies.  Using an extended metaphor to relate scenes from the movie Silence of the Lambs to the current legal regime, Michael argues that technology companies in particular should be interested in the statute because restrictive covenants matter so much to them:

Technology companies should be especially interested in HB 173. This is so because restrictive covenants are particularly important in the technology field. “Tech” companies have to be especially vigilant to protect their confidential, company-specific information because so much of their value is bound up in this information, unlike brick-and-mortar assets that dominate the balance sheets of companies in other industries. Instead, tech companies derive much of their worth from information that is, by its nature, portable. Also, because of the novelty of what tech companies often do, they are more likely to have key employees whose move to a competitor could have serious repercussions. The savvy tech company should have tailored agreements for its key employees, and HB 173 will give those companies more latitude in protecting their information and tailoring their agreements.

The article highlights a few of the new rules that Michael expects will be especially important for technology companies, such as the rules on the permissible scope of a non-compete or the requirements for a non-disclosure provision. Overall, Michael argues that the statute will provide greater flexibility for technology companies in protecting their interests, while acknowledging that technology companies may have a harder time poaching employees from their competitors.

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On April 29, 2009, Governor Sonny Perdue signed HB 173, legislation intended to revamp the way that non-compete, non-solicit and non-disclosure agreements are enforced in Georgia. 

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The Massachusetts House of Representatives has before it two competing bills relating to non-competition clauses to consider this Spring.  Representative Lori Erlich has sponsored House Bill No. 1799, which sets forth the standards by which a non-compete provision could be measured for enforceability.  The proposed statute includes (i) a ban on non-competes all together for any employee earning less than $100,000 in compensation, (ii) a mandate that any non-competition agreement entered into after employment must be based on consideration other than continued employment (presumably cash, although it is unclear), and (iii) the requirement that the employer must give the employee at least two weeks' notice of the agreement before it can become effective. 

In addition, and this is perhaps the most rigorous demand -- a non-compete agreement may be enforceable only if the the employer pays to the employee "for the full restricted period and without offset for any income the employee may receive from other noncompetitive activities, a minimum of the greater of:  (1) compensation equal to fifty percent of the employee's annual gross base salary and commissions at the time of the employee's termination or (2) $100,000." The proposed statute does not affect employee or customer non-solicitation agreements and expressly excludes the rights of companies to act to protect trade secrets and confidential information from misappropriation by way of an injunction. 

The other statute, House Bill No. 1794 submitted by Representative Will Brownsberger, proposes to ban non-compete and non-solicitation agreements in their entirety.  This bill reportedly is gaining support by those who believe that Massachusetts high-tech corridor has not been competitive with California's Silicon Valley because Massachusetts allows non-compete provisions and California does not.  

Although both statutes apply only prospectively by their terms, if either is passed, they clearly would affect all future contracts with employees governed by Massachusetts' law. 

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April 02, 2009
Daily Journal   Reprinted and/or posted with the permission of Daily Journal Corp. (2009).

The California Supreme Court's decision in Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), reaffirmed that employee non-competition agreements are void in California unless they fall within narrow exceptions to Business and Professions Code Section 16600.

Notwithstanding the Edwards decision, it may be possible for employers to enforce non-competition forfeiture provisions in California by including them in retirement plans subject to the Employee Retirement Income Security Act of 1974. ERISA is a federal statute that governs most employee benefit plans (except those provided by government entities and churches), including retirement plans. ERISA plans are protected by a well-formed pre-emption doctrine that applies to most state laws except those regulating insurance, banking or securities matters.

In a series of cases dating back as early as 1980, the 9th Circuit has examined the inclusion of non-competition forfeiture provisions in ERISA plans and has determined that such clauses are permissible under ERISA, with some limitation, and state law is pre-empted on this issue.

It is important to point out that a non-competition forfeiture provision in an ERISA plan cannot apply to any amount an employee voluntarily contributes to a plan because such amounts are always automatically 100 percent vested and not otherwise subject to forfeiture. Similarly, a forfeiture provision added to an ERISA plan could not apply to benefits earned prior to the adoption of the amendment.

Also, ERISA's vesting rules generally establish a maximum time period over which employer contributions to a plan must vest. At the time most of the relevant 9th Circuit cases were decided, ERISA permitted employers to choose between one of two vesting schedules for employer contributions. One schedule was a 10-year "cliff vesting" schedule whereby an employee was zero percent vested until he or she worked for the employer for 10 years, at which time the employee became 100 percent vested. The other schedule provided for a graduated vesting schedule that allowed an employee to vest in incremental percentages (usually 10-20 percent) over time, but not to exceed 15 years.

These vesting rules have been amended a number of times over the years, and currently, employer contributions to profit-sharing and 401(k) plans must vest under either a three-year cliff vesting schedule or a six-year graduated schedule at the rate of 20 percent, beginning with the second year of service.

Accordingly, including a forfeiture provision in a profit-sharing or 401(k) plan may not be as effective as it was when the relevant cases were decided. Now, however, it may be more effective to include non-competition forfeiture provisions in top-hat or other executive compensation plans (which are generally ERISA plans that are exempt from the vesting rules). And there are others commentators who have suggested adding forfeiture provisions to ERISA-covered severance plans as another way of achieving this goal. No 9th Circuit cases have examined whether a forfeiture provision could be included in a top-hat or ERISA-covered severance plan but the arguments in favor of ERISA pre-emption should be the same as in the relevant cases. Instructively, the 2nd Circuit has held that state law was pre-empted by ERISA in the context of a top-hat plan containing a non-competition forfeiture clause and found that the forfeiture provision was valid. One of the earliest cases to examine the inclusion of a non-competition forfeiture provision was the pre-ERISA case of Muggill v. The Reuben H. Donnelley Corporation, 62 Cal. 2d 239 (1965). In Muggill, the California Supreme Court analyzed the validity of a provision in a pension plan that provided that an employee's right to receive payments from the plan would be terminated if he went to work for a competitor. The court held that the pension plan became part of the employment contract and, therefore, the forfeiture provision was invalid under Section 16600 - "[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void."

ERISA was enacted in 1974 and, thereafter, the 9th Circuit's first occasion to analyze a non-competition forfeiture provision in an ERISA plan was in Hummell v. S.E. Rykoff & Co., 634 F.2d 446 (9th Cir. 1980). In Hummell, the court examined a plan provision that provided for the forfeiture of a percentage of the competing former employee's retirement benefits derived from employer contributions. The plan stated that the forfeiture provision only applied to former employees with less than 15 years of experience with the company who competed with the company (those with more than 15 years were fully vested, regardless of competitive activity).

In examining an issue of first impression, the court held that ERISA does not prohibit limited non-competition provisions that apply to amounts in excess of the minimum vesting requirements in ERISA. Ultimately, the court held that the forfeiture provision in the plan was invalid as to the plaintiff because he had more than the minimum years of service required to be 100 percent vested under that plan. Thus, the forfeiture provision was valid but it could not be applied by the company.

In Lojek v. Thomas, 716 F.2d 675 (9th Cir. 1983), the court examined a non-competition forfeiture provision contained in an ERISA-governed profit sharing plan sponsored by a law firm. The provision called for the forfeiture of all employer contributions made on behalf of an attorney who left the firm before completing 10 years of employment and engaged in competitive employment within two years of leaving within a five-county area.

The trial court granted partial summary judgment on a number of issues including that ERISA pre-empts Idaho state law on vesting and forfeiture of pension plan rights and non-competition forfeiture clauses are valid under ERISA. Lojek appealed arguing, inter alia, that Idaho common law on non-competition clauses should control and invalidated the provision. The court disagreed and held that the district court properly decided that ERISA pre-empted Idaho law and federal law governed the validity of the plan.

The plan at issue contained a vesting schedule more liberal than required by ERISA. It allowed attorneys to fully vest after completing five years of employment (the cliff vesting provision under ERISA at the time was 10 years). If an attorney worked for at least 10 years, the non-competition provision did not apply. As a result, the court held that the vesting schedule was valid.

Similarly, in Clark v. Lauren Young Tire Center Profit Sharing Trust, 816 F. 2nd 480 (9th Cir. 1987), the plaintiff argued that a forfeiture clause in an ERISA plan violated Oregon law and the plaintiff urged to the court to incorporate that law and invalidate the provision. In rejecting the plaintiff's argument, the court held that the reasoning in Lojek applied and that state law played "no part in assessing the validity of [a non-competition forfeiture provision] in an ERISA plan."

The court in Clark further held that non-competition forfeiture clauses in ERISA plans are valid so long as the plan provides that benefits earned after 10 years of service cannot be forfeited. Because ERISA's vesting requirements have been reduced, it is likely that a court reviewing facts similar to Clark today would require that the plan provide that benefits earned after three years of service cannot be forfeited (assuming the court followed the ERISA preemption authority).

Finally, in Weinfurther v. Source Services Corporation Employees Profit Sharing Plan and Trust, 759 F.Supp. 599 (N.D. Cal. 1991), the court reiterated that non-competition forfeiture clauses in the Ninth Circuit are valid (citing Lojek and Clark with approval).

Accordingly, based on the 9th Circuit authorities discussed above, employers have a plausible argument that non-competition forfeiture provisions included in ERISA plans should be analyzed under ERISA and are not subject to Business and Professions Code Section 16600. Employers should considering including ERISA plan provisions providing that an employee forfeits employer contributions exceeding ERISA's minimum vesting rules if the employee violates a non-competition provision included in the plan. The non-competition forfeiture provisions should be limited in scope and duration to the extent necessary to protect legitimate business interests.

Additionally, employers may consider trying to extend the ERISA approach to top-hat plans and ERISA severance plans (with structured payouts over time).

These approaches are not without risk and counsel should be consulted before including any non-competition forfeiture provisions as there is always a possibility that notwithstanding ERISA preemption that a court may find that it does not apply based on the strong public policy of Section 16600.

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On April 1, 2009, the Georgia Senate passed HB 173 on restrictive covenants.  The vote tally was 45 in favor and 2 opposed.   The legislation will now await Governor Sonny Perdue's signature. 

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As discussed in our March 9^th and 17^th postings, Illinois Senate Bill SB 2149 seeks to dramatically alter the landscape of trade secret enforcement and litigation in Illinois by, among other things, (a) requiring disclosure of trade secrets before a party issues written or oral discovery; (b) awarding attorneys’ fees to the prevailing party in a trade secrets case; and (c) mandating that a court enter an attorneys’ fees award against any party that subsequently amends its initial trade secret disclosure. Apparently not to be outdone, the Illinois House of Representatives is considering whether to enact a statute that would dramatically limit an employer’s ability to enforce non-competition agreements, and change the way restrictive covenant cases are handled in Illinois.

Currently, non-competition/restrictive covenant enforcement is governed by Illinois case, as opposed to statutory, law. Illinois case law does not limit the type or category of employee who can be subject to a restrictive covenant. Instead, the court examines the covenant to determine if the covenant is reasonably written (i.e. reasonable in both temporal and geographic scope) to protect a “legitimate business interest.”  A “legitimate business interest” exists if the employer demonstrates (1) near-permanent customer relationships that the employee would not know about but for his employment or (2) that the employee acquired trade secrets or other confidential information during his employment and subsequently tried to use the trade secrets for his own benefit. Lawrence & Allen, Inc. v. Cambridge Human Resource Group, Inc., 226 Ill. Dec. 331, 340, 685 N.E. 2d 434, 443 (2^nd Dist. 1997). 

In contrast, House Bill HB 4040 limits non-compete enforcement to employees or independent contractors who:

•                     have substantial involvement in the executive management of the employer’s business;

•                     have direct and substantial contact with the employer’s customers;

•                     possess knowledge of the employer’s trade secrets and/or proprietary information;

•                     possess such unique skills that they have achieved “a high degree of public or industry notoriety, fame, or reputation as a representative of the employer,” or

•                     are among the highest paid 5% of the employer’s work force for the year immediately preceding the separation.

HB 4040 also changes Illinois law so that an employer loses the right to enforce a non-competition covenant if the employer fails to notify the new employee two weeks prior to the first day of his employment that a covenant not to compete is required, or if the covenant is not accompanied by a “material” advancement, promotion, bonus or compensation increase. In addition, HB 4040 alters the court’s ability to determine whether a non-competition covenant is reasonable in temporal and geographic scope (an analysis that is done on a case-by-case basis) by creating a rebuttable presumption that a non-competition covenant is invalid if:

•                     the covenant exceeds one year;

•                     the geographic restrictions in the covenant cover areas beyond which the former employee provided services “during the one year preceding his termination;”

•                     the covenant concerns personal services activities that the employee did not perform during the “one year preceding termination of the employment.”

One of the few similarities between HB 4040 and Illinois case law is that HB 4040 does allow the court to modify a non-competition covenant to “make the covenant reasonable under the circumstances.”   However, HB 4040 goes on to state that, if a court chooses to modify the covenant, then the court cannot impose a damages award for the employee’s original breach of the covenant. Instead, the court can award damages only for conduct that occurs after the modification. Finally, HB 4040 instructs a court to interpret any attorneys’ fees provision found in a non-competition covenant as allowing either the employer or the employee to recover their attorneys’ fees; and further empowers the court to award attorneys’ fees to the employee if, through a declaratory judgment action brought by the employee, the court declares the non-competition covenant unenforceable.

We will continue to monitor HB 4040’s progress through the Illinois House of Representatives.

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In Azzouz v. Prime Pediatrics, P.C., Case No. A08A2340, 2009 WL 619189 (Ga. App. Mar. 12, 2009), the Georgia Court of Appeals upheld a trial court’s grant of an interlocutory injunction on behalf of Prime Pediatrics, P.C. against Dr. Rami Azzouz. Dr. Azzouz entered into a detailed non-competition provision upon the commencement of his employment with Prime. The provision is as follows:

Employee hereby covenants and agrees with Employer that during his employment pursuant to the terms of this Agreement and for a period of two (2) years following the termination of his employment for any reason, the Employee shall not practice pediatric medicine or any pediatric sub-speciality within the following counties located in the State of Georgia: Whitfield, Murray, Gordon, Catoosa, and Walker except as an Employee of the Employer pursuant to the terms of this Employment Agreement.

Nothing contained herein however shall be construed so as to prohibit the Employee from practicing medicine as a pediatrician outside the territory set forth above before the expiration of said two (2) years, or within the territory as described above after the expiration of two (2) years, nor from prohibiting the Employee from practicing specifically any specialty of medicine other than pediatrics....

The parties agree that prohibited competition shall include maintaining pediatric privileges at any hospital located in the prohibited area, advertising in any form, including but not limited to, telephone, white and yellow pages, radio, newspaper advertisements, signage advertising, keeping or maintaining an office within the prohibited geographical area, posting web-sites showing business locations in the prohibited geographical area, or mailings to patients of Employer within the prohibited geographical area.

Non-compete provisions in Georgia typically are limited to the language of the first paragraph of Dr. Azzouz’s non-compete section: a prohibition on competing in a specific field and a specific geographic area for a specific period of time. Prime Pediatrics added the subsequent paragraphs that have the effect of providing greater detail as to what is and is not prohibited by the provision. These subsequent paragraphs proved important when Dr. Azzouz left Prime Pediatrics to open a competing practice and litigation ensued.

Dr. Azzouz argued that the third paragraph barred him from working in any hospital that advertises within the five-county area covered by the non-compete provision. If this interpretation were correct, then the non-compete provision would have been overly broad and unenforceable. The Court of Appeals found that this paragraph was “not constructed perfectly” and then proceeded to add in semicolons to make the provision clearer:

The parties agree that prohibited competition shall include ..., advertising in any form, including but not limited to [ (1) ] telephone, white and yellow pages, radio, newspaper advertisements, signage advertising, keeping or maintaining an office within the prohibited geographical area[; (2) ] posting to web sites showing business locations within the prohibited geographical area [;] or [3] mailings to patients of Employer within the prohibited geographical area.

In so doing, the Court of Appeals relied on O.C.G.A. § 13-2-2(6), which provides that the rules of grammatical construction may be disregarded when interpreting a contract in order to give effect to the parties’ intent. Although the Court of Appeals’ action could be construed as blue-penciling (which is prohibited in Georgia for restrictive covenants in the employment context), the Court of Appeals was able to rely on statutory and common law authority that permits minor changes for grammatical purposes.

The Court of Appeals also cited the second paragraph of the non-compete section, noting that Dr. Azzouz’s construction of the third paragraph was inconsistent with the provision of the second paragraph stating that Dr. Azzouz was free to practice any specialty of medicine other than pediatrics. In the end, the additional paragraphs following the basic non-compete provision first gave Dr. Azzouz an angle of attack and then negated that angle.

Azzouz is interesting because Court of Appeals assumed that the trial court’s factual conclusions were correct. Yet, in other instances, the Court of Appeals has refused to enforce non-compete provisions based on fact-specific arguments made by defendants before a trial court. For instance, in Beacon Sec. Technology, Inc. v. Beasley, 286 Ga. App. 11, 648 S.E.2d 440 (2007), the Court of Appeals refused to enforce a non-compete provision because the record reflected that the employer did not prove that the employee performed each of the prohibited activities in each of the counties listed in the non-compete provision. It is possible that Azzouz could have made a similar argument regarding his provision of pediatric services in the five-county area covered by the non-compete provision, but he failed to get a transcript of the proceedings below.

Azzouz further illustrates that non-compete provisions, although disfavored under Georgia law, are useful in certain professions. Georgia has a strict rule that a non-compete provision has to be limited to the geographic area worked by an employee. This can create problems for employees who have very large assigned areas (such as sales personnel with nationwide books of business) or employees who have no assigned areas (such as research scientists). Physicians, on the other hand, typically see patients from defined geographic areas. As such, it often can be easier to draft and enforce a non-compete provision against a doctor.

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EqualLogic, Inc. v. Shea, (N.H. Superior Court, Hillsborough County).

In an unusual reversal, a Nashua, New Hampshire judge admitted recently that she had erred in granting a preliminary injunction barring a former executive for computer data storage company EqualLogic from working for a competitor. 

EqualLogic was acquired by computer giant Dell for approximately $1.4 billion shortly before area vice president of sales Richard Shea left EqualLogic to take an identical position with LeftHand Networks, a direct competitor in the data storage industry. Dell subsequently sought to enforce the non-compete provision of Shea’s employment contract, which prohibited him from rendering any services to a competitor within twelve months of his departure from EqualLogic. According to Shea, Dell took the overly broad position that the non-compete prevented him from talking to any EqualLogic customers or former customers, although the law allows a company to protect only its actual business interests and goodwill.

In July 2008, Judge Diane Nicolosi granted Dell’s motion for a temporary restraining order, and in September 2008, she converted the TRO to a preliminary injunction barring Shea from working for LeftHand entirely. But Shea challenged the injunction, arguing that it was improperly granted because Judge Nicolosi had failed to apply the three-part test for injunctive relief, considering the likelihood of success on the merits, the risk of irreparable harm, and the absence of an adequate remedy at law. Specifically, Shea’s attorney asserted, Dell’s position on the non-compete went above and beyond protecting its legitimate business interests and goodwill since Shea had agreed not to contact any EqualLogic customers or former customers, and Dell was now seeking to prevent Shea from contacting even potential customers who had no association with EqualLogic. The court admitted its error and lifted the injunction, concluding that EqualLogic was neither likely to succeed on the merits nor in danger of suffering irreparable harm.

While the injunction was in effect, however, Shea was forced to resign from LeftHand, forsaking both his wages and stock options that later increased in value due to LeftHand’s subsequent sale to Hewlett Packard. Arbitration between Shea and Dell over the employment agreement has not yet been resolved, and the agreement leaves open the option for Shea to seek damages. Although the ultimate outcome is uncertain, the case serves as a reminder of the potential risks to employers who seek to broadly enforce non-compete provisions.

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On February 2, 2009, the Wall Street Journal published an “advisor alert” for “The World of Investment Planning.” The alert, titled “Staying Mum When Switching Firms” discusses the sensitive issues a broker faces when he/she leaves one financial investment firm for another. Although the alert correctly notes that “discussing an impending move with clients before resigning is probably the most dangerous thing you can do,” the article provides flawed advice with respect to removing the former employer’s confidential information.

Specifically, the alert discusses an initiative called the “Protocol for Broker Recruiting.” The protocol, which has been signed by companies such as Bank of America (which signed the protocol in order to retain brokers from Merrill Lynch) and Citigroup, concerns certain client information such as addresses, phone numbers, email addresses and account types. Under the protocol and despite the fact that this information is typically considered confidential/trade secret information, a broker may take this client information to his new firm. More importantly, the protocol allows the broker to use this confidential information to contact his/her former clients about transferring their accounts to the new firm. 

The Wall Street Journal alert states that brokers who are moving to or from “firms that are not part of the [protocol] should still follow its guidelines.” This advice is flawed because the advice/alert fails to inform the broker that a non-protocol firm will not excuse a broker’s removal of confidential information simply because the broker followed the protocol. Nor will following the protocol allow the broker to ignore the confidentiality and non-solicitation provisions that are likely founder in the broker’s employment agreement with the non-protocol firm. Put another way, following the Wall Street Journal’s advice when leaving a firm that has not signed the protocol could subject the broker, and the broker’s new firm, to litigation.  Such litigation could concern the breach of an employment agreement and the theft of confidential trade secret information and could lead to restraining orders and injunctions being entered against the former broker and the broker’s new firm.

In addition, firms who signed the protocol should be aware of the protocol’s impact on their ability to enforce restrictive covenants contained in their employment agreements. For example, Merrill Lynch found out in 2007 that it could not enforce its non-disclosure and non-solicitation agreements against a former broker because Merrill Lynch had signed the protocol. Merrill Lynch, Pierce, Fenner, and Smith, Inc. v. Brennan, 2007 WL 632904 (N.D. Ohio, Feb. 23, 2007). Consequently, both brokers and firms need to be aware of the protocol’s potential impact and should consult with competent counsel prior to hiring brokers.

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In Southern Fire Analysis v. Rambo, No. M2008-00056-COA-R3-CV, 2009 WL 161088 (Tenn. Ct. App. Jan. 22, 2009), the Tennessee Court of Appeals reversed a trial court’s dismissal of a complaint alleging violations of three non-compete agreements. The facts are as follows:

Plaintiff Southern Fire Analysis is in the business of investigating fires on behalf of insurance company clients. Southern Fire Analysis employed James Jennings and Glenn Johnson as fire investigators. Jennings and Johnson signed “Corporate Resolution” documents in 1996 and 1997, respectively, that stated the following:

WHEREAS, in the opinion of this Board, it is for the best interests of this Corporation to adopt a No-Compete Agreement, be it

RESOLVED, That a No-Compete Agreement shall remain in effect for a period of Six (6) Months from the date of Termination with the Corporation by James D. Jennings, and shall cover an area of up to and including a One Hundred & Fifty (150) Mile radius from Nashville, Tennessee.

In 2004, Jennings and Johnson changed from being employees to being independent contractors. The Independent Contractor Agreements that Jennings and Johnson executed with Southern Fire Analysis stated that “[t]he Independent Contractor must have and maintain and must provide [Southern Fire] with documents of”... a “Valid Non-Compete Agreement effective for six (6) month time period.” Southern Fire Analysis also hired David Edge in 2005. Edge signed an independent contractor agreement, but Southern Fire Analysis was unable to locate a non-compete agreement attached to or part of the independent contractor agreement.

On July 2, 2007, Jennings, Johnson, and Edge resigned from Southern Fire Analysis, along with Southern Fire Analysis’s Nashville office manager, Michael Rambo. The four individuals started working for Southern Fire, Unified Investigations and Science, a competitor of Southern Fire Analysis. One month later, on August 3, 2007, Southern Fire Analysis initiated an action against Rambo, Jennings, Johnson and Edge. Southern Fire Analysis alleged that Edge, Jennings and Johnson were working in violation of their respective non-compete agreements. Southern Fire Analysis attached copies of the Corporate Resolutions and Independent Contractor Agreements for Jennings and Johnson. It further alleged, upon information and belief, that Rambo removed Edge’s Independent Contractor Agreement and Non-Compete Agreement from Southern Fire Analysis’s files. The Complaint also included a breach of the duty of loyalty claim against Rambo and civil conspiracy claims against all four defendants.

On September 18, 2007, all four defendants moved to dismiss, arguing that the non-compete agreements were invalid. Specifically, defendants argued that Southern Fire Analysis had not pled a protectable business interest, the non-compete agreements were overbroad in their scope, and if valid, the non-compete provisions had expired six months after the Independent Contractor Agreements were signed. Additionally, Edge moved to dismiss the breach of contract claim on the ground there was no evidence that he had entered into a non-compete agreement. The trial court granted the Motion to Dismiss, finding that “the documents relied upon by Plaintiff and attached to the Petition as non-compete agreements between it and Defendants Edge, Jennings, and Johnson are unenforceable and fail to support the claims alleged in the Complaint.” It is unclear from the Court of Appeals’s decision whether the trial court provided any further reasoning in reaching its decision.

The Tennessee Court of Appeals reversed the trial court’s finding, reciting the Tennessee standard that: “Covenants not to compete are enforceable if an employee or independent contractor would otherwise be able ‘to exercise an unfair advantage in future competition with his employer, and if they are no broader in duration or as to the territory they embrace than is reasonably necessary to secure the protection of the business or good will of the employer.’” The Court of Appeals pointed out that:

• Southern Fire Analysis attached to its Complaint copies of the alleged non-compete agreements with Jennings and Johnson.
• Southern Fire Analysis alleged upon information and belief that Edge had signed a non-compete agreement and an independent contractor agreement identical to those of Jennings and Johnson, but they could not be produced because Rambo, had removed the signed documents from the company’s files.
• Southern Fire Analysis alleged that the non-compete agreements were signed by the defendants in exchange for specialized training.
• Finally, Southern Fire Analysis alleged that defendants were competing within 150 miles of its Nashville office, the same geographic area in which they worked as fire investigators for Southern Fire Analysis.

Thus, the Court of Appeals found that Southern Fire Analysis had made a sufficient showing under Tennessee law to survive a motion to dismiss. The Court of Appeals did not explain why the trial court was wrong. Instead, it described the allegations made by Southern Fire Analysis in its Complaint and then concluded that the allegations were sufficient to set forth a claim for breach of contract. It is not clear if the Court of Appeals held that the trial court applied the wrong standard or erred in applying the right standard, possibly because the trial court likely did not set forth its reasoning. 

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Apple issued a press release today stating that the litigation between IBM and former IBM executive Mark Papermaster has been resolved and that Papermaster will commence employment with Apple on April 24, 2009. Papermaster will join Apple as its senior vice president of Devices Hardware Engineering, reporting to Apple CEO Steve Jobs. 

This development takes place 81 days after Judge Kenneth Karas of the Southern District of New York enjoined Papermaster from violating his Noncompetition Agreement by working in a competitive position for Apple. The April 24, 2009 date is significant because it is exactly six months after Papermaster’s October 24, 2008 resignation from IBM. As such, it appears that the parties compromised by agreeing that Papermaster would comply with half of the one-year non-compete period set forth in the Papermaster’s Noncompetition Agreement.

Judge Karas also entered a Consent Order and Stipulated Order of Dismissal with Prejudice today. That Order sets forth the contours of the Parties’ settlement in greater detail. Papermaster can commence work with Apple on April 24, 2009, but he remains under an obligation not to use or disclose any IBM Confidential Information, as that term is defined in his Noncompetition Agreement. 

In light of the fact that IBM asserted in its pleadings that Papermaster would inevitably disclose IBM’s Confidential Information by working for Apple, the non-disclosure requirement does create some enforcement dilemmas for the parties. To address those dilemmas, the Order sets forth that Papermaster will contact IBM’s Vice President and Assistant General Counsel Ron Lauderdale if he has questions as to whether specific information meets the definition of Confidential Information. IBM’s determination must be “made promptly, reasonably and in good faith,” but such a determination shall be “final and binding and not subject to review in any way.” Between July 1 and July 15, 2009 and then again between October 1 and October 15, 2009, Papermaster must execute a statement under penalty of perjury that he has not used or disclosed IBM Confidential Information, and that he does not intend to do so.

Judge Karas’s Order also dissolved the November 7, 2008 preliminary injunction in the case and dismissed IBM’s claims and Papermaster’s counterclaims with prejudice

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In Zupnik v. All Florida Paper, Inc., No. 3DO8-1371, 2008 WL 5412090 (Fla. 3rd D.C.A. Dec. 31, 2008), the Florida Court of Appeals for the Third Circuit reversed a trial court’s entry of a temporary injunction against Stewart Zupnik and Dade Paper & Bag Company. The Court’s reasoning was that the restrictive covenants in question had expired and All Florida Paper did not provide evidence of misappropriation. The facts of the case are as follows:

Zupnik is a sales representative with experience selling paper and janitorial products to customers in the food industry. On March 14, 2004, Zupnik signed an Agreement with All Florida that stated that the "employment shall be for a term of two years." The Agreement gave Zupnik the option to remain with All Florida as an at-will employee if he so elected within 72 hours of the expiration of the two-year term. The Agreement also contained a one-year non-compete and five-year non-disclosure of confidential information provisions, both of which were triggered post-employment by the termination of the term of employment.

After the expiration of the two-year term, Zupnik formed his own company – South Florida Paper Products – and conducted negotiations with Dade Paper & Bag Company as a potential supplier. All Florida subsequently alleged that Zupnik shared confidential information with Dade Paper in a meeting at a local restaurant. At an evidentiary hearing, the only evidence that All Florida offered of such a disclosure was testimony from a private investigator that: (1) Zupnik appeared to give Dade Paper operations manager William Baltzell a folder; and (2) Zupnik and Baltzell had All Florida invoices at the table..

The trial court enforced the non-compete provision and also found that Zupnik had shared trade secrets and confidential information with Dade Paper. The Third Circuit Court of Appeals reversed, holding that the non-compete and non-disclosure restrictions expired at the end of the two-year term. The expiration of the two-year term did not constitute a "termination" to trigger the post-employment restrictions. The Court of Appeals also overturned the trial court’s finding that Zupnik and Dade Paper misappropriated trade secrets and confidential information. The Court of Appeals held that All Florida did not show that its invoices and pricing information were confidential or that defendants misappropriated pricing information.

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Wade Roush reports on xconomy.com  that a Massachusetts legislator is reintroducing legislation in Massachusetts with the intent to ban non-compete agreements.    According to Roush's article,

The bill Huang and Brownsberger are writing would outlaw non-compete agreements in new employment contracts in Massachusetts. It wouldn’t pertain to mergers, acquisitions, or other situations where competition becomes an issue, and it wouldn’t be retroactive. And it would do nothing to change the law regarding the other trade-secrets protections companies employ, such as non-disclosure agreements.

The article indicates that there may be hearings in the Spring.

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Massachusetts Rule of Professional Conduct 5.6 prohibits non-competition agreements for attorneys, and provides in part: “A lawyer shall not participate in offering or making . . . a partnership or employment agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement. . . .” The Massachusetts Supreme Judicial Court recently held that a law partnership agreement imposing financial consequences on all partners voluntarily withdrawing from the partnership, whether they compete with their prior firm or not, does not violate this rule.

In the case of Pierce & others v. Morrison Mahoney, LLP, the Supreme Judicial Court evaluated claims of former Morrison Mahoney partners that their partnership agreement’s amended separation clause violated Rule 5.6 because it provided that partners voluntarily leaving the partnership forfeited certain financial benefits if they departed before having served for 20 years as a partner or after having attained the age of sixty. Originally, the clause had restricted the financial benefits to partners who did not compete with the firm, but the Supreme Judicial Court held in a prior case concerning the same law firm that such a non-competitive restriction was against the public policy in favor of allowing clients to retain an attorney of their choosing and thus violated Rule 5.6. The firm revised the clause in response to the prior case.

Despite this revision, several partners who had left the firm challenged it as violating Rule 5.6, in that it worked a de facto constraint on competition. The Supreme Judicial Court, however, rejected that argument, noting that the revised policy did not provide any disincentive in taking a particular client. That the law firm had created an appropriate incentive for its partners to stay with the firm until they turned 60 or had been partners for 20 years did not violate public policy, according to the Supreme Judicial Court, and it rejected the claims of the former partners.

This case demonstrates that although attorney non-competition agreements remain against public policy, the purpose of that policy is to promote unfettered client access to attorneys, not, as the Supreme Judicial Court put it, to “protect lawyer mobility.” Law firms employing similar restrictions should take care that they are applied across the board to all partners leaving the firm, not just ones that compete with it. In that manner, incentive programs like the one employed by Morrison Mahoney will survive judicial scrutiny, at least in Massachusetts.

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Board of Regents, State of Iowa and University of Iowa v. Warren, No. 8-620 / 08-0017 (Iowa Ct. App.).

The Iowa Court of Appeals last week affirmed a trial court’s denial of an injunction sought by the College of Medicine at the University of Iowa to prevent a former professor from practicing medicine in a nearby city.

Since 2001, Dr. Thomas Warren had been employed as an assistant professor where he spent approximately eighty percent of his time conducting cancer research. With his remaining time, he provided medical care to patients at Cancer Care of Iowa City and at the University of Iowa Hospitals and Clinics under a “Faculty Practice Plan,” which was directed by and generated revenue for the University. When he began working at the University, Dr. Warren signed a non-compete agreement in which he agreed that, following a voluntary termination of his employment, he would refrain for a two-year period from engaging in the practice of medicine in any community in which he had practiced through his College of Medicine-sponsored program, defined as encompassing a fifty-mile radius from the practice sites.

Shortly after resigning from the University in 2005, Dr. Warren began treating patients at Iowa Blood and Cancer Care in Cedar Rapids, but did not bring any former patients with him. Several months later, the Board of Regents and the University sought to enforce the non-compete agreement, arguing that the University competed for patients against other facilities in the county where Dr. Warren now worked.

Although the Iowa courts have a reputation for being pro-employer in terms of enforcing restrictive covenants, the appellate court affirmed the denial of the injunction. Under Iowa law, the long-standing legal standard is whether the restriction is reasonably necessary to protect the employer’s business, unreasonably restrictive of the employee’s rights, and prejudicial to the public interest. Here, the court concluded that the University had failed to show that it suffered or will suffer a loss of business at its hospitals and clinics, as Dr. Warren had not developed close relationships with his patients and had not attempted to solicit them to follow him to his new employer. The court also found that the public interest weighed heavily against enforcement of the agreement based on the shortage of physicians in Cedar Rapids and the resulting negative effect on the community if Dr. Warren is not permitted to treat cancer patients there. The court noted that although the time and geographic area restrictions do not appear to be unduly restrictive, it need not address this element because the other elements militated against enforcement. It remains to be seen whether the University will seek to appeal this to the state supreme court.
 

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On November 21, 2008, Judge Kenneth Karas of the Southern District of New York published his November 7, 2008 Amended Opinion and Order granting IBM’s Motion for Preliminary Injunction against former IBM executive Mark Papermaster. Judge Karas granted the Motion following extensive briefing from the parties, as well as a November 6, 2008 hearing on the Motion. The parties did not offer in-court witness testimony at the hearing, instead choosing to rely on the affidavits that they had submitted. Interestingly, Judge Karas notes at the outset of the Opinion and Order that IBM learned for the first time at the hearing that Papermaster had started work with Apple.  

In the Facts section of the Opinion and Order, Judge Karas synthesizes the numerous affidavits submitted by the parties. Judge Karas does reference IBM’s new type of digital storage device, the mention of which led a number of tech-focused analysts following the case to write about the possibility that IBM’s new “Racetrack” technology is at the heart of the matter. That said, Judge Karas does not reference this technology in the “Discussion” section, indicating that Racetrack is not at the center of the dispute (at least not at present).

In evaluating the legal merits of IBM’s Motion, Judge Karas engages in an analysis of whether Papermaster would inevitably disclose the IBM trade secrets known to him. In so doing, Judge Karas takes IBM’s argument, which had focused on Papermaster breaching the restrictive covenants contained in his Noncompetition Agreement, and shifts it to an inevitable disclosure argument, which is more focused on trade secret misappropriation than breach of contract. 

Judge Karas articulates that Papermaster’s new role makes him responsible for improving Apple’s iPods and iPhones, “that is, to make sure that they store more information, do it more quickly, and use less power in doing so.” Judge Karas concludes that Papermaster would inevitably disclose his knowledge of microprocessors and the “Power” architecture in performing the responsibilities of his position at Apple. In support of his conclusion, Judge Karas cites to Apple’s reference to Papermaster’s knowledge of microprocessor design in its internal deliberations prior to hiring Papermaster.

Judge Karas also focuses on the sequence of events that led to Apple hiring Papermaster. Apple initially elected not to offer Papermaster the position heading its iPod/iPhone division in early 2008. Apple then purchased P.A. Semi, a microchip company that competes with IBM in the microprocessor market, in April 2008. Apple subsequently re-interviewed Papermaster and offered him the position of Senior Vice President, Device Hardware Engineering on October 10, 2008. Apple’s change of heart regarding Papermaster after it purchased P.A. Semi led Judge Karas to conclude that Papermaster would inevitably disclose IBM trade secrets in setting the technical specifications for the microprocessors that P.A. Semi may produce for the iPod and iPhone.

Although it is by no means the centerpiece of his Opinion and Order, Judge Karas also addresses IBM’s claim that Papermaster would breach his Noncompetition Agreement by working for Apple. The Judge finds that the Agreement is reasonable in geographic and temporal scope. He also determines that Papermaster would violate the Agreement by working for Apple because Apple competes with IBM in the chip market, especially after purchasing P.A. Semi.

Papermaster filed a Notice of Interlocutory Appeal on November 20, 2008. In that Notice, Papermaster is appealing Judge Karas’s decision granting IBM’s Motion for Preliminary Injunction. The Court has sent the certified record to the Second Circuit Court of Appeals, although the appeal has not yet been docketed.

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There have been several developments in the litigation between IBM and its former executive Mark Papermaster since the Court enjoined Papermaster from working for Apple on November 6, 2008. First, the Court has ordered IBM to post a bond in the amount of $3,000,000 to cover any potential finding that IBM wrongfully obtained its injunction against Papermaster. 

Papermaster filed his Answer, Affirmative Defenses, and Counterclaims on November 13, 2008. In his Counterclaims, Papermaster sets forth his arguments that the non-compete provision of his Noncompetition Agreement with IBM is unenforceable. Papermaster argues that the provision purports to prevent him from working for any company that competes with IBM, even if: (1) he is not working for the part of the company that competes with IBM; or (2) he is not doing work similar to the work he performed for IBM. Papermaster also argues that the worldwide scope of the non-compete is overly broad, as is the one-year time limitation because of the speed with which information becomes outdated in the world of technology. Finally, Papermaster argues that the New York choice of law provision in the agreement is unenforceable because he lives in Texas, he will be working for a California company, and he has no contacts with New York. Papermaster does not seek any relief in the Counterclaims beyond a declaratory judgment that the Noncompetition Agreement is overly broad and that it should be governed by Texas or California law.

One particular footnote in IBM’s Reply in Support of its Motion for Preliminary Injunction has led to a good deal of speculation regarding IBM’s motivation and interest in bringing its claims against Papermaster. In footnote 1 of its Reply, IBM states that it has developed a memory device that would enable an iPod to store 500,000 songs, all while being cheaper to produce. This device also would permit an iPod to run on a single battery charge for weeks at a time. IBM does not contend that Papermaster worked on this particular technology. 

Various observers of the technology industry have speculated that the unnamed technology referenced in the footnote is “racetrack memory,” a technology that allegedly uses the spin of an electron to keep track of data. If the observers are correct, then they may have put meat on the bones of one of IBM’s arguments to counter Papermaster’s claim that IBM and Apple do not compete. The argument, as set forth in IBM’s Reply, is that Apple used to buy personal computer chips from IBM and now buys iPod and iPhone chips from Intel, an IBM competitor. If Apple used its P.A. Semi to produce chips for the iPod and iPhone, the argument goes, then it will deprive IBM of the chance to sell such chips to Apple.

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New York Supreme Court Justice Debra James has issued a preliminary injunction restraining a former employee of a dog care business, which provides services such as dog walking, feeding and grooming, from competing with his former employer within a ten (10) mile radius of his former employer’s business. The action is entitled The Paw Shop, LLC v. Brian Mestre, New York County Supreme Court, Index No.: 601950/08, and Justice James’s order has likely left the Defendant growling. 

Defendant commenced employment with Plaintiff in January 2007 as a receptionist, kennel manager, driver and assistant dog trainer. On July 27, 2007, Defendant signed an “Employee Non-Compete Agreement,” which included a two year, ten (10) mile radius restrictive covenant against direct competition with Plaintiff. The covenant was to be effective from the date of termination, and the restrictive radius was to be measured from the location of Plaintiff’s business at the time of termination; the covenant was to be effective regardless of the reason of Defendant’s termination. At the time of entering into the non-compete agreement, Defendant received a pay-raise as consideration.

Defendant’s employment was terminated in May 2008, and Plaintiff shortly thereafter commenced the action and moved for the preliminary injunction enforcing the restrictive covenant, alleging that the Defendant had been observed performing dog walking services for the Plaintiff’s clients within the restricted radius.

In granting Plaintiff’s motion, Justice James found that the duration and scope of the restrictive covenant were not “unduly burdensome to the defendant.” Although silent as to its reasoning with regards to the duration, the Court found that the ten (10) mile radius was reasonable because: “defendant lives more than ten miles away from plaintiff’s business, and during the period of the covenant may certainly provide services to dog owners in the neighborhood where he resides.”

The Court found that the Defendant’s services were likely to be “unique” and/or “extraordinary,” by reason of affidavits of former customers of Plaintiff averring such. Ironically, these affidavits were submitted by Defendant in opposition to the motion. Surprisingly, given the result, the Court found that Plaintiff had failed to make a showing that Defendant had either used Plaintiff’s customer lists or used confidential client information. Regardless of this lack of showing, however, the Court nevertheless granted the preliminary injunction, citing holding finding that Plaintiff was being irreparably harmed by Defendant’s providing dog walking services to Plaintiff’s clients within the restricted area.

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On November 6, 2008, Judge Kenneth Karas of the United States District Court for the Southern District of New York granted preliminary injunctive relief to IBM and ordered that a former executive, Mark Papermaster, refrain from working for Apple. 

According to IBM’s Complaint, Papermaster worked for IBM as a member of the Company’s elite Integration and Values Team, which has a hand in developing corporate strategy. On June 21, 2006, Papermaster executed a Noncompetition Agreement with IBM that forbids Papermaster from engaging in or associating with any competitors within the area for which Papermaster had job responsibilities at IBM. At the time of his resignation, Papermaster served as IBM’s Vice President for a unit that designs and delivers servers using “blade” technology.   

Papermaster announced his intent to resign on October 13, 2008. IBM made efforts to retain Papermaster, offering him a salary increase, as well as the possibility of a year’s salary in return for not competing against the company. Papermaster declined these offers and resigned from employment with IBM on October 21, 2008. Papermaster set his last day of employment as October 24, 2008. Upon joining Apple, Papermaster was slated to become the Senior Vice President for Devices Hardware Engineering. According to Apple, Papermaster would supervise the development of iPods and iPhones in this position.

On October 22, 2008, IBM sued Papermaster in the Southern District of New York, and filed a Motion for Preliminary Injunction two days later. In the Complaint, IBM asserts that Papermaster breached the terms of the Noncompetition Agreement and misappropriated trade secrets. IBM specifically alleges that it competes with Apple in three areas: servers, personal computers, and microprocessors. The Noncompetition Agreement contains an exclusive jurisdiction clause mandating that all actions under the Agreement take place in the state and federal courts for Westchester County, New York. 

Papermaster responded to IBM’s Motion for Preliminary Injunction with several arguments. Papermaster argued that Apple does not compete with IBM because Apple is in the consumer electronic products market, whereas IBM focuses on business systems such as servers and IT infrastructure. More specifically, Papermaster claimed that the needs of microprocessors for servers and consumer electronics are different, with the former emphasizing speed and the latter emphasizing efficient use of power. Papermaster also contended that IBM could not show that it faced irreparable injury because it permitted Papermaster to continue to work for IBM and access its confidential information for two weeks after Papermaster stated his intention to resign. If Papermaster was privy to so much IBM confidential information and represented such a competitive threat, the argument goes, then why was he permitted to remain employed by IBM with unfettered access to its various systems and facilities after announcing his intention to join Apple?

Papermaster also argued that injunctive relief was inappropriate because the Noncompetition Agreement was unenforceable as written for two reasons. First, Papermaster offered that the Agreement was overbroad in that it purported to prevent him for working for a competitor, regardless of whether his acts were actually competitive. Second, Papermaster contended that the one-year time period covered by the non-compete provision was an “eternity” in the electronics industry and thus should not be considered reasonable under the circumstances. Third, Papermaster asserted that the agreement was overbroad because IBM claimed that the Agreement purported to cover the entire world. Papermaster further asserted in a footnote that because Papermaster lives in Texas and works in California, New York law should not govern the dispute, but it acknowledged that it did not have the space to fully develop this argument.  You can find IBM's reply brief here.

Although Judge Karas granted IBM’s Motion for Preliminary Injunction at the conclusion of the November 6, 2008 hearing, in the entry for the case on the Court’s docket, Judge Karas sets forth that an Opinion will follow. Until such time, it is unclear which arguments the Court found persuasive.  The case nonetheless continues.  At present, the parties are litigating the issue of the amount of a bond to be paid by IBM to the Court.  It also is likely that the parties will now want to engage in expedited discovery, a topic that will be discussed in a November 18, 2008 court conference.

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As a result of the instability in the financial markets generally and at financial institutions in particular, the financial services industry has experienced significant turnover in 2008. The below chart recently found in the New York Times reflects that the financial services industry has experienced more layoffs than any other industry.

Because of the importance of relationships between brokers and other customer-facing personnel in the financial services industry on the one hand and customers on the other, restrictive covenants are commonplace in the industry. These covenants typically take the form of: (1) customer non-solicitation covenants, in which employees agree not to solicit the clients of their former employees for a set period of time; and (2) non-disclosure covenants, in which employees agree not to use confidential information such as client lists and account or trading information.

It is likely that the significant turnover in the financial services industry will lead to an increase in the number of disputes between financial firms and their former employers, especially as those employees who were laid off find new positions in the industry and seek to mine relationships with former customers. (The obvious exception here is that employees laid off by liquidating financial institutions do not face the prospect of being sued by their former employers.)

an additional factor that can lead to an increase in restrictive covenant litigation in the financial services industry is the prevalence of larger firms buying smaller or distressed firms. Acquisitions of new companies often lead to restrictive covenant litigation because the employees of the purchased company find themselves working in a new work culture. A common scenario in such a situation is for the employee to bristle at the new culture, leave the company shortly after the acquisition, and then solicit their former clients. 

One factor that will reduce the tide of restrictive covenant litigation is the Protocol for Broker Recruiting. The Protocol, which has been signed by a number of (but by no means all) financial services institutions, identifies with particularity the information that departing brokers may take to their new employers. The Protocol also sets forth the clients that departing brokers may solicit after leaving. The Protocol was created for the purpose of reducing litigation between financial institutions and normalizing the process of broker movement. As such, it becomes especially important in the current environment for financial services institutions.

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Eric Rush (a/k/a Eric Romero), a 37-year old dance instructor in Texas, was jailed last week when he violated the Court's order enforcing his non-compete agreement with his former employer, Arthur Murray Dance Studios in Plano, Texas.  The Associated Press reported that Rush a/k/a Romero was unrepentent. 

Rush acknowledged in a jailhouse interview that he advertised his services and provided forbidden dance lessons to students in the area.

But in his defense, Rush said, he couldn't help himself.

"I love to dance," Rush told The Dallas Morning News. "It's my soul."

(Assoc. Press Oct. 18, 2008.)

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Earlier this year, the Georgia Court of Appeals made news in Atlanta Bread Company Int'l v. Lupton-Smith, Court of Appeals Case No. A08A0348, when it struck down in-term restrictive covenants of a franchisee on the grounds that the in-term restrictive covenants did not pass the test of reasonableness applied to post-term restrictive covenants.  In this case, the franchisee had opened several allegedly competing stores at the same time that he was operating Atlanta Bread Company franchises.  Atlanta Bread Company then terminated his franchise.   The Court of Appeals ruled that the post-term restrictive covenants and the in-term covenants were inextricably tied and because the post-term restrictive covenants did not pass muster, the in-term covenants also failed. 

The case has sparked great interest within the franchise community, as the International Franchise Association has indicated that the lower court decision would wreak havoc on franchise systems in Georgia by  rendering  "unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia, including many of the most well-known and respected franchises in the world."   The Court of Appeals ruling was cast as opening the door for franchisees potentially to compete with their own franchisors during the term of the franchise agreement.  Georgia applies strict scrutiny review to post-termination restrictive covenants between franchisees and franchisors, which is the same standard applied to such agreements between employees and employers.  As a result, Georgia will not blue pencil such an agreement, even though it will blue pencil a non-competition covenant contained in the sale of a business.  

On October 6, 2008, The Georgia Supreme Court granted Atlanta Bread Company's petition for certiorari.  The Court agreed to hear, in particular, the following questions:

1. Did the [Court of Appeals] err in holding that under Jackson & Coker v. Hart, 261 Ga. 371 (1991), the reasonableness standard applicable to post-termination restrictive covenants also applies to in-term restrictive covenants?

2. Did the [Court of Appeals] err in applying to in-term restrictive covenants in franchise agreements the rule against allowing the blue-pencil doctrine of severability.

The Supreme Court's decision to grant certiorari means that oral argument is mandatory.  The case will proceed on the January 2009 oral argument calendar. 

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Nixon Peabody v. Taylor Wessing France, 2008 NY Slip Op. 51885(U) (Sup. Ct. Monroe Cty. Sept. 16, 2008).

A trial court in upstate Monroe County, New York earlier this month granted summary judgment for law firm Nixon Peabody LLP (“Nixon”), which sought a declaratory judgment and injunctive relief as a result of alleged tortious interference with prospective business relations by French law firm Taylor Wessing France (“Taylor Wessing”). 

On July 31, 2007, in anticipation of entering into merger discussions, the two firms had executed a Mutual Non-Disclosure Agreement (the “Agreement”) containing a non-solicitation provision stating that neither firm would “employ or offer partnership directly or indirectly” to any partners or attorneys of the other firm for a period of two years from the date of the agreement. The merger negotiations eventually broke down in October 2007. However, Taylor Wessing’s founding partner subsequently joined Nixon and brought with him a dozen of Taylor Wessing’s non-equity partners. 

When Taylor Wessing sought to enforce the Agreement’s non-solicitation provision, Nixon filed this action, seeking a declaration that the Agreement was unenforceable and requesting injunctive relief preventing Taylor Wessing from interfering with its former partners’ right to join Nixon. Taylor Wessing brought suit against Nixon in New York County Supreme Court (subsequently consolidated with the Monroe County action and transferred to Monroe County) asserting claims for breach of the Agreement, aiding and abetting a breach of fiduciary duty, and tortious interference with contractual relations.

In a detailed decision that could have significant consequences for law firms engaged in merger or acquisition talks, the Monroe County trial court held that the Agreement was unenforceable as violative of New York State public policy. Citing to a 1989 New York case that “codified” ethics opinions by the ABA and the New York County Lawyers Association, the court noted that it is unethical for an attorney to include a restrictive covenant in an employment contract with another attorney. However, the court went on to observe that the policy “embraced” by this rule is not limited solely to employment agreements, and that this authority has been “woven into the fabric of New York case law.” The court concluded that the rationale behind the rule — protecting lawyers’ autonomy and the ability of clients to freely chose their counsel — applies to the Agreement in this case which, as the court characterized it, contained “an out-right prohibition[n] on the practice of law,” to which the affected non-equity partners had not agreed and of which they had no knowledge.  The court also granted summary judgment in favor of Nixon on Taylor Wessing’s fiduciary duty and tortious interference claims. The slip opinion can be viewed here . 

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 Following is a Press Release from the Georgia House of Representatives.

Speaker Richardson Appoints Representative Kevin Levitas to Chair House Study Committee on Restrictive Covenants in the Commercial Arena

ATLANTA –Speaker of the House Glenn Richardson (R-Hiram) has appointed Representative Kevin Levitas (D-Atlanta) to chair the House Study Committee on Restrictive Covenants in the Commercial Arena.

“I am confident that Representative Levitas will be an asset to this study committee. He is an extremely diligent worker, and I know he will work well with the other Representatives appointed to this committee,” Richardson said.

House Resolution 1879 established the House Study Committee on Restrictive Covenants in the Commercial Arena to examine the proper functioning of restrictive covenants in today’s marketplace and to fulfill the legislature’s role in defining public policy in this area.  

A restrictive covenant is an agreement between an employer and an employee (or an independent contractor) that limits the ability of a former employee to unfairly compete against the employer after termination of employment. 

In the absence of clear direction from the General Assembly, Georgia courts have issued conflicting decisions and voided many of these agreements in their entirety, often on the basis of a strict reading of a technical defect in one part of an agreement. 

Levitas said, “It is time that the legislature studied this issue in depth and provided clear guidance to the courts regarding the sustainability of these private agreements between private contracting parties and how to make them fair to all parties.” Levitas said that the study committee will examine court precedent and hear testimony from witnesses regarding the effect of the current state of the law.

“I am honored that Speaker Richardson has appointed me to chair this study committee,” noted Levitas. “The history and treatment of restrictive covenants in Georgia have never been fully studied before by the General Assembly. It is imperative that we carefully examine all aspects of this important issue so that both employer and employee can know their rights and duties after employment has ended.”

Levitas remarked, “Both parties need to know with certainty what they can and cannot do, and that is why legislation in this area is so important. In addition to providing certainty to the parties, clarifying the law will have a significant impact on Georgia’s economy and the ability of the state to attract businesses to this state and to keep them here.”

Levitas noted the he expects that the committee will hear from a diversity of witnesses with differing viewpoints on the subject. Levitas said that he intends for the committee “to bring together all necessary points of view and to gather all of the facts so that we can, once and for all, clearly define and bring certainty to this important area of the law.”

The committee will hold its first meeting at 9:00 a.m. on Wednesday, September 24, in Room 132 of the State Capitol. The other members of the committee are: Representative Tim Bearden (R-Villa Rica), Representative Butch Parrish (R-Swainsboro), Representative Richard Smith (R-Columbus), Representative Brian Thomas (D-Lilburn) and Representative Al Williams (D-Midway).

###

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In Baird and Warner Residential Sales, Inc. v. Mazzone, No. 1-07-2179, the Illinois Appellate Court, First District reversed the circuit court’s determination that a restrictive covenant between Patricia Mazzone and her former employer, real estate broker Baird & Warner, was unenforceable as a matter of law. The ruling was issued in June as an unpublished order but was later published on August 15, 2008, upon the motion of Baird & Warner, which requested publication to provide guidance to the real estate industry where restrictive covenants are commonplace.

Baird & Warner sued Mazzone and her current employer, competing broker Midwest Realty Ventures, seeking to enjoin Mazzone for violating the restrictive covenant that prohibited her from soliciting Baird and Warner employees and independent contractors for one year following the end of her employment there. Although the circuit court initially granted a temporary restraining order and ordered expedited discovery, Mazzone and Midwest Realty quickly moved to dismiss on the ground that the non-solicitation agreement was unreasonable, overly broad, and thus enforceable because it sought to impose a “poison pill” whereby any competitor that hired any Baird & Warner manager was then precluded from hiring any of Baird & Warner’s thousands of employees and independent contractors. 

Baird & Warner opposed the motion, contending that, based on other language in the agreement, the covenant should be interpreted to apply only to the Baird & Warner office where Mazzone had worked.   But the circuit court dismissed the complaint and dissolved the TRO, concluding that the plain language of the agreement was not limited to the one office and declining to “blue pencil” the agreement because doing so would discourage precise drafting of agreements.

In an interlocutory appeal, the Appellate Court determined that even though the agreement was ambiguous as to whether it applied to one office or all of the company’s employees, “there is insufficient evidence to support a finding that the agreement was overly broad.” The court noted that under Illinois law, a court determining the reasonableness of a restrictive covenant should consider, among other factors, the hardship caused to the employee and the effect upon the general public. Here, the court concluded, there was no evidence on the face of the complaint to weigh those factors, and therefore it cannot be determined that the covenant is unreasonable as a matter of law. 

Based on this ruling, the court concluded that it need not address Baird & Warner’s alternative argument that the circuit court erred in refusing to exercise its “blue pencil” powers to modify the non-solicitation agreement to render it enforceable.

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A maritime attachment arising out of a contract action is appropriate where the underlying contract’s nature and character is one of maritime and not simply a non-competition agreement, the Second Circuit ruled recently in Williamson v. Recovery Ltd. Partnership, __ F.3d __, 2008 WL 3876570 (Aug. 22, 2008).

The plaintiffs in Williamson had assisted a recovery operation for the S.S. Central America, a steamship that sank off the coast of South Carolina in 1857. In return for a fraction of a percentage of any recovery, the plaintiffs had executed non-disclosure and non-competition agreements. After a successful recovery operation, defendants were able to sell the gold, silver, and valuable artifacts recovered from the S.S. Central America. But defendants never paid the plaintiffs their share, forcing the plaintiffs to bring a breach of contract action in Ohio State Court. 

Defendants removed the State Court action to federal court, and plaintiffs then filed a maritime action in the United States District Court for the Southern District of New York, in which plaintiffs sought an attachment on the salvage from the S.S. Central America. After the district court resolved, among other things, an order to show cause on the attachment in favor of plaintiffs, defendants appealed.

On appeal before the Second Circuit, the defendants argued that plaintiffs’ non-compete agreements were not maritime contracts (and thus there was no federal jurisdiction and prejudgment interest), but instead only non-competition agreements. The Second Circuit disagreed, noting that the test for whether a contract sounds in maritime law is its nature and character, and whether the contracts “principle objective . . . is maritime commerce . . . .” Thus, because the principle objective of the non-competition agreements concerned maritime operations (a salvage recovery operation), the Second Circuit concluded that “[w]hile the Defendants may be correct in stating that these are just standard non-compete, nondisclosure, and lease contract agreements, they are incorrect in arguing that the contracts are therefore not maritime contracts.”

Accordingly, companies entering into non-competition and non-disclosure agreements regarding maritime commerce should expect those contracts to provide federal maritime jurisdiction as non-competition agreements and maritime contracts are not mutually exclusive.

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On August 7, 2008, in Edwards v. Arthur Andersen LLP, No. S147190, the California Supreme Court seemingly ruled that Section 16600 of the Business and Professions Code prohibits every attempt by an employer to enforce a non-competition agreement. The court indicated that the only exceptions are those expressly set forth in the statute (agreements in connection with the sale or dissolution of a business).

The same day, a class-action complaint was filed in Contra Costa County Superior Court, Vokes, et al. v. Central Garden & Pet Co., No. C 08-01994, that could test the reach of the Edwards decision.  Plaintiffs are asking the court to invalidate a non-compete agreement signed by Vokes when he became Central Garden’s Senior VP Sales and Trade Relations and, on behalf of all all Central Gardens employees, seeking to invalidate all of Central Gardens’ non-compete agreements as violating Section 16600 and related California statutes.

For more than 20 years prior to going to work for Central Gardens, Vokes had been employed by Doskocil, a competitor of Central Gardens. When he left in January 2007, he was VP of Sales. Upon becoming employed by Central Gardens as its Senior VP Sales and Trade Relations, he signed a non-compete agreement. It provided for 24 months of paid post-termination “independent contractor” status (according to the complaint, however, the compensation amount was “a small fraction of his wages as [a Central Gardens] employee”). The agreement mandated non-competitor employment and non-customer solicitation, in virtually any geographic market served by Central Gardens' market, during and for the 12 months following the “independent contractor” period.

In July 2008, Vokes resigned from Central Gardens and returned to Doskocil, in Texas. Central Gardens immediately sued in Texas to enforce the agreement and obtained a TRO (according to the Contra Costa County complaint, ex parte and without notice) against Vokes and Doskocil. They then filed the Contra Costa County complaint.

Whether the Contra Costa County court will adjudicate the complaint or will stay the action in light of the earlier-filed Texas complaint is uncertain. Also unclear is whether the Contra Costa County Court will certify the class and whether the agreement might be enforceable at least during the 24-months “independent contractor” period. The outcome of this case, if it proceeds, will be interesting.

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 By Robert Milligan, Kurt Kappes and James McNairy

The California Supreme Court released its highly anticipated decision in Edwards v. Arthur Andersen LLP  today and held that employee non-competition agreements are invalid, even if narrowly drawn, unless the agreement falls within a statutory exception. 

In doing so, the Court rejected the Ninth Circuit’s narrow restraint exception, which excepted the prohibition contained in Business and Professions section 16600 on non-competition agreements where one was barred from pursuing only a small part or limited part of the business, trade or profession.

In its decision, the Court limited its review to two issues:

1)      To what extent does Business and Professions Code section 16600 prohibit employee non-competition agreements;

2)      Is a contract provision requiring an employee to release “any and all” claims unlawful because it encompasses nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

The Court concluded that Business and Professions Section 16600 prohibits employee non-competition agreements unless the agreement falls within the applicable statutory exceptions of sections 16601, 16602, or 16602.5. The Court also held that a contract provision whereby an employee releases “any and all” claims does not encompass nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

On the first issue, the Court found that California state courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. Section 16660 states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” (emphasis added) The chapter excepts non-competition agreements in the sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). 

The Court noted that it had previously invalidated an otherwise narrowly tailored agreement as an improper restraint under section 16600 because it required a former employee to forfeit his pension rights on commencing work for a competitor (citing Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243). The Court, quoting Muggill, stated section 16600 invalidates provisions in employment contracts and retirement pension plans that prohibit “an employee from working for a competitor after completion of his employment or imposing a penalty if he does so unless they are necessary to protect the employer’s trade secrets.”

The two clauses at issue in Edwards’ agreement with Andersen provided:

1)      If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client. 

2)      For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) [Los Angeles] to which you were assigned during the eighteen months preceding release or resignation. 

Andersen argued that the Court should interpret the term “restrain” under section 16600 to mean simply to “prohibit,” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade, or business are illegal. 

The Court rejected that argument and found that Andersen’s non-competition agreement was invalid because the two specific clauses at issue in the agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession. 

Earlier in the decision, the Court expressly stated it did not address the applicability of the “so-called trade secret exception to section 16660.” Before the Supreme Court granted the petition for review in Edwards, the lower appellate court’s decision remanded the case to the trial court to determine if the trade secret exception applied, i.e. the non-competition agreement was necessary to protect trade secrets. The Court’s disposition indicates that the issue is closed though and that there will be no such remand to the trial court:

We hold that the noncompetition agreement here is invalid under section 16600, and we reject the narrow-restraint exception urged by Andersen. Noncompetition agreements are invalid under section 16600 in California even if narrowly drawn, unless they within the applicable statutory exceptions of sections 16601, 16602, or 16602.5

Andersen asked the Court to adopt the limited or “narrow-restraint” exception to section 16600. The Court noted that confusion over the Ninth Circuit’s application of section 16600 arose in a paragraph in the Ninth Circuit’s decision in Campbell v. Trustees of Leland Stanford Jr. Univ. (9^th Cir. 1987) 817 F.2d 499, in which the Ninth Circuit stated that some California state courts have excepted application of section 16600 “where one is barred from pursuing only a small or limited part of the business, trade or profession” (citing Boughton v. Socony Mobil Oil Co. (1964) 231 Cal.App.2d 188 and King v. Gerold (1952) 109 Cal.App.2d 316). The Court found that the reasoning in these state court cases does not provide persuasive support for adopting the narrow restraint exception because Boughton involved the use of land, not a restriction upon a plaintiff’s practice of a profession, and King relied upon a trade secret exception to the statutory rule. 

The Court acknowledged that recent Ninth Circuit cases have followed Campbell to create a narrow-restraint exception to section 16600 in federal court. The Court stated that California state courts have not embraced the Ninth Circuit’s narrow restraint exception and stated “no reported California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that California courts have been clear in their expression that section 16660 represents a strong public policy of the state which should not be diluted by judicial fiat” (citing Scott v. Snelling and Snelling, Inc. (N.D. Cal. 1990) 732 F. Supp. 1034, 1042).

In sum, while the Court’s decision clearly states California does not recognize a “narrow restraint” exception to the general rule that employee non-competition agreements are invalid, the Court did not specifically address when non-solicitation of customer and employee clauses are permissible to protect trade secrets. 

The San Francisco Chronicle also has posted an article about this case.

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In an order dated July 25, 2008, the Georgia Court of Appeals reiterated that non-compete provisions in Georgia cannot prohibit an ex-employee beyond performing services related to the employer’s business. Avion Systems, Inc. v. Thompson, No. A07A1488, 2008 WL 2854300 (Ga. App. Jul. 25, 2008). In Avion Systems, the Court of Appeals was asked to determine whether the following non-compete provision was enforceable:

For a period of twelve (12) months following the completion of project, the Employee unconditionally agrees to not deal directly, indirectly, or by any other means, either individually or in association with another individual or organization for any pecuniary gain with Corporation's customer or their client to whom he is assigned at the particular job site for that particular division or subdivision with whom Employee had contact....

Despite the fact that the non-compete provision was limited to 12 months in duration and to the customer to whom the employee was assigned, the Court of Appeals held that the provision was unenforceable. The restriction ran afoul of the prohibition in Georgia against “in any capacity” restrictions:

Here, the covenant did not specify the activities in which Thompson was prohibited from engaging, but instead prohibited her from dealing with a client “for any pecuniary gain,” regardless of whether her activities were related to Avion’s business. The provision was thus overbroad and unenforceable, as it is not reasonably necessary to protect the interests of Avion.

Avion Systems stands as a reminder that Georgia has very particular requirements for the enforcement of non-compete provisions and that an employer must pay attention to those requirements to have any chance of enforcing post-employment restrictions.

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