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

By Rebecca Woods

Although Virginia is already generally hostile to non-competition agreements, enforcing only those that are very limited in function, geographic scope, and duration, a bill has been proposed in the 2012 session of the Virginia General Assembly that would severely restrict the enforceability of non-compete agreements. House Bill 1187 proposes to add to the Code of Virginia a provision that, with limited exceptions, would deem unlawful "any contract that serves to restrict an employee or former employee from engaging in a lawful profession, trade, or business of any kind." The limited exceptions would only allow businesses, partners in a partnership, or members of a limited liability company to agree to refrain from carrying on similar business in the area in which it or they had been conducting such business. The bill excepts from its coverage nondisclosure agreements intended to prohibit the sharing of certain information such as trade secrets and proprietary or confidential information.

The effect of the bill, if passed, would be to invalidate all employee non-compete agreements. Proponents of the bill claim it would transform Virginia into an entrepreneur haven like Silicon Valley. Opponents have not yet made public pronouncements, but it is generally expected that business interests will lobby against the bill.

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By Rebecca Woods

The Oklahoma Supreme Court recenty held that noncompete agreements are reviewable by a court, even if the agreement contains an arbitration clause and there is no claim as to the validity or enforceability of the arbitration clause. The Howard ruling is consistent with prior rulings by the court that evidence a hostility to the U.S. Supreme Court’s broad interpretation of the Federal Arbitration Act (“FAA”). The court also found the non-compete agreement at issue was in such serious violation of Oklahoma’s statutory limitations on non-compete agreements, see Title 15 O.S. 2001 § 219A, that it refused to blue pencil the agreement and struck it in its entirety.

An employer, Nitro-Lift Technologies, LLC (“Nitro-Lift”) sought to enforce against two former employees non-compete agreements that prohibited the former employees from, in relevant part, (1) owning, managing, operating, joining, controlling, participating, being connected with (as an officer, director, employee, consultant, etc.), loaning money to, or selling or leasing equipment to any business or person engaged in the nitrogen generation business in the oil and gas industry in the U.S; (2) canvassing, soliciting, approaching, or enticing away any past or present Nitro-Lift customers or suppliers; and (3) engaging, employing, soliciting, inducing, or attempting to influence any Nitro-Lift officer or employee to terminate their employment. This non-compete was to apply for a period of two years post employment. After Nitro-Lift served the employees with a demand for arbitration for allegedly violating the non-compete, the employees filed a motion for declaratory judgment, seeking a determination that the non-competes were null and void. The trial court held that the arbitration agreement was valid and enforceable and dismissed the employees’ complaint. On appeal, the Oklahoma Supreme Court reversed the dismissal and held that the employees were entitled to permanent relief.

The Howard ruling rebukes the U.S. Supreme Court’s broad application of the FAA and concludes that state courts should determine, in the first instance, whether a contract is valid and enforceable, even if the validity of the arbitration clause is not at issue. Combined with the court’s prior rulings, and with the court’s unwillingness to blue pencil the contract, the Howard ruling also indicates an apparent hostility by the court to arbitration clauses in employment contracts. 

The Howard court quickly dispatched U.S. Supreme court precedent by invoking its own ruling in Bruner v. Timberlane Manor Ltd. Partnership, 2006 OK 90, 155 P.3d 16, which contained an “exhaustive review” of U.S. Supreme Court decisions that “were found not to inhibit our review of the underlying contract’s validity.” Without analysis, the Howard court then broadly declared that “the existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.” At issue in the Bruner decision was whether a nursing home agreement, which required arbitration of all disputes, was enforceable when Oklahoma law had an anti-arbitration statute with respect to claims against nursing homes. The Bruner court concluded that the nursing home contract did not involve interstate commerce and thus, Oklahoma’s anti-arbitration statute for nursing home contracts was not preempted by the FAA. The Howard court engaged in no analysis of interstate commerce. If it had, it would have been difficult to conclude that interstate commerce was not involved, as the multi-state employer at issue also sought to enforce the non-compete across state lines. Nor was there any issue in the Howard case of a direct conflict between state law and the FAA. The issue in Howard was simply whether a non-compete was enforceable under Oklahoma law and whether that determination should be made by a court or an arbitrator. The Howard decision makes clear that, in Oklahoma, the enforceability of a contractual provision is for courts, not arbitrators.

This ruling is directly at odds with the U.S. Supreme Court’s rulings with respect to the broad application of the FAA. For example, in Buckeye Check Cashing, Inc. v. Cardenga, 546 U.S. 440 (2006), the Supreme Court held that a challenge to a check-cashing contract as illegal under various Florida lending and consumer protection laws was improper, and that such challenges, even as to void contracts, should be heard in the first instance by an arbitrator. Id. at 5 (“[U]nless the challenge is to the arbitration clause itself, the issue of the contract’s validity is considered by the arbitrator in the first instance.”) The Supreme Court rejected the Florida Supreme Court’s conclusion that “enforceability of the arbitration agreement should turn on ‘Florida public policy and contract law.’” Id. at 6 (citation omitted). It is difficult to see a ready, and material, distinction between the Cardenga ruling and the Howard facts: in Howard, there was no contest as to the arbitration clause itself, and the employer was merely seeking to enforce a statutorily impermissible (as opposed to illegal) contract.

With respect to the non-compete agreement, it was plainly at odds with Oklahoma law. Oklahoma law provides, in relevant part, that employees “shall be permitted to engage in the same business as that conducted by the former employer or in a similar business as that conducted by the former employer as long as that former employee does not directly solicit the sale of goods [or] services . . . from the established customers of the former employer.” 20 Title O.S. 2001 § 219A. Any provision at odds with this section “shall be void and unenforceable.” The court concluded that Oklahoma allows an employer to bar a former employee from soliciting goods or services from the employer’s established customers only. The court then readily found all three prongs of Nitro-Lift’s non-compete agreement to be in violation of the statute. The court then declined to modify the agreement, characterizing the agreement as “offensive” and concluding that revising the agreement to comply with Oklahoma law would require the court to “decimate its provisions.”

Lessons for employers with contracts to which Oklahoma law applies? (1) Do not rely upon an arbitration clause to avoid litigation of any non-compete agreement; and (2) limit the agreement to the statutory limitations or it may be voided in its entirety.

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By Paul Freehling

As a result of a recent ruling by the Montana Supreme Court in a case of first impression in that state, an employer there -- as in several other states -- ordinarily will not be permitted to enforce a non-compete provision in an employment agreement where the employer was solely responsible for ending the employment relationship. Significantly, the ruling might be different if the employee misappropriated trade secrets.

Wrigg, a CPA, started working for JCCS in Helena as a staff accountant in 1987 and was promoted to shareholder in 2003. She signed a series of two-year employment agreements each of which contained a provision which had the effect of imposing a monetary penalty if, during the 12 months after termination “for any reason,” she rendered certain professional services to a competitor of JCCS. In May 2009, JCCS informed Wrigg that the agreement which would be expiring June 30, 2009 would not be renewed. After she left JCCS, she was hired by another accounting firm but for significantly less compensation because, allegedly, of that firm’s concerns about the JCCS covenant. She filed a declaratory judgment suit against JCCS, seeking to invalidate the non-compete. JCCS counterclaimed based on the penalty clause and prevailed at trial, but the Montana Supreme Court reversed in all respects. Wrigg v. Junkermier, Clark, Campanella, Stevens, P.C., Case No. DA 11-0147, 2011 MT 290 (Nov. 22, 2011).

In its unsuccessful effort to persuade the Supreme Court to affirm, JCCS cited Dobbins, Deguire & Tucker, P.C. v. Rutherford, MacDonald & Olson, 218 Mont. 392, 394-97, 708 P.2d 577, 578-80 (1985), a decision also involving an accountant. In Dobbins, that court reversed and remanded a lower tribunal’s holding that a non-compete covenant virtually identical to the one in Wrigg was unenforceable. But JCCS’ reliance on Dobbins was misplaced, according to Montana’s highest court in Wrigg, because the trial court in Dobbins did not address the issue of whether the “covenant served a legitimate business interest.” In both cases, the high court stressed that “Montana law strongly disfavors covenants not to compete” but added that it may be enforceable if it does not impose an unreasonable burden on the parties and the public. So, according to Wrigg, all that the Dobbins Court meant was that the trial court needed “to make factual findings as to the covenant’s reasonableness.”     

In Wrigg, by contrast, the Supreme Court said that because JCCS was responsible for Wrigg’s termination, it could not show that its “legitimate business interest” would be furthered by enforcement of the non-compete (according to Wrigg’s appellate brief, the accountants in Dobbins left their employment voluntarily). Therefore, under the circumstances in Wrigg  (involuntary termination) but not necessarily in Dobbins (voluntary), penalizing an accountant for pursuing her livelihood during the 12 months after her employment ended apparently was considered to be an unwarranted punishment. JCCS’ contention that Wrigg repeatedly had consented to the non-compete provision as written -- “termination for any reason” -- did not carry the day.

The Montana Supreme Court asserted in Wrigg that the applicable legal principle where an employee is terminated without cause is that “courts should scrutinize highly a covenant’s enforcement given the involuntary nature of the departure.” Intense scrutiny is required because the employer could have prevented harmful competition “simply by maintaining the employment relationship.” Further, “An employer’s decision to end the employment relationship reveals the employer’s belief that the employee is incapable of generating profits for the employer. It would be disingenuous for an employer to claim that an employee was worthless to the business and simultaneously claim that the employee constituted an existential competitive threat.” The court said that its ruling is supported by decisions from Iowa, New York, Pennsylvania, Tennessee, and the Seventh Circuit Court of Appeals (interpreting Illinois law).

Employers be aware: A non-compete provision in an agreement with an employee who is discharged without cause and who does not misappropriate trade secrets may be unenforceable.

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By Molly Joyce

The Idaho Supreme Court, in the case of T.J.T., Inc. v. Mori, 2011 WL 5966870, No. 37805 (Id. Nov. 30, 2011), recently found that a two-year non-compete agreement executed in connection with the sale of a business was enforceable under California law, despite the fact that the seller also became an employee of the purchasing company as a result of the sale. The Idaho high court also remanded the case for consideration of whether the non-compete agreement’s overbroad geographic restriction could be “blue-penciled” to comply with California law.

The case arose out of a 1997 non-compete agreement between plaintiff, T.J.T., and defendant, Mori, executed in connection with the sale of Mori’s tire and axel recycling business, Leg-It Tire Company, Inc., based in California. The agreement prohibited Mori from operating anywhere within 1,000 miles of any facility owned or operated by T.J.T. or Leg-It for two years following the termination of his employment with T.J.T. Although Mori became an employee of T.J.T. as part of the deal, his employment was governed by a separate employment agreement. 

Mori worked for T.J.T. until February 7, 2007. Within weeks of his resignation, Mori began work with a competitor of T.J.T. In June 2007, T.J.T. filed a complaint seeking injunctive relief and a constructive trust based on several claims, including breach of fiduciary duty and breach of contract. The district court denied T.J.T.’s request for injunctive relief and ultimately granted Mori’s motion for summary judgment, finding that the agreement was void under California law. The district court concluded that the agreement was tied to Mori’s employment instead of the sale of his business, and that the durational and geographical scopes of the agreement were too broad. 

The Idaho Supreme Court reversed and remanded the district court’s opinion. First, the court held that the non-compete provision was indeed enforceable. The court recognized that, as a general proposition, California has a strong public policy against non-compete agreements. An exception, however, to this prohibition is in the case of the sale of the goodwill of a business, citing California Business and Professions Code § 16601, the purpose of which “is to permit the purchaser of a business to protect himself or itself against competition from the seller which competition would have the effect of reducing the value of the property right that was acquired.” Citing Monogram Industries, Inc. v. SAR Industries, Inc., 64 Cal. App. 3d 692, 701, 134 Cal. Rptr 714, 720 (Ct. App. 1976). 

Mori argued that the non-compete provision was clearly tied to his employment with T.J.T., and therefore unenforceable. The Idaho Supreme Court disagreed, noting that “California courts have held that a non-competition agreement can be incidentally linked to the seller’s employment agreement with the buying business without offending section 16600 [which prohibits non-compete agreements generally].” Even though Mori’s non-compete agreement referred to Mori’s employment with T.J.T. to determine its duration and enforceability, the court found that such an “incidental” link does not necessarily mean the provision is unenforceable. Instead, the court reasoned that Mori’s employment only came about as part of the larger transaction -- the sale of the business to a competitor -- and was therefore enforceable.

The Idaho Supreme Court also found that non-compete provision’s duration, which was to last for a period “ending two (2) years following Seller’s termination of employment with the Company for any reason,” was not unreasonable. Mori argued that the non-compete was not enforceable beyond six years (his term of employment, which was four years, plus two years). Yet, the court found that because the language of the non-compete agreement was not tied to the employment agreement, it existed independently of the employment agreement and operated pursuant to its own plain terms. Again relying on the language of California Business and Professions Code §16601, which provides that a seller may agree to refrain from competing so long as the buyer carries on a like business, the court found that the agreement was not unreasonable because T.J.T. continued to operate in the same line of business that Mori’s former business (Leg-It) did at the time of the alleged breach.

Finally, the Supreme Court remanded the case to the district court for consideration of whether geographical component of the non-compete, which prohibited Mori from working anywhere within 1,000 miles of any facility owned or operated by T.J.T. could be judicially narrowed, or “blue-penciled,” to comply with California law. The court recognized that the geographical restriction was indeed overbroad under California law as written, but queried whether the provision could be narrowed. The court reasoned that courts construing California agreements have the authority to narrow otherwise enforceable provisions pursuant to the portion of Section 16600 of the California Business and Professions Code that provides that “[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.” The agreement at issue also contained a “Reformation” clause, giving courts the power to reform the agreement to the extent necessary to be enforceable.  The court was careful to note that while California courts refuse to modify the agreements before them, they do have a continuing ability to narrow the scope of an otherwise valid agreement. 

The T.J.T. court concluded that the key factor in determining a covenant’s proper geographic scope is the determination of what area is necessary to protect the goodwill of the sold business from competition by the seller. The Idaho Supreme Court refused to narrow the agreement, finding that the parties demonstrated a genuine issue of material fact as to the scope of Leg-It’s business. It nonetheless remanded the case to the district court to determine the question of fact and whether the agreement could be narrowed within a scope that was reasonably necessary to protect the goodwill of the sold business.

Although this case involves an Idaho court construing California law, T.J.T. serves as a reminder that one should not automatically assume that a California non-compete agreement with certain employees (particularly those selling their interest in a business) is always unenforceable – even if the party seeking to enforce the agreement is the employer or former employer of the defendant. Likewise, just because a California non-compete agreement contains an overbroad restriction, that might not render the entire non-compete agreement unenforceable if it can be narrowed in scope by the court. 

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By Scott Humphrey

Illinois courts have traditionally followed the three pronged rule of reasonableness test when determining whether to enforce a restrictive covenant:

           a.         is the restriction no greater than what is required to protect the
                       legitimate business interest of the employer;

            b.         does the restriction impose undue hardship on the employee;

            c.         is the restriction injurious to the public.

However, on September 23, 2009, the Illinois Fourth District Appellate Court, in Sunbelt Rentals, Inc. v. Ehlers, 394 Ill.App.3d 421, held that a court need not consider the first prong of the rule of reasonableness test, an employer’s legitimate business interest, when determining whether to enforce a restrictive covenant. We previously blogged on this decision. The Sunbelt decision has been widely criticized since its publication and Illinois’ four other Appellate districts have declined to follow it. 

Today, the Illinois Supreme Court effectively reversed, and ended all further discussion on Sunbelt in Reliable Fire Equipment Co., v. Arredondo, 2011 IL 111871 (December 1, 2011).  While writing that it “emphatically disagreed” with the Sunbelt decision, the Illinois Supreme Court scolded the Fourth District Appellate Court for “overlooking or misapprehending” Illinois Supreme Court precedent that calls for a court to consider all three prongs of the rule of reasonableness test, including an employer’s legitimate business interest, when determining whether to enforce a restrictive covenant.   

The Reliable Fire decision also resolves another dispute that has been raging in the Illinois Appellate Courts for sometime; what is the proper test for assessing whether an employer has a business interest worthy of restrictive covenant enforcement/protection. Some Illinois Appellate courts have ruled that only “trade secrets” and “near permanent customer relationships” establish a legitimate business interest. Other Illinois Appellate courts have taken a more flexible approach, and look at the following seven factors when assessing whether an employer has a legitimate business interest:

1)         the number of years required to develop the customer;

2)         the amount of money invested to acquire customers;

3)         the degree of difficulty in acquiring customers;

4)         the extent of personal customer contact by the employer;

5)         the extent of the employer’s knowledge of its customers;

6)         the duration of customer association with the employer; and

 7)         the intent to retain employer-customer relations.

In Reliable Fire, the Illinois Supreme Court sides with the more flexible approach. Specifically, the Illinois Supreme Court informs its lower courts that only considering whether an employer has trade secrets and/or near permanent customer relationships is insufficient when assessing a legitimate business interest. Rather, Illinois Courts are to consider “the totality of the facts and circumstances of the individual case” when assessing whether a “legitimate business interest exists.” The “totality of the facts and circumstances” can include, but is not limited to, an evaluation of near permanent customer relationships, the former employee’s access to confidential information, the seven factors identified above, and/or anything else found in the common law. Moreover, the Reliable Fire decision declines to place any weight on the possible “facts and circumstances” that could create a legitimate business interest because “the same identical contract and restraints may be reasonable and valid under one set of circumstances, and unreasonable and invalid under another set of circumstances.” 

Thus, Reliable Fire appears to expand what an employer can state/argue is a legitimate business interest, and gives the trial court significant discretion when deciding what factors establish a legitimate business interest and whether to enforce a restrictive covenant. We will continue to monitor Illinois courts to see if the Reliable Fire holding leads to any changes in how trial courts assess and enforce restrictive coventants.

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As previously reported on this blog, the Virginia Supreme Court recently issued an important new non-compete decision which impacts the enforceability of non-compete agreements in Virginia and serves as a reminder that employers may want to review their agreements with employees and update them as appropriate. Here is a Seyfarth One Minute Memo on this important new case.

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By Marcus Mintz

Earlier this month, the Virginia Supreme Court issued an opinion in which it clarified the burdens an employer must meet to enforce a non-compete against a former employee. Specifically, that the employer must demonstrate that the non-compete is no broader than necessary to protect the employer’s “legitimate business interests” and does not “unduly burden” the ex-employee’s right to earn a living. Home Paramount Pest Control Cos., Inc. v. Shaffer, No. 101837, 2011 WL 5248212 (Va. Nov. 4, 2011). In doing so, the Virginia Supreme Court overruled a 1989 opinion in which it upheld the exact same non-compete brought by the plaintiff’s predecessor-in-interest. See Paramount Termite Control Co. v. Rector, 238 Va. 171, 380 S.E.2d 922 (1989). While a dissenting justice took issue with the court’s departure from its prior decision and the effect it may have on parties looking to rely on established precedent, the majority held that its 1989 opinion was effectively eroded over time and its current holding reflected the current state of the law.

The case itself focused on the “function,” or activity, restrictions within the non-compete which the plaintiff, Home Paramount Pest Control Companies, Inc. (“Pest Control”), sought to enforce against its former employee, Justin Shaffer (“Shaffer”). Pest Control claimed that Shaffer’s new employment with a direct competitor violated his non-compete. The specific language at issue prohibited Shaffer from “engage[ing] directly or indirectly or concern himself/herself in any manner whatsoever in the carrying on or conducting the business of exterminating, pest control, termite control and/or fumigation services as an owner, agent … stockholder” for two years in any area in which the employee worked on behalf of Pest Control. However, the case never went to the merits because the circuit court held that the activity restriction of the non-compete was overbroad on its face and consequently, was unenforceable.

Upon appeal, the Virginia Supreme Court affirmed the circuit court and held that the function restriction was facially over-broad because it could prevent Shaffer from performing any duties at a competitor, irrespective of whether such duties were similar to the duties Shaffer held at Pest Control or would have any effect on Pest Control’s legitimate business interests. For example, the court noted that on its face, the non-compete prohibits Shaffer from owning stock in a publicly-traded company which owned a pest control business and Pest Control was not found to have a legitimate business purpose “in such a sweeping prohibition.” After comparing the instant restrictions to non-competes which were upheld in several recent cases, the court affirmed the circuit court’s ruling that Pest Control failed to prove that its chosen language furthered its legitimate business interests and did not unduly burden Shaffer’s right to earn a living.

Ultimately, employers seeking to enforce a non-compete under Virginia law (as well as many other jurisdictions) must take care to utilize language which narrowly tailors the activity restrictions of a non-compete to actual services and/or activities which actually or potentially compete with the former employer and threaten its legitimate business interests.

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Courts around the country are split as to the circumstances under which the parties’ choice of law set forth in a non-compete agreement will be honored. In a recent diversity jurisdiction case ruling, Arizona U.S. District Court Judge David Campbell recently refused to enjoin violations of a non-compete clause which said that the law of Washington State applied. He held that Arizona had a greater interest than Washington in the case before him, and that Arizona’s “fundamental policy” (a) requires courts in that state to be less tolerant than courts in Washington with regard to enforcing broad non-compete clauses, and (b) prohibits Arizona jurists (unlike their Washington counterparts) from using a “blue pencil” to make such clauses reasonable. He concluded that an Arizona court would be unwilling to enforce the parties’ agreement in the circumstances here. Pathway Med. Technologies, Inc. v. Nelson, Case No. CV11-0857 PHX DGC (D.Ariz., Sept. 30, 2011).

For two years, Nelson was a sales representative in Arizona for Pathway, a developer, manufacturer and seller of medical devices for the treatment of arterial disease. While employed, he signed a confidentiality agreement in which he promised that for one year after his employment ceased, he would not “divert or take away,” or “attempt or assist” anyone else in diverting or taking away, any Pathway customer. The agreement recited that it is governed by Washington law. 

Following his resignation from Pathway, he was hired by a direct competitor and allegedly engaged in the prohibited conduct for the benefit of the competitor and the detriment of Pathway. Pathway sued Nelson and the competitor, and moved for temporary and preliminary injunctive relief. Judge Campbell denied both motions.

Arizona courts determine the enforceability of a choice of law provision in a non-compete clause by applying Sections 177 and 188 of the Restatement (Second) of Conflicts of Laws. According to the court’s reading of those sections, the parties’ choice will be honored only if they “could have agreed in their contract to the same provisions that the chosen law would impose, and could have done so under the law of the state with the most significant contacts with the transaction.” Washington law differs from that of Arizona in the two respects described above. First, Arizona “requires that non-compete provisions be narrowly drafted and no greater than necessary to protect the employer’s legitimate interests,” whereas Washington enforces agreements “even if they are quite broad and last for long periods of time.” Second, in contrast to the law of Washington, Arizona “courts may not rewrite non-compete agreements to make them reasonable.” 

The contract was negotiated and signed in Arizona, the state where Nelson lived and where he performed his duties both for Pathway and for its competitor. The court held that application of Washington law in this case would be contrary to the “fundamental policy” of Arizona law. The non-compete clause here had no express geographical limitations. Further, it applied to all Pathway customers including those with whom Nelson never had had contact. Finally, the phrases “divert or take away any customer,” and “attempt or assist” such diversion or taking away, were deemed to be unduly vague.

Employers who want to enforce non-compete agreements containing a choice of law provision must take care to select operative language that meets legal requirements not only of the chosen state but also those of the likely forum state if its law is different.

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            Once triggered by a debtor's bankruptcy petition, the automatic stay suspends a parties' right to commence or continue an action against property of the debtor’s estate. In general, a party can seek relief from the automatic stay for a variety of reasons, including for cause, lack of adequate protection or that the debtor has no equity in the property and the property is not necessary for reorganization. In a case of first impression, a district court in Pennsylvania has found that an injunction enforcing a non-compete provision in a franchise agreement was not a "claim" against the bankruptcy estate, under 11 U.S.C.S. § 101(12), since the injunction was a form of equitable relief for which an award of damages was not a viable alternative, and, thus, the injunction was not subject to the automatic stay.

            In In Re Stone Resources, Inc., __ B.R. __, 2011 U.S. Dist. LEXIS 4017925 (E.D. Pa. Bankr. September 11, 2011) (unpublished) the debtor entered into a franchise agreement in 2000 which allowed it to use the franchiser's trademarks and proprietary processes in its stone restoration and maintenance business. The agreement contained a covenant that prohibited the debtor from competing with the franchiser or its affiliates for two years after the agreement ended, and the franchiser sued the debtor in federal district court in May 2010, seeking an order enforcing that covenant. The U.S. District Court for the Eastern District of Pennsylvania issued a preliminary injunction in December 2010, which required the debtor to cease its business operations and turn over assets to the franchiser.

            The franchisee declared Chapter 11 bankruptcy in February 2011, and the franchiser asked the bankruptcy court to dismiss the debtor's bankruptcy case pursuant to 11 U.S.C.S. § 1112(b) or, in the alternative, to grant the franchiser relief from the automatic stay under 11 U.S.C.S. § 362(d) (1) so it could enforce the preliminary injunction. The bankruptcy court denied the franchiser's motion holding that there was no evidence that the debtor declared bankruptcy in bad faith, and lifting the stay so the franchiser could enforce the district court's injunction would have made it impossible for the debtor to reorganize its business and pay its creditors.

            The franchisor then appealed to the District Court. The District Court held that the bankruptcy court abused its discretion in denying franchisor’s motion for stay relief in order to enforce preliminary injunction ordering a debtor to, inter alia, cease and desist in the operation of a business in accordance with the terms of a covenant not to compete. The District Court found that where the only remedy available for a cause of action is an equitable remedy that claim is not dischargeable in bankruptcy and not subject to the automatic stay. 

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By Kate Perrelli, Erik Weibust, and Ryan Malloy

On September 15, 2011, the Massachusetts legislature’s Joint Committee on Labor and Workforce Development heard testimony on House Bill 2293. The bill, originally introduced in 2009 as House Bill 1799, and as previously blogged on here, here, and here, aims to codify Massachusetts common law pertaining to non-compete agreements and to simultaneously afford greater procedural protections to those affected by the contractual restrictions on mobility in employment. 

Changes to the Previous Draft

            The revised bill was re-filed in January 2011. Changes include the elimination of a threshold that confined the use of non-compete agreements to employees earning over $75,000 per year in favor of a requirement that courts more broadly consider the economic impact on an affected employee before deciding whether to enforce a non-compete agreement. Additionally, it permits garden leave clauses of up to 2 years if the affected employee receives adequate compensation (the 1-year limit to non-compete agreement duration otherwise remains).  

            Bill 2293 also provides for mandatory attorneys’ fees to employees. However, an employer can avoid paying fees if the court determines that it took “objectively reasonable efforts to draft the rejected or reformed restriction so that it would be presumptively reasonable.” Finally, the new bill would permit the signing of mid-employment non-compete agreements so long as “fair and reasonable” consideration is provided to the affected employee.

            Like its predecessor, Bill 2293 does not apply retroactively, nor does it affect non-solicitation, non-disclosure, or other non-employment related non-compete agreements, such as those in the context of the sale of a business. The bill continues to reject the inevitable disclosure doctrine, and provides that non-compete agreements must be in writing and signed by both parties.

The Legislative Hearing

            Nearly 15 affected individuals, ranging from hairdressers and parents of college-age children to attorneys and legislators, testified before the Committee last Thursday. Although most testified in favor of the bill, some voiced concerns about mandatory attorneys’ fee awards and the perceived threat of an upswing in costly litigation. For instance, a representative of the Smaller Business Association of New England (SBANE) insisted that small business owners, who must now pay to comply with the Wage Act and mandatory employee healthcare legislation would suffer an added financial hardship if this bill is passed and opined that the bill would permit judges to ignore contract terms and create an atmosphere of unpredictability surrounding non-compete agreement validity.   

            Other critics expressed concern about the bill, and in particular three specific issues: 1) the unclear definition of “fair and reasonable consideration”; 2) the presumption that a 6-month non-compete agreement is sufficient to protect employer interests; and 3) the court’s ability to deny enforcement of otherwise valid contractual obligations. There was a shared belief by some that the present state of the common law provides adequate coverage and that statutory modification of the law would adversely affect local industries, particularly in the current economic climate.   

            Others praised the bill’s efforts to reform a complex and unpredictable realm of common law. The Massachusetts Employment Lawyers Association (MELA), an employee-rights organization, asserted that non-compete reform is necessary because abusive practices are pervasive and employees are being exploited under the current law. Other concerns expressed about the status quo include that unlimited non-competes create a chilling effect on hiring. Of course, the common law does not generally permit unlimited non-competes, but rather only those that are reasonably limited in time and geographic scope. Likewise, Secretary of Housing and Economic Development Greg Bialeck voiced the Patrick administration’s view that reform is necessary and that now is the time to do so.

            The drafters of the bill insist that it is not intended to alter the substance of existing common law. Instead, the point of the statute is purportedly to add consistency and procedural protections for the benefit of employers and employees alike. In the drafters’ view, it will be easy for employers to avoid the mandatory payment of legal fees, for example, if they comply with the bill’s safe harbors.

            As evidenced by the testimony of both the bill’s drafters and constituents, several important issues remain outstanding in Massachusetts, particularly in the areas of attorneys’ fees and the court’s equitable power. Compromise will be necessary on many of these points. It may be some time before the dust settles and a final draft is presented to the legislature, but efforts to create a statutory scheme to guide the use and enforcement of non-compete agreements is well underway. 

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Lane, a 16-year employee of food distributor Nash Finch Co. in Nebraska, was terminated in June 2011. He promptly filed a declaratory judgment suit in a Nebraska state court against his former employer, challenging the enforceability of non-competition clauses in a series of incentive compensation plans in which he was a participant. His challenge included, but was not limited to, the Minnesota forum selection and choice of law provisions -- Nash Finch was headquartered in Minnesota -- which were included in the 2010 Long-Term Incentive Program (LTIP) but in none of its predecessors. After removing the case to federal court based on diversity of citizenship, Nash Finch moved to dismiss for improper venue or, alternatively, to transfer the entire case pursuant to 28 U.S.C. §1404(a), including the dispute over the plans without forum selection and choice of law requirements, to the federal court in Minnesota as a more convenient forum. The Nebraska court denied the motion to dismiss but, over Lane’s objection, granted the motion to transfer.   

Lane maintained that the non-competition clauses, as written, were not reasonably necessary to protect Nash Finch’s legitimate business interests and were unduly harsh and oppressive. He contended, among other things, that the clauses identified by name so many competitors for whom he was prohibited from working that he effectively was precluded from employment in the food distribution industry. He also insisted that (a) there was no consideration for the forum selection and choice of law provisions in the LTIP, and (b) the outcome of the case, if it was tried in a Minnesota court, would be contrary to Nebraska public policy because Minnesota permits blue penciling of restrictive covenants if necessary to protect a legitimate business interest whereas Nebraska courts do not. The Nebraska federal court declined to rule on the merits of those contentions.  However, it reasoned that the Minnesota court would be obligated to follow the same Restatement (Second) of Conflicts of Laws rules as would a Nebraska court in deciding whether to enforce the choice of law provision. Lane v. Nash Finch Co., Case No. 8:11 CV 241 (D.Neb., Sept. 26, 2011). 

Another interesting part of the opinion deals with denial of Nash Finch’s Federal Rule of Civil Procedure 12(b)(3) motion to dismiss for improper venue because of the forum selection clause. After examining the split of authority regarding such motions in similar circumstances, the court decided that venue was proper under 28 U.S.C. §1391. However, even though the other incentive programs did not contain a mandate that litigation must be filed in Minnesota, the court decided that judicial economy would be better served by resolution of all of Lane’s claims in a single forum.

This case involves an interesting application of Section 1404(a) to forum selection and choice of law provisions included in only the last of a series of employment agreements each of which contains a non-competition clause. The court decided that the plaintiff’s choice of a forum, in a lawsuit alleging that all of those clauses were unenforceable, was insufficient to prevent transfer to the federal court in the selected forum state even though only one of the agreement contained forum selection and choice of law provisions. As many seasoned non-compete litigators can attest, the forum selected for a non-compete action often plays a prominent role in whether the forum court will enforce the non-compete.

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By Bob Stevens and Daniel Hart

As we have discussed on this blog before, on May 11, 2011, Georgia reissued its new Restrictive Covenant Act (the “New Act”). The New Act reflected a fundamental change in Georgia’s law regarding restrictive covenants because it permitted Georgia courts to “blue pencil” (i.e., partially enforce) restrictive covenants that otherwise would be overbroad and, therefore, completely unenforceable under then-existing Georgia case law. While the New Act permits Georgia courts to partially enforce overbroad restrictive covenants, it does not require that they do so.

For the first time since Georgia passed the New Act, a Court in Georgia has elected to exercise its discretion to blue pencil restrictive covenants that it found to be overbroad. In Pointenorth Insur. Group v. Zander, No. 1:11-cv-3262-RWS, 2011 U.S. Dist. LEXIS 113413 (N. D. Ga. Sept. 30, 2011), the Court found that, among other things, the non-solicitation covenant contained in the employment agreement at issue was overbroad because it extended to any of the former employer’s clients, not just the ones with whom the former employee had contact during her employment. 

Rather than attempting to excise or mark out the overbroad provision and enforce the remaining restrictive covenants, the Court modified or altered the restrictive covenant and enjoined the former employee only from soliciting the clients with whom she had contact while employed by the plaintiff. The Court also enjoined the new employer from soliciting the same clients. 

This suggests that at least the Court interprets the New Act as providing it with the discretion to re-write restrictive covenants to make them enforceable, rather than merely providing a court with the power to remove overbroad covenants. It remains to be seen if other courts in Georgia follow the Pointenorth Court’s lead and use the New Act as a basis for re-writing restrictive covenants that are found to be overbroad. For the time being, this decision represents the lone voice on the stage and indicates that there may be a willingness to modify restrictive covenants instead of simply excising them and enforcing the remaining provisions.

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By Dan Hart

As we have written on this blog before, on May 11, 2011 Georgia reissued its new Restrictive Covenant Act (“New Act”) in order to resolve concerns about the constitutionality and effectiveness of a nearly identical statute that the state’s legislature had previously enacted in 2009. The 2009 version of the statute was contingent on voters’ approval of a ballot referendum to amend the Georgia Constitution, which voters overwhelmingly approved on November 2, 2010. The 2009 statute was clear that it was not retroactive and did not apply to contracts entered into before the purported effective date of the statute (November 3, 2010). Following the same approach, the New Act is also clear that it is not retroactive and does not apply to agreements entered into before May 11, 2011.

Despite the clear inapplicability of the New Act to agreements entered into before May 11, 2011, a question has emerged about whether courts must nonetheless apply Georgia’s current public policy when deciding whether to honor choice of law provisions in agreements that predate the New Act.

We previously reported about the recent decision of a federal district judge in the Northern District of Georgia in Boone v. Correstaff Support Servs., Inc., 2011 WL 2358666 (N.D. Ga. June 9, 2011). In that case, the court held that, when deciding whether to honor a choice of law provision in an agreement with restrictive covenants, a court should look to Georgia’s current public policy rather than the public policy that existed at the time that the agreement was signed. The court has now reversed course and held that it must apply Georgia’s public policy as it existed at the time that the agreement was signed, even though the state’s public policy has now changed. Boone v. Correstaff Support Servs., Inc., 2011 WL 3418382 (N.D. Ga. Aug. 3, 2011).

In the Boone case, a former employee and his current employer sought a declaratory judgment and injunctive relief prohibiting the employee’s former employer from enforcing a non-compete agreement. Although the employee resided in Georgia, the agreement in question contained a Delaware choice-of-law provision. Before the plaintiffs filed their declaratory judgment action in Georgia, the defendants had filed their own lawsuit in Delaware seeking to enforce the agreement. The defendants, therefore, moved the Georgia court to dismiss the declaratory judgment action so that the Delaware could rule on the enforceability of the agreement under Delaware law.

The Georgia federal district court initially granted the defendants’ motion, reasoning that, although Georgia’s public policy at the time the agreement was signed was hostile to restrictive covenants, Georgia’s public policy has now shifted such that Georgia law is no longer inconsistent with Delaware law (which is more lenient toward restrictive covenants than was prior Georgia law). The court thus reasoned that application of Delaware law to the dispute would not violate Georgia’s public policy and that a court in Delaware would be in a better position to apply Delaware law than a court in Georgia.

After the plaintiffs filed a motion for reconsideration, the court reversed its own earlier judgment and denied the motion. In reversing course, the court cited the Georgia Court of Appeals’ recent decision in Bunker Hill Int’l, Ltd. v. Nationsbuilder Ins. Servs., Inc., 710 S.E.2d 662 (Ga. Ct. App. 2011). In that case, the Georgia Court of Appeals had refused to honor an Illinois choice of law provision in a restrictive covenant agreement between a Georgia employee and his former employer. Although the Court of Appeals recognized that Georgia law changed in November 2010 with Georgia voters’ adoption of a constitutional amendment permitting broader enforcement of restrictive covenants, the agreement at issue was entered into in 2008. Thus, the Court of Appeals applied the law that existed in Georgia prior to the constitutional amendment.

The federal court in Boone interpreted the Bunker Hill decision as requiring it to apply Georgia’s public policy as it existed at the time that the agreement at issue was entered into – and not the state’s current public policy – when determining whether to enforce the Delaware choice-of-law provision. The court also cited two other opinions of the Georgia Court of Appeals that, at least in the federal court’s view, had reached the same conclusion. See Gordon Document Products, Inc. v. Serv. Techs., Inc., 708 S.E.2d 48, 52 n.5 (Ga. Ct. App. 2011) (“Our analysis in this case is unaffected by any recent legislative proposals or changes.”); Cox v. Altus & Hospice, Inc., 706 S.E.2d 660, 663-64 (Ga. Ct. App. 2011) (“We therefore apply the law of restrictive covenants as it existed before [ratification of the constitutional amendment in November, 2010].”). Because the federal court previously had applied Georgia’s current public policy to the case, the court reasoned that it had made a clear error of law in its prior order and, accordingly, reversed its prior decision.

At first glance, the federal court’s newest decision in Boone may seem to suggest conclusively that courts may never consider Georgia’s current public policy on restrictive covenants when interpreting agreements entered into before the effective date of the New Act and/or the related constitutional amendment. On closer inspection, however, that answer appears less conclusive because the Boone court did not consider one important procedural nuance. The Boone court noted that the Georgia Court of Appeals’ decision in Bunker Hill came “after the effective date of the New Act.” Although that is a correct observation, the Boone court neglected to note that the lower court judgment that was on appeal in Bunker Hill was entered on October 6, 2010 – long before the effective date of the New Act and nearly a month before voters approved the constitutional amendment ballot referendum on November 2, 2010. The lower court judgments that were on appeal in the other two cases cited by the Boone court likewise were entered prior to the effective date of either the New Act or the constitutional amendment – specifically, the Cox judgment was entered on March 3, 2010, while the Gordon judgment was entered on December 17, 2009.

This fact is significant because, at the time that the lower courts entered their judgments in those cases, Georgia’s current public policy was not yet in effect. Since the Georgia Court of Appeals’ jurisdiction on appeal was limited to determining whether the lower courts had committed reversible error, the Court was required to consider the public policy that existed at the time that the lower courts issued their opinions and not the public policy that existed at the time that the Court of Appeals issued its decisions in those cases. A far different scenario exists where a trial court is tasked with making a de novo determination about whether enforcement of a contractual choice of law provision would contravene Georgia’s public policy regarding restrictive covenants. In such situations, a trial court arguably is required to apply the public policy of Georgia as it currently exists, even if that public policy contravenes the public policy that existed in Georgia at the time that the agreement in question was entered into. Only time will tell whether Georgia courts follow this approach or the approach followed by the Boone court.

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           In a recent decision, a California Second District Appellate Court upheld a trial court “issue sanction,” which effectively enforced, albeit temporarily, a five-year, unlimited geographic scope employee noncompete agreement against the defendant former employee. NewLife Sciences v. Weinstock, -- Cal.Rptr.3rd --, No. B223212, 2011 WL 2739653 (July 15, 2011). While such noncompete agreements are normally void and unenforceable under California’s well-known statutory bar against employee noncompetes (see Cal. Bus. & Prof. Code § 16600), the court stated that the temporary enforcement of the employee noncompete was a permissible issue sanction against the former employee, who time and time again refused to appear for depositions or answer hundreds of deposition questions. The court did not appear to rule on plaintiff’s argument that the noncompete fell within the sale-of-business exception under Section 16601, even though the court acknowledged that argument in its opinion. Section 16601 makes enforceable a reasonable non-competition clause executed by any “person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity . . . .”  Section 16601 protects the purchaser of a business against competition from the seller.

            Some may argue, and the dissent so stated, that the decision may conflict with California’s settled public policy against employee noncompetes. Nevertheless, the decision is an example that courts sometimes find ways to enforce noncompetes if there is strong evidence of the former employees’ untoward conduct, particularly discovery abuses.

The Parties and the TMR Device

           Plaintiff NewLife Sciences (“NLS”) purchased from defendant Weinstock and his company the patent rights to a Therapeutic Magnetic Resonance Device (“TMR”), which was developed for pain management therapy, and all the other assets of the company. As part of the transaction, NLS hired Weinstock (who was not a doctor) as its chief science and technology officer and board chairman for five years. Weinstock’s employment contract provided, in relevant part, that he (i) could be terminated at any time for “fraudulent or unlawful conduct,” (ii) could not compete with NLS while working there, and, (iii) for five years after his employment, could not compete “directly or indirectly with any activity now or in the future engaged in by NLS.” The post-employment noncompete contained no geographic limitation.

            NLS terminated Weinstock in December 2007 for administering TMR services outside of a physician’s presence, in violation of California law, FDA rules, and NLS policy. NLS demanded that Weinstock return to NLS all of its property, including the patented TMR devices. Weinstock did not do so. He continued marketing the devices, and administering treatments.

NLS’s Lawsuit and the Trial Court’s Ruling

            NLS sued Weinstock, claiming breach of the noncompete, and other tortious conduct directed at NLS. NLS produced evidence that Weinstock was smearing NLS in the marketplace, appeared on a television show pawning himself off as the owner of the TMR patent, and soliciting customers and investors for the TMR operations. The trial court denied Weinstock’s early motion to strike, which was based on the Section 16600 noncompete bar. Weinstock subsequently refused to appear for his deposition, answer relevant deposition questions, and produce documents as ordered by the court. Weinstock cited the statutory bar as justification for his refusal to respond to discovery. As punishment for what the trial court called his “arrogant and contemptuous disregard for the orders of this court,” the trial court entered a severe issue sanction against Weinstock, such that the following issues were established for all purposes in the litigation:

1.                  Weinstock breached his employment contract by competing with NLS while still employed;

2.                  The noncompete was enforceable;

3.                  Weinstock breached the noncompete post-employment by using the TMR device without proper physician supervision; and

4.                  Weinstock’s breach caused NLS damages.

            Based on the issue sanctions and NLS’s evidence, the trial court entered a preliminary injunction against Weinstock and his affiliated companies from competing with NLS throughout the litigation, including an injunction against making or marketing the TMR device or something similar, and soliciting new, potential or existing customers for TMR devices. The trial court later entered terminating sanctions against Weinstock, and awarded NLS default judgment against Weinstock. He appealed.

Appellate Court Decision and Dissent

            The Appellate Court upheld the trial court’s preliminary injunction and default judgment. The court did not examine the merits of the Weinstock’s Section 16600 or NLS’s 16601 argument. Rather, the court held that the trial court did not abuse its discretion by entering the issue sanction, and later awarding default judgment in favor of NLS and against Weinstock. Defendants’ repeated and willful non-compliance with the trial court’s discovery orders, the Appellate Court held, were sufficient to warrant the court’s sanctions.

            The dissent stated that the trial court should not have enforced an illegal noncompete by way of a discovery sanction. The trial court and the Appellate Court majority should not have set aside, in the name of discovery sanctions, California’s strong public policy against employee noncompetes. At a minimum, the dissent stated, the trial court should have held an evidentiary hearing on whether the noncompete fell under the Section 16601 sale-of-business exception.

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By Bob Stevens

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Starting this year, restrictive covenants in employment agreements and other business-related agreements in Georgia are subject to new rules governing who can enter into these agreements, how these agreements should be written, and how disputes will be handled by the courts.

What's changed - for businesses, the bench and the bar? What's remained the same? What can we do? What should we do?

Please join us for this webinar, the third in our 2011 Trade Secrets Webinar Series-as we break-down the new law, highlight important features, and provide tips on how to protect businesses' investment in their people and their confidential information in Georgia. Our experienced panel of Seyfarth attorneys will be joined by Kevin Levitas, a former member of Georgia House of Representatives, who played a key role in the passage of the new law.

When:

Thursday, July 21, 2011

2:00 p.m. to 3:15 p.m. Eastern

1:00 p.m. to 2:15 p.m. Central

12:00 p.m. to 1:15 p.m. Mountain

11:00 a.m. to 12:15 p.m. Pacific

 Who Should Attend:

General Counsel, In-House Labor and Employment Counsel, In-House Intellectual Property Counsel, HR Directors and HR Supervisors, Chief Technology Officers, Chief Security and Information Officers, and Competitive Intelligence Professionals

Speakers:

Kevin Levitas, Former Member Georgia House of Representatives

Erika Birg, Seyfarth Shaw LLP

Bob Stevens, Seyfarth Shaw LLP

Register Here

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A Robert Samuelson piece in the Washington Post on the mismatch between the skills of job seekers and the requirements for open positions may seem like an unlikely place to find an angle on non-compete restrictions. However, in his column on the unemployment rate, Samuelson makes an argument that touches on the role that non-competes can play for employers and employees. In explaining why many individuals who are currently unemployed have struggled to find jobs despite the fact that a number of employers have listed openings, Samuelson theorizes as to why many companies have not responded to the situation by increasing training for new employees:

Companies traditionally provided much training, but that may also have changed. Loyalties have weakened. Companies are more willing to fire; workers are more willing to jump ship. Training may seem a poor investment because workers won’t stay long enough to earn a return. In the McKinsey [Global Institute] survey, companies denied cutting training budgets. But [Georgetown’s Anthony] Carnevale and others think the training has altered. Before, firms provided more basic training in business or technology skills; now, firms expect workers to come with these skills and focus training on firm-specific practices and systems.

In a nutshell, Samuelson’s argument is that a fluid job market acts as a disincentive for employers to train new employees on the general skills required for a position. Rather, they are looking for employees who have the general skills already. 

If this analysis is correct, then one potential response by employers to the situation would be greater use of restrictive covenants because such covenants are an important tool for employers to protect their investment in training. An employer is more likely to spend time and money to train an employee if it knows that the employee is likely to stay for a significant period of time. A non-compete restriction acts as an incentive for an employee to stay. Moreover, the law in many states recognizes the linkage between training and non-compete provisions in that a significant expenditure in training can be a legitimate interest to support the enforcement of such a covenant. In short, if an issue in the job market is a concern that money spent on training will be wasted, then use of non-compete provisions can be a solution.

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A recent decision by the Texas Supreme Court makes it easier for employers to enforce restrictive covenants in Texas. Employers often seek to obtain these types of contracts with key employees to prevent them from going to work for competitors or to leave to start competing businesses. The enforceability of such contracts is typically governed by state law, resulting in a patchwork of differing standards across the United States, with some states favoring enforcement, and others precluding such agreements altogether. Please read Seyfarth Shaw's One Minute Memo on the new case.

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By Dan Hart, Atlanta

Following Georgia Governor Nathan Deal’s signing of House Bill 30 (“H.B. 30”) on May 11, Georgia’s Restrictive Covenant Act is now law, effective immediately. The Governor’s signing of the bill caps months of debate and speculation about the effective date of a nearly identical bill that the Legislature enacted in 2009. That legislation, H.B. 173, was contingent on voters’ approval of a ballot referendum to amend the Georgia Constitution – a measure that voters overwhelmingly approved last November. Although the legislature clearly intended the 2009 bill to become effective the day after last November’s election, uncertainty about the effective date of the constitutional amendment raised concerns about the effective date of the statute.  Accordingly, the legislature enacted H.B. 30 to fix these problems. (For our previous posts on this issue, see here and here.)   The new law thus applies to all restrictive covenants entered into on or after the statute’s May 11 effective date.

The statute effects a sea-change in the law in Georgia, which historically has been an inhospitable forum for employers seeking to enforce restrictive covenants against former employees. Among other changes, the Act creates statutory presumptions under which courts must presume that restraints two years or less in duration are reasonable in time and that restraints more than two years in time are unreasonable. It also eases the drafting requirements for specific restrictive covenants, abolishes the previously existing requirement of a time-restriction for non-disclosure provisions, and creates a statutory burden-shifting regime whereby, if employers can meet an initial burden of showing that restrictive covenants are in compliance with the statute, parties challenging such restrictive covenants bear the burden of establishing that the covenants are unreasonable. Perhaps most significantly, the new law also permits Georgia courts to “blue pencil” (i.e., partially enforce) restrictive covenants that otherwise would be overbroad and, therefore, completely unenforceable under existing Georgia case law.

With the new law now officially enacted, should employers now assume that Georgia courts will always uphold restrictive covenants against their employees? Not exactly. As ESPN’s Lee Corso might say, “Not so fast, my friends!” Employers should continue to exercise caution in this area for at least three reasons:

First, the Restrictive Covenant Act applies only to restrictive covenants entered into on or after May 11, 2011.   Existing Georgia case law applies to restrictive covenants entered into on or before November 2, 2010 (the day that Georgia voters approved a constitutional amendment upon which the new law depends), and might also apply to restrictive covenants entered into between November 3, 3010 and May 10, 2011. For that reason, employers may continue to face an uphill battle in enforcing restrictive covenants that predate the new law unless they meet the narrow requirements that previously existed under Georgia law.

Second, while the Act permits Georgia courts to partially enforce overbroad restrictive covenants, it does not require that they do so. Until case law develops under the new statute, employers and their lawyers cannot be certain of what situations Georgia courts will exercise or decline to exercise their blue-penciling power. Based on law in other jurisdictions, however, it appears likely that Georgia courts may decline to exercise their blue-penciling power in cases where they believe that employers have unreasonably overreached for the purpose of creating an in terrorem effect on employees. Thus, employers should continue to exercise restraint when drafting restrictive covenants and should avoid drafting unreasonably broad covenants with the expectation that they will be fixed by the courts.

Third, although most provisions of the Act are beneficial to employers, the Act places restrictions on the types of employees who may be subjected to true non-compete provisions (as opposed to non-solicitation or nondisclosure provisions). Such provisions may be enforced only against employees who:

·        “Customarily and regularly solicit for the employer customers or prospective customers;”

·        “Customarily and regularly engage in making sales or obtaining orders or contracts for products or services to be performed by others;”

·        Perform specified management duties (which are set forth in the Act using language that closely follows the U.S. Department of Labor’s (“DOL) definition of the Fair Labor Standards Act’s (“FLSA”) “executive” exemption);

·        Perform the duties of a “key employee” (which the Act defines as “ an employee who . . . has gained a high level of influence or credibility with the employer's customers, vendors, or other business relationships or is intimately involved in the planning for or direction of the business of the employer or a defined unit of the business of the employer” or “an employee in possession of selective or specialized skills, learning, or abilities or customer contacts or customer information who has obtained such skills, learning, abilities, contacts, or information by reason of having worked for the employer”); or 

·         Perform the duties of a “professional” (which the Act defines using language that closely follows the DOL’s definition of the FLSA’s “professional” exemption.

Before requiring employees to execute new non-compete agreements, employers should ensure that employees who are subject to the restriction fall within one of the definitions included in the statute.

Notwithstanding these necessary precautions, employers might consider revamping their standard restrictive covenants to take full advantage of the changes created by the Act. When undertaking such an effort, employers may want to consider the following issues:

·        Are your non-solicitation provisions consistent with the language approved by the Act? The Act provides that “[a]ny reference to a prohibition against ‘soliciting or attempting to solicit business from customers’ or similar language shall be adequate [for non-solicitation restrictions] and narrowly construed to apply only to: (1) such of the employer’s customers, including actively sought prospective customers, with who the employee had material contact; and (2) products and services that are competitive with those provided by the employer’s business.” Because this provision loosens the previously-existing rules for drafting non-solicitation covenants, employers may be able to streamline the language that they use for such covenants.

·        Are your definitions of restricted geographic territories and competitive activities consistent with the language approved by the Act? The Act provides that “[a]ctivities, products, or services [covered by a restrictive covenant] shall be considered sufficiently described if a reference to the activities, products, or services is provided and qualified by the phrase ‘of the type conducted, authorized, offered, or provided within two years prior to termination’ or similar language containing the same or a lesser time period.” Likewise, the Act provides that “[t]he phrase ‘the territory where the employee is working at the time of termination’ or similar language shall be considered sufficient as a description of geographic areas if the person or entity bound by the restraint can reasonably determine the maximum reasonable scope of the restraint at the time of termination.” These provisions significantly loosen rules that previously existed for drafting restrictive covenants in Georgia and may likewise provide some employers with an opportunity to streamline their agreements.

·        Are your nondisclosure provisions drafted as broadly as reasonable? Existing case law in Georgia requires nondisclosure provisions to bear a reasonable time limitation (usually a period of two years or less) with respect to any information that does not constitute a “trade secret” as defined by relevant law. Consistent with this requirement, many employers in Georgia historically have drafted their nondisclosure covenants to apply to a period of two years or less. Because the Act abolishes the requirement of a time limitation for nondisclosure covenants, employers should consider whether they want to revise the language in their existing nondisclosure covenants.

If you are interested in reviewing your existing restrictive covenant agreements for compliance with the new statute, or if you would like assistance drafting such agreements for your workforce, contact a Seyfarth Shaw Trade Secrets Group attorney.

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 A recent Iowa U.S. district court decision upheld two-year, geographically reasonable, non-compete agreements signed by 26 veterinarians while they were employed by Iowa Veterinary Specialties, P.C. (IVS), a Des Moines, Iowa clinic they owned. When two of the vets and IVS’s operations manager learned that its sale to ISU Veterinary Services Corporation (VSC) was imminent, they used IVS’s business information and facilities to assist them in opening a competing veterinary clinic. VSC is a non-profit subsidiary of Iowa State University (ISU) which is home to the oldest veterinary college in the U.S. The purchase of IVS was made with public funds and was intended to be part of ISU’s mission to regain and enhance its veterinary college academic preeminence. The acquired assets included the non-compete agreements.   

VSC sued the two vets and the operations manager, seeking a preliminary injunction. Except as against the operations manager, who had not signed a non-compete agreement, the injunction was entered. The court held that VSC had met its burden of showing a likelihood of success on the merits and that the balance of the equities favored VSC, and the court concluded that “enforcement of valid non-competition agreements serves the public interest.” However, the court did order VSC either to post a $2 million surety bond or to provide a binding representation from ISU that it will pay any judgment the vets may obtain against the University. ISU Veterinary Services Corp. v. Reimer, 2011 WL 1595337 (S.D. Iowa Apr. 27, 2011).

The vets contended that an injunction would bankrupt them, but the court turned that contention against them by stating it showed that VSC had no satisfactory remedy at law. Moreover, VSC proved that the purchased entity had experienced a decline in its revenue and in the number of its patients since the defendants became competitors, thereby showing how harmful denial of injunctive relief would be. 

The court also rejected arguments made by the vets regarding the supposed unfairness or ambiguity of the non-compete agreements, adding that the vets were highly compensated, sophisticated and well-educated, and that the non-compete had substantial monetary significance. So, they should have retained counsel for advice before signing. Assertions that Iowa law prohibits public bodies from competing with private enterprise, and that Iowa’s Veterinary Practice Act prohibited VSC from practicing veterinary medicine, likewise were to no avail.  

Iowa law says that “discharge by the employer is a factor opposing the grant of an injunction” to enforce a non-compete agreement. One of the vets had not been offered a position by VSC. However, that individual had “expressed a complete unwillingness to remain” after the acquisition, and so an offer to him of employment would have been futile. 

The principal message of the VSC case is that sophisticated signatories to reasonable non-compete agreements have an uphill battle when faced by an injunction action. Nevertheless, a very substantial bond requirement (as here) could prove to be a significant obstacle to enforcement of an injunction.

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A recent Indiana Court of Appeals opinion, designated as non-precedential, discussed that state’s law concerning non-competition agreements. Most significant, the court upheld a commitment not to solicit the employer’s current or recent customers for two years even though the covenant contains no geographical limitation. However, provisions precluding any “contact with” such customers, and forbidding acceptance of “referrals of” them, were “blue penciled.” The court reversed the entry of summary judgment for the ex-employees and remanded for trial. Think Tank Software Dev. Corp. v. Chester, Inc., No. 64A03-1003-PL-172 (Ind. Ct. Appeals, Apr. 11, 2011).

Think Tank Software Development Corporation, and a number of companies affiliated with it (collectively, “Think Tank”), sued 10 former employees almost all of whom went to work for defendant Chester, Inc. Think Tank and Chester are competitors, engaging in what the court called “computer-related business activities.” Think Tank alleged violation of covenants not to compete and misappropriation of trade secrets. 

After more than five years of motion practice and discovery, the trial court granted summary judgment to the defendants on the grounds that the covenant not to compete “is overbroad and is therefore unenforceable . . . and cannot be reformed,” and that the property rights in which Think Tank claimed confidentiality did not constitute trade secrets. What the trial court apparently viewed as the covenant’s fatal flaw was that it was unlimited as to an applicable territory. Further, the affidavit of a former Think Tank director of technology seemingly demonstrated that the company had no protectable business information.

The Court of Appeals disagreed. Although upholding a two-year restriction on solicitation of recent former customers, the appellate court struck as unreasonable the prohibition against contacting them. Similarly, the court approved a ban on selling to, servicing, consulting, or negotiating with those customers, but a prohibition on acceptance of referrals of new customers -- for example, by the ex-employer’s customers -- was invalidated. Indiana recognizes “blue penciling” as an option for a court. The absence of a territorial restriction was not fatal, according to the court, because “the class of prohibited contacts [customers who had been such within two years of the former employees’ termination] is well defined and specific, thereby eliminating the need for any geographical limitation.” 

As for trade secrets, the appellate tribunal held that Think Tank sufficiently raised genuine issues of material fact with respect to whether the company’s “customer identities” and “tailored solutions to the customers’ information technology needs combine to form confidential information.” Similarly, Think Tank provided enough evidence of “its extensive security provisions in protecting” that information to withstand a motion for summary judgment.

The enforceability of a non-compete and non-solicitation agreement in a particular case frequently turns on the applicable facts and circumstances, the precise wording of the restriction, and the jurisdiction. The question of whether particular information qualifies as a trade secret also is fact-intensive. When in doubt, contact a Seyfarth Shaw Trade Secrets Group attorney.

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As we have posted previously, there is some question regarding the effective date of Georgia's Restrictive Covenant Act, O.C.G.A. § 13-8-50 et seq., the statute passed by the Georgia General Assembly in 2009 and authorized by passage of an enabling constitutional amendment in November 2010. The RCA changes Georgia’s legal regime regarding restrictive covenants.  Because of the uncertainty regarding the statute’s effective date (and resulting potential constitutional issues), the General Assembly has been considering a bill - House Bill 30 - that would re-enact the RCA to end any constitutional questions. 

HB 30 also addresses a second issue regarding the RCA. There has been some debate as to the meaning of the provisions of O.C.G.A. § 13-8-56, specifically whether it applies only to in-term covenants. HB 30 revises that section of the non-compete statute by making it clear that the presumptions contained in O.C.G.A. § 13-8-56 apply to in-term and post-term covenants. This provision is important to businesses and employersfor a number of reasons, including that Georgia employers will be permitted to list specific competitors in place of specifying a geographic area in a non-compete restriction. 

On Tuesday, February 22, 2011, the House of Representatives passed HB 30 by a margin of 104 to 58. The bill is now before the Senate. We will continue to monitor the progress of the bill.

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By Paul Freehling

The national CPA firm of Mayer Hoffman McCann P.C. (“MHM”), based in Missouri, scored a major victory when the Eighth Circuit Court of Appeals affirmed a trial court’s injunctions and liquidated damages award of $1,369,921 against four former stockholder-employees in Minnesota. The injunctions prohibited them from soliciting MJM’s clients, directed them and their employees to make their office and home computers available to a computer forensic expert, and enjoined them from using (and ordered them to return) MJM’s trade secrets and confidential information. The appellate court’s decision is notable because of its analysis of when non-compete covenants and contractual liquidated damages provisions are enforceable, but also because of the court’s view that non-solicitation agreements are unenforceable.   

In 2005, the individuals executed a Stockholders Agreement pursuant to which they covenanted not to solicit MHM’s clients and customers for two years after leaving MHM’s employ. However, in 2008, immediately after their resignation from MHM, the individuals started a competing firm which proceeded to serve at least 124 MHM clients. 

The covenants were challenged as lacking in consideration, being contrary to Missouri law, and having unenforceable remedy terms. The court discussed and rejected almost every challenge. Mayer Hoffman McCann, P.C. v. Barton, 614 F.2d 893 (8th Cir. 2010).

With regard to consideration, the defendants relied on a 1996 Missouri appellate court decision that invalidated, for lack of sufficient consideration, a non-compete clause contained in a buy-sell agreement. That court, however, was influenced by the absence of a contemporaneous employment contract and the failure of the buy-sell agreement to state that the clause was intended to protect special interests of the buyer.   In the Mayer Hoffman case, the individuals who signed the covenants were employees. Further, the Agreements contained mutual promises, recited that the purpose of the covenants was protection of MHM’s legitimate special interests -- its proprietary trade secrets to which the individuals had access -- and did not include restrictions greater than fairly required. So, consideration was adequate.

Several Missouri appellate court opinions identify the types of agreements in which restrictive covenants are permissible. No reported case involved a covenant ancillary to a shareholder’s agreement relating to a professional corporation. But the Eighth Circuit Appeals Court held that since a few decisions upheld covenants in agreements with various kinds of close corporations, and a professional corporation is a type of close corporation, the covenants at issue are enforceable. The two-year covenant was without geographical restrictions, but it was limited to MHM clients who the defendants solicited, and that was held to conform with Missouri law.

The defendants claimed that the non-compete clause failed because MHM had no protectable interest in clients who the individuals had begun servicing before signing the Stockholder Agreements. The court disagreed. MHM had invested money, time and effort in strengthening the pre-existing relationships. The court did concur with the defendants that, under Missouri law, MHM had no protectable interests in the defendants’ co-workers’ continued employment, and so the non-solicitation clause was unenforceable.

The Agreements provided that a violator of the covenant not to compete would owe liquidated damages equal to the sum of MHM’s total billings, for the two years prior to violation of the covenant, to the clients the violators successfully solicited. Overruling the defendants’ contention that the damages clause created an unenforceable penalty, the court held that the clause was valid because an accurate estimate of damages was difficult to make, and two years’ billings was a reasonable forecast of the harm caused by the individuals’ breach of contract. 

The injunctive and monetary award in Mayer Hoffman might be harsher than some courts would have rendered. However, the contract violation here was particularly egregious. In any event, the opinion suggests how to draft enforceable trade secret protection agreements, non-compete covenants, and liquidated damages clauses. The decision shows the horrendous consequences that may be faced by anyone who misappropriates trade secrets and breaches a covenant not to compete. For questions about the Mayer Hoffman case or other trade secret issues, please contact the Trade Secrets team at Seyfarth Shaw.

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We informed our readers on March 31, 2009 about Illinois House Bill 4040, titled "Illinois Covenants Not to Compete Act" (link). House Bill 4040 attempted to limit 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.

House Bill 4040 also attempted to change Illinois law by:

• eliminating an employer’s ability to enforce a non-competition covenant if the employer failed 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;
• 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;" or if the covenant concerns personal services activities that the employee did not perform during the "one year preceding termination of their employment;"
• forbidding a court, if it chooses to modify an existing covenant, from imposing a damages award for the employee’s original breach of the covenant;　
• instructing a court to interpret any attorneys’ fees provision found in a non-competition covenant to allow either the employer or the employee to recover their attorneys’ fees
• empowering 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.

House Bill 4040 was introduced by Representative Rosemary Mulligan (Republican - 65th District) and never made it out of committee. Hence, the Bill terminated when the Illinois House of Representatives concluded its session. However, Representative Jil Tracy (Republican - 93rd District) introduced a bill identical to House Bill 4040 on January 12, 2011. Representative Mulligan became a co-sponsor of Representative Tracy’s bill, House Bill 0016, on February 4th. So far, House Bill 0016 has not attracted significant public attention or traction in the Illinois House. Nevertheless, we will continue to monitor House Bill 0016 and any other actions the Illinois House or Senate may undertake with respect to non-competition agreements or trade secrets.

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Dakota Beef, a South Dakota processor and seller of organic beef products, hired Scott Lively in 2006 to be its CEO. He signed an employment agreement prohibiting him for two years after his employment terminated from disclosing confidential information, soliciting Dakota Beef’s customers, and competing in the organic beef business, anywhere Dakota Beef conducts business. South Dakota law permits such contracts. Lively was fired in November 2008. In May 2010, he began competing against Dakota Beef which filed suit against him the next month seeking a TRO and a preliminary injunction. Six days later, a South Dakota federal judge entered the requested TRO and set the matter for a preliminary injunction hearing one week thereafter. Howard Venture LLC v. Lively, 2010-2 Trade Cases ¶ 77,200 (D.S.D., June 23, 2010).

Finding that “Dakota Beef is in a business that relies heavily on customer lists and customer good will developed over a substantial period of time,” the court reasoned that “In competing against Dakota Beef and soliciting its customers, it is likely that Lively will either intentionally or unintentionally disclose [Dakota Beef’s] confidential information,” and that if a TRO was not entered, Dakota Beef could not be compensated for all damages sustained because of the difficulty of proving them. While recognizing that wrongful grant of a TRO could cause greater injury to a new business like Lively’s than denial might damage Dakota Beef’s established business, the court concluded that the irreparable harm to Dakota Beef’s “competitive place in the organic beef marketplace” by disclosure of its confidential information tipped the balance in favor of granting the TRO.

Lively’s confidential relationship necessarily would have provided him access to Dakota Beef’s trade secrets, the court said, and since there was no evidence that Dakota Beef had disclosed its trade secrets to anyone not in a confidential relationship or that they had “been legitimately discovered and openly used by others,” Dakota Beef was found to have “a fair chance of prevailing on the merits.” Finally, the court determined that a TRO was warranted because there is a public interest both in the enforcement of lawful contracts and in “fair competition by protecting confidential and secret information.”

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The question has been raised:  What is the effective date of Georgia’s new non-compete statute, O.C.G.A. § 13-8-50 et seq.?

This Act shall become effective on the day following the ratification at the time of the 2010 general election of an amendment to the Constitution of Georgia providing for the enforcement of covenants in commercial contracts that limit competition and shall apply to contracts entered into on and after such date and shall not apply in actions determining the enforceability of restrictive covenants entered into before such date. If such amendment is not so ratified, then this Act shall stand automatically repealed.

Georgia’s electorate ratified Amendment 1 - the Constitutional amendment that enables the changes to Georgia’s restrictive covenant law - with 67.6% of the cast ballots. 

Article X, Section I, Paragraph VI of the Georgia Constitution, however, provides that amendments become effective on January 1 following an election “[u]nless the amendment or the new Constitution itself or the resolution proposing the amendment or the new Constitution shall provide otherwise.”  The enabling amendment and the resolution proposing the amendment are silent as to the effective date. 

Hence, already there is debate as to when the amendment will take effect. 

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On November 2, Georgians voted overwhelmingly in favor of updating Georgia's restrictive covenant law. The new law is codified at O.C.G.A. 13-8-50 et seq. 

The law is not retroactive, so it does not affect existing contracts.  However, for many businesses who have learned that their agreements are not enforceable under Georgia law as it existed previously, now is the time to review the statute and consider updating the agreements.  The law affects not only employer-employee agreements but also franchisor-franchisee, distributorship, lease, partnership and employer-employer agreements.  

In the law, Georgia also adds blue-penciling to the mix for the first time for many agreements (previously, the courts would blue pencil in the instance of sale of business and in some cases partnership agreements, but the blue pencil was not applied uniformly).  

This is a new day in Georgia and there will be much to be watched, written, and learned about the new law and courts' interpretations of the statutory language in the next few months.  Stay tuned.  

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Many states allow courts to take certain actions to "modify" restrictive covenants in employment agreements.  This issue is a topic of hot debate in Georgia, as the voters will decide on November 2, 2010 whether to allow "blue penciling" in Georgia.  Blue penciling, strictly defined, is the ability of a court to strike, excise, or cull, certain severable portions of an agreement so as to enforce the agreement solely to the extent it is reasonable.  Other states allow (and may require) a court to alter the agreement, rewriting or reforming the agreement to make it enforceable to give effect to the parties' intent. 

Here is a break-down of how states handle "blue penciling" or modification of restrictive covenants.  Of course, this is not intended to be a substitute for legal advice but a general guide. 

As part of its efforts to codify its non-compete law, Georgia is seeking to allow "blue-penciling." The statute defines "modification" as

the limitation of a restrictive covenant to render it reasonable in light of the circumstances in which it was made.  Such term shall include

(A) Severing or removing that part of a restrictive covenant that would otherwise make the entire restrictive covenant unenforceable; and
(B) Enforcing the provisions of a restrictive covenant to the extent the provisions are reasonable.

O.C.G.A. sections 13-8-51(11)-(12).  It does not allow for reformation and it does not allow a court to rewrite the contract.  The National Employment Lawyers Association Georgia Affiliate has published an advertisement that suggests otherwise.  The ad says that "Judges would be required to re-write the covenant as they see fit . . . "  However, in accordance with the definitions of "modification" and "modify,"  "a court may modify a covenant that is otherwise void and unenforceable as long as the modification does not render the covenant more restrictive with regard to the employee than as originally drafted by the parties."  O.C.G.A. section 13-8-53(d) (emphasis added).  The court is not required to do so. 

Amendment One, which is on the ballot in November, only gives the general assembly the ability to empower courts to "limit the duration, geographic area, and scope of prohibited activities."  HR 178.  Because "modification" under the statute is limited to severing or narrowing the covenant, and the general assembly would not be given the right to empower courts to reform or re-write restrictive covenants, there should be no legitimate concern about judicial modification in Georgia.  Instead, Georgia would join many other states that employ "blue-penciling."

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On August 19, 2010, the Eleventh Circuit Court of Appeals reversed a district court's denial of a motion for injunctive relief regarding enforcement of an employer's non-compete and non-solicitation provisions. Mohr v. Bank of New York Mellon Corp., No. 10-11890, 2010 WL 3273059 (11th Cir. Aug. 19, 2010). Applying Georgia law, the Court found the non-compete agreement to be enforceable, despite the fact that it forbid two employees from working within 50 miles of 27 cities in Georgia and South Carolina and 16 cities in 12 other states. The agreement was signed as part of the sale of a business, a situation that is afforded the most latitude under Georgia restrictive covenant law.

The Court supported its decision by citing mostly other Georgia decisions that involved a single city. The Court did not consider whether the employees had contacts within each of the 43 cities, but rather focused on the Bank's business territory. Because the agreement was entered into as part of the sale of a business, the Court only considered the employer's contacts and not the employees'.

The Court held that a preliminary injunction should have been issued to enforce the non-compete because, without the injunction, the Bank would be deprived of the benefit of its bargain in buying the business.

The Court's decision indicates a new willingness to enforce a geographically expansive non-compete under Georgia law. The effect of this decision on future litigation is unknown, but will certainly be interesting to watch.

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The Georgia Court of Appeals issued two decisions in July addressing restrictive covenants in Georgia. In both instances, the Court of Appeals upheld trial court findings that the covenants were unenforceable under existing Georgia law.

In Peachtree Fayette Women’s Specialists, LLC, v. Turner, the Court of Appeals agreed with Superior Court Judge Tommy Hankinson of the Griffin Judicial Circuit that a non-compete provision is unenforceable if it covers any territory in which the employee did not work. The non-compete provision in question restricted Dr. Heather Turner from practicing at a number of hospitals, including Piedmont Hospital in Atlanta. The record reflected that Dr. Turner never worked at Piedmont Hospital and that the physicians at Peachtree Fayette Women’s Specialists had resigned their staff privileges there. PFWS argued that because its principal, Dr. William Cook, had worked previously at Piedmont and established it as a referral source, it had a legitimate interest in preventing competition there. The Court of Appeals rejected this argument, noting that Dr. Turner did not work at Piedmont and therefore that PFWS did not have an interest in preventing her from working there. Because current Georgia law does not permit modification of restrictive covenants in employment agreements, the entire non-compete was invalidated, including the provisions that did protect PFWS’s legitimate interests.

In Fine v. Communication Trends Inc., the Court of Appeals agreed with Fulton County Superior Court Judge Melvin Westmoreland that a customer non-solicitation provision was unenforceable because it prevented contact with customers with an eye to providing competitive services. The case was contested between Communications Trends, a business engaged in media planning, purchasing, and cable network programming, on the one hand and its former employee Lynette Fine, on the other. Fine’s new employer, Allscope Media, was also a party. The non-solicitation covenant at issue stated as follows:

4. Nonsolicitation of Clients. The Employee hereby also agrees and covenants with [CTI] that throughout the period of his employment and for a period of two (2) years immediately following cessation of Employee's employment with [CTI], the Employee shall not solicit advertising media placement business similar to [CTI] on behalf of any persons or entity other than [CTI], either directly or indirectly, whether as a shareholder, partner, joint venturer, consultant, employee, officer, agent or otherwise, from any person or entity (or otherwise contact, call upon, communicate with or attempt to communicate with any such person or entity with a view to providing advertising media placement services competitive or potentially competitive with [CTI][.] )

(Emphasis added.) The trial court found and the Court of Appeals agreed that the highlighted portion rendered the entire provision unenforceable because it would prevent Fine from communicating with customers that seek her out. Georgia law permits employers from preventing competitive solicitation by former employees, but it forbids covenants that purport to prohibit acceptance of business. The Court of Appeals found that CTI’s covenant ran afoul of this rule.

(As an aside, the trial court’s finding that the covenant was unenforceable prevented the resolution of a very interesting factual question. The record reflected that Fine attended a large cable industry dinner after joining Allscope and provided her new Allscope business cards to executives affiliated with CTI’s clients.  Fine testified that she informed CTI’s clients that she was not allowed to solicit them and that they would have to provide a statement in writing that she had not done so in order to continue doing business with her at Allscope. Fine further testified that if CTI’s clients contacted her and sent emails stating that they had not been solicited, she accepted their business. Fine’s activity falls in the gray area of solicitation and would have presented a difficult question for a fact-finder.)

The Court of Appeals also found that Fine did not violate the non-disclosure of confidential information provision of her agreement with CTI when she provided revenue projections to Allscope. The fact that the revenue information was not client-specific proved to be decisive.

The Court of Appeals did, however, reverse the trial court’s decision to grant Fine’s motion for summary judgment on a duty of loyalty claim brought by CTI. CTI alleged that Fine breached her duty of loyalty by: (1) making detailed disclosures to Allscope regarding the revenues generated by various CTI clients; (2) failing to provide adequate notice prior to her resignation; and (3) deleting client contact information and destroying CTI’s files that had been in her possession. The Court of Appeals found that the former two allegations were insufficient to state a claim for breach of the duty of loyalty, but the final allegation was sufficient. 

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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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