Non-Competition Agreements[dagger]

Woolf, Linda S

I.

INTRODUCTION

Non-competition agreements (or restrictive covenants) have become increasingly important tools in preventing former employees from utilizing or disclosing proprietary and confidential information once the employment relationship ends. A non-compete provision is an agreement between an employee and his or her employer whereby the employee contracts not to compete with the employer following termination of the employment relationship. These agreements generally prevent the employee from engaging in the same business/profession, soliciting the company's customers and revealing the company's confidential information for the benefit of the former employee or the benefit of a new employer. Although most (but not all) jurisdictions recognize reasonable covenants not to compete, a multitude of statutory and common laws provide various restraints on their validity and enforcement. As such, it is critical to consult applicable state statutes and decisions, since the agreements may be prohibited (e.g., California non-compete provisions are generally unenforceable) and/or limited by statutory and/or case law (e.g., Alabama non-compete agreements are void unless they fall within a statutory exception). Subject to that caveat, this article discusses the general requirements for non-compete agreements and the enforceability of such agreements.

II.

ENFORCEABILITY OF NON-COMPETE AGREEMENTS

Most jurisdictions recognize and enforce reasonable covenants not to compete. A covenant is reasonable if the following criteria are met: (a) the agreement protects a legitimate business interest of the employer; (b) the agreement is reasonably limited in duration and geography so as to not impose undue hardship upon the former employee; and (c) the agreement does not violate public policy. Several jurisdictions also require the agreement to be supported by additional consideration in the form of a benefit to the employee.

A. Legitimate Business Interests

A restrictive covenant is reasonable and enforceable when it protects some legitimate interest of the employer beyond the mere interest in protecting the employer from competition. Those extended legitimate interests generally assume some version of the criteria noted below.

1. Trade secrets and Confidential Information

An employer has a legitimate business interest in keeping former employees from using its trade or business secrets or other confidential information in competition against it. Even in the absence of a demonstrable trade secret, the employee may be enjoined from using confidential information obtained during his employment under certain circumstances.1

2. Customer Relationships and Specialized Training

An employer is entitled to protect its customer relationships or the knowledge that its employees gained solely by reason of their employment with the company.2 Furthermore, although an employer does not have a protectable interest in the general knowledge and skill of an employee, some courts will enforce non-compete agreements if the employer's services are unique.3

B. Scope, Geography and Duration

A non-compete agreement should be limited by type of activity, geographical area and duration. The extent to which the agreement is limited is crucial in determining the reasonableness of the agreement. If(I) the agreement proscribes activities more extensive than necessary; (2) the agreement covers a geographical area more extensive than necessary to protect the interests of the business; or (3) the agreement lasts longer than is required to protect those interests, the agreement will be deemed unreasonable and unenforceable. Thus, employers can protect their interests, but they must narrowly tailor restrictive covenants as to scope,4 geography and duration.5

C. Public Policy

Courts generally will not enforce restrictive covenants that contravene public policy.6 Restrictive covenants affecting attorneys, for example, are generally unenforceable as a violation of professional conduct codes.7 In addition, non-compete agreements with health care professionals are sometimes rigorously scrutinized out of concern that the public will be deprived of a qualified practitioner if such an agreement is enforced.8 Courts have even found that where an agreement is ambiguous, subjecting the employee to uncertainty offends public policy.9

D. Consideration

Several jurisdictions also require that any non-compete agreement be supported by additional consideration in the form of a benefit to the employee. The type of consideration can be important and varies with each state. In most states, signing a non-compete agreement at the inception of one's employment is valuable consideration sufficient to support a covenant not to compete.10 After the employment relationship begins, an employer can provide consideration for signing a non-compete agreement by providing new responsibilities, a cash payment or other benefit." While continued employment is sufficient consideration in some courts,12 it is insufficient consideration in others.13

III.

NON-COMPETITION AGREEMENTS IN CONNECTION WITH THE SALE OF A BUSINESS

While covenants not to compete in employment contracts are generally not favored by the law, a lesser degree of scrutiny is applied to covenants that are ancillary to the sale of a business.14 The rationale behind this distinction when analyzing covenants not to compete focuses on the different nature of each contract. A contract of employment inherently involves parties of unequal bargaining power, whereas a contract for the sale of a business is far more likely to be entered by parties of equal footing.15 As a result, a covenant entered into as part of the sale of a business generally can be drafted more broadly than one entered into as part of an employment contract.16

A. Enforcement

Whether the terms of the non-compete agreement are reasonable typically turns on the specific facts of each transaction.17 Indiana courts apply a three-pronged test to determine whether covenants not to compete ancillary to the sale of a business are overbroad. The elements of this test consist of the following:

1. whether the covenant is broader than necessary for the protection of the covenantee in some legitimate interest;

2. the effect of the covenant upon the covenantor; and

3. the effect of the covenant upon the public interest.18

Of primary importance are the questions whether the covenant not to compete is reasonable to the covenantee and whether it is reasonable as to time, space and activity.19

Four factors are considered in determining whether the protection afforded a covenantee in a territorial restraint covenant ancillary to the sale of a business is reasonable under the circumstances. These factors can be listed as follows:

1. the type of business sold;

2. the effect of including territory into which the transferring business did not extend,

3. the extent of the purchaser's original business, and

4. the period of restraint.20

The most important of these factors is the type or nature of the business purchased. For this purpose, businesses are categorized in three ways: businesses involving (1) services, (2) distribution of goods, and (3) the production, manufacturing, or processing of goods.21 In regard to duration, courts typically will examine the amount of the purchase price to determine reasonableness.22

B. Assignability of Non-Competition Clauses

Divested businesses frequently are parties to pre-existing employment contracts containing non-compete provisions. Jurisdictions are split, however, on whether employment contracts containing covenants not to compete are assignable to the new owner in the event of a sale of the business.23 The majority of these states have concluded that the restrictive covenants are not assignable.24 Some of these jurisdictions have based their decisions on a finding that the employment contracts are personal to the parties and may not be assigned.25 Other jurisdictions have concluded that employment contracts involve personal services and are not assignable without the parties' consent.26

Several other jurisdictions have taken a less restrictive view; these generally allow non-competition agreements to be assigned absent specific language in the agreement prohibiting such assignment.27 The decision in AutoMed Techs., Inc. v. Eller reasoned that the identity of the party enforcing a restrictive covenant should make "very little" difference to the employee.28 Furthermore, because courts only enforce covenants to the extent that they are reasonable and necessary to protect an employer's legitimate interests, an employee will not be prejudiced by having the contract assigned to a successor business.29

In situations where an employee consents to assignment, an issue may arise regarding whether the purchase and sale of the business goodwill should be interpreted to include the purchase and sale of an employment agreement with a non-compete clause when that employment agreement is not explicitly included in the list of purchased assets. In Campbell v. Millennium Ventures, ZZC,30 the court noted this issue of first impression, and determined that when a purchaser buys the "goodwill" of the seller, "logic suggests" that the goodwill sold includes the employment agreement.31 Furthermore, the court was persuaded that the purchase agreement included assignment of the employment agreement since the employment agreement was not listed in the purchase agreement as an excluded asset. That factor operated in conjunction with other circumstances surrounding the purchase agreement (e.g., the employee's consent to the assignment).

IV.

ENFORCING THE AGREEMENT

A. Burden of Proof

The party seeking to enforce the non-compete agreement bears the burden of proving its reasonableness by clear and convincing evidence.32

B. Judicial Enforcement

Courts take one of three positions when approaching covenants not to compete: (1) an agreement that is overly broad and unreasonable in scope, duration and/or geography will not be enforced;33 (2) an overly broad agreement can be "blue-penciled" by deleting the offending provisions and enforcing the remaining contract;34 or (3) an overly broad agreement can be redrafted or revised to provide reasonable protection to an employer's legitimate business interest.35

C. Remedies

Upon a breach of the agreement, the non-breaching party is entitled to money damages and/or injunctive relief. Generally, courts prescribe relief under one or more of the theories noted below.

1. Injunctive Relief

An employer may seek injunctive relief to enforce the terms of the restrictive covenant. For example, an employer may seek to prevent the former employee's solicitation of customers or key employees, or to prevent disclosure of trade secrets or other confidential information. Ordinarily, injunctive relief may be granted only upon a showing that: (1) the plaintiff's remedies at law are inadequate, causing irreparable harm pending resolution of the substantive action; (2) the plaintiff has a reasonable likelihood of success at trial; (3) the plaintiff's threatened injury outweighs the potential harm to the defendant resulting from the injunction sought, and (4) the injunction will serve the public interest.36 An employer may be entitled to preliminary injunctive relief where it can demonstrate that it is likely to suffer irreparable harm if such relief is not granted before a decision on the merits can be rendered.37 Injunctive relief may be denied, on the other hand, where the former employer fails to demonstrate that such relief is necessary to protect its legitimate business interest.38

2. Actual Damages

Although it may be impossible to ascertain an exact amount of lost profits resulting from the breach of a non-compete covenant, an award of damages is not precluded. Rather, the plaintiff must provide evidence that establishes damages with a fair degree of probability.39

3. Liquidated Damages

A liquidated damages clause in an employment contract is governed by the same rules that prevail under other contracts.40 In order to recover liquidated damages under a contract, "(1) injury caused by the breach must be difficult or impossible of estimation in fact and not merely contended by the contract; (2) the parties must intend to provide for damages; (3) and the sum stipulated must be a reasonable pre-estimate of the probable loss."41

4. Other Theories of Relief upon Breach

Beyond injunctive relief and damages, there are other theories of relief that may be sought upon breach. These include:

(a) Uniform Trade secret Act (USTA);

(b) Unfair Competition and Deceptive Trade Practice State Statutes;

(c) Breach of Fiduciary Duty;

(d) Intentional Interference with Contractual Relations, or

(e) Conspiracy.

D. Possible Defenses to Enforcement

An employer's material breach of the employee's employment contract may provide a defense to enforcement.42 Failure to provide sufficient consideration also may provide a defense to enforcement of a restrictive covenant.43 In addition, enforcement may be challenged if the agreement is unreasonable in light of its scope, geography or duration, as previously discussed. Standard contract defenses such as fraud or promissory estoppel also may apply.

V.

CONCLUSION

Employers must take proactive measures to protect company information. Careful attention to statutory and common law is required when drafting non-compete agreements. Although such agreements may not provide full protection from disclosure of company information, non-compete agreements can be extremely effective in protecting the proprietary and confidential information of a business when drafted properly.

[dagger] Submitted by the author on behalf of the FDCC Employment Litigation and Civil Rights section.

1 PADCO Advisory, Inc. v. Omdahl, 179 F. Supp. 2d 600 (D. Md. 2002).

2 Smith v. HBT, Inc., 445 S.E.2d 315 (Ga. Ct. App. 1994) (employer has an interest in the customer relationships its former employee established and/or nurtured while employed); Cohoon v. Financial Plans & Strategies, Inc., 760 N.E.2d 190 (Ind. Ct. App. 2001) (employer had a legitimate, protectable interest in good will of its clients and "past" clients with whom employee had direct contact during last twelve months of his employment); Rogers v. Runfola & Assocs. Inc., 565 N.E.2d 540 (Ohio 1991) (legitimate business interest exists to keep employees from disclosing internal information and client relationships developed at employer's expense); Fair Assocs., Inc. v. Baskin, 530 S.E.2d 878 (N.C. Ct. App. 2000) (protection of customer relationships against misappropriation by a departing employee is a legitimate interest of an employer); but see Prof'1 Bus. Servs. Co. v. Rosno, 589 N.W.2d 826 (Neb. 1999) (agreement can only restrict former employee from soliciting customers or clients with whom former employee did business and had actual contact); Ken J. Pezrow Corp. v. Seifert, 602 N.Y.S.2d 468 (App. Div. 1993) (customer lists readily available from outside sources are not protected).

3 Willis of New York, Inc. v. DeFelice, 750 N.Y.S.2d 39 (App. Div. 2002) (insurance brokerage firm was entitled to enforce restrictive covenants against its former high-level employee to prevent the employee from soliciting firm's clients after employee joined firm's competitor because employee's services were unique); Vantage Tech., L.L.C. v. Cross, 17 S.W.Sd 637 (Tenn. Ct. App. 1999) (an employer may have a protected interest in the unique knowledge and skill that an employee receives through special training by his employer, at least when such training is present along with other factors tending to show a protected interest).

4 see, e.g., Howard Johnson & Co. v. Feinstein, 609 N.E.2d 930 (111. App. Ct. 1993) (agreement's activity restraint was carefully tailored and narrowly drawn to meet parties' interests); cf. Modern Environments, Inc. v. Stinnett, 561 S.E. 2d 694 (Va. 2002) (non-compete clause prohibiting employee from working in any capacity for competitor was overbroad and unenforceable); Marshall v. Gore, 506 So. 2d 91 (FIa. Dist. Ct. App. 1987) (computer programmer could not be prohibited from working in any computer business, but only firm competing with employer in software relating to dairy feeding and management); Moore v. Eggers Consulting Co., 562 N.W.2d 534 (Neb. 1997) (agreement precluding employee from entering into business with anyone of whom he had knowledge because of his employment rather than clients with whom he had done business was unenforceable).

5 see, e.g., Cardiovascular Surgical Specialists v. Mammana, 61 P.3d 210 (OkIa. 2002) (non-compete clause precluding surgeon from practicing cardiovascular and thoracic surgery within twenty-mile radius of former practice was overbroad and unenforceable where closest hospital outside twenty-mile radius was 100 miles away from location of former practice); Hopper v. All Pet Animal Clinic, Inc., 861 P.2d 531 (Wyo. 1993) (enforcement of one-year term appropriate); Sheffield v. Stoudenmire, 553 So. 2d 125 (Ala. 1989) (five-year restriction and fifty-mile radius restraint was not reasonably related to agency's interest); Pinnacle Performance, Inc. v. Hessing, 17 P.3d 308 (Idaho Ct. App. 2001) (agreement was unreasonable where employee was hired for a four-month period on single project and prohibited from performing any services for any past or present clients in any geographical area for two years).

6 see Dowd & Dowd, Etd. v. Gleason, 693 N.E.2d 358 (111. 1998).

7 see, e.g., id.; Jacob v. Norris, McLaughlin & Marcus, 607 A.2d 142 (N.J. 1992).

8 Valley Medical Specialists v. Farber, 982 P.2d 1277 (Ariz. 1999); but cf. Cardiovascular Surgical Specialists v. Mammana, 61 P.3d 210 (OkIa. 2002) (upholding non-compete clause precluding surgeon from soliciting patients of former practice for one year, except where patient affirmatively requested surgeon to continue providing his or her medical services).

9 Power Dist. Inc. v. Emergency Power Eng'g, 569 F. Supp. 54 (E.D. Va. 1983).

10 see, e.g., Fair Assocs., Inc. v. Baskin, 530 S.E.2d 878 (N.C. Ct. App. 2000).

11 see, e.g., Davis & Warde, Inc. v. Tripodi, 616A.2d 1384 (Pa. Super. Ct. 1992).

12 Coastal Unilubc, Inc. v. Smith, 598 So. 2d 200 (FIa. Dist. Ct. App. 1992); Leatherman v. Mgmt. Advisors, Inc., 448 N.E.2d 1048 (Ind. 1983).

13 LyIe R. Jager Agency v. Steward, 625 N.E.2d 397 (111. App. Ct. 1997); Milncr Airco, Inc. v. Morris, 433 S.E.2d811 (N.C. App. 1993).

14 Habif, Arogeti & Wynne, P.C. v. Baggett, 498 S.E.2d 346 (Ga. Ct. App. 1998).

15 Watson v. Waffle House, 324 S.E.2d 175 (Ga. 1985).

16 Gale Indus, v. O'liearn, 570 S.E.2d 661 (Ga. Ct. App. 2002); Rent-A-Center v. Canyon Television & Appliance Rental, 944 F.2d 597 (9th Cir. 1991); H&R Block v. Eovelace, 493 P.2d 205, 210 (Kan. 1972).

17 Rent-A-Center v. Canyon Television & Appliance Rental, 944 F.2d 597 (9th Cir. 1991).

18 Fogle v. Shah, 539 N.E.2d 500 (Ind. Ct. App. 1989).

19 Id. (citing 46 A.L.R.2d 114, 147-151 (1951)).

20 Id. (citing 46 A.L.R.2d 114,228-260(1951)).

21 Id.

22 Bowen v. Carlsbad Ins. & Real Estate, 724 P.2d 223, 225 (N.M. 1986) (citing Bonneau v. Meaney, 178 N.E.2d 577, 579 (Mass. 1961)); see also Valley Mortuary v. Fairbanks, 225 P.2d 739, 743 (Utah 1950) (twenty-five year covenant ancillary to sale of business was valid and enforceable); DB A Enter, v. Findlay, 923 P.2d298,301 (CoIo. Ct. App. 1996) (five years plus term of covenant was reasonable); Bicycle Transit Auth., Inc. v. Bell, 333 S.E.2d 299, 304 (N.C.I985) (seven-year covenant was reasonable).

23 Hess v. Gebhard & Co., 808 A.2d 912 (Pa. 2002).

24 id.

25 W. (citing Sisco v. Empiregas, Inc., 237 So. 2d 463 (Ala. 1970) (stating that covenants not to compete are personal to the performance of the company and the employee and are not assignable, particularly as they involve a relationship of personal confidence between the two parties); Smith, Bell & Hauck, Inc. v. Cullins, 183 A.2d 528 (Vt. 1962)).

26 Id. at 919 (citing Trinity Transp. v. Ryan, 1986 WL 11111 (Del. Ch.1986) (contract is for personal services and not assignable); SDL Enters, v. DeReamer, 683 N.E.2d 1347 (Ind. Ct. App. 1997)); sen also Phillips v. Corporate Express Office Prods., 800 So. 2d 618 (FIa. Dist. Ct. App. 2001) (holding that non-compete agreements were personal services contracts and not assignable without the parties' consent); Clark Substations, L.L.C. v. Ware, 838 So. 2d 360 (Ala. 2002) (same).

27 Artomick Int'l., Inc. v. Koch, 759 N.E.2d 385 (Ohio Ct. App. 2001); see also AutoMed Techs., Inc. v. Eller, 160 F. Supp. 2d 915, 924 (N.D. 111. 2001) ("without any Illinois precedent holding that restrictive covenants may never be assigned without consent, we are unwilling to anticipate new public policy restrictions on contract rights.").

28 AutoMed Techs., Inc. v. Eller, 160 F. Supp. 2d 915, 924 (N.D. 111. 2001).

29 Id.

30 55 P.3d 429 (N.M. Ct. App. 2002).

31 Id. at 436.

32 Raimonde v. Van Vlerah, 325 N.E.2d 544 (Ohio 1975); AEE-EMF, Inc. v. Passmore, 906 S.W.2d 714 (Mo. Ct. App. 1995); Clark v. Mt. Carmel Health, 706 N.E.2d 336 (Ohio Ct. App. 1997).

33 Presto-X-Co. v. Beller, 568 N.W.2d 235 (Neb. 1997).

34 Commercial Bankers Life Ins. Co. of Am. v. Smith, 516 N.E.2d 110 (Ind. Ct. App. 1987).

35 Raimonde v. Van Vlerah, 325 N.E.2d 544 (Ohio 1975).

36 See, e.g., Washel v. Bryant, 770 N.E.2d 902 (Ind. Ct. App. 2002); John T. Callahan & Sons, Inc. v. City of Maiden, 713 N.E.2d 955 (Mass. 1999); City of Cleveland v. Cleveland Elec. Ilium. Co., 684 N.E.2d 343 (Ohio Ct. App. 1996).

37 Shred-It, USA, Inc. v Mobile Data Shred, Inc., 202 R Supp. 2d 228 (S.D.N.Y. 2000).

38 see PADCO Advisory, Inc. v. Omdahl, 179 F. Supp. 2d 600 (D. Md. 2002) (denying permanent injunction enjoining former employee from misappropriating confidential customer database where evidence showed that former employee did not physically take tangible records, customer list was constantly changed, and employee's memory of list contents two years after he left would not qualify as trade secret).

39 Prairie Eye Center, Etd. v. Butler, 768 N.E.2d 414 (111. App. Ct. 2002); Scobell Inc. v. Schade, 688 A.2d 715 (Pa. Super. Ct. 1997).

40 see Habif, Arogeti & Wynne, P.C. v. Baggett, 498 S.E.2d 346 (Ga. Ct. App. 1998).

41 Capricorn Sys., Inc. v. Pednekar, 546 S.E.2d 554 (Ga. Ct. App. 2001).

42 Ward v. Am. Mut. Liab. Ins. Co., 443 N.E.2d 1342 (Mass. Ct. App. 1983).

43 McCandless v. Carpenter, 848 P.2d 444 (Idaho Ct. App. 1993).

Linda Woolf is a partner and founding member of the Baltimore firm ofGoodell, DeVr les, Leech & Dann, LLP, and head of its commercial litigation department. She is a magna cum laude graduate of the University of Baltimore Law School and was the Managing Editor of its Law Review. Ms. Woolf is a member of the Executive Board of the Maryland Association of Defense Counsel, co-chair of its Appellate Committee and past editor of its quarterly publication, THE DEFENSE LINE. Ms. Woolf's practice focuses on commercial litigation, business torts, employment and insurance coverage disputes. She is a frequent lecturer and faculty member for continuing legal education programs sponsored by the Maryland Institute for the Continuing Professional Education of Lawyers (MICPEL), including its nine-day Intensive Trial Advocacy Program. In addition, she is a member of the FDCC Business Tort and Commercial Litigation, Employment Litigation and Civil Rights and Insurance Coverage sections, the Defense Research Institute, and past chair of the Network of Trial Law Firms, Inc.

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