Robert K. Jones and Stephen B. Coleman from our Phoenix office have written on the Jackson Lewis website about a significant new court of appeals decision in Arizona striking down restrictive coveants in an employment agreement as overbroad. The article can be viewed here: Confidentiality, Non-Compete Agreements Held Unenforceable against Former Employee, Arizona Court Holds.
The Court of Appeal for California’s Fourth Appellate District recently confirmed that the California Uniform Trade Secrets Act (CUTSA), a broad statute intended to be the last word in trade secret misappropriation cases, does not preclude separate but related common law claims, so long as these claims are not based entirely on the trade secret misappropriation. The ruling echoes similar decisions from other California appellate districts and is helpful to businesses seeking to protect against unfair competition.
In Angelica Textile Services, Inc. v. Park, case number D062405, (Order dated October 15, 2013), the plaintiff, Angelica, sued its former employee, Park, asserting causes of action for misappropriation of trade secrets under CUTSA, breach of contract, breach of fiduciary duty, interference with business relationships, unfair business practices, unfair competition, and conversion. The claims generally arose out of Park’s alleged solicitation of Angelica’s largest customers for a new competing venture he had established while still employed by Angelica, allegedly with the help of hundreds of documents over which Angelica claimed trade secret protection. The trial court granted Park’s motion for summary adjudication with respect to the non-CUTSA claims, holding that those claims were preempted by CUTSA, which, “[a]t least as to common law trade secret misappropriation claims . . . occupies the field in California.” A jury then went on to rule against the company on its CUTSA claims.
The Court of Appeal reversed the dismissal of the non-CUTSA claims. With respect to the breach of contract claim, the court relied on CUTSA’s language to hold that the statute “does not displace breach of contract claims, even if they are based in part on the alleged misappropriation of a trade secret.” In preserving Angelica’s other claims, it held that “CUTSA does not displace noncontract claims that, although related to a trade secret misappropriation, are independent and based on facts distinct from the facts that support the misappropriation claim.” Accordingly, to the extent Angelica’s claims were based at least in part on conduct other than the misappropriation of its trade secrets, its remedies were not limited to those under CUTSA.
The court held that Angelica’s claims were permissible because it did not allege that Park breached his contract with the company, and violated its duties to the company, by misappropriating its trade secrets. Rather, its breach of contract claim was based on Park’s alleged violation of a noncompetition agreement with the company (while Park was still employed), its conversion claim was intended to redress Park’s acquisition of the company’s documents in the event they were not entitled to trade secret protection, and its other claims were based on both the breach of contract and the breach of Park’s duty of loyalty to Angelica. Thus, because none of the claims depended on the trade secret claim, none were barred by CUTSA.
Angelica does not break new ground, but it is a helpful clarification of California’s developing law regarding trade secrets and unfair competition. In particular, California businesses may be comforted to know that the state’s strong public policy against restrictions on competition does not leave them without the means to remedy unfair competition that does not involve the misappropriation of protected trade secrets. In pleading non-CUTSA claims akin to those above, the victims of unfair competition should be careful to make clear exactly which conduct forms the basis of its claims and should consider making explicit the fact that such claims are not based on the misappropriation of trade secrets.
We have previously written about tolling provisions on this blog. In a decision from the U.S. District Court for the District of Minnesota, Judge Patrick J. Schiltz held that, under Minnesota law, non-compete terms do not automatically reset upon violation. The decision in U.S. Water v. Watertech of America, No. 13-CV-1258 (PJS/JSM), concerned a motion for a preliminary injunction to enforce an 18 month non-compete signed by a former employee of U.S. Water, Sveinn Storm. At the time of the decision there were only four weeks left until the 18 month term expired on October 30, 2013. At the hearing on the motion, U.S. Water argued that the covenant not to compete should not expire on October 30, 2013 because the agreement contained a provision that tolled the non-compete during any violation and, in the alternative, that a contractual non-compete term automatically resets upon violation. In rejecting both arguments, the court noted as follows:
First, contrary to U.S. Water’s assertion, the agreement signed by Storm does not include a tolling provision. Second, U.S. Water has not cited (and the Court has not found) any judicial decision holding that, under Minnesota law, a violation of a covenant not to compete automatically resets the term of that covenant. Given that “[i]n Minnesota, employment noncompete agreements are looked upon with disfavor, cautiously considered and carefully scrutinized,” (citation omitted), the Court doubts very much that any Minnesota court would give an employer a “fresh set of downs” every time a former employee violates a covenant not to compete.
The Court held the parties to their agreement that Storm would refrain from contacting any of U.S. Water’s customers before October 30, 2013, but denied the motion for a preliminary injunction. Unfortunately, it is not revealed in the Court’s decision what, if any, language the plaintiff was relying upon in its assertion that the agreement contained a tolling provision. This case is a glass half-full and half-empty for plaintiffs relying on tolling agreements. On the one hand, it throws cold water on the argument that common law allows for automatic tolling, although other Minnesota courts have at least entertained the idea of equitable tolling. On the other hand, it does not directly say that a carefully written contractual tolling provision would not be enforceable.
The First Circuit Court of Appeals issued its most significant decision to date on non-solicitation provisions in restrictive covenants by upholding a preliminary injunction in Corporate Technologies, Inc. v. Harnett, No. 13-1706 (August 23, 2013). The court affirmed a decision from the District of Massachusetts granting a preliminary injunction to an employer whose former employee used a targeted email blast to announce his new position with a competing company. In upholding the injunction, the court took a much broader view of the meaning of “solicitation” than that argued by the defendant employee and shed light on the “hazy” line separating “actively soliciting” business from “merely accepting” it.
Brian Harnett, an account/executive salesman, signed an agreement containing non-solicitation and non-disclosure provisions when he joined the former employer nearly a decade earlier. Upon leaving to work for a competitor, Harnett sent an email to a “targeted list of prospects,” approximately 40 percent of whom were customers of his former employer. Based on their receipt of the email, customers contacted Harnett and at least one of the former employer’s customers eventually completed a sale with Harnett’s new company. Harnett also had significant business contacts with at least four of his former employer’s customers.
Harnett argued that because the customers were the ones initiating contact, subsequent business activity could not be considered solicitation. The court, however, held that solicitation “can take many forms” and found Harnett’s argument unpersuasive. In forming its opinion, the court noted:
[t]he employer ordinarily has the right to enforce the covenant according to its tenor. That right cannot be thwarted by easy evasions, such as piquing customers’ curiosity and inciting them to make the initial contact with the employee’s new firm.
The court determined that in solicitation cases, placing an emphasis on who made the initial contact would undermine the former employers’ bargained-for protections, as the term “initial contact” has an “amorphous nature” and can easily be “manipulated.” Instead, the court announced a belief that the identity of the party making the initial contact should be “just one factor” in “drawing the line between solicitation and acceptance.”
The First Circuit’s decision follows Massachusetts appellate case law. In Alexander & Alexander, Inc. v. Danahy, the Appeals Court of Massachusetts also took a broad view of solicitation and described the difference between accepting and receiving business as “more metaphysical than real.” Alexander v. Alexander, Inc. v. Danahy, 488 Mass. App. Ct. 23, 30 (Mass. App. Ct. 1986).
The Corporate Technologies, Inc. decision is likely to be relied upon by employers seeking to enforce non-solicitation clauses, especially in the First Circuit. It also offers important lessons for employers in the hiring context. Employers should advise newly hired employees with non-solicitation agreements to be careful in their dealings with former customers. Seemingly innocuous email blasts may violate their non-solicitation agreements, even if a former customer reaches out to them first.
The Wall Street Journal on line has taken a recent interest in non-competes in a pair of recent one-line articles (protected by pay wall) on August 12 and August 14, 2013. Both pieces cite to a study commissioned by the Journal showing that the number of lawsuits filed over non-competes went up 60 percent between 2002 and 2012 (from about 475 to 760). In “Litigation Over Noncompete Clauses is Rising,” authors Ruth Simon and Angus Loten theorize that non-competes are having a “damping effect on U.S. entrepreneurship.” While there is little evidence for this theory, it does appear that non-compete litigation is at an all time high. Certainly adequate legal protections against unfair competition also are important for economic growth.
The article also points to proposed legislative changes in New Hampshire, Massachusetts, and, as reported here, New Jersey, to limit enforceability of non-compete agreements, in part based on arguments that this might spur employment and economic activity. What the article did not mention that is that it arguably has become easier to enforce non-compete agreements in other states, including Georgia and Texas, than it was just a few years earlier. Non-compete law continues to vary widely from state to state and it would be premature to say there is a national trend to impose greater limitations in this area.
In “Companies Loosen the Handcuffs on Non-Competes” (August 12, 2013), the Journal reported what it saw as a trend of employers taking a “looser attitude toward enforcing non-compete agreements” by invoking trade-offs between the old and new employer over duration, duties and compensation. Negotiated resolution to non-compete disputes is nothing new, but the Journal’s story is a good reminder that it often pays to be creative, and flexible, when faced with one of these issues. On the other hand, readers of the Journal should not take away the misperception that non-competes are never enforceable or can always be resolved. In appropriate situations, properly drafted agreements can be and often are enforced by the courts.
The Indiana Court of Appeals determined in an unpublished opinion that an employer presented a prima facie case that a five-year restriction in a non-compete agreement was reasonable. Mayne v O’Bannon Publishing Co., 36 IER Cases 279 (Ind. Ct. App. 2013). Elizabeth Mayne operated a small commercial printing business in Louisville, Kentucky for some time and decided to close the business and accept employment with O’Bannon Publishing Co. just across the Ohio River in Southern Indiana. O’Bannon did not purchase Mayne’s business, but it did purchase at least one printing press from her and paid her a commission, over and above salary, for customers she brought over. Mayne settled into her new position as manager of O’Bannon’s print shop and developed close relationships with the company’s customers. Because O’Bannon only employed one or two other employees at any given time (often teenagers), Mayne worked closely and directly with O’Bannon’s customers over the course of her five years of employment, particularly its repeat business clients. Mayne was the go-to person for O’Bannon’s business customers and offered direct, personal assistance to them. Indeed, the evidence established that Mayne became the face of the business and “customers loved [her].”
Mayne ultimately resigned her employment with O’Bannon and purchased a competing print shop business within one-half mile of O’Bannon’s shop. O’Bannon filed suit and was granted a preliminary injunction on the basis of the non-compete agreement in Mayne’s employment agreement. On appeal, Mayne argued that O’Bannon failed to establish a reasonable likelihood of success at trial in order to support preliminary injunctive relief. Specifically, Mayne argued that the five-year restriction in her non-compete agreement unreasonable as a matter of law. The Court of Appeals disagreed.
The Court conceded that a five-year restriction is longer than most such restrictions deemed reasonable under Indiana law, stating, “To be sure, five years is a lengthy period for these types of restrictions.” And, in fact, the Court had to reach back to Indiana appellate cases decided in 1989 and 1964 to find other examples of a five-year restriction upheld as reasonable. Nonetheless, the Court relied on the close relationships developed by Mayne during her employment with O’Bannon to uphold the restriction. Additionally, the Court noted that the geographic scope of the non-compete agreement was limited to two Southern Indiana counties and cited the fact that Mayne previously operated a print shop in Louisville, Kentucky.
This case – albeit an unpublished decision – may give encouragement to drafters of non-compete agreements to reach further with regard to time restrictions. However, it must be noted that the Court based its decision on the unusually close relationship Mayne developed with O’Bannon’s customers and also cited to the very limited geographic scope of the non-compete agreement. Indiana courts will continue to review non-compete agreements for reasonableness as to the time, activity, and geographic area restrictions.
The North Dakota Supreme Court upheld a judgment finding two employees of SolarBee, Inc., a North Dakota corporation that manufactures solar-powered water circulators, liable for a total of $621,800 in damages for breaching a non-compete agreement while still employed. The Court’s decision in SolarBee, Inc. v. Walker, No. 2012015 (June 24, 2013), is a reminder that employers are not completely without legal remedies in North Dakota, a state which generally bars restraints on solicitation or competition after employment ceases. (See North Dakota Century Code, Section 9-08-06.)
The decision in SolarBee is also remarkable in that the plaintiff did not plead breach of employment contract in its complaint. Plaintiff sued for breach of a proprietary information agreement (a separate document), misappropriation of trade secrets, breach of fiduciary duty, civil conspiracy and unlawful interference with business. At trial, the employment agreements were admitted into evidence without objection. Plaintiff argued that the defendants “breached” both the proprietary information agreements and the employment agreements. The trial court agreed and the North Dakota Supreme Court affirmed, allowing an “amendment by implication” where the claim was raised by plaintiff in pre-trial briefing and at trial without objection by defendants.
It also is interesting that the Court’s decision SolarBee suggests that plaintiff’s claim for breach of fiduciary duty was dismissed because it was premised on a North Dakota statute, N.D.C.C. Section 59-01-09, that was repealed in 2007. In many states, competing while employed would constitute a violation of breach of a common law duty of loyalty. It does not appear that the North Dakota Supreme Court has recognized a duty of loyalty based on common law, although it has found a similar duty under N.D.C.C. Section 34-02-14 (stating in part “[a]n employe who has any business to transact on the employee’s own account similar to that entrusted to the employee’s employer shall give the latter the preference always.”) See Warner and Company v. Solberg, 634 N.W.2d 65, 72 (N.D. 2001). Employers doing business in North Dakota should continue to tread carefully and consider the use of employment contracts which prohibit competition while employed, as well as other protections, in the absence of clarity on the scope of an employee’s duty of loyalty under North Dakota common law.
Earlier this year, Jackson Lewis opened a new office in San Juan, Puerto Rico serving clients throughout the Commonwealth. We thought we would take the opportunity to discuss the enforceability of non-competes under Puerto Rico law. As in many other jurisdictions, the validity and enforceability of non-competition agreements in Puerto Rico depends on the reasonableness of the restrictions imposed. Employers must also strictly follow the requirements set forth by the Puerto Rico Supreme Court in Arthur Young & Co. v. Vega, 136 D.P.R. 157 (1994), to wit:
1. The employer must have a legitimate interest to protect and the non-competition agreement must be drafted so as to not impose any limitations beyond those needed to protect the interest. The existence of the employer’s interest needs to be directly related to and will depend on whether the employee’s position in the company enables him/her to effectively compete with his/her employer in the future.
2. The restrictions on the employee must be circumscribed to activities similar to those the employee is engaged in. Thus, a non-compete that restricts a former employee from working in other capacities will be declared invalid.
3. The time span of the restrictions may not exceed a term of twelve (12) months after the employee’s termination date. Any additional term is deemed excessive and illegal per se.
4. The geographic area covered by the restriction must be strictly limited to that necessary to prevent actual competition between employer and employee.
5. When referring to clients, the non-compete clause should refer only to (i) those personally serviced by the employee during a reasonable period before his/her last date of employment; and (ii) which at the time, or for a period immediately before said date, were still the employer’s clients. The Puerto Rico Supreme Court has further suggested that restrictions applicable to potential clients would be considered to be excessively broad and, therefore, invalid. See PACIV, Inc. v. Pérez Rivera, 159 D.P.R. 523 (2003).
6. The employer must provide valid and sufficient consideration in exchange for the employee signing a non-competition agreement. As to newly hired employees, the offer of employment is deemed adequate consideration, provided the employee executes the non-competition agreement as of his/her hire date. As to current employees, additional consideration must be provided in order to secure a valid non-compete. Additional consideration could consist of a promotion, additional employment benefits, or the enjoyment of substantial changes of a similar nature in the employment conditions. Mere job tenure, however, will not be deemed as sufficient and adequate consideration for the non-competition agreement.
7. The non-competetion agreement must be in writing.
It should further be noted that the Puerto Rico Supreme Court has expressly rejected the “blue pencil approach,” as well as the partial enforcement method, which allow the parties to modify non-competition agreements to adjust them to reasonable standards and further permit courts to enforce non-competition agreements as modified by the parties. Thus, failure to comply with any of the above-mentioned requirements will cause the entire non-competition agreement to be void and unenforceable. For this reason, we strongly recommend that employers conducting business in Puerto Rico secure legal advice in connection with the preparation and execution of non-competition agreements and other restrictive covenants for employees working in Puerto Rico.
A New Jersey federal court recently granted a defendant-company’s motion to compel arbitration pursuant to a non-compete agreement between the plaintiff-company and two former employees who had discontinued employment with the plaintiff and went to work for the defendant. The case is Precision Funding Group, LLC v. National Fidelity Mortgage, Civ. No. 12-5054 (RMB/JS), 2013 U.S. Dist. LEXIS 76609, 2013 WL 2404151 (D.N.J. May 31, 2013).
Precision Funding Group (“PFG”) and National Fidelity Mortgage (“NFM”) are competing mortgage brokerage firms. This action arose when two PFG employees, John Itri and Matthew Prizzi, resigned from their positions and started working for NFM. While at PFG, Itri and Prizzi had signed employment contracts containing a non-compete clause, prohibiting them from working for a competitor within two years from leaving PFG. These agreements also contained an arbitration clause providing that “[a]ny controversy, dispute, or claim of whatever nature arising out of, in connection with, or in relation to … this agreement … shall be settled, at the request of any party by the final and binding arbitration … determined by the arbitrator….”
PFG brought suit against NFM and subsequently filed arbitration complaints against Itri and Prizzi, making similar allegations in each complaint, contending that Itri and Prizzi recruited PFG employees to join NFM and engaged in misleading activities to steal existing PFG clients. In a six-count complaint against NFM, Precision alleged defamation, commercial disparagement, conversion, unfair competition, intentional interference with a prospective contractual relationship, and intentional interference with a contractual relationship.
NFM, a non-signatory to the employment agreements, sought to compel PFG to arbitrate its claims pursuant to the agreements with Itri and Prizzi, arguing that the allegations arise out of the agreements and that the claims brought in the present case and those in arbitration are “inextricably intertwined.” In response, PFG argued that there was an insufficient nexus between the claims and that the claims in the present case fall outside the scope of the arbitration clause, or alternatively, that the case should be stayed pending the outcome of the arbitration proceedings between Itri, Prizzi, and PFG.
The court noted that PFG had no contractual obligation to arbitrate claims against NFM because no agreement between the parties existed. It held, however, that arbitration could be compelled in this case under a theory of equitable estoppel. Specifically, a non-signatory to an arbitration clause may compel a signatory to arbitrate if either (1) the issues to be litigated are “inextricably intertwined” with the arbitration agreement, or (2) there is a sufficient nexus as well as an integral relationship between the parties. Here, the court determined that NFM had standing to compel PFG’s claims to arbitration because the claims arose directly from the actions of Itri and Prizzi which are subject to arbitration.
The court disagreed with PFG’s contention that a sufficient relationship for purposes of compelling arbitration requires a parent/subsidiary relationship, a successor corporation, or a signatory acting as an agent for a non-signatory. Rather, a non-signatory merely needs to be “closely aligned” with parties to the agreement to compel arbitration, a standard satisfied by NFM’s employment of Itri and Prizzi and PFG’s claims having arisen directly from that employment relationship.
Concluding that NFM had standing to compel arbitration, the court then had to determine whether PFG’s claims fell within the scope of the agreement. In responding affirmatively the court noted a general presumption in favor of arbitrability, the broad reading typically afforded to the “arising out of” language used in the arbitration clause, and that NFM’s liability depends on whether Itri and Prizzi have breached their non-compete agreements.
The court’s ruling in Precision Funding indicates a broad judicial inclination favoring arbitrability even when sought by non-signatories, particularly where claims against non-signatories are based on the actions of parties having an arbitration agreement with the plaintiff. Defendant-employers seeking to compel arbitration should consider this and explore employment agreements relating to a dispute notwithstanding their status as a non-party. Employers who could be potential plaintiffs may want to carve out non-compete provisions from their arbitration clauses as arbitrating non-compete issues can be awkward and injunctive relief may be more difficult to obtain on an expedited basis.
A California federal court recently dismissed a lawsuit seeking a declaration that a non-compete agreement is unenforceable under California law, upholding the parties’ Washington forum selection clause. Meras Engineering, Inc. v. CH20, Inc., No. C-11-0389 EMC (N.D. Cal. Jan. 14, 2013). CH20 is a Washington corporation with its principal place of business in Washington. Meras Engineering, a competitor of CH20, is a California corporation with its principal place of business in California. Rich Bernier and Jay Sughroue are citizens of California who used to work for CH20 almost exclusively in California. Their employment agreements with CH20 each contained a non-compete clause, a Washington choice of law clause, and a forum selection clause designating Washington as the exclusive forum for lawsuits over their agreements.
Bernier and Sughroue resigned from CH20, became employed by Meras, and along with Meras brought this lawsuit, seeking a declaration that the CH20 non-compete agreements are unenforceable under California’s well known public policy that non-compete agreements are not enforceable (with limited exceptions not applicable here) as established by Cal. Business & Professions Code section 16600. Shortly thereafter, CH20 filed an action in Washington federal court to enforce its non-compete agreements and moved to dismiss the California action, contending the California court should enforce the parties’ forum selection clause. In the interim, the Washington court held that it was appropriate in that case to enforce the parties’ choice of law provision – i.e. that the non-compete provision would be governed by Washington law, which generally permits enforcement of reasonable non-competes, rather than by California law.
The California court granted CH20’s motion, dismissing the California action. Applying federal decisional law regarding the enforceability of forum selection clauses, the court held the issue was whether enforcement of the forum selection clause would contravene a strong California public policy. Meras argued that enforcing the parties’ forum selection clause would violate California public policy against the enforcement of non-compete agreements, because the Washington court had already held that it was appropriate to apply Washington law under the parties’s choice of law provision. The court disagreed, holding that argument incorrectly conflated the choice of forum issue with the choice of law issue. The court noted that Washington and California apply the Restatement of Conflict Laws section 187. Accordingly, the same choice of law test applies, whether the forum is Washington or California.
Meras Engineering exemplifies three trends among the Washington and California courts. First, we have been seeing increasing non-compete litigation between Seattle-based employers and Silicon Valley-based employers and their employees. Second, California federal courts have repeatedly rebuffed efforts to adjudicate the enforceability of non-competes between Washington-based employers and Californi-based employees in California, especially where the parties agreed to a Washington forum selection clause. Third, Washington federal courts have increasingly enforced Washington choice of law clauses in non-competes, giving an opening to non-California employers to chip away at California’s public policy prohibiting such restraints on employee mobility.
