Joint B-School/Law School Study Sheds Empirical Light on Use of Non-Competes in CEO Contracts

By on February 21, 2013

A recent study by three business and law school professors analyzed a random sample of 1,000 CEO employment contracts for 500 American companies over a seventeen year time span. The study determined how often the contracts included non-competes, whether the use of non-competes has increased over time, whether the use of non-competes is correlated to profitability, what industries are more likely to use the restrictions to protect their information and competitive advantage, and whether the use of non-competes is related to the enforceability of restrictive covenants in the company’s jurisdiction. The findings are interesting for attorney practitioners and may be useful for in-house corporate attorneys.

After analyzing their data, the authors concluded that there was a “statistically significant trend toward more non-compete clauses in CEO contracts over time” and that the data suggest that employers are “more aware than ever of the importance of using [non-compete] clauses to protect against the loss of firm specific investments and knowledge[.]” The finding is apparently the “first reliable evidence to confirm widely held assumptions in the academic and practitioner literature that non-competes are being used more in recent years.” The data also showed that if a company uses a non-compete once in a CEO contract, it was much more likely to include one in subsequent CEO contracts. Over the entire time period, 79% of all CEO contracts reviewed contained a non-compete. The use of non-competes increased in the mid-2000’s, peaking in 2008 when 88.9% of CEO contracts contained them, and dropping back to 78.7% in 2010. The sample pool included contracts from jurisdictions like California where restrictive covenants are generally not enforced. Not surprisingly, according to a multivariate regression analysis, CEOs were less likely to have non-competes in their employment contracts if they were being enforced in jurisdictions that did not permit such restrictions. Interestingly, the study also showed that approximately 65% of California firms did have non-competes in their CEO contracts, despite their unenforceability.

The authors also concluded that long term contracts are more likely to include non-competes than short term contracts, which also makes sense. Finally, there was some correlation between use of non-competes and profitability as more profitable companies were more likely to use them. The working paper is entitled, “When do CEOs Have Covenants Not to Compete in Their Employment Contracts” and the authors are Norman Bishara from the Stephen M. Ross School of Business at the University of Michigan, Kenneth J. Martin from New Mexico State University and Randall S. Thomas from Vanderbilt Law School and the Owen School of Business, Vanderbilt University. The paper is currently under submission for law review publication. It was discussed on November 20, 2012 on the Harvard Law School Forum on Corporate Governance and Financial Regulation and is available on the Social Science Research Network Site.

Georgia Court of Appeals Refuses to Enforce Florida Forum Selection Clause

By Todd Van Dyke on February 21, 2013

The Georgia Court of Appeals refused to enforce a forum selection clause in a restrictive covenant agreement entered into by a Georgia resident because it would have led to a different result than applicable Georgia law. Carson v. Obor Holding Company, LLC (Nov. 20, 2012). Obor Holding provides software and staffing services to clients in the defense industry. The company conducts business in Florida and Georgia. Alan Carson, the former Vice President of Sales, was a Georgia resident, having lived in Georgia since 1984. He executed Obor Holding’s Operating Agreement in February 2007. Pursuant to the Operating Agreement, the business of Obor Holding is conducted by a four-person Management Committee, with each member of that committee being a Director of the company. Carson served as a member of the Management Committee and a Director of Obor Holding until his resignation on September 2, 2011.

The Operating Agreement contained several restrictive covenants that apply to Directors of the company, including a covenant of non-disclosure, a non-solicitation covenant, and a non-compete covenant. The Operating Agreement also had a forum selection clause, which states that any legal actions brought for the purpose of “enforc[ing] any rights or obligations” thereunder “shall be [brought] in Orange County, Florida.” The choice of law provision states that the Operating Agreement shall be governed by Florida law.

Carson filed a lawsuit in Georgia state court seeking to enjoin Obor Holding from enforcing any of the restrictive covenants against him because they were unenforceable under Georgia’s old non-compete common law and public policy (which apply to agreements signed before the new Restrictive Covenants Act went into effect on May 11, 2011.) Obor Holding filed a motion to dismiss based on the forum selection clause. Carson opposed the motion, arguing that the trial court should find the forum selection clause unenforceable because allowing a Florida court to decide the enforceability of the non-compete covenants would violate Georgia’s public policy under the old non-compete law. The trial court granted the motion to dismiss and Carson appealed.

The Georgia Court of Appeals reversed. The Court held that choice of forum clauses are prima facie valid and presumptively reasonable. Such clauses, however, are not enforceable if (i) the covenants violate Georgia public policy and (ii) a Florida court would be likely to find the covenants enforceable. The Court held that the covenants violated Georgia’s old non-compete common law. For example, the customer non-solicitation covenant was unenforceable because it was not limited to customers with whom Carson had contact and, alternatively, it did not contain a territorial limitation. The Court also held that a Florida court was likely to enforce the covenants. Accordingly, Carson was entitled to litigate the case in Georgia.

As noted above, Georgia’s non-compete law applies to covenants signed on or after May 11, 2011. The new law generally makes restrictive covenants more enforceable, similar to Florida law. Consequently, the result in this case may have been different if Georgia’s new non-compete law and the public policy it represents had applied to Carson’s agreement.

Videotaping of Machine Permitted Over Trade Secrets Objection

By John A. Snyder on February 11, 2013

A federal court in the Northern District of Mississippi has allowed a plaintiff in an employment law dispute to conduct an on-site inspection for purposes of videotaping the machine which he formerly operated in Morton v. Cooper Tire & Rubber Co., (N.D. Miss. Dec. 10, 2012). Morton, an amputee with a prosthetic leg, asserted that he was denied a reasonable accommodation a claim under the Americans with Disabilities Act and then constructively discharged. Morton asserted he could do the job if allowed a couple of ten-minute breaks to adjust his prosthetic leg during his 12 hour shift. Cooper Tire countered that Morton had requested several 30 minute breaks, which it claimed was not a reasonable accommodation, and that Morton was unable to perform the essential functions of the job.

In discovery, Morton requested an inspection of the Tupelo, Mississippi plant to photograph and videotape the machine he had worked on while it was being operated by another employee, to show the physical demands of operating the machine. Cooper Tire objected and sought a protective order, asserting that trade secrets would be revealed and that the requested discovery had little to no relevance to the case. Morton responded with a motion to compel. Although it directed the parties to enter into an appropriate protective order, the court generally rejected Cooper Tire’s contentions, holding that testimony would not be a reasonable substitute for the inspection and that the videotaping and photography which Morton sought was necessary to show he was able to perform his essential job functions. The court noted that the machine would not be modified during the inspection and that Morton was not seeking information about other machines and processes beyond the one that he worked on. The court also noted that Morton had signed a confidentiality agreement when he started working for Cooper Tire, whereby he agreed not to disclose information about the company during and after employment. This, coupled with the protective order limiting disclosure only as necessary for the lawsuit, was determined to adequately address Cooper Tire’s trade secret concerns. In allowing the limited inspection, the court expressly noted that “[t]his is not a suit by a competitor who might have ulterior motives for seeking discovery,” suggesting that the result might differ depending upon the type of case.

The decision highlights the types of concerns about trade secrets that can come into play during run-of-the mill employment litigation. Employers and their attorneys should take care to protect trade secrets and confidential information by, among other things, using existing non-disclosure agreements to which former employees agreed to be bound and seeking protective orders to ensure that such information will be utilized only for purposes of the litigation at hand.

Eighth Circuit Affirms Severance Repayment by Executive Who Breached Non-disclosure Obligations

By John A. Snyder on January 31, 2013

Our contributor John A. Snyder writes on the Jackson Lewis website about an interesting decision out of the Eighth Circuit involving an executive of Hallmark Cards, Inc. who was ordered to pay back $735,000 in severance benefits and an additional $125,000 she earned at a competitor because she disclosed information about Hallmark’s processes and market research in violation of her separation agreement. The case also involved findings that the executive deliberately destroyed computer files and an adverse inference instruction to the jury. The entire article can be viewed here.

You Fired Me, So Now I Can Compete – True or False?

By Clifford R. Atlas on January 28, 2013

We have often been asked: if an employer fires an employee, can a non-compete or non-solicitation agreement be enforced? Some federal district courts interpreting New York law had said “no.” A recent decision from the Second Circuit Court of Appeals, Hyde v. KLS Professional Advisors Group, LLC, 2012 U.S. App. LEXIS 21111 (2nd Cir. October 12, 2012), clarifies and narrows the scope of those prior decisions.

The previous line of thinking stemmed from a handful of decisions from the U.S. District Court for the Southern District of New York suggesting that if an employee is fired without cause, his or her restrictive covenant is not enforceable, citing Post v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 48 N.Y.2d 84, 421 N.Y.S.2d 847 (1979). The Post case, however, involved the forfeiture of benefits arising from the breach of a restrictive covenant, and applied New York’s “employee choice doctrine.”

Under the employee choice doctrine, a restrictive covenant can be enforced without regard to its reasonableness, if the employee was given a choice between accepting a benefit (such as deferred compensation or other monetary payment) and relinquishing his or her right to compete on the one hand, and rejecting the benefit and retaining the right to compete on the other hand. See Morris v. Schroder Capital Management International, 7 N.Y.3d 616, 825 N.Y.S.2d 697 (2006). Central to the employee choice doctrine is the freedom of the employee’s choice. Accordingly, New York courts have made it clear that if an employee were fired, the employer could not take advantage of the employee choice doctrine and instead must establish that the agreement satisfies the general rule of reasonableness applicable to restrictive covenants in New York.

In Hyde, the Second Circuit stated (in dicta):

Having concluded that Hyde failed to establish irreparable injury, we need go no further. In the interest of judicial economy, however, we note our reservation about the district court’s preliminary interpretation of New York law. Relying on Post v. Merril Lynch, Pierce, Fenner & Smith, 48 N.Y2d 84, 397 N.E.2d 358, 421 N.Y.S.2d 847 (1979), the district court concluded that restrictive covenants are per se unenforceable in New York against an employee who has been terminated without cause. But in Post, the New York Court of Appeals held only that when an employee was terminated without cause, the employer could not condition the employee’s receipt of a previously earned pension funds on compliance with a restrictive covenant. Id. at 89, 421 N.Y.S.2d at 849. We caution the district court against extending Post beyond its holding, when a traditional overbreadth analysis might be more appropriate.

Indeed, courts in New York routinely have enforced restrictive covenant agreements against employees who were terminated from employment involuntarily. Instead of creating a per se prohibition against restrictive covenants in New York, the fact that the defendant-employee may have been terminated without cause is a factor that will weigh in the usual reasonableness analysis, and the balancing of the equities in cases where a preliminary injunction is sought.

North Dakota Non-Compete Law Shares History with California

By on January 17, 2013

North Dakota has one of the fastest-growing workforces in the country as the result of recent advances in extracting natural gas and oil. As more employers seek to hire in or transfer employees to the Peace Garden State, many are surprised to discover that North Dakota law prohibits non-compete agreements. North Dakota Century Code Section 9-08-06. It is perhaps better well known that California also prohibits non-competes. California Business and Professions Code Section 16600.

Remarkably, both states inherited their non-compete laws from the same New York attorney, David Dudley Field II. Field was born in 1805 and practiced law in New York where he became convinced that the common law would benefit from unification and simplification. He traveled to Europe to study French and English legal codes and returned home to prepare a code of civil procedure which was adopted by New York in 1850.

Field then set his sights on the systemic codification of all state law which he completed in 1865. His model civil code, which eventually became known as the Field Code, was largely rejected by New York. Several new states coming into existence at that time, however, including North Dakota and California, adopted the Field Code, including its restriction on non-compete agreements. Although some have assumed the North Dakota Field Code was based on the California Revised Field Code of 1872, in fact the Dakota Territory enacted the Field Code in 1865.

Because of the common legal origins, North Dakota courts have cited with approval to California precedent in interpreting their own non-compete law. E.g. Werlinger v. Mutual Serv. Cas. Ins. Co., 496 N.W.2d 26 (N.D. 1993) and Franklin v. Forever Venture, Inc., 696 N.W.2d 545 (N.D. 2005). Employers wishing to protect themselves from unfair competition in North Dakota should tread carefully. They may choose to consider a strategy similar to the approach they take to protect business information in California. And certainly, employers should consult with an attorney for specific advice.

NY Appellate Division Rejects Challenge to Forum and Choice of Law by California Defendant

By Clifford R. Atlas on January 11, 2013

In the latest chapter of an ongoing dispute between Aon Risk Services and Alliant Insurance Services (stemming from Alliant’s hiring of dozens of Aon employees and accepting millions in annual revenue from former Aon clients), on January 10, 2013, the New York State Supreme Court, Appellate Division, First Department issued a decision upholding key rulings of the trial court that enforced Aon’s restrictive covenant agreements. Aon Risk Services, Northeast, Inc., et al v. Cusack, et al, Index no. 551673/11 (1st Dep. January 10, 2013.)

Specifically, the Appellate Division rejected the forum non conveniens argument advanced by a California-based individual defendant, Peter Arkley. The court found that Arkley had previously engaged in business activities in New York, and had involved himself in the lawsuit even before he was named as a co-defendant. Further, the court credited the trial court’s conclusion that Arkley’s previously-filed declaratory judgment action ion California was merely:

a preemptive measure undertaken to gain a tactical advantage so as to negate the force and effect of the restrictive covenants, which the parties and freely agreed upon,

and not entitled to deference. The Appellate Division also upheld the parties’ contractual choice of Illinois law. The court noted that, “New York courts are willing to enforce parties’ choice of law provisions” and generally to construe agreements to give effect to the parties’ intent. And finally, the court upheld the preliminary injunction barring business relationships with certain former Aon clients and solicitation of Aon employees.

Beyond the flurry of motions and decisions in this case that make it great entertainment (see Justice Fried’s decision from December 20, 2011, 34 Misc. 3d 1205A, 946 N.Y.S. 2d 65, 2011 N.Y. Misc. LEXIS 6392), this decision highlights the efficacy and importance of choice of law clauses in restrictive covenant agreements. It also highlights the willingness of New York courts to hear non-compete cases involving former employees living and working outside of New York. Accordingly, employers should consider using choice of forum and choice of law clauses in their agreements, to maximize consistency and enforcement of their agreements.

Court Orders Monitoring to Ensure Employee does not Breach Non-Compete

By on December 4, 2012

A U.S. District Judge in Connecticut recently issued an injunction against a former employee of Amphenol Corp and his new employer, TE Connectivity, Ltd, despite the lack of any evidence of competition in breach of his non-compete agreement. The decision in Amphenol v Paul, Civ. No. 3:12cv543 (D. Conn. Nov. 9, 2012), involved a former business unit director of Amphenol who had been responsible for product development, marketing and sales of Amphenol’s electronic and fiber optic connectors. He signed a non-compete agreement which prohibited work on any competitive product that was in development during the 12 months preceding his termination of employment or about which he had received confidential information.

The employee joined TE Connectivity as a vice president of a business unit that did not compete with Amphenol. Amphenol discovered, however, that he had forwarded 2,000 work-related emails to his personal account before resigning and that he had taken other business files with him. Although the Court found that the employee technically was not competing with Amphenol in his new role, the Court determined that there were “indicia” of a risk of unfair competition. The Court therefore ordered TE Connectivity to distribute a written memo reminding its managers that the employee was to have no involvement with competing products, to search its electronic systems to confirm that the employee did not upload any of Amphenol’s files, and to place a filter on the employee’s email account to ensure that he was firewalled from any competitive activities. The Court also placed specific limits on the former employee’s scope of work (including restrictions on participating in the pending acquisition of a competing company, a ban on contacting former Amphenol employees, and an order not to work in the area of connectors or interconnectors) and ordered him not to use or disclose confidential information.

The court’s decision serves as an example of creative injunctive relief that may be useful in similar contexts.

eBay Sued to Halt Enforcement of “No Hire” Agreement

By John A. Snyder on November 27, 2012

The U.S. Department of Justice has filed an antitrust lawsuit against eBay, Inc. in the United States District Court for the Northern District of California. The suit, filed on November 16, 2012, claims that eBay violated antitrust laws by entering into an agreement not to hire or recruit the employees of a competitor, Intuit, Inc. The DOJ asserts that the agreement eliminated competition in the marketplace, stifling access to better job opportunities and salaries of affected employees.

The DOJ alleges that the agreement applied to employees at the highest levels at each company, covering specialized computer engineers and scientists, and barred the companies from soliciting each other’s employees. In addition, at least as to eBay, the agreement barred the company from hiring any employees at all. The DOJ alleges this arrangement started no later than 2006 and lasted at least until 2009. The complaint alleges that eBay’s recruiters were told not to pursue applications that came from Intuit employees and even to throw out resumes received from them. The suit alleges that Meg Whitman, eBay’s CEO, and Scott Clark, founder of Intuit and chair of its executive committee, were closely involved in crafting and enforcing the agreement. In an odd twist, Cook was also on the eBay board when he was complaining about eBay’s recruitment of Intuit personnel.

The relief sought by the DOJ includes preventing eBay from enforcing the Inuit agreement as well as prohibiting eBay from entering into any similar agreement with any other companies. Further, the DOJ’s Antitrust Division partnered with the California Office of the Attorney General, which conducted its own investigation and filed a similar lawsuit on the same day. Intuit is already subject to a settlement with the DOJ in another case prohibiting it from entering into “no hire” agreements, which might explain why Intuit was not named in this complaint.

Employers invest heavily in time and money to recruit, train and develop talent. They have legitimate interests in protecting their confidential information and avoiding unlawful interference with their personnel relationships. In rare circumstances, however, peace agreements with competitors to not poach each other’s talent can trigger scrutiny under antitrust laws. Jackson Lewis attorneys are available to assist employers as they navigate this minefield.