In this eleventh article in the continuing series “The Restricting Covenant,” I discuss the “Restatements of the Law,” which, while not law per se, are important secondary legal sources that should not be overlooked when tackling thorny restrictive covenant disputes.
Relevance of the Restatements in Non-Compete Cases
In many states, decisions regarding the validity and enforceability of non-compete agreements are made pursuant to the “common law.” The common law is a body of law developed over a course of time from judicial decisions and rulings. The Restatements of the Law attempt to “restate,” organize, and explain the common law of the United States. They are organized into 15 different areas of law, including Agency, Conflict of Laws, Contracts, Judgments, Property, Restitution, Torts and Trusts. They are published by the American Law Institute (ALI) and written by professors, judges and private attorneys. Each “statement of law” has a specific section, and each section is accompanied by “Comments,” “Illustrations” (with hypos), and “Reporter’s Notes” (with case citations).
Many courts around the country consider the Restatements highly persuasive. They are frequently referenced, relied upon, and in some cases, adopted verbatim as the law. However, they are not without critics. The late-Supreme Court Justice Antonin Scalia, in his dissent in Kansas v. Nebraska (2013), for example, “cautioned” reliance on the modern Restatements: “The object of the original Restatements was ‘to present an orderly statement of the general common law.’ . . . Over time, the Restatements’ authors have abandoned the mission of describing the law, and have chosen instead to set forth their aspirations for what the law ought to be.” Despite some notes of caution, reliance and citation to the Restatements by judges remains widespread and significant in many restrictive covenant cases.
Top Five Restatements Cited in Non-Compete Cases
Although there might be countless reasons why courts would refer to the Restatements of the Law in non-compete cases, below is my very unscientific attempt at compiling a “Top Five List of the Most Frequently Cited Sections of the Restatements in Non-Compete Cases.”
- Restatement of Contracts
- the restraint is greater than is needed to protect the promisee’s legitimate interest, or
- the promisee’s need is outweighed by the hardship to the promisor and the likely injury to the public.
- a promise by the seller of a business not to compete with the buyer in such a way as to injure the value of the business sold;
- a promise by an employee or other agent not to compete with his employer or other principal;
- a promise by a partner not to compete with the partnership.
- Restatement of Conflict of Laws
- Restatement of Unfair Competition
The first question in any non-compete case is whether the non-compete is valid and enforceable. In deciding this issue, courts often refer to the Restatement (Second) of Contracts Sections 186 (Promise in Restraint of Trade), 187 (Non-Ancillary Restraints on Competition), and 188 (Ancillary Restraints on Competition), and the accompanying Comments and Illustrations. For example, Section 188 instructs that:
(1) A promise to refrain from competition that imposes a restraint that is ancillary to an otherwise valid transaction or relationship is unreasonably in restraint of trade if:
(2) Promises imposing restraints that are ancillary to a valid transaction or relationship include the following:
Numerous courts have cited one or more of these three Sections when determining whether a promise to refrain from competition is valid and enforceable as a matter of applicable state law.
Another issue that is litigated frequently in non-compete cases is which law should apply to resolve the legal dispute. In drafting non-compete agreements, companies often have flexibility in choosing what state law and venue will apply for the resolution of legal disputes between the parties. The employer might choose the state of its principal place of business or its place of incorporation, which might be different from where the employee lives and works. An employee might decide to file a lawsuit in a jurisdiction that is different from the one specified in the non-compete agreement. See “Former Executive’s Race to California Hits a Roadblock in New York” by David J. Woolf.
A federal court sitting in diversity (two parties residing in different states) would apply the forum state’s choice of law rules. So, for example, if an Indiana-based company were to file a lawsuit in federal court in Indiana against a former employee who lives and works in California for violating a non-compete agreement (with an Indiana choice of law provision), a federal judge in Indiana would apply Indiana’s choice of law rules to determine whether Indiana or California law should apply.
In determining which law and forum should apply, courts often cite to Restatement (Second) of Conflicts of Laws Sections 187 (Law of the State Chosen by the Parties) and 188 (Law Governing in Absence of Effective Choice by the Parties) and the accompanying Comments and Illustrations. These Sections provide helpful guidance in this very murky, uncertain, and constantly evolving area of the law.
After a court has determined which law applies and where it should be adjudicated, and assuming the court were to find that the non-compete agreement were valid, another hotly-debated issue is whether the employer has a legitimate protectable business interest to enforce the agreement.
Courts around the country have cited with approval to Restatement (Third) of Unfair Competition:
- §39 (Definition of Trade Secret)
- §40 (Appropriation of Trade Secrets)
- §41 (Duty of Confidence)
- §42 (Breach of Confidence of Trade Secrets)
- §43 (Improper Acquisition of Trade Secrets)
- §44 (Injunctions: Appropriation of Trade Secrets)
- §45 (Monetary Relief: Appropriation of Trade Secrets), and
- The accompanying Comments and Illustrations on trade secret and other legitimate business interest issues.
For example, in a dispute involving a former employee’s alleged misappropriation of a medical device company’s trade secrets and confidential information, the Sixth Circuit Court of Appeals, addressed “the relationship of three separate categories of business information: (1) ‘trade secrets,’ (2) contractually protected ‘confidential information,’ and (3) ‘general skills and knowledge.’” At the start of the court’s analysis, the Circuit Judge explained that, “The Restatement (Third) of Unfair Competition succinctly sets out the legal meaning of these three categories of information and how the three should be applied in this case.”
“Tortious interference with contract” is a cause of action often asserted against a competitor in non-compete cases. For guidance, many courts turn to Restatement (Second) of Torts Section 766 (Intentional Interference with Performance of Contract by Third Person), which states, “One who intentionally and improperly interferes with the performance of a contract . . . between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.” This Section contains detailed Comments and helpful Illustrations, which trace the historical development of this tort and discuss its different elements, including malice and causation.
In addition, courts cite to Section 767 (Factors in Determining Whether Interference is Improper), which sets forth a list of seven factors to consider in determining whether an actor’s conduct in intentionally interfering with a contract or a prospective contractual relation was improper:
- the nature of the actor’s conduct;
- the actor’s motive;
- the interests of the other with which the actor’s conduct interferes;
- the interests sought to be advanced by the actor;
- the social interests in protecting the freedom of action of the actor and the contractual interests of the other;
- the proximity or remoteness of the actor’s conduct to the interference; and
- the relations between the parties.
There is a separate Comment Section discussing each factor in more detail. Courts also cite to Section 768, which deals specifically with the question of whether competition is a proper or improper “interference” with contractual relations.
Rounding out my Top Five is Restatement (Third) of Agency Sections 8.01 and 8.04. Many jurisdictions permit a separate cause of action for breach of an employee’s duty of loyalty to his or her former employer.
Section 8.01 supports this cause of action, stating “An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship.” In addition, Section 8.04 provides that, “Throughout the duration of an agency relationship, an agent has a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal’s competitors. During that time, an agent may take action, not otherwise wrongful, to prepare for competition following termination of the agency relationship.” This “preparing for competition” issue is often hotly contested in non-compete cases. And courts are all over the map with respect to rulings on what is and is not “wrongful” preparation for competition after the employment relationship has ended.
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The goal of this Series is to provide a brief overview and some interesting insights and practical pointers when dealing with unique issues or special circumstances that might arise in the context of restrictive covenants. It is not intended to provide and should not be construed as providing legal advice. Each situation is different, and if legal advice is needed, you should seek the services of a qualified attorney who is knowledgeable and experienced in this area of the law to address your specific issues or needs. Stay tuned for future articles in this Series, which discuss the restrictive covenant issues and the restrictive covenant landscape for many other occupations and industries, including managers, nurses, physicians and more.