Hiring Employees Who May Be Bound by Post-Employment Restrictive Covenants? Caution, Restrictions May Apply

By: Daniel H. Aiken

Employers frequently want to hire talented employees who are bound by post-employment restrictive covenants (e.g., non-competes, or customer/employee non-solicitation covenants).  Often, a plain reading of the prospective hire’s agreement raises questions about whether joining your company would violate the agreement.  This requires strategic, and sometimes creative, planning.  Depending on your jurisdiction, deciding to hire an employee despite their post-employment restrictive covenants may involve taking a calculated risk that some parts of the post-employment restrictions are not enforceable, while deciding that there are some aspects your company can live with and that you expect the new employee to follow.  The following provides some basic guidance.

1.  Assess the business impact of the restrictions by determining the precise scope and duties of the prospective job.  Even though the individual may be subject to post-employment restrictive covenants, the job for which you intend to hire him/her may not fall within the restrictions.  Or, inasmuch as most restrictive covenants will expire — sometimes in a matter of months — you may decide that the company can tailor the scope of the intended position so that the new employee can still add value, but not perform work that would violate the individual’s obligations to his/her former employer.  Can the person be employed in a capacity that does not violate the restrictions until they lapse?  Can the person be employed outside the geographically restricted area or assigned to existing customers different from those of the former employer?

2.  Review and analyze the legal risk.  Analyze the true legal risk of proceeding.  By “true” legal risk, I mean the likelihood that the former employer will succeed if it takes legal action, as well as the likelihood the former employer will actually take legal action.  This should include an analysis of the scope of the restrictions and their enforceability given the applicable state law, whether the action will be brought in federal or state court, as well as an assessment of the likelihood that a court will enforce the restrictions.  This will vary according to the applicable state law and circumstances.  You should also consider more practical issues such as the former employer’s litigation history, the importance of the potential hire to the former employer, and the extent to which employment with your company differs from the prior employment.  Other practical considerations should include a review of the industry and whether post-employment restrictions are commonplace, whether the two companies compete for the same customers, and a frank review of your company’s flexibility in defining the scope of the intended position.

3.  Hire away, or don’t, but proceed with caution.  Having analyzed the legal risk and business impact of the restrictive covenants on your proposed hire, determine whether you are comfortable proceeding with the hire in the intended position, or if there is a different, or modified position, that would still suit the company’s needs while lessening the legal risk.  Analyze and take available appropriate steps to minimize the risk of being sued, or, if sued, the risk of a lengthy or costly suit.  Communicate, in writing, what you expect of the new employee.  For instance, you and counsel may reach the conclusion that the prospect’s non-competition restrictions are overly broad and will not be enforced under the circumstances, but that a court is likely to enforce a customer non-solicitation covenant.  Accordingly, you may decide to move ahead with the hire, and plan to keep the new employee away from former customers.

Typically, the  company’s offer letter is a good place to memorialize such expectations.  In our scenario, the offer letter should state, as a condition of employment, that the new employee does not possess and/or will not use his former employer’s confidential information and that the employee will not solicit former clients (as well as any other restrictions that your company expects to be followed).  The employee, especially if sophisticated or if represented by an attorney, may seek indemnification for any legal action taken by his former employer.  Determine whether you are willing to entertain such a request.  Consider also what type of an “out” you have, both of the employment relationship and/or indemnification, i.e., what recourse does the company have if ensuing litigation is going badly or you find the new employee was not truthful about not taking any confidential information from the former employer?

4.  Protect your company from the beginning.  Companies often get into trouble when recruiting a prospective employee long before the actual hire.  Employees may pitch their importance by showing you their customer list or sales volume, but these items are likely to be considered confidential by their employer, if not trade secrets.  Further, the employee may offer to bring with them a junior colleague and provide you with confidential information about the employee or may start contacting customers about his or her intentions.  Those actions may have already violated the person’s restrictive covenants.  Ground rules for such activity should be established during the interview process, in writing, if possible.  Also obtain written confirmation that the potential hire is not under any undisclosed restrictions and communicate, in writing, that the prospective employee is not to disclose or use confidential information or trade secrets and is not to take or bring any property or information belonging to the employer.  Follow through and make sure the person complies fully with those requirements.

Although there is no way to prevent a suspicious former employer from challenging your company’s hire of one of its employees, following this guidance will place your company in a better position in the event of such a challenge.

Forum Selection Clauses and Non-Compete Agreements

Editor’s Note: The following post by Kate Gold, Partner in the Los Angeles office, appears in the latest issue of the California HR Newsletter.  To sign-up to receive the California HR Newsletter click here.

Forum Selection Clauses and Non-Compete Agreements

The Issue: You are a California employer with out-of-state headquarters, and your executive works and lives in California.  Your employment agreement has a one-year post-termination non-compete. Can you enforce it?

The Solution: In general, no, but the answer may depend on whether you have a valid forum selection and choice of law clause that provides for resolution in a state that permits reasonable post-termination non-competes.

Analysis: In general, California employers cannot enforce post-termination non-competes and a party cannot circumvent California restrictions on non-competition with a choice of law provision designating a more non-compete friendly jurisdiction.  However, the Supreme Court’s recent decision in Atlantic Marine Construction Co.,
Inc. v. U.S. District Court for the Western District of Texas,
134 S. Ct. 568, 571 U.S. ___ (Dec. 3, 2013) held that contractual forum selection clauses should be enforced in all but the most exceptional cases, and therefore may be helpful to employers who seek to enforce non-competes against employees who work or live in states, like California, that disfavor restrictive covenants.

Indeed, some recent California federal district court cases have focused on whether the employment agreement has an out-of-state forum selection and choice of law clause.  In Meras Engineering, Inc. v CH20, Inc., the Washington-based employer was permitted to enforce its Washington forum selection and choice of law clauses against its California sales associates who left for a California competitor.  The Washington court concluded it was proper to apply Washington law as provided by the employment agreements.  The California court dismissed the California employees’ lawsuit in favor of the Washington forum selection clause.

Similarly, in two other recent California district court cases, Plaintiffs were former California employees who signed employment agreements with restrictive covenants and Pennsylvania forum selection clauses.  In both cases, the employees argued the cases should not be transferred because the more restrictive covenant friendly Pennsylvania courts would enforce the non-compete, which contravenes a strong California public policy.  Both California courts however, focused on the reasonableness of the forum selection clause, rather than on the clauses’ effect.  Both found that the possibility a Pennsylvania court might apply Pennsylvania law to the non-compete clause was not a sufficient basis to invalidate the forum selection clause.

In light of these recent cases, California employers should consider whether they have a reasonable and enforceable basis for selecting an alternative forum and choice of law for their executive agreements, and, in consultation with
counsel, draft carefully tailored restrictive covenants that comply with that state’s law.

Significant Illinois and Massachusetts Non-Compete Rulings

By: Mark E. Furlane and Alan S. King

Two recent cases should give employers pause as to whether their restrictive covenants with their at-will employees are enforceable.  On May 28, 2013, a United States District Court in Massachusetts held that under Massachusetts law, a confidentiality agreement signed by an at-will employee was unenforceable where the employee’s title, duties, remuneration and other terms of employment had materially changed since signing the agreement.  Then, on June 24, 2013, an Illinois Appellate Court held that unless an at-will employee is employed for at least two years, restrictive covenants the employee signed at the beginning of employment are unenforceable for lack of adequate consideration.  Moreover, the Illinois court held it was irrelevant whether the employee quits or is terminated before two years of employment.  While the rulings rely on the applicable state law, they address important points that may have broader application than only in Massachusetts and Illinois.

In Smartsource Computer & Audio Visual Rentals v. Robert March et al, D. Mass. (May 28, 2013), Smartsource filed an action to enforce its noncompete agreements with its former employee, March.  March was hired by Smartsource in 2006 as a Senior Account Executive, and signed an offer letter with a simple confidentiality agreement/restriction.  In 2007, March was promoted to Branch Sales Manager, in 2008 to Regional Sales Manager, in 2010 to Regional General Manager, and again in 2012 to Regional Sales Manager.  With each change his job responsibilities and compensation changed.  Citing to Massachusetts law, the court denied the requested injunctive relief to Smartsource.  Although stopping short of a definitive ruling on the merits, the court noted that “it may well be under [Massachusetts case authority], March’s 2006 confidentiality agreement has been abrogated, and he is not bound by any restrictive covenants.”  March and the Massachusetts cases cited therein suggests that when material changes to an employment relationship are contemplated, the employer should consider revisiting the existing restrictive covenant agreement and consider whether a new agreement is advisable.

More recently, the Illinois Appellate Court for the First District (Cook County) in Eric D. Fiefield et al v. Premier Dealer Services, Inc., (Ill. App. Ct., 1st Dist. June 24, 2013), answered the question as yet definitively unanswered in Illinois:  What additional employment period after the signing of a restrictive covenant agreement is sufficient consideration to make the agreement enforceable against an at-will employee?  The Court answered at least two years, even where the employee signs the restrictive covenant at the outset of employment.  Fiefield had worked for the predecessor company that was acquired by Premier.  Fiefield was then hired by Premier in late October 2009, and as a condition of employment Fiefield was required to and did sign an employment agreement containing a two-year restrictive covenant.  Fiefield signed the agreement on October 30, 2009 and started work on November 1, 2009.  On February 12, 2010, Fifield resigned to go to work for a competitor.  Fiefield and his new employer then filed suit against Premier seeking a declaratory judgment that the restrictive covenant agreement was unenforceable.  The circuit court ruled the agreement was not enforceable because it lacked consideration.  Premier appealed and the Appellate Court affirmed, agreeing that there was inadequate consideration.  The court held that regardless of whether Fiefield had signed the agreement before he started work or after he started work, “Illinois courts have repeatedly held there must be at least two years or more of continuous employment to constitute adequate consideration in support of a restrictive covenant…This rule is maintained even if the employee resigns on his own instead of being terminated.”

The Premier decision will surely send employers in Illinois scrambling to reconsider the validity of their at-will employee restrictive covenant agreements in Illinois.  However, help may be on the way as Premier has filed a petition for leave to appeal the decision to the Illinois Supreme Court.  Granting review is within the Court’s discretion, and the Illinois Chamber of Commerce and other employer groups are backing Premier’s bid.  Even if the case is not reviewed or reversed, however, there are a number of possible solutions to the Premier consideration problem.  These include offering employees consideration for the non-compete in addition to simply offering at-will employment (such as a “bonus” payment or possibly elaborating on the consideration offered to include, for example, training, access to customers and valuable confidential information and trade secrets) or offering employees some form of term employment contract.

If you have at-will employees with restrictive covenants less than two years old, and you view confidentiality and restrictive covenant agreements important to your business, or if your agreements with your employees significantly predate their current job positions, compensation and other conditions, these cases should sound the alarm to review your competitive advantage protections.

Former Executive’s Race to California Hits a Roadblock in New York

By: David J. Woolf

Like many things in life, there is a perceived formula for success in non-compete cases:  If you are the former employee or his or her new or would-be new employer, conventional wisdom dictates that you identify the restrictions early and consider filing a preemptive declaratory judgment action in a state that is hostile to such agreements (provided the facts permit).  California is the most well-known example, but there are others.  The plan works best if the former employee lives in California (or similarly hostile state) or has other significant connections by virtue of his past or intended future employment.  But now, a New York appellate court has thrown conventional wisdom a curve.

Michael Cusack and Peter Arkley were former Aon executives.  They left Aon on June 13, 2011 to pursue lucrative opportunities with a competitor, Alliant Insurance Services.  The same day, 38 other Aon employees also left, and 22 more followed shortly thereafter.  Aon’s clients came too, with over $20 million in client revenue allegedly flowing from Aon to Alliant.

Arkley and Cusak, along with Alliant, following the familiar formula, filed for a declaratory judgment to invalidate their restrictive covenant agreements in California federal court on the same day they resigned.  Arkley’s chances of success in California seemed particularly good because, although his employment agreement was governed by Illinois law, he both lived and worked in California, and he planned to continue to do so with Alliant.

Aon responded by filing suits in Illinois and New York state courts, and found success in New York in particular.  The New York trial judge, undeterred by the action in California and Arkley’s California connections, enjoined him soliciting business from, and entering into any business relationship with, any of Aon’s clients whom he either procured or whose accounts he worked on in the 24 months prior to his departure.  She also enjoined him from soliciting any Aon employees to work for Alliant.

In January, a New York appellate court affirmed.  The court rejected Arkley’s calls to defer to the first-filed California action, calling it “a preemptive measure undertaken to gain a tactical advantage so as to negate the force and effect of the restrictive covenants, which the parties had freely agreed upon.”  The New York court seized upon the fact that the parties’ agreement had selected Illinois law to govern and held that Illinois law provided for enforcement.

Although the outcome was arguably an unusual one insofar as a New York court entered an injunction against someone who lived and worked in California and intended to do so in his new employment, so too were the facts involved, on many levels.  First, the conduct at issue was particularly egregious in that it involved, among other things, former employees allegedly taking the equivalent of hundreds of thousands of printed pages of documents, including highly-sensitive documents; a coordinated departure strategy that included filing a declaratory judgment action in California within an hour of the key executives’ resignations; a mass exodus of both employees and clients; and alleged violations of an earlier-issued temporary restraining order.  Second, the executives involved were high-level employees, who received seven-figure compensation from Aon, at least in part in consideration of the very restrictions they sought to avoid.  Third, the restrictive covenants at issue were not blanket non-competes, but rather restricted the executives from disclosing confidential information, from calling on the customers that they serviced for Aon, and from soliciting other Aon employees for employment.  In different circumstances, involving lower-level employees, who are alleged to have engaged in less egregious conduct and/or who are subject to broader restrictive covenants, the former employer may not fare as well.

Still, the takeaways are unmistakable.  First, choice of law is critical, and an employer loses a tactical advantage when it fails to select a state law that, if not favorable to it, at least gives it a fair shot.  Second, living and working in California is not the end all be all, and racing into a California court does not guarantee the former employee and his new employer freedom from the employee’s post-separation obligations.  Solid facts and a solid agreement, presented in a jurisdiction that follows a more traditional approach to restrictive covenants, can still result in success for the former employer.

FTC Approves Settlement of Noncompetition Case Against Renown Health Voiding Ten Physicians’ Noncompetition Agreements

By: Mark E. Furlane

On November 30, 2012, the Federal Trade Commission voted 5-0 to approve the settlement of a complaint it filed against Renown Health on August 3, 2012.  A settlement was promptly reached between the FTC and Renown Health avoiding the unwinding of two acquisitions made by Renown Health of two independent local cardiology groups.

The complaint alleged that Renown Health’s acquisition of competitor cardiology groups in Reno, Nevada, Sierra Nevada Cardiology Associates, Inc. (“NCA”) and Reno Heart Physicians, Inc. (“RHP”), and the employment of the 32 physicians employed by these entities, “is likely to lead to anticompetitive effects including increased prices and reduced non-price competition.”  The acquisitions resulted in Renown Health employing approximately 97% of the cardiologists serving private patients in the Reno area.  The FTC complaint focused on the fact that all of the employed physicians were subject to employment agreements containing noncompetition and non-solicitation provisions prohibiting them from practicing medicine or soliciting former patients for two years in the Reno area after termination of their employment.  As a result of the noncompetition and non-solicitation agreements, competition for cardiology services would have to come from without, which the complaint alleged to be unlikely because of certain barriers to market entry.  The State of Nevada, through its attorney general, worked with the FTC in investigating and resolving the matter.  The Nevada AG filed a similar complaint and entered into an agreement with Renown Health similar to the FTC consent decree.

The parties reached a settlement this fall through an agreed consent decree that would avoid having to unravel the mergers.  The FTC has now approved the consent decree under which Renown Health released up to ten cardiologists previously employed by NCA or RHP from their noncompetition and non-solicitation restrictions.

This result signals a cautionary note for those hospitals and health care systems with an overly large market share in a geographical market who seek to further expand their employed physicians in a given practice area.  In this case, the 88% market share for the cardiologists was a daunting statistic for Renown Health to overcome.  Going forward, this is just one more potential road block that health care providers must consider before acquiring additional physician practices and increasing its employed physician roles.

 

California Rejects Enforcement of Restrictive Covenant in Employment Agreement

By: Elena S. Min

A California Court of Appeal recently rejected a covenant not to compete included in an employment agreement, although it was related to a transaction for the sale of goodwill of a business – one of the well-recognized exceptions to the general rule in California that limits restrictive covenants.

In Fillpoint, LLC v. Maas, No. G045057 (Cal. Ct. App. Aug. 24, 2012), Michael Maas, a shareholder in Crave Entertainment Group, Inc., sold his shares in the company when it was acquired by Handleman Company.  That transaction was executed through a stock purchase agreement which contained a three year covenant not to compete.  A month later, Maas entered into an employment agreement, which contained a one year covenant not to compete that became effective as of the date of the termination of his employment with Crave.  Three years after the sales transaction, Maas resigned from Crave and began working for a competing company.  Handleman’s successor, Fillpoint, LLC, sued Maas for breaching his employment agreement (as well as his new employer for interference with contract).

Fillmore argued that the restrictive covenant in Maas’ employment agreement was enforceable because it fell within the sale of goodwill exception contained in California Business and Professional Code section 16600.  The Court of Appeal rejected that argument and found that, although the stock purchase agreement and employment agreement constitute a single transaction and each agreement referenced the other, only the purchase agreement was focused on protecting the acquired goodwill.  In contrast, the Court of Appeal stated that the covenant contained in the employment agreement impermissibly targeted an employee’s fundamental right to pursue his or her profession and was therefore unenforceable.

This recent decision reaffirms the limited scope of the exceptions to the general rule in California that covenants not to compete are unenforceable.  Therefore, employers must be mindful when drafting such covenants to ensure that they fall squarely within one or more of the recognized exceptions.