This week we return to the subject of restrictive covenants in employment agreements, and to discuss actual cases that decided the question of enforceability. We already know that laws regarding non-competes vary from state to state. We also know that deciding whether to enforce a restrictive covenant will require courts to engage in a case by case, fact-sensitive analysis. Even so, we can still find some cases that will provide guidance. So, let’s look at a few cases!
In Payment Alliance International, Inc., v. Ferreira, 530 F. Supp. 2d 477 (S.D.N.Y. 2007) the United States District Court for the Southern District of New York upheld a restrictive covenant that prohibited an executive from working for a direct competitor anywhere in the continental United States for two years, notwithstanding that he would not be receiving his salary during those two years. At first glance, this restriction seems overbroad. Remember how I said here and here that courts will take into consideration (and usually not enforce) non-competes that make it extremely difficult if not impossible for the former employee to make a living? So why did this court enforce such a seemingly overbroad restrictive covenant? Although courts often refuse to enforce such a broadly written non-compete, in some cases, courts will uphold the restriction if it is necessary to protect the employer’s legitimate business needs.
The Ferreira court felt that the following circumstances justified such sweeping restrictions: a) the employer, a provider of electronic payment processing services primarily for point of sale terminals and ATM’s, had merchant customers in every state in the continental US, b) Mr. Ferreira was quite knowledgeable about his former employer’s new (and secret) software application and c) he had accepted a new job working in a similar capacity, with a direct competitor. The court apparently found the software application to be a trade secret (click here for a review of trade secrets) and that working for a direct competitor in the same capacity created the risk that he would inevitably disclose (and perhaps use) a trade secret. The court also noted that a) Mr. Ferreira received compensation at the time he signed his employment agreement (which included the non-compete) and b) He was not barred from all gainful employment within the credit industry, just from working in a similar capacity for a direct competitor. He was not barred from any operational roles in the credit industry, for example.
In contrast, the Virginia Supreme Court in Home Paramount Pest Control Companies, Inc. v. Justin Shaffer, et al. (Record No. 101837 2011) struck down a similarly broad prohibition. Justin Shaffer signed an Employment Agreement prohibiting him for two years from termination of employment from “engag[ing] directly or indirectly or concern[ing] himself…in any manner whatsoever” in extermination “as an owner, agent, servant, representative, or employee, and/or as a member of a partnership and/or as an officer, director, or stockholder of a corporation, or in any manner whatsoever”. This court however, refused to uphold the non-compete when the employee went to work for a direct competitor. Other than this case having been decided by a different court, how is it different from Ferreira? In Ferreira, the former executive would not only have been working for a direct competitor, but would have been doing so in the same capacity in which he worked for PAI. Furthermore, Ferreira had very specific knowledge of information that clearly was a trade secret. In this case however, the restrictive covenant sought to prevent Shaffer from working for a competitor regardless of whether he would have been engaging in the same activity as he did for his former employer. Moreover, unlike the employer in Ferreira, Home Paramount was unable to offer a justification for such a blanket prohibition. There was no indication that any trade secrets were involved, or that working for a competitor would have resulted in unfair competition against Paramount.
Before moving on to the next case there is one more issue of note. Up until this case, Virginia, by virtue of Paramount Termite Control Co. v. Rector 238 Va. 171, a precedent-setting case from 1989, was essentially a “blue pencil state” (Click here for a ‘refresher’ on what that term means). Home Paramount therefore thought its non-compete was still “safe”. It assumed that if the court found any part of it to be unenforceable, it would simply edit those parts to make it enforceable. In refusing to do so, the court said “[W]e have incrementally clarified that law since that case was decided in 1989. In the intervening twenty-two years, we have gradually refined its application…” The court then listed subsequent cases, and held that “[T]o the extent that Paramount Termite conflicts with any portion of our holding today, Paramount Termite is overruled”.
How about just one more case, but with a twist? Can or will a court enforce non-competition restrictions that could extend beyond the period specified in the employment contract? The United States District Court for the District of New Jersey did in Jackson Hewitt Inc v. Childress 2008 U.S. Dist. LEXIS 4640 (D.N.J. 2008). Here the former employee openly refused to comply with his non-compete obligations, and filed for bankruptcy two days after his former employer sought a preliminary injunction against him. Filing for bankruptcy will hold pending claims in abeyance. By the time the district court was able to address the issue, (i.e. the bankruptcy was resolved and the stay on pending undischarged claims lifted) the 24-month non-compete period had expired. Issuing a new 24-month injunction, based on the non-compete period in the contract, was the only meaningful remedy available. Not to have done so would have effectively allowed the employee to profit from his own wrongdoing and allow Jackson Hewitt to be unfairly hurt.
Did I mention that determining enforceability requires a case-by-case, fact-sensitive analysis? Yes? Well, I guess it cannot hurt to mention it again!
Tune in next week when The Emplawyerologist addresses the last remaining key employment contract provisions, works-for-hire and assignment clauses.
Click here to learn more about Janette Levey Frisch, author of The Emplawyerologist.