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finding two years unreasonable for non-solicitation agreement for employee home inspection services, and considering bargaining power, that the agreement was a form agreement, and that others were not required to sign the same agreement
Summary of this case from Ainslie v. Cantor Fitzgerald, L.P.Opinion
C.A. No. 18924
Submitted: August 14, 2001
Decided: September 26, 2001
Daniel R. Losco, Esquire, LOCSO MARCONI, Wilmington, Delaware, Attorney for Plaintiff
Charles Gruver, III, Esquire, CHARLES GRUVER, III P.A., Hockessin, Delaware, Attorney for Defendant.
MEMORANDUM OPINION
I. INTRODUCTION
The operator of a home inspection business has sued a former employee home inspector. The action concerns a standard form written covenant, entered into in the context of an at-will employment relationship, that obligates the employee for a period of two years following termination of his employment not to compete with his employer within an extensive geographical area and not to solicit business from the employer's referral sources. After being terminated, the employee immediately opened a competing business within the proscribed geographical area and solicited referrals from persons known to him to have referred business to his former employer.
I conclude that the covenant not to compete is unreasonable and should not be enforced by injunction because the nature of the plaintiffs business is such that it has no trade secret or proprietary information that allows for the possibility of unfair competition by the former employee. The fact that the former employee became, as a result of his former employment, a certified home inspector does not support the entry of an injunction because the skills obtained by the former employee belong to him. Moreover, it would work a hardship on the former employee and his dependents to prevent him from utilizing his training and qualifications as a home inspector within the geographic area defined in the covenant. I do, however, grant plaintiffs request for final injunctive relief enforcing the covenant not to solicit business or referrals of business from the former employer's sources of business or referrals of business. Those relationships are proprietary to the former employer's business, constituting as they do goodwill, and are entitled to reasonable protection from appropriation by the former employee. But, because the trial record showed that the former employer's clientele was both non-exclusive and relatively fluid, I will limit the duration of that injunction to one year from the date of the former employee's termination.
II. FACTUAL AND PROCEDURAL BACKGROUND
RHIS, Inc. ("RHIS"), t/a Reliable Home Inspection Services, is a home inspection company for prospective home buyers doing business primarily in Delaware, Chester and Delaware Counties in Pennsylvania, and Cecil, Hartford, and Kent Counties in Maryland. In July 1997, RHIS hired Jeffrey Boyce as a home inspector. Boyce had no prior experience as a home inspector, but had worked in various capacities in the construction business before joining RHIS.
On July 15, 1997, after a brief "probationary" period of employment, Boyce was offered a permanent position and executed with RHIS a covenant not to solicit and a covenant not to compete (collectively, "the covenant") that operates for a period of two years following the date Boyce leaves the employ of RHIS. The covenant provides in relevant part that Boyce will not "solicit or seek to solicit . . . any client of [RHIS] or referral source of [RHIS]." "Referral source" is defined as "any individual or entity which has referred a client to [RHIS] during the time [Boyce] is employed by [RHIS]." The covenant further provides that Boyce will not "[w]ithin the State of Delaware and within a one hundred mile radius of [RHIS's] present place of business own, manage, operate, be employed by, attempt to solicit business for, or control any business similar to or competitive with that conducted by [RHIS]." This agreement was a standard form document that RHIS expected many of its employees to sign.
The only direct on-the-job training Boyce received at RHIS was to accompany John Kerrigan, who with his wife owns RHIS, on three home inspections. Thereafter, RHIS sent Boyce out on solo inspection jobs. Kerrigan and RHIS did encourage Boyce to become a candidate-member of the American Society of Home Inspectors ("ASHI"), a national organization of home inspectors. Once obtained, full ASHI membership provides a home inspector with a valuable credential and expands the client-base he can service since some clients require ASHI certification.
As an ASHI candidate-member, Boyce was required to perform 250 solo home inspections, complete 30 hours of continuing education, and pass two written examinations over a three-year period. RHIS paid several thousand dollars for Boyce's ASHI dues, continuing education materials, and exam fees so that Boyce could pursue his ASHI certification. RHIS also provided Boyce with the opportunity to perform the 250 solo home inspections needed to complete the program leading to ASHI certification. Of course, RHIS received substantial benefits from Boyce's associate membership in ASHI and his performance of more than 250 solo home inspections because RHIS was able to bill each of those inspections to its clients at a substantially higher amount than the fixed cost of paying Boyce.
RHIS obtains a large part of its business from realtors, who refer their client home-buyers to it. RHIS devotes substantial resources toward the establishment and maintenance of these referral relationships, which constitute an important element of its good will. In the course of performing his job at RHIS, Boyce became acquainted with a number of these referral sources and developed a relationship with them himself. In some instances, for example, referral sources who contacted RHIS would specifically ask to have Boyce assigned to a job because they preferred working with him to working with Kerrigan or other employees of RHIS.
Boyce's employment history at RHIS was not uniformly satisfactory. Over the years, RHIS unilaterally lowered Boyce's rate of compensation per job, raised it, and then lowered it again. These actions were taken in response to problems perceived by RHIS in Boyce's job performance, including mistakes he made that cost RHIS money to correct. Boyce was dissatisfied with his changing rate of compensation and also by the fact that, over time, the number of inspections that he was being asked to perform decreased.
In or about 1999, Boyce began to express his interest in opening his own home inspection business and, according to his testimony, initially believed that the period of the covenant had expired on the second anniversary of its date of execution. After speaking with a friend who suggested that the restrictive period of the covenant would not begin to run until Boyce's employment with RHIS ended, Boyce approached a secretary at RHIS and asked for a copy of the agreement. After reviewing the document, Boyce understood the terms of the agreement as written.
On February 18, 2001, Boyce unilaterally cancelled an appointment for a home inspection. Kerrigan fired Boyce after learning of this. Kerrigan knew of Boyce's desire to open a competing business and reminded him about the covenant during his exit interview. Boyce responded ambivalently, telling Kerrigan that he needed to work. Boyce is 39 years old and has one child who is dependent on his earnings for support. Boyce testified that he was no longer physically able to perform the sorts of jobs he used to have in the construction business.
One week after his termination, Boyce opened Delaware Home Inspections, an entity in direct competition with RHIS, and located within ten miles of RHIS. Boyce performed at least 60 home inspections, generating $13,060 (gross revenue) between March 21, 2001 and July 2001. A significant number of Boyce's referral sources for these jobs were realtors who were among RHIS's base of referral sources, and with whom Boyce had become acquainted while working for RHIS.
On May 24, 2001, RHIS brought this action to enjoin Boyce "from owing [sic], operating, managing, working for or controlling any business engaged in providing services substantially similar to those provided by RHIS . . . [and] from soliciting or attempting to solicit the past or present clients [and referral sources] of RHIS." RHIS also seeks an award of "compensatory and punitive damages" for the intentional breach of the covenant as well as for libel and defamation of plaintiff's business.
Of course, as is well known, this court lacks jurisdiction to make an award of punitive damages. Beats v. Washington Int'l, Inc., Del. Ch., 386 A.2d 1156, 1159-60 (1978); see generally Donald J. Wolfe, Jr. Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, § 2.5 (2000).
III. LEGAL ANALYSIS
The evidence at trial was sufficient to prove that Boyce both operates a competing business within the proscribed geographic area and has solicited and is soliciting RHIS referral sources. Boyce defends, however, by arguing first that there is no contract between him and RHIS, and second that the covenant should not be enforced by injunction in the circumstances present. I address these arguments in turn.A. Was there a valid contract between Boyce and RHIS?
First, Boyce argues that there was no consideration to support the covenant between him and RHIS because he and RHIS signed the covenant 12 days after he began working for RHIS. of course, a covenant not to compete must be supported by consideration. As Chancellor Marvel noted in Faw, Casson Co. v. Cranston:
It is generally agreed that mutual promises of employer and employee furnish valuable considerations each to the other for the contract. However, when the relationship of employer and employee is already established without a restrictive covenant, any agreement thereafter not to compete must be in the nature of a new contract based upon new consideration.
Faw, Casson Co. v. Cranston, Del. Ch., 375 A.2d 463, 466 (1977) (quoting James C. Greene Co. v. Kelley, 134 S.E.2d 166 (1964)).
Boyce argues that he became an employee of RHIS on July 3, 1997, the day he began working for RHIS and performing inspections, albeit accompanied by RHIS president John Kerrigan. Therefore, because he was not asked to sign the covenant until July 15, 1997, the argument goes, there was no new consideration for the promises he made in it.
RHIS counters that Boyce was not hired on July 3, 1997 but was still a job applicant or a probationary employee until he was asked to sign the covenant 12 days later. As RHIS points out, the application for employment that Boyce signed on July 3, 1997 states, "Please note all offers of employment at RHIS, Inc. are subject to a 30 day probationary period." According to Kerrigan, before an applicant could be hired by RHIS, he or she needed to demonstrate an ability to work with customers and competency in performing inspections. It was only after Boyce accompanied Kerrigan on several home inspections and demonstrated his ability to perform the work that RHIS decided to offer him permanent employment.
Boyce disputes that he was a probationary employee, pointing out that he had received a small fee for the three home inspections on which he accompanied Kerrigan. Furthermore, it is undisputed that Boyce was covered by RHIS's workers compensation insurance before he was asked to sign the covenant. Boyce argues that these factors demonstrate that he was already an employee of RHIS at the time he was asked to sign the covenant.
I am satisfied from my review of all the evidence that Boyce was asked to sign the covenant in connection with the decision by RHIS to offer him permanent employment. Only after Kerrigan was satisfied that Boyce would be able to do the work required of him did RHIS agree to offer Boyce permanent employment as a home inspector. This change of employment condition from a probationary hire to a permanent employee is sufficient consideration to support the covenant. In Faw, Casson Co., Chancellor Marvel held that a covenant not to compete signed as a condition to accepting an offer of promotion was supported by adequate consideration. Similarly, Boyce understood that the prospect of obtaining permanent employment at RHIS depended on his willingness to sign the covenant. Under Faw, Casson Co., I find that there is consideration to support the covenant.
"[T]he agreement not to compete was an integral part of the overall promotion agreement and an element of consideration tendered by the defendant in exchange for his promotion to the position as manager . . . a failure of consideration did not occur in the present case." Faw, Casson Co., 375 A.2d at 467.
Next, Boyce argues that RHIS breached the terms and conditions of his employment contract by unilaterally changing his rate of pay, thus, releasing him from any obligation to perform the covenant. The testimony showed that Boyce's pay was reduced on two separate occasions. The fact is that Boyce never treated these changes in his pay as a material breach of his employment contract. Instead, he accepted RHIS's unilateral actions and continued his employment by RHIS. Given these circumstances, I cannot conclude that RHIS' s actions led to the termination of the covenant.
Boyce cryptically states in his pie-trial brief that "[e]very contract or agreement entered into in Delaware imposes upon each part a duty of good faith and fair dealing in its performance and its enforcement." Boyce may be arguing that the subsequent pay reductions breached the implied covenant of good faith and fair dealing by "trapping" Boyce in an unfair employment arrangement. This issue was not developed either factually or legally at trial and will not be discussed in this opinion.
Finally, Boyce argues that Kerrigan misrepresented the terms of the covenant to him at the time of its execution. Boyce claims that Kerrigan told him that the covenant only covered the two year period following the date of its execution, July 15, 1997. Trial testimony on this point was sketchy, proving little of what was said at the time Boyce signed the covenant. From my review of all the facts and circumstances, I am unable to conclude that Kerrigan, either intentionally or unintentionally, misrepresented the term of the covenant to Boyce. Boyce was neither rushed while reading it, nor was he prevented from taking the document home overnight or to a lawyer. Boyce, instead, quickly reviewed the document and signed it.
Under Delaware law, "a party's failure to read a contract [cannot] justify its avoidance." RHIS gave Boyce an adequate opportunity to review the terms of the covenant, and he executed it of his own volition. I note as well that the language of the covenant is clear, rather than confusing or ambiguous. Boyce understood it when he re-read it in 1999, and I am certain that Boyce would have been able to appreciate its meaning at the time he executed the agreement had he simply paid closer attention.
Graham v. State Farm Mut. Auto. Ins. Co., Del. Supr., 565 A.2d 908, 913 (1989).
In conclusion, I find that the covenant was supported by consideration and that RHIS engaged in no unfair practices in securing Boyce's signature on the document.
B. Is the covenant between Boyce and RHIS enforceable?
Next I turn to the question of whether the covenant is enforceable under Delaware law. In KPMG Peat Marwick LLP v. Fernandez, this court said that "[u]nder Delaware law, a former employee's . . agreement not to compete will be specifically enforced, in the proper circumstances, and is not void as against public policy, when its purpose and reasonable operation is to protect the legitimate interest of the former employer."
Del. Ch., 709 A.2d 1160, 1161 (1998). See also Faw, Casson Co., 375 A.2d at 465, wherein the court said: "an agreement by an employee not to follow his trade or business for a limited time and in a limited geographical area is not void as against public policy when the purpose of such agreement and its reasonable effect is to protect an employer from sustaining damages which an employee's subsequent competition may cause. . . ."
As Chancellor Allen recognized in Bernard Personnel Consultants v. Mazarella, applications for orders specifically enforcing contracts of this nature give rise to two sets of legal issues. The first set of issues goes to whether or not there is an enforceable contract, and "include questions concerning the reasonableness of the restriction agreed upon: is it appropriately limited in time and space, given the circumstances present; does it protect a legitimate interest of the employer; is it oppressive." Further, as is stated in comment (g) to the Restatement to the Law of Contracts, Second, § 188: "[p]ost-employment restraints are scrutinized with particular care because they are often the product of unequal bargaining power and because the employee is likely to give scant attention to the hardship he may later suffer through loss of his livelihood. This is especially so where the restraint is imposed by the employer's standardized printed form."
Del. Ch., C.A. No. 11660, Allen, C., mem. op. at 5-6 (Aug. 28, 1990).
The second set of issues is confronted when there is found to be a valid contract and focus on the balancing of equities in weighing whether or not to issue an injunction. These latter issues "reflect the traditional concern of a court of equity that its special processes not be used in a way that unjustifiably increases human suffering. . . . [I]n no context does [this principle] remain more vital than in the specific enforcement of restrictions upon a person's ability to seek alternative employment in a field in which she has acquired experience."
Bernard Personnel Consultants, Del. Ch., C.A. No. 11660, mem. op. at 6.
The evidence at trial did not establish that RHIS employs any trade secrets or proprietary processes in its business that could be used by Boyce to compete against RHIS unfairly. Instead, the focus of RHIS's trial evidence was on two things: (1) that it paid for Boyce to acquire his ASHI certification and, thus, had some right to prevent Boyce from using that certification to compete against it, and (2) that, as a part of his employment at RHIS, Boyce developed relationships with RHIS's business referral sources that he should not be able to exploit to the detriment of RHIS.
This fact distinguishes this case from Computer Aid, Inc. v. MacDowell, Del. Ch., C.A. No. 17481, Jacobs, V.C. (July 26, 2001), where the employer operated an extensive proprietary training program.
The fact that RHIS assisted Boyce in obtaining his ASHI certification does not give it any legitimate interest in preventing Boyce from using that certification to compete. At trial, Kerrigan testified and Boyce did not deny that Kerrigan introduced Boyce to ASHI, that RHIS paid for Boyce to become ASHI certified, and that RHIS was instrumental in helping Boyce obtain the 250 necessary solo inspections. The law is clear, nevertheless, that Boyce, not RHIS, owns both Boyce's membership in ASHI and the right to exploit it commercially. In Bernard Personnel Consultants, Chancellor Allen stated that "[a]n employee who achieves technical expertise or general knowledge while in the employ of another may thereafter use that knowledge in competition with his former employer, so long as he does not use or disclose protected trade secrets."
I need not consider whether or not RHIS could have contracted for Boyce to repay to it the costs associated with obtaining ASHI membership in the event that he did not remain its employ for some set period of time. This lesser obligation would be both better suited to the injury complained of and less restrictive of competition.
Bernard Personnel Consultants, Del. Ch., mem. op. at 4 (The knowledge and skills gained while in the employ of another belong to the employee and she is free to exploit them fairly).
Id. at 8 (quoting Wilmington Trust Co. v. Consistent Asset Mgmt. Co., Inc., Del. Ch., C.A. No. 8867, mem. op. 13-14 (Mar. 25, 1987)). "The rule is no different when an employee begins his employment innocent of any knowledge in a field and acquires all of his expertise while on his employer's payroll." Id.
The second point raised at trial relates more directly to the covenant not to solicit RHIS referral sources than to the covenant not to compete itself. The trial evidence established both that Boyce's employment put him in a position to develop relationships with RHIS's "customers" (in this case, the realtors who referred business to it) and that RHIS has a legitimate interest in protecting those relationships from competition by Boyce. Moreover, the evidence at trial was clear and convincing that Boyce has succeeded in exploiting those relationships and, in doing so, has diverted business from RHIS. Boyce had access to and was familiar with RHIS' s referral sources, and Boyce admitted that he had retained copies of many of the work orders listing the referral sources that he received from RHIS. Indeed, the trial evidence showed that over 78 percent of Boyce's business had been obtained from RHIS's referral sources. This rises to a level greater than coincidental or innocent solicitation of a former referral source. Rather, I conclude that Boyce consciously focused his efforts on securing clients from RHIS "s referral base.
The record before me indicates that there are certain clients from that referral base that preferred Boyce to RHIS, others who were indifferent and others who continued to refer business solely to RHIS. To the extent that Boyce's formation of a new business entity brought greater freedom of choice to the region's realtors in steering clients to a home inspector, and to the extent that additional competition both maintains a downward pressure on the cost of such inspections and created incentives to improve the quality thereof, there was a net social gain created by Boyce's move. However, this gain must be controlled both to the degree that RHIS had the right to protect its proprietary interest in the goodwill it had developed over the years and to the degree that RHIS had contracted with Boyce to do so.
The question is whether RHIS reasonably required Boyce to promise not to solicit RHIS's referral sources for a period of two years and, if so, whether it should be enforced by the special injunctive powers of this court. Under Delaware law, a restriction will not be enforced "that is more restrictive than [an employer's] legitimate interests justify or that is oppressive to [an employee]" The evidence at trial established that RHIS "s referral sources are not, in the main, exclusive relationships. That is, those who refer business to RHIS often also refer business to its competitors. The evidence also suggested that, in this business, referral sources are relatively transient, frequently shifting their referrals among different home inspection firms.
Norton v. Cameron, Del. Ch., C.A. No. 15212, mem. op. at 8, Steele, V.C. (Mar. 5, 1998).
Nevertheless, Boyce did sign the agreement and was aware of its meaning. The question then is, if two years is unreasonable, what is a reasonable period to prohibit Boyce from utilizing RHIS's reference network? Joint Exhibit 19 demonstrates that over a five year period from 1996 to the present, the average realtor referred a client to RHIS once every three to four months. Hence, in the normal course of business, a one year period should be sufficient to enable RHIS to regularize communications with the typical realtor previously managed by an employee who has left the firm. This is generous in that it assumes no efforts on RHIS's part. With even rudimentary business records RHIS could easily and immediately correspond with those realtors with whom a fired employee had most often worked so as to preclude those realtors' referrals leaving with that employee.
See Computer Aid, Inc., Del. Ch., .A. No. 17481, mem. op. at 11 (one year reasonable period of restriction, applying Pennsylvania law).
On the basis of this evidence, I am led to conclude that, in the market for home inspection services, a two year restriction on a former employee soliciting business from his former employer's referral network is unreasonably long. A period of two years is quite simply not necessary to protect RHIS's legitimate interests in its good will and could unreasonably burden competition in the home inspection services market. Moreover, the circumstances surrounding the execution of the agreement, including the unequal bargaining power between RHIS and Boyce, the form nature of the agreement and the fact that RHIS did not require some other, more highly qualified home inspectors to execute similar agreements, all suggest that it would be unfair to enforce such a two year period of non-solicitation on Boyce.
Employees of RHIS were not uniformly required to sign the non-compete clause that Boyce did, and there is evidence that those with ASHI certification or other qualifications that placed them on a more equal bargaining level with RHIS refused to sign the non-compete when they were asked to do so and were hired nonetheless.
I will issue an injunction lasting until the one year anniversary of Boyce's termination and precluding Boyce from soliciting business from any person known by him to have been a referral source of RHIS. In addition, for the same period of time, the injunction will preclude Boyce from performing home inspection services at the request of any of the realtors listed on Joint Exhibit 19. Those are all RHIS referral sources for which Boyce had already performed services at the time of trial.
C. Damages and fees
Finally, I will award RHIS damages equal to 25 percent of the gross revenues generated by Boyce or Delaware Home Inspection for the 47 jobs that are listed on Joint Exhibit 19 and for any additional jobs performed for the same referral sources since the date of that exhibit. I have chosen 25 percent as the appropriate amount because Kerrigan testified at trial that profit margins in the home inspection business varied between 25 percent and 50 percent. Since he was unable to be more precise in testifying to RHIS's profit margins, it is appropriate to award damages at the bottom end of the range identified by Kerrigan.
The demand by RHIS for an award of attorney's fees is denied. Normally, under the so-called American Rule, parties to litigation bear their own attorneys' fees and expenses. A possibility of fee shifting is recognized where the conduct giving rise to the litigation is so egregious in nature as to justify an award of fees as an element of damages. As Chancellor Allen explained in Barrows v. Bowen, however, this is a narrow exception, rarely to be encountered:
Brice v. Stare, Del. Supr., 704 A.2d 1176, 1178 (1998) (citing Goodrich v. E.F. Hutton Group, Del. Supr., 681 A.2d 1039, 1043-44 (1996)).
Arbitrium (Cayman Islands) Handels AG v. Johnston, Del. Ch., 705 A.2d 225, 233 (1997), aff'd, Del. Supr. 720 A.2d 542 (1998).
While this court can imagine situations which may be so egregious as to warrant an award of attorney's fees on the basis of fraud, the American Rule would be eviscerated if every decision holding defendants liable for fraud or the like also awarded attorney's fees. Even more harmful would be to extend this narrow exception to situations involving less than unusually deplorable behavior.
Del. Ch., C.A. No. 1454-S, 1994 WL 514868, 1994 Del. Ch. LEXIS 164, Allen, C., mem. op. at 5-6 (Sept. 7, 1994).
Plainly, Boyce's conduct does not meet this difficult standard. In the absence of a special fee shifting provision in the contract signed by him, I will not require Boyce to pay RHIS's fees relating to this litigation.
IV. CONCLUSION
For the reasons stated above, plaintiffs claim for permanent injunctive relief for violation of the non-compete covenant is DENIED. Plaintiffs claim for permanent injunctive relief on the non-solicitation agreement is GRANTED in part, and damages allowed to the extent specified in this opinion. Plaintiffs claim for an award of attorney's fees is DENIED.
Plaintiff should submit an appropriate form of order on notice within 10 days of the date of this opinion.