Non-Competes and Other Restrictive Covenants

Executive Compensation Blog originally appears on CompensationStandards.com

Non-Competes and Other Restrictive Covenants

Occasionally, I still hear an executive or counsel blithely remark that: "non-competes are not enforceable anyway, right?" Wrong. The courts will enforce carefully drafted non-compete provisions. Today's Blog, prepared with the help of Jeff Bosley and Jason Aschenbrand of Winston & Strawn's Employment Law Department, summarizes a few notable recent cases.

Global Restrictions May be Enforceable

The Eastern District of Pennsylvania and the Third Circuit have largely eliminated the geographic scope requirement in non-compete covenants for employers engaged in global or on-line businesses. In Quaker Chemical Corp., 509 F. Supp. 2d 469 (E.D. Pa. 2007) and Victaulic Co. v. Tieman, 499 F.3d 227 (3d Cir. 2007), the courts held that the notion of an overly broad geographic limitation has become antiquated in today's global economy. Instead, employers can craft broad geographic restrictions as long as they are consistent with the scope of the employee's duties. The employee in Quaker was a global manager whose duties extended beyond a particular region. Additionally, Quaker's customers were located across the world and it competed with only a small set of other companies for the business of these worldwide customers. Because Quaker and the employee's new employer were direct competitors in a specialized market, the global non-compete restriction was reasonable despite the absence of a geographic limitation. As the Court made clear, just as nationwide restrictive covenants are reasonable for national companies, worldwide restrictive covenants can be reasonable for global companies.

While employers must analyze specific requirements for an enforceable restrictive covenant on a jurisdiction-by-jurisdiction basis, this decision reinforces a growing trend that the courts will evaluate the reasonableness of geographic restrictions in the context of the business at issue. Where an employer can demonstrate that the employee who it is trying to restrict was and is involved in nationwide or worldwide activities, certain jurisdictions will abandon a strict geographic restriction requirement.

Employer May Be Prevented from Enforcing Non-Compete if it Terminates Employee Unfairly

In Lantech.com v. Yarbrough, 2007 WL 2669115 (6th Cir. 2007), the Sixth Circuit, applying Kentucky law, held that an employer may be prevented from enforcing a non-compete covenant if it terminated an employee unfairly. Curt Yarbrough worked for Lantech.com for four years as a regional sales manager, consistently receiving performance bonuses during every quarter except his first and last. Despite this, he was told he was not performing up to par, and was given a 90-day period to improve his job performance. Lantech fired Yarbrough before the 90 days were up, even though his territory produced record sales and he had increased his personal sales – a termination that Lantech's director of human resources called "abnormal." Yarborough was fired over the phone, he was not given a reason for his termination, he was denied a severance, and his insurance was terminated almost immediately. Lantech claimed that it fired Yarbrough because he stayed at home too often and he was not making an impact in the field.

Shortly after his termination, Yarbrough began working for a competitor and Lantech sued him for breach of his non-compete covenant. Both the District Court and the Sixth Circuit held that Lantech's actions towards Yarbrough weighed against enjoining him from competing. The District Court noted that Lantech had made certain misrepresentations to Yarbrough, including its statement that he would be afforded a full 90 days to improve his sales. It also found Yarbrough's termination to be abrupt, peremptory, without explanation, and in violation of its own policies. The Sixth Circuit upheld the decision to deny an injunction based on the equities, rather than on the merits. The Court held that the circumstances surrounding termination can preclude an employer's enforcement of its non-compete covenants. Additionally, the Court noted that under Kentucky law (as in most jurisdictions), a court has broad discretion to determine whether a non-compete covenant is reasonable.

Court Refuses to Enforce Covenants That Included Provisions Extending the Restrictions in the Event of a Breach

In H & R Block E. Ents. Inc. v. Swenson, 745 N.W.2d 421 (Wis. Ct. App. 2007), the Wisconsin Court of Appeals held that two-year non-competition and non-solicitation covenants entered into by employees of H & R Block Eastern Enterprises Inc. were unenforceable because they provided they would be "extended by any period(s) of violation." The defendants were six former employees of H&R Block who left to start a new competing business. H&R Block sued, alleging that the former employees were breaching the restrictive covenants in their employment agreements. The trial court granted summary judgment in favor of the former employees.

On appeal, the Wisconsin Court of Appeals acknowledged that H&R Block had a clear interest in protecting its customer goodwill after the employees' departure, and further assumed that the two-year duration was reasonable. The Court took issue with the extension of the two-year period by "any period(s) of violation." H&R Block contended that the provisions were reasonable because "the effect is to restrain the former employees for a total of only two years, and if two years is reasonable, then the extension for a violation to make up a total of two years is reasonable as well," as "a one-day violation leads to a one-day extension, a one-week violation to a one-week extension." The Court rejected H&R Block's argument on several grounds.

Employers should carefully review covenants that provide for extensions in the event of a breach in order to prevent such extensions from invalidating otherwise valid restrictions.