Restrictive covenants: a comparative jurisdiction perspective - Essay Example

John Doe Prof. Richard Roe Labor Law 26 April 2006 Restrictive Covenants: A Comparative Jurisdiction Perspective The object of this essay is to examine the current legal viewpoints on the legality and enforceability of the different kinds of restrictive covenants in labor law, and see the differences the jurisdictions of Texas and Maryland have held on the matter vis--vis that of Massachusetts. Post employment restraints have been around for centuries, but have been popularized in the legal profession due to a number of suits that are based on whether or not a certain restrictive covenant is legal, reasonable, or enforceable to the case at bar. Misappropriation of trade secrets, breach of a duty of loyalty, industrial espionage, breach of nondisclosure agreements and breach of covenants not to compete are some of the more common restrictive covenants employers have used in attempting to protect their business interests with regard to former employees. Thus far, most case law has upheld the doctrine that restrictive covenants have to be viewed and adjudged as regards the various intrinsic circumstances surrounding the business. These factors include the nature of the employer's business and the character of the employment involved, the situation of the parties, the necessity of the restriction for the protection of the employer's business and the right of the employee to work and earn a livelihood. A topic that has been seen as particularly problematic is that of restrictive covenants as applied to at-will employees. This is generally so because of the fact that at-will employees may be fired for any reason whatsoever, whether good or bad, or even anent one. Courts have been particularly careful in rulings relating to this topic, in order to prevent the evil created by the unfair dismissal of an at-will employee who is further restricted from finding other employment due to a restrictive covenant. The jurisdiction of Texas has had long history in trying to resolve cases involving these issues. Since the late 1980's the Texas Supreme Court has been steadfast in not enforcing restrictive covenants. This prompted the Texas legislative body to create legislation that expands the situations in which covenants could be properly enforced, therefore attempting to reverse the Texas Supreme Court's policy of upholding worker's free movement above business investments. Upon its approval, the Texas Supreme Court did not apply the law to at-will employees, prompting amendments to the law to include at-will employees with the limitations abovementioned as to the reasonableness of time, geographic location, etc. Light vs. Centel Cellular Co. saw the first implementation of that law, in effect upholding a restrictive covenant not to compete against an at-will employee who left the company after it was bought out. The Court held so on the basis that the at-will employment agreement contained several terms, thus the covenant was ancillary to an enforceable agreement. But as regard the covenant not to compete, the court held that it was not ancillary to the agreement's enforceable aspects, thus unenforceable in itself. This case is slightly similar in timeliness and circumstances to the Massachusetts case of Ikon Office Solutions, Inc. vs. Belanger. Both cases were decided in the 1990's and both involve an employee who was working for a company that was bought out. Both cases upheld the doctrine that should a portion of a restrictive covenant be found unenforceable, the enforceable portions would be upheld, and only the unenforceable portions struck down. The intrinsic issue of customer contacts has been the most commonly litigated post-employment issue. In the form of restrictive covenants, employers use them to protect customer information from being used for the benefit of a competitor through the hands of a former employee who had been in contact with those customers. The manner in which cases of this nature are decided also relate to the circumstances within the case itself, such as the question on whether or not a customer list could be regarded as a trade secret warranting protection. Maryland's Court of Appeals decision in Ruhl vs. F.A. Bartlett Tree Expert Co. enforced a restrictive covenant in preventing a manager of a tree service from practicing that trade for two years. Although he did not possess any trade secrets and the work did not involve solicitation of customers, the court still upheld the covenant on the ground that it was necessary to protect F.A. Bartlett's business in a highly competitive industry and the goodwill established between Ruhl and Bartlett's customers were important to its success. All Stainless vs. Colby is a noteworthy case to assess in relation to Ruhl, as the Massachusetts Supreme Court upheld a restrictive covenant in relation to the limitation as to time but declared unenforceable the scope of geographical locations for being too broad. The similarities and differences between the two cases are as follows: 1) Both cases involve an employee who resigned. 2) Both cases involve a two year covenant not to compete. 3) Both cases involve businesses in highly competitive industries. However, mention must be made as to the position of the employees in both cases. Ruhl was only a manager and neither did possess any trade secrets nor involve solicitation of customers, yet he was restrained from practicing the only trade he knew how to do. All Stainless involved an employee who had a hand in gaining and maintaining goodwill of the employer's customers and was not assigned any managerial functions. Yet, Ruhl was left without any viable means to practice his trade for two years in six counties, while All Stainless' case was not enforced only to the areas where the employee had contacts with his former employer's customers. Neither of the employees in Ruhl and All Stainless had access to any business or trade secrets or confidential information. Becker vs. Bailey followed the Ruhl case by taking a narrow approach to restrictive covenants and its enforceability. Here, the Maryland Court of Appeals struck down a covenant because the circumstances did not warrant it, by stating that"[] covenants may be enforced only against employees who provide unique services, or to prevent the future misuse of trade secrets, routes or lists of clients, or solicitation of customers." A relaxed view of such covenants became evident in the case of Hebb vs. Stamp, Harvey & Cook which upheld a covenant to prevent an employee from soliciting customers he himself generated, on the basis that such information and goodwill was owned by the employer despite the procurement was due to the employee's skills. Because he had been paid for his labor, the company became the rightful owner of the information. A noteworthy case to mention vis--vis Hebb is the Massachusetts case of Richmond Brothers, Inc. vs. Westinghouse Broadcasting Co. Inc, wherein the Massachusetts Supreme Court struck down a restrictive covenant contracted between Richmond and a talk show host ex-employee who had left the former's employ to work out of state. Due to changes in the business structure, the employee had to find work anew and ended up in as a talk show moderator in a station in competition with his former employer. The Court struck down the contention that the employee's success as a talk show host was due to the expense and work put in promotions by Richmond. The Court held that the former employee's popularity may have been attributed to his own personality and ability, and it is difficult to determine that the expenses and work of Richmond resulted in that popularity. Clearly, the master-servant law doctrine used in the Hebb case was not applied in the case of Richmond Brothers. In Hebb, the employer was upheld as rightful owner of the patronage and customer relations established by its employee through the latter's labor and skills. The Richmond ruling went the other way and held that despite the labor and expenses of the employer, the successes of the employee as talk show host were most likely attributable to him and not the employer. In conclusion, there are clearly differences in how the jurisdictions of Massachusetts, Maryland and Texas view the delicate balance between restraining an employee's right to work for whomever he wishes or uphold the business interests of the employer. But all of these jurisdictions have held that should any restrictive covenant be too broad in time, geographic location or would impair ordinary competition, such unenforceable provision would be declared void. Works Cited All Stainless, Inc. vs. Colby 364 Mass. 773. 308 N.E.2d 481. 1974. Becker vs. Bailey Hebb vs. Stamp, Harvey & Cook Ikon Office Solutions, Inc. vs. Belanger. 59 F.Supp.2d 125. 1999. Light vs. Centel Cellular Company Richmond Brothers, Inc. vs. Westinghouse Broadcasting Company, Inc. 357 Mass. 106. 256 N.E.2d 304. 1970. Ruhl vs. F.A. Bartlett Tree Expert Co Richmond Brothers, Inc. vs. Westinghouse Broadcasting Company, Inc. 357 Mass. 106, 256 N.E.2d 304 (1970) Facts: Richmond Bros. operated WMEX radio station with Gerald Jacoby as a radio announcer. Jacoby had been with WMEX since 1957 to 1965, as a radio show host, and mostly under written contracts. October 15, 1964-Jacoby and the Richmond signed a 3-year employment contract that contained a restrictive covenant which provided that upon cease of employment, Jacoby cannot engage in radio, television, or advertising businesses anywhere in New England without Richmond's written permission for a period of at least three years. In early 1965, Jacoby informed Richmond that he wanted to terminate his contract because due to a good employment opportunity with WBBM in Chicago. On June 19, 1965, Jacoby and Richmond entered into a new contract that terminated Jacoby's employment on August 28, 1965 and contained the same restriction effective until October, 1970. August 29, 1965- Jacoby began broadcasting over Station WBBM, in Chicago, but was terminated 3 years later due to station changes. Jacoby negotiated with Westinghouse and soon after began broadcasting for WBZ's television and radio stations as a talk show moderator. When Richmond found out of Jacoby's employment with WBZ, it filed the suit in equity to enjoin Westinghouse from employing Jacoby and enjoining Jacoby from broadcasting and announcing until the contract's restrictive covenant is met on October 14, 1970. Trial Court held against the petitioner, thus the appeal. Issue: Whether or not the restrictive covenant in the contract with Jacoby was reasonable, thus Richmond deserves the injunction and relief. Ruling: No. The restrictive covenant in the 1965 contract is no longer reasonably necessary for the protection of Richmond's business. Enforcement of the covenant beyond the years of Jacoby's absence from Boston would merely be protecting the plaintiff against ordinary competition. It is not entitled to such protection. The following are the Court's rulings with regard to Richmond's assertions: 1. Covenant was reasonable as to time: In determining whether a restriction as to time is reasonable, we must consider the nature of the Richmond's business and the character of the employment involved, as well as the situation of the parties, the necessity of the restriction for the protection of the employer's business and the right of the employee to work and earn a livelihood. While we recognize the unusual nature of the radio broadcasting industry, its relationship with the listening public and the unique nature of its performers, we are unable to perceive any business interest of Richmond which merits the length of 'protection' it would receive by the enforcement of the covenant. Jacoby was not involved in the solicitation of advertisers while an employee of Richmond and thus was not in a position whereby his competition with Richmond would result in any exploitation of previous contacts and injure Richmond's established business. Also, there was no evidence introduced which would indicate that Richmond had lost any advertisers since Jacoby returned to the Greater Boston area. Also, the nature of the broadcasting industry is such that Jacoby was not in possession of any Richmond's trade secrets or confidential information communicated to him during the course of his employment. 2. Jacoby is successful in the Boston area because of Richmond's expense and work in promoting him: Even though a broadcasting company may have expended large sums to promote a performer's popularity with the listening public, it would be difficult to determine that such expenditures and promotion have resulted in the performer's popularity. The performer's popularity may well be attributed to his own personality and ability. Even assuming that assertion by Richmond, Jacoby's absence for almost three years from the Boston area sufficiently protected any business interests of Richmond. Rule/Doctrine: An employer cannot by contract prevent his employee from using the skill and intelligence acquired or increased and improved through experience or through instruction received in the course of the employment. The employee may achieve superiority in his particular department by every lawful means at hand, and then, upon the rightful termination of his contract for service, use that superiority for the benefit of rivals in trade of his former employer. All Stainless, Inc. vs. Colby 364 Mass. 773, 308 N.E.2d 481 (1974) Facts: All Stainless does business selling steel fasteners, nuts, bolts, screws and stainless steel pipe valves and fittings to industrial purchasers and distributes in all the New England States and New York. In January of 1961, William Colby was employed by All Stainless and entered into an agreement which contained a restrictive covenant. That covenant stated that upon termination of Colby's employment, he would not compete with All Stainless in New England and New York for two years. The contract was from month-to-month and termination was through 30day written notice. In July of 1966, Colby and All Stainless entered into a new contract which contained a similar restrictive covenant. Two years later on May 30, 1968, Colby left All Stainless and began working for a manufacturing company which was not a competitor of All Stainless. In November of 1969, around 17 months from his leaving All Stainless, Colby began working for Accurate Fasteners, a competitor of All Stainless, as an outside salesman. When all Stainless learned of Colby's employment by Accurate, it filed the bill in equity seeking preliminary and permanent injunctions to enforce the covenant plus damages. The Trial Court Judge granted the preliminary injunction but later dissolved it through Colby's motion and filing of a bond. The case was held against All Stainless, as the judge ruled the restrictive covenant as unenforceable. Thus, this appeal by All Stainless. Issue: Whether or not the restrictive covenant was unenforceable. Ruling: NO. The geographical area covered by the covenant was too broad but the two year limitation was not unreasonable The geographical area assigned to Colby by Accurate included that portion of New Hampshire which he had not covered during his years at All Stainless, a portion of eastern Massachusetts lying westerly of the area he had covered for All Stainless and five towns (Billerica, Burlington, Belmont, Watertown and Arlington) which he had covered for All Stainless. Clearly, Accurate was careful in selecting the areas to avoid the territory held by Colby with All Stainless (with the exception of the 5 towns). Colby's work for All Stainless and Accurate involved gaining and maintaining the good will of his employer's customers in a competitive sales environment. He was not assigned any managerial functions. Clearly the geographical limitations on Colby's sales activities were far too broad. A former employer is not entitled by contract to restrain ordinary competition. Any restraint must be consistent with the protection of the good will of the employer. Although Colby was not in a position of knowledge of some business secret or confidential information, he had close association with the All Stainless' customers and may cause those customers to associate the former employee, and not the employer, with products of the type sold to the customer through the efforts of the former employee. All Stainless has shown that it had good will in the sales area served by Colby. However, All Stainless failed to show that its good will could have been harmed through sales activity by Colby outside of the sales territory formerly assigned to him. We see, therefore, no justification for enforcement of the restriction beyond Colby's former sales territory. We believe that the sales function performed by Colby, involving repeated attempts to sell to potential customers in the same geographical area, is similar to the function of a route salesman in terms of its potential effect on the employer's good will with its customers. Rule/Doctrine: A covenant not to compete contained in a contract for personal services will be enforced if it is reasonable, based on all the circumstances. In determining whether a covenant will be enforced, in whole or in part, the reasonable needs of the former employer for protection against harmful conduct of the former employee must be weighed against both the reasonableness of the restraint imposed on the former employee and the public interest. If the covenant is too broad in time, in space or in any other respect, it will be enforced only to the extent that is reasonable and to the extent that it is severable for the purposes of enforcement. Augat, Inc. vs. Aegis, Inc. 409 Mass. 165, 565 N.E.2d 415 (1991) Facts: Isotronics, Inc. is a subsidiary of Augat, Inc. and manufactures metal microcircuit packages. Jeremy Scherer (defendant) was a stockholder who sold Isotronics to Augat in 1975, and continued in Isotronics until 1980. Later, he worked as VP and consultant to Augat until 1983. After his agreement not to compete with Isotronics expired, Scherer formed Aegis, which would compete directly with Isotronics. He talked to Greenspan (VP and GM of Isotronics) and offered him a job and stake in Aegis. Prior to this, it was clear that Greenspan was the reason for Isotronics' success but was unhappy and had thought of forming his own company also in 1983, a fact known to four other senior managers. In 1984, both Scherer and Greenspan spoke to the four managers and invited them to work for Aegis. Greenspan and Three of those four managers committed to leave Isotronics for Aegis if the company would be funded. Later in the year, Scherer was able to get the funding necessary, and Aegis produced its first products in May of 1985. When it learned of these facts, Augat and Isotronics filed several causes of action against Aegis and Scherer. The Trial Court Judge held in favor of Augat and Isotronics, on a portion of theories of liability asserted by them. They later brought this appeal. Issue: Whether or not Augat and Isotronics deserve damages resulting from a breach of duty of loyalty by Greenspan or the other managers. Ruling: NO. Although Greenspan breached his duty of loyalty, Augat and Isotronics failed to show any loss due to such act. 1. As to the contention that Greenspan gave trade secrets of Isotronics' gross annual sales that was used in the business proposal used by Scherer in getting the funding necessary: The fact that Isotronics held 2/3 of the market was known to people in the industry and Isotronics did not keep that fact confidential. In fact, the approximate volume of sales was generally known in the industry, and that these financial data were made known to securities analysts. Also, the figures used by Scherer were approximations that could have been computed from using the generally available information. Thus, such are not confidential information that demands protection. 2. As to liability due to Greenspan's breach of his duty of loyalty to Isotronics: Greenspan was a VP and ran all aspects of Isotronics under general supervision, and was responsible for staffing. One duty included maintaining at least one backup employee for each managerial position. Greenspan clearly violated his duty to protect Isotronic's interests against the loss of key employees to Aegis. He was still GM when he invited the other senior managers to join Aegis, which included the VP for Marketing, the new product design manager, the most experienced engineer, the manufacturing manager, and the engineering manager. However, there is no evidence to show that Isotronics had suffered any losses or damages due to these acts of Greenspan. Rule/Doctrine: An at-will employee may properly plan to go into competition with his employer and may take active steps to do so while still employed. The general policy considerations are that at-will employees should be allowed to change employers freely and competition should be encouraged. Pettingel vs. Morrison, Mahoney and Miller 426 Mass. 253 687 N.E.2d 1237 (1997) Facts: Richard Pettingel and Joseph Regan became partners in the law firm of Morrison, Mahoney and Miller in 1982 and 1987, respectively. In 1989, the firm enacted partnership agreements which contained a waiver of all benefits due if a partner voluntarily withdraws from and engages in competition with the firm. This agreement was accepted. In 1993, Pettingel and Regan withdrew from the firm and formed their own partnership. They brought suit to claim payment of funds due to them as partners. The firm cites the waiver in the agreement as a defense, since it states that if a partner withdraws from the firm and competes with it, he forfeits those funds. Pettingel and Regan assert that the agreement violates S.J.C. Rule 3:07, Canon 2, Disciplinary Rule 2-108(A) and public policy, thus, void. Trial Court through judgment on the pleadings held in favor of Pettingel and Regan stating the provisions that purport to forfeit the rights of a competing former partner are against public policy and unenforceable. Thus this appeal. Issue: Whether or not the forfeiture provision in the partnership agreement is void. Ruling: YES. Judicial consideration of the enforceability of a forfeiture provision in a partnership agreement has focused on ethical rules concerning restrictions on the rights of a lawyer to practice after withdrawal from a law firm. DR 2-108(A) (practically the same as Rule 5.6, Massachusetts Rules of Professional Conduct) applies in this case which restricts the right of a lawyer to practice law after the termination of a relationship created by the agreement, except as a condition to payment of retirement benefits. Pettinger and Regan are voluntary withdrawing, not retiring. Thus they should be paid the sums due to them prior to their withdrawal. The basic concerns of DR 2-108(A) are the interests of the clients, not the interrelationship of the partners and former partners. We generally enforce non-competition agreements between employers and former employers to the extent they are reasonable. In this case, all parties participated in the violation by including the offending provision in the partnership agreement, and this does not preclude enforcement of the forfeiture clause unless there is some policy underlying the violated rule that compels us not to enforce the forfeiture clause in whole or in part. The strong majority rule in this country is that a court will not give effect to an agreement that greatly penalizes a lawyer for competing with a former law firm, at least where the benefits that would be forfeited accrued before the lawyer left the firm. Rule/Doctrine: The concern is to protect the clients and potential clients of the withdrawing lawyer and the law firm. An enforceable forfeiture for competition clause would tend to discourage a lawyer who leaves a firm from competing with it. This in turn would tend to restrict a client of potential client's choice of counsel. Ikon Office Solutions, Inc. vs. Belanger 59 F.Supp.2d 125 (1999) Facts: From 1983 to 1996 Arthur Belanger worked for MBS Business Systems, Inc. as a photocopy equipment salesman. In 1996, Alco Standard Computing (later changed name to Ikon) bought MBS and retained Belanger as a major account representative responsible for soliciting and services high volume accounts in Hampden, Hampshire and Franklin counties. October 1, 1996- Belanger and nine other sales representatives attended a meeting held by the sales manager Schnepp. In that meeting, the sales representatives signed an employment contract with Ikon, which contained two restrictive covenants. The first covenant restricts a sales representative from competing within a particular geographic are for two years from termination of employment. The second covenant restricts any sales representative from contacting any customer learned about during the employ with Ikon. December 31, 1997- Belanger left Ikon. Later, Belanger worked for Tortus-Tek, an internet and web design company. He later resigned, and for some time received unemployment compensation. On January 1999 he joined DocuSource, a company where he also invested $15,000. DocuSource engages in distribution of copying equipment, and Belanger runs its West Springfield office. Ikon filed suit against Belanger seeking enforcement of the restrictions. Trial Court Judge held against Ikon, stating that Ikon would not likely succeed on the claim since the agreement was signed AFTER employment had begun, and no evidence of consideration for acquiescence in the restrictions. Thus, this appeal by Ikon. Issue: Whether or not the restrictive covenants are reasonable and enforceable. Ruling: Yes. Reasonable as to geographic location. BUT NOT reasonable as to 2 year period and customer contact restriction. It is reasonable to restrict Belanger from the territory in which he worked in the 18 months prior to terminating with Ikon and easy enough for the parties to ascertain that region. However, the customer specific covenant subsumes all customers developed over the course of Belanger's employment with MBS and Ikon. The two year restriction, although not uncommon, it is not categorically appropriate in this case when the time of employment was only slightly greater than one year. MBS did not have a non-competition covenant, and even Ikon did not condition Belanger upon its purchase of MBS. Only later did it put the contract and conditions into writing and acceptance of Belanger. Ikon could not have suffered irreparable harm since Ikon had already more that a year's benefit from the covenants, sufficient time for it to protect its business contacts and goodwill. The loss of customer goodwill is not necessary irreparable. Rule/Doctrine: Non-competition agreements are enforceable to the extent that they are reasonable and necessary to protect the employer's legitimate interests while not interfering with ordinary competition. Read More