Enforceable Noncompete Agreement Key to $2 Million Judgment Against Former Employee

Key.jpgA recent Michigan trial court decision from the Oakland County Circuit Court illustrates the significance that noncompete agreements can have for employers and individuals who sign such agreements. 

Specifically, Crain's Detroit Business reported that an Oakland County Circuit court entered a judgment in excess of $2 million against Matt Prentice, a former employee and a well-known Metro Detroit restaurateur. This judgment arose out of a lawsuit filed against Mr. Prentice for claims of breach of a noncompete agreement and other related claims. 

The lawsuit against Mr. Prentice was originally filed on July 11, 2012. It claimed that Mr. Prentice failed to comply with a noncompete agreement he signed in 2009 after the Matt Prentice Restaurant Group assets were acquired by an entity called Trowbridge Restaurants Inc. that was created by Stan Dickson. Mr. Dickson then hired Mr. Prentice to operate the restaurant assets. However, Mr. Prentice left Mr. Dickson's company on March 29, 2009 to open up a restaurant called Morels and a steakhouse that would be called Detroit Prime (As an aside, both provided phenomenal dining experiences).

In handing down the decision, the Oakland County Circuit Judge, Michael Warren, framed the issue to be decided as: 

At stake in this case is whether a sophisticated business owner can negotiate and sign a clear and unambiguous agreement (in which he agrees its terms are reasonable) and purposefully breach it without consequence? Because the answer is 'no,' the Court renders the judgment in favor of the Plaintiffs. 

As noted above, that judgment was in excess of $2 million against Mr. Prentice. 

Closing Thoughts

A common question our law firm is asked by companies, usually start-ups, and individuals is what is the value or significance of having a noncompete agreement.

For companies, the question is usually asked in order to understand the business justification for expending resources for incorporating a noncompete agreement into their employment practices. For individuals, the question is often asked because the employee has previously signed a noncompete agreement but is now thinking about competing against his or her current employer by taking a job with a competitor or starting a new business.

In addressing both the company and individual interests, a decision like this is a good reminder that regardless of the perspective, i.e., a company seeking to enforce a noncompete agreement or an employee accused of breaching a noncompete agreement, the value and significance of having an enforceable noncompete agreement cannot be understated because it can have significant ramifications in terms of damages and eliminating competition. 

For more information about enforcing noncompete agreements see our prior post: My former employer can't prevent me from working, right? Dissecting the Enforceability of a Noncompete Agreement, search this site for other noncompete agreement articles, and contact Jason M. Shinn to discuss noncompete agreement law specific to your situation.    

The Challenge of Balancing Noncompete Agreements with Business Growth

Stone Balanced.jpg

In a previous post (Noncompete Agreements - A Hurdle to Employment and Innovation?), we discussed research that suggested noncompete agreements hinder innovation.

Expanding on why innovation is hindered, in any context in which a noncompete agreement is entered into e.g., an employment relationship, a founder whose start-up is being acquired, or an owner selling his or her business, such an agreement will universally restrict an individual from competing against the other party in a particular geographic area and market.

Geographical restrictions under a noncompete agreement, however, may become an even more significant impediment to innovation than originally contemplated by either party to the agreement for two reasons: Noncompete agreements are always broadly drafted to begin with and after entering into such agreements companies frequently expand business operations (think of acquisitions, joint ventures, or obtaining new customers) or enter into new business markets. 

For example, a typical noncompete agreement will provide some description of the business and geographical area in which the individual may not compete. Consider the following example:   

Employee shall not directly or indirectly engage in any geographical area where the Company is doing business or is making preparations to do business in any line of business that is similar to or competitive with that conducted by the Company ... 

The problem for those creating innovation, i.e., employees, entrepreneurs, founders, etc., is that the day the individual signs the noncompete agreement, the geographical and business restrictions may be relatively limited. But as time passes, those restrictions may significantly expand as the company grows. 

Assume for example that the noncompete restriction only applies to Michigan where the company is located and doing business. But after entering into the noncompete restriction that Michigan company acquires a California company. Or it enters into a joint venture with a Chinese company. And what if a Texas based customer is landed? Or consider what happens if the company is in the business of "X" when the noncompete agreement is entered into but later expands into "Y" and "Z" business? Now the noncompete restrictions arguably expand to reflect these changed circumstances in terms of geography and lines of business.  

Expanding Business Under Noncompete Agreement Should be Shared Concern for Individuals and Companies  

A court addressing a dispute under a noncompete agreement will generally require that geographic limitations be tailored so that the scope of the agreement is no greater than is reasonably necessary to protect the legitimate business interests of the party seeking to enforce the noncompete agreement. Both companies and individuals need to be mindful of this issue, but for different reasons. 

For companies who use noncompete agreements to protect their competitive business interests, nailing down the geographical scope of a noncompete agreement is a critical element for making sure it will be enforced. This is because, Michigan courts have refused to enforce and otherwise modify an overly broad noncompete agreement that lacked a geographic scope and blocked a former employee from performing “any services” for clients. A Complete Home Care Agency, Inc v Gutierrez, (2004).

So from the company's perspective, it is critical to balance the need for having a noncompete agreement that is specific enough to withstand the Monday-morning quarterbacking of a judge tasked with determining what is "reasonable" but broad enough to account for business growth from the time the noncompete agreement is signed.

Conversely, an immediate red-flag for any entrepreneur or employee entering into a noncompete agreement is what happens if/when the company expands its operations, lines of business, or customer base. The tradeoff of restricting your options for future employment or starting a business may make sense if you are taking a position with a company only doing business in Southeast Michigan in one area of business. But the same may not be true if those restrictions now expand outside of Michigan or the original market.

Conclusion

For more information about noncompete restrictions and agreements, as well as strategies for drafting and enforcing noncompete agreements, contact Jason M. Shinn. Since 2001, Mr. Shinn's legal practice has focused on drafting noncompete agreements and litigating noncompete disputes involving business and individuals.

Noncompete Agreements - A Hurdle to Employment and Innovation?

Noncompete Hurdle to Innovation.jpgNoncompete agreements and other restrictive covenants are customarily found in employment agreements and provided for in the sale of a business.

In the employment context, companies simply do not want a former employee to take its business and set up shop or to go work for a competitor. In connection with the sale of a business, the buyer does not want the seller competing with the buyer who has paid for the business.

In each situation, there are certainly legitimate business interests to be protected and justifications for enforcing a noncompete agreement. But outside these immediate stakeholders - employees and employers - does society benefit from having noncompete agreements enforced?

The answer to this question probably depends upon your perspective. And having the benefit of representing both companies and individuals in noncompete disputes, I can certainly appreciate the diverging views on both sides of the question. But there is scholarly evidence that outside of these immediate stakeholders, enforcement of noncompete agreements hinders innovation.

Specifically, a 2011 report (Non-Compete Covenants: Incentives to Innovate or Impediments to Growth (May 28, 2009)) by a management professors Olav Sorenson and Sampsa Samila found evidence that the enforcement of noncompete agreements impeded innovation. The authors noted: 

... [T]he enforcement of non-compete clauses significantly impedes entrepreneurship and regional growth. Based on a panel of metropolitan areas in the United States from 1993 to 2002, our results indicate that, relative to regions in states that enforce non-compete covenants, an increase in the local supply of venture capital in states that restrict them has significantly stronger positive effects on (i) the number of patents, (ii) the number of firm starts, and (iii) employment.

Perhaps in response to such findings, Michigan legislation has been introduced in the last couple of years that restricted the use of "afterthought" non-compete agreements, i.e., noncompete agreements entered into after an individual begins employment. However, that legislation stalled and there is no indication on the legislative horizon that it will be revived.   

Old Controversy, Same Contention 

Controversy and contention over the use and enforcement of noncompete agreements dates back to the early eighteenth century. Bishara, Norman and Martin, Kenneth J. and Thomas, Randall S., When Do CEOs Have Covenants Not to Compete in Their Employment Contracts? (October 18, 2012) (citing the 1711 case of Mitchel v. Reynolds, (1711) 24 Eng. Rep. 347 (Q.B.); I P. Wms. 181).

While under current Michigan law there is no controversy as to whether noncompete agreements can be enforced, the use and enforcement of noncompete agreements is no less contentious. And when it comes to contention, a multitude of issues can and often will be at issue in a dispute over a noncompete agreement. But enforcing or challenging the enforceability of a noncompete agreement under Michigan law invariably boils down to four issues: 

  1. Does the agreement protect a legitimate business interest?
  2. Is the duration reasonable?
  3. Is the geographical restriction reasonable?
  4. Is the type of employment or line of work restriction reasonable?

The challenge for both employers and individuals, however, is identifying and organizing the facts within the framework of these issues to build a defensible position. And similar to Mr. Shakespeare's observation that "the devil can cite Scripture for his purpose," individuals and employers will often find support for their respective positions within the noncompete agreement and the employment relationship when it comes to the enforceability of a noncompete agreement.  

For more information about Michigan noncompete law or to speak with a noncompete attorney, contact Jason M. Shinn. He has drafted and negotiated noncompete agreements on behalf of employers and individuals since 2001. Mr. Shinn has also negotiated pre-lawsuit resolutions to noncompete disputes and, when necessary litigated the enforceability of noncompete agreements in Ohio, Michigan, and federal courts.

Employment Agreement Shortening Time for Bringing FLSA and Equal Pay Act Claims Invalidated by Court

Signing Contract.jpgOn August 6, 2013, the Sixth Circuit Court of Appeals (the federal jurisdiction that includes Michigan) ruled that provisions in employment agreements that shorten the statute of limitations period in which employees are permitted to file claims under the Fair Labor Standards Act (FLSA) and Equal Pay Act (EPA) are invalid.

Specifically, in Boaz v FedEx Customer Information Services, Inc. (PDF), the employee claimed that she was paid less for performing the same duties as a male employee and that FedEx failed to pay her overtime.

In response to the complaint, FedEx sought to rely on its employment agreement in defending the claims, which provided, “To the extent the law allows an employee to bring legal action against Federal Express Corporation, I agree to bring that complaint within the time prescribed by law or 6 months from the date of the event forming the basis of my lawsuit, whichever expires first.” Based on this provision, the district court dismissed the employee’s claims because the last alleged illegal activity occurred more than six months prior to the filing of the lawsuit.

On appeal, the Court reversed the decision to dismiss the employment lawsuit. It reasoned that U.S. Supreme Court decisions provide that employees may not prospectively or retrospectively waive their FLSA rights to minimum wages, overtime or liquidated damages. While the express terms of FedEx's contract only limited the time period in which an employee could bring such claims, the Court made the jump that as applied to the employee’s claim, the six-month limitation period acted as a waiver of her FLSA rights and was therefore invalid. 

The Sixth Circuit also reinstated the EPA claim applying the same reasoning it used to reinstate the FLSA claim.  

The Take Away For Employers

Michigan employers should take the Boaz v FedEx decision as a sign to review their current employment agreements to assess their current contractual limitation periods and update them as may be required or to otherwise improve contractual protections that may be available to the employer.

But the bottom line is that Michigan employers cannot rely on employment agreements to shorten the statute of limitations provisions provided for in the FLSA and EPA. The FedEx decision, however, should not affect decisions enforcing limitation periods in employment agreements as applied to other claims.

For more information about federal and Michigan employment law compliance and employment agreements, contact Jason M. Shinn. Mr. Shinn is an employment attorney who has been addressing state and federal employment legal issues since 2001.

Enforceability of a Noncompete Agreement will Often Depend Upon Context.

QuestionMarks.jpgIt may sound odd for a noncompete attorney to say this, but when it comes to enforcing a non-compete restriction, the applicable law is often less important than the context in which the noncompete restriction arises.

To better understand this point, consider that noncompete restrictions, sometimes referred to as covenants not to compete, often arise in three broad situations:

  1. A noncompete restriction between an employee and the employee's employer;
  2. A noncompete restriction between a seller and the buyer in connection with the sale of a business; and
  3. A noncompete restriction given by a member in a limited liability company or corporation, who may also be an employee of that LLC.

Certainly all three of these categories of noncompete agreements will share commonality when it comes to the enforceability of a particular noncompete restriction. But each category will not likely receive the same level of scrutiny from a court responsible for determining whether a particular noncompete restriction is enforceable. Accordingly, it is important to understand these differences in order to draft a noncompete restriction that will likely be enforced

Common Principles Applicable to Noncompete Agreements

As to the commonality, the enforceability of any non-compete restriction under any of the above circumstances will generally depend on whether the restriction protects the reasonable competitive business interest of the party seeking to enforce the restriction, which will in turn generally depend upon the duration, geography, and scope of the covenant.

As with most legal issues, the devil is in the details, and the details of your particular noncompete restriction will need to be reviewed by an experienced noncompete attorney. And because noncompete law is state specific, that noncompete attorney should be licensed in the state whose law applies to the enforceability of the noncompete agreement. But here are few general principles likely to apply to each situation. 

Noncompete Restriction Employee / Employer 

Generally, the reasonableness of non-compete clauses in the context of employee restraints is scrutinized more rigorously than the reasonableness of a covenant not to compete for a sale of business or in connection with acquiring an ownership interest in a company.

While there are many issues that can threaten the enforceability of an employee noncompete agreement, one hotly contested issue is whether the employer's noncompete agreement impermissibly prevents all competition, which is not a legitimate business interest. Instead, the noncompete agreement must prevent the employee from gaining an unfair advantage in competition with the employer.

Noncompete Restrictions in the Sale of a Business

One the one hand, the reasonableness of a covenant not to compete in the sale of a business is determined under the same rule applicable to an employer-employee non-compete clause. But on the other hand, courts addressing noncompete restrictions arising in the context of a sale of a business recognize the equal bargaining power of freely contracting parties for a covenant not to compete for a sale of business. For this reason, courts almost always focus only on the reasonableness of the application of the restraint to the specific facts of the transaction under discussion. 

Noncompete Restrictions and Acquiring Membership in a Closely Held LLC

Michigan case law analyzing non-compete restrictions between members in a closely held LLC or for that matter, even among shareholders in a closely held corporation is limited. However, the limited case law suggests that broader restrictions are likely to be enforceable in such situations. 

For example, this blog previously discussed the case of Landscape Forms, Inc v William Quinlan (2012), which involved a dispute between William Quinlan, a former employee of a Landscape Forms, Inc., a closely held corporation, challenged a non-compete agreement with Landscape. During his employment, Quinlan received stock pursuant to his employee compensation plan. The stock purchase agreements in which Quinlan received stock all contained noncompetition provisions “forbidding LFI shareholders from competing with LFI for five years after ceasing to be a shareholder.” 

The trial court had evaluated the non-compete clause in the context of an employment agreement between Quinlan and Landscape. Under that evaluation, the court elected to reform the agreement to shave off two years of the post-employment restriction, i.e., restriction reduced from five years to three years. 

The Court of Appeals disagreed, noting that the noncompetition agreement arose out of the stock purchase agreements made between the company and Quinlan rather than the employment agreement. While the Court of Appeals agreed that the trial court may reform the agreement, the Court of Appeals sent the case back to the trial court “to make modifications to the scope and duration of [the] non-competition provision as necessary to render it reasonable." In other words, the Court of Appeals signaled that because the noncompete restriction did not arise in the context of an employee and employer, shortening the duration of the noncompete agreement may have been improper. 

Conclusion

The above points show that when it comes to noncompete agreements, courts have a certain degree of discretion when it comes to determining whether they are enforceable, i.e., is the scope and duration of the non-compete clause reasonable. That discretion, however, will depend upon the context in which the noncompete agreement arises with noncompete agreements in employment relationships being the most scrutinized and noncompete agreements in the sale of a business or in closely held companies being the least scrutinized. 

For more information on Michigan noncompete law, enforcing or challenging the enforceability of a noncompete agreement, and best practices in drafting an enforceable noncompete agreement, contact Jason Shinn

Michigan Noncompete Agreements - Making 2013 a Better Year for Your Business

New Year Baby.jpgBusiness owners had a lot to cry about when it came to 2012 Michigan court decisions addressing noncompete agreements.

But, as discussed below, a lot of this frustration arose out of poorly drafted noncompete agreements and failing to fully evaluate the relevant circumstances involving changing employment relationships before reducing those changes to written employment agreements. 

Landscape Forms v. Quinlan, (Oct. 2012): This case involved a number of legal issues arising out of a dispute between William Quinlan, who had been employed by LFI, a closely held Michigan corporation. During his employment, Quinlan obtained stock in LFI pursuant to an employee compensation plan, which also included noncompetition provisions forbidding LFI shareholders from competing with LFI for a period of five years after ceasing to be a shareholder. Quinlan was permitted to retain his stock when his employment with LFI ended, but he contended that the noncompetition provisions were unenforceable.

For Michigan business owners, this case should be carefully understood in relation to offering employees stock options or other company ownership interests and imposing future employment restrictions under a noncompete agreement.

This is because the court concluded that the noncompetition provision at issue was not an employer-employee agreement subject to Michigan's noncompete statute (MCL 455.774a). At first, this result may seem surprising because Quinlan originally became a stockholder based on his employment and could not have become a stockholder in any other way.

But the Court's conclusion was based on the wording of the noncompete restriction, which specifically provided they were made between the company and the shareholders not employees. Accordingly, an entirely different analysis was required with respect to enforcing the noncompete restriction at issue.

The Take-Away: Companies offering employee stock or other ownership interests need to carefully evaluate such transactions in their entirety. One such consideration is whether any noncompete restrictions will be based on an employee/employer relationship or based on company ownership. Generally speaking, there may be more strategic reasons for a company to base noncompet restrictions on shareholder/ownership status as opposed to the employee/employer relationship, including the potential for obtaining broader restrictions.  

Van Tol v. Woodward, (Oct. 2012): This noncompete arose out of a very common fact pattern: An individual and employer enters into one agreement with noncompete restrictions and then later both enter into a new agreement. The question often becomes what, if any, noncompete restrictions survive. 

To illustrate this point, John L. Woodward began working for Van Tol, Magennis & Lang, Inc. (Van Tol) as an insurance agent in 1996. In September 2004, Woodward signed a new employment agreement with Van Tol. In the 2004 employment agreement, Woodward agreed that he would not compete with Van Tol for a period of three years after leaving Van Tol's employ. 

In January 2009, Woodward entered into a "Stock Redemption Agreement" with Van Tol. The agreement contained the following paragraph:

Merger. It is understood and agreed that all understandings and agreements heretofore had between the parties hereto are merged in this contract which alone fully and completely expresses their agreement. This Agreement may not be changed or terminated orally.

Ultimately, the Court decided that because there was an ambiguity as to the scope of their agreement to nullify earlier agreements, including the covenant not to compete, further litigation was necessary to resolve these fact issues.

The Take-Away: The situation of employers and employees entering into multiple agreements over the life of an employment relationship is a common occurrence. This is especially important in the context of terminations and severance packages.

In this regard, I've had a noticable uptick in the number of matters where disputes arose concerned whether prior noncompete restrictions survived a severance agreement. In representing individuals in these situations, in almost every instance a negotiated resolution was reached where the employer ended up with less in terms of noncompete restrictions than had been originally drafted.  

To avoid the uncertainty and litigation costs, any time an employer or employee is entering into an agreement, careful consideration should be given to what prior agreements may have been reached and whether any such agreements are intended or not intended to survive or otherwise be left undisturbed.

For more information about Michigan noncompete law or , contact Jason M. Shinn, who regularly represents companies and individuals in responding to Michigan noncompete issues and noncompete lawsuits.

Transitioning from Employee to Shareholder: Businesses and Individuals Need to Pay Careful Attention to Noncompete Agreements

GoldFish-Transition.jpgCompanies routinely require employees to sign noncompete agreements. But what happens to these employee noncompete agreements if your company offers that same employee stock options or other opportunities to acquire an ownership interest in the company? 

As explained below, when an individual transitions from employee to owner or plays the dual role of employee/owner, companies need to carefully examine the impact on applicable noncompete and stock-ownership agreements in order to avoid unintended consequences. 

Individual Going from Employee to Owner Under Stock Option Plan.

Consider for example a recent Michigan Court of Appeals decision involving a one-time employee in a Michigan closely held corporation. The employee, Quinlan, obtained company stock pursuant to an employee compensation plan during his employment with Landscape Forms, Inc. 

The stock purchase agreements Quinlan entered into contained noncompetition provisions restricting Landscape shareholders from competing with Landscape for a five-year period after ceasing to be a shareholder. After his employment ended, Quinlan was permitted to retain his stock.

An eventual lawsuit between Quinlan and his former employer was filed that involved a number of different legal issues. One such issue relevant to this article and that should cause business owners to carefully examine their current employee stock ownership programs involved the enforceability of the of the noncompete agreement that Quinlan had entered into as part of his stock acquisition.

Differences Between an Employee Nonncompete Agreement and a Shareholder Noncompete Agreement.

Returning to the Quinlan case, the employee contended that the noncompetition agreement he previously entered into was not enforceable under Michigan's noncompete statute (MCL 455.774a). One particular advantage that employers have under Michigan's noncompete statute is that if an employee noncompete agreement is found to be unreasonable, a court may "limit [an] agreement to render it reasonable in light of the circumstances in which it was made and specifically enforce the agreement as limited" after it has been revised by the court.However, for various strategic reasons I do not recommend employers relying on a court to revise an unenforceable noncompete agreement. 

d MCL 

The Court of Appeals, however, disagreed with the the trial court’s finding that the noncompetition provisions were employer-employee agreements and therefore specifically governed by Michigan's noncompete statute. Instead, the Court concluded that the stock purchase agreements containing the noncompete restrictions were made between the company and the shareholders - not the company and employees. Accordingly, Michigan's noncompete statute was not applicable and the lawsuit was returned to the trial court to evaluate certain issues relative to the noncompete agreement, including when Quinlan ceased being a shareholder.

The Take-Away for Employers and Employees

For Michigan business owners interested in offering employees with stock options or other deferred compensation, many issues must be considered. In addition to the financial issues, business owners need to focus how such options may affect personnel policies and employment agreements, including noncompete agreements.

As the above case illustrates, employee noncompete agreements and shareholder noncompete agreements will be treated differently. Based on experience, such differences can provide employers with significantly more advantages than may otherwise be available under an employee noncompete agreement and correspondingly significantly more restrictions for the individual.

For these reasons, both employers and employees should consult with an experienced noncompete and business lawyer before entering into an employee stock option or ownership agreement. Feel free to contact Jason M. Shinn for information about these issues. 

DIY Employment and Noncompete Agreements: Are You Getting What you Pay For?

DIY InstructionsThe storm that has devastated the U.S. east coast has been dubbed "Frankenstorm" because of the devastating effect of a number of separate natural conditions coming together to create a monstrous "super storm."  

While with less devastation and real-life danger, employers often experience their own employment storms as a result of stitching together various employment agreements in a "do it yourself" approach to managing employment issues. Certainly businesses can't be faulted for trying to limit their operational expenses, but too much cost-cutting may end up hurting the business in the long run. 

Take for example a noncompete dispute matter my law firm recently handled:  Specifically, we had the opportunity to take advantage of a "Frankenstein-like" HR strategy to challenge an employer's noncompete agreement and reach a resolution that favored my sales representative client.     

Generally speaking, the employer's new employment hire package contained two separate employment related provisions: One provision of the agreement contained a boiler-plate noncompete restriction. It was discovered that this noncompete provision actually came from the employer's out-of-state supplier and who knows where it came from before this.  

The other provision of the employment agreement contained a 90 day probationary period. The agreement and both provisions, however, had not been reviewed by legal counsel for the employer.

This failure explains why the two provisions - the probationary period and noncompete provision - conflicted. So setting aside the legal sufficiency of both, the real benefit for my client was that in piecing the two agreements together there was a solid argument that one provision negated the other. 

Free Employment Law Forms: Be Careful to Avoid You Getting What you Pay for.

The problem for the employer began and ended with its employment offer letter that provided in part "Either the employee or [employer] may terminate the employment within the introductory period, without consequences ..." 

So the argument to be made was as follows: To give full effect to the employer's provided agreement that if the individual's employment was terminated within the 90 day probationary period it would be "without consequence," required that the noncompete would also be of no consequence. 

The end result was that the discrepancy created by the employer's documents was enough to negotiate a favorable resolution for my client, including voiding the employer's noncompete provision calling for a year post-employment restriction and 60 mile restriction. 

The Take-away for Employers

Certainly companies have easy access to information over the Internet or through other, non-legal sources that can be used to prepare employment-related contracts, including offer letters and noncompete agreements. If this is the route your company chooses to take, at a minimum, companies should verify that any non-attorney drafted employment forms are valid for your state, are current, and are legally sufficient for your business needs and valid in your company's jurisdiction. 

But taking a "DIY" approach as your company's employment/HR strategy is certainly without risks as demonstrated by the above example.  As the above example illustrates, it is likely that had the employer's agreement been properly drafted by legal counsel, the employer would have ended up with what it intended; an enforceable noncompete restriction that protected the employer's reasonable competitive business interests by limiting its former sales representative from working in the specified geographical location for one year.

For more information about how noncompete agreements can protect your business against unfair competition, see Locking Down Trade Secrets Begins with Enforceable Noncompete and Nondisclosure Agreements or contact attorney Jason Shinn

Preventing an Employee From Working for a Competitor Unravels without an Enforceable Noncompete Agreement

Unraveled.jpgA fantastic, but often overlooked movie is True Romance. The movie stars Christian Slater whose character, Clarence Worley, delivers the following line:

If there's one thing this last week has taught me, it's better to have a gun and not need it than to need a gun and not have it.

This line should also be in the mind of every employer when it comes to using employee noncompete agreements. A recent decision by the Michigan Court of Appeals where the court sided against the employer in a dispute between it and the former employee reinforces this point. This decision also provides important insight to individual employees for avoiding liability for improperly competing against their former employers.   

Employee is Hired. Employee Departs. But where is the Noncompete Agreement? 

In Michigan One Funding, LLC v. MacLean, the individual employee was employed as Michigan One's president, but shortly thereafter resigned to leave for a competitor. 

While employed, Mr. McLean had signed an employment agreement requiring, among other items, that he return all of the company's property upon termination of his employment. Significantly and ultimately to the detriment of the former employer, Mr. McLean did not enter into any noncompete agreement.

If You Are Trying to Prevent a Former Employee From Working for a Competitor, Creative Legal Theories May Pay the Price of Admission to get into the Courthouse, But without a Noncompete Agreement, Don't Expect to Stay Too Long.  

Shortly after Mr. McLean's departure, his former employer filed a lawsuit to obtain a preliminary injunction to prevent him from working for a competitor. However, because there was no noncompete agreement in place, the former employer was left to cobble together the facts and circumstances into various claims, including conversion, unjust enrichment, and a violation of the Computer Fraud and Abuse Act. The Court was not buying this and found that the plaintiff employer simply did not have any proof that its former employee had actually stolen or used any of its confidential information.

In reaching this decision, the court rejected the former employer's argument that because its competitor's business actually increased after the former employee's arrival, there must have been a disclosure of its confidential information. But the court found, again, that there was no proof of any causal relationship between the increase business and claimed disclosure. Accordingly, the court ended up dismissing the employer's lawsuit, which was affirmed on appeal.    

Lessons Learned For Employers - It is Better to have an Enforceable Noncompete Agreement and Not Need it than Need a Noncompete Agreement and Not Have it.  

For employers, the shortest distance between preventing a former employee from going to a competitor and unfairly competing is an enforceable noncompete agreement. This is because supporting such a claim in a lawsuit is significantly streamlined and an easier preposition rather than resorting to creating a Frankenstein-like amalgamation of legal theories like those relied upon above.

Additionally, having a noncompete agreement means that employers avoid - or at least put off - having to "put up or shut up" in terms of convincing a court your company should be able to prevent an individual from working for a competitor. In other words, the court above picked apart the former employer's claims at the begninning of the litigation because there was little to no evidence of disclosure. 

In contrast, with a noncompete agreement, an employer's proof is much more straightforward: Did the employee sign a noncompete agreement; Is that noncompete agreement enforceable; and Did the former employee breach the noncompete agreement? This analysis is intentionally simplified and omits a number of elements to be addressed in a noncompete lawsuit, but it illustrates the entirely different and employer-friendly analysis that a court will likely engage in.

Also in terms of unearthing evidence, it can be an expensive up-front cost because of the frequent need for computer forensic examinations to show the former employee took and used trade secret or confidential information to unfairly compete. Based on our law firm's experience, in the Metro Detroit market these examinations can run a couple thousand dollars per PC/laptop, which excludes attorney involvement time for reviewing the results making them an expensive gamble for employers. And without a noncompete agreement, an employer is left to double down on the bet that some digital dirt will be found.

In the case under discussion, the parties actually discussed and Mr. McLean agreed to submitting his personal computers and storage devices to a computer forensic examination. It is also noteworthy that this forensic examination did not take place due to no fault of Mr. McLean. In other words, the employer seemed to be the reason for why this computer forensic examination did not take place. 

Lessons Learned for Employees - Don't Get Into a Noncompete/Unfair Competition Dispute in the First Place, but in any event, Plan for the Worse.     

For individuals, Mr. McLean appears to be a text book example of how to leave one employer for a competitor.

First, Mr. McLean returned all files and information that he had access to during his employment. 

Second, he also confirmed that he was in compliance with the terms of the employment agreement in that he had returned all of his former employer's information.

Third and most importantly, Mr. McLean's representations appeared to be truthful, especially in light of his agreement to make his home computers and portable storage devices available to a court appointed computer expert for a forensic inspection.  

Fourth, prior to his resignation, Mr. McLean did delete a number of computer files (416 to be exact) consisting of old work files that were outdated work product. This deletion, however, was in compliance with whatever policies his former employer had in place and the files were retrieved by the former employer's IT personnel.

In this regard, it is important for departing employees to understand and comply with whatever computer policies an employer has in place. It is also important not to take extraordinary efforts to circumvent those policies, which may raise suspicion. For example, while Mr. McLean did delete files, he did so without using any sort of software deletion tool to irretrievably delete those files.         

Conclusion 

Certainly the steps taken by Mr. McLean did not insulate him from a lawsuit. But that lawsuit was ultimately dismissed in his favor, which is the next best result.

This Blog has written extensively about claims under the Computer Fraud and Abuse Act (see also this link) arising in the employment relationship. For more information about noncompete agreements and court actions for breach of a noncompete agreement. To discuss your specific noncompete agreement questions, contact Jason Shinn, whose law firm specifically focuses on noncompete law and litigation

Trade Secret Misappropriation - $taggering Numbers For Employers to Consider

Safe and Barbwire.jpegLast week I attended the State Bar of Michigan's Information Technology Law Section Seminar, Core Legal Issues in a High-Tech Business World. It was a great overall day of presentations.

One presentation that stood out from a business owner's perspective, however, was given by attorney Leigh Taggart - Protecting Software Trade Secrets.

Trade Secret Misappropriation by the Numbers: Another Thing to Keep Employers Up at Night.

Mr. Taggart discussed a survey about trade secret litigation that covered 394 federal district court cases with written opinions issued between 1950 and 2008. The numbers further break-down as follows:

  • The number of federal trade secret cases doubled between 1988 and 1995 and doubled again 1995 to 2004;
  • With respect to trade secret misappropriation, 90% of misappropriators were known to trade secret owner: Employees were involved in 59% of trade secret misappropriation claims and business partners made up 31% of trade secret misappropriations; and
  • When it came to what law applied, Michigan trade secret law was applied in 6% of the federal court cases, which was only behind Illinois (11%), New York (10%), and California (8%).

Significantly, when state court cases (appellate courts, not trial court decisions) were analyzed - 358 cases between 1995 and 2009 - the number of known misappropriators was similar (93%), but employees made up 78% of the misappropriation claims and business partners 15%.

Estimated $45 to $300 billion in annual losses due to
trade secret misappropriation

According to Mr. Taggart's presentation, these misappropriation numbers translate into an estimated $45 to $300 billion in annual losses. 

Next Actions Employers Should be Taking to Protect Trade Secrets

For me, as well as most employers, the number that stands out is that employees are the biggest threat when it comes to misappropriation claims. Accordingly, two critical issues that employers should be addressing:   

The first line of defense in trade secret protection is using smart, well-drafted employment agreements, that contain noncompete agreements and nondisclosure provisions. Such agreements are certainly a "best practice," but they also provide significant strategic value when it comes to trade secret litigation.

Specifically, a breach of contract claim will more likely be easier to prove than a trade secret claim. And once a breach of contract claim is established, it is much more likely that a trade secret claim will also be successful.

The second benefit provided by appropriate employment agreements, such as noncompete and nondisclosure agreements is that it is an easy, objective means to show that the employer has taken reasonable steps to protect against improper disclosure of the alleged trade secret.

For employees, especially those with entrepreneurial goals for starting their own business, it is important to understand the scope of their contractual obligations before taking steps to start-up their business and compete against their prior employer.

This analysis begins with any noncompete or nondisclosure agreement signed by the employee and what restrictions are in place. It is equally important to evaluate whether the noncompete or nondisclosure agreement will likely be enforceable. For more information on these issues, see Are You Shooting Yourself in the Foot by Making this Common Mistake Before Starting Your New Business?

For more information about Michigan trade secret law or the drafting noncompete agreements or noncompete lawsuits see My former employer can't prevent me from working, right? Dissecting the Enforceability of a Noncompete Agreement or What Happens When a Noncompete Agreement is Violated? A Blueprint for Noncompete Litigation. Also, contact Jason Shinn with any additional questions. 

My former employer can't prevent me from working, right? Dissecting the Enforceability of a Noncompete Agreement

Scalpel.jpgAfter an individual's employment is terminated and that individual begins working for a competitor or starts his or her own business, a common question asked by both the individual and the former employer is whether a noncompete agreement can be used to restrict one's post employment opportunities.    

The short answer is ... well, there really is not a short answer because the enforceability of a noncompete agreement will depend upon any number of facts and circumstances.

Having said this (isn't it just like a lawyer to talk out of both sides of his mouth?) under Michigan law, noncompete agreements are enforceable as a matter of course, but such enforcement is subject to numerous requirements, some of which are discussed below. 

Employers and Employees May Enter into Noncompete Agreements under Michigan Law. 

Under the Michigan Antitrust Reform Act (MARA), MCL 445.771 et seq., an employer and employee are free to enter into an agreement to protect the employer’s “reasonable competitive business interests” and to prevent post employment competition by the employee, as long as the agreement is reasonable in duration, geographical scope, and the type of activity restrained. MCL 445.774a. The employer has the burden of showing the reasonableness of the noncompete agreement.

Dissecting What Makes a Noncompete Agreement Enforceable or Unenforceable

So let's dissect exactly what an employer or employee should consider in determining what impact a noncompete agreement will have on future employment opportunities and competitive interests.   

  • What is Protectable as a "competitive business interests? 

Noncompetition agreements may be used to protect interests such as “trade secrets, confidential information, close contact with the employer’s customers or customer lists, or cost factors and pricing.” In essence, if something provides your business with an advantage over your competition, it should be a "competitive business interest" that is worth protecting.  

  • What is not Protectable as a "competitive business interest? 

Noncompete agreements cannot, however, prohibit future use of an employee’s “general knowledge or skill.”  

  • The Scope of the Restriction Must be Reasonable. 

The noncompete restrictions that must be "reasonable" generally involve geography and time, i.e., how long is the restriction in place? In this regard, the Devil is certainly in the details and it is those details that will drive the analysis to determine if a noncompete agreement will be upheld as reasonable or struck as unreasonable.

In dissecting those details, the following considerations will be critical to the analysis of the enforceability of a noncompete agreement:  

  1. Broad Geographic Limitations May be Reasonable.  The reasonableness of a geographic restriction will depend on the nature and scope of the employer’s business and the nature of the employee’s duties and responsibilities. Under some circumstances, an employer may be entitled to a global restriction to protect the employer’s reasonable competitive business interests. For instance, applying Michigan law, a worldwide noncompetition agreement has been considered “reasonable if the employer actually has legitimate business interests throughout the world.” In that case (Superior Consulting) the employer conducted business in 43 states and several foreign countries, which supported the court's conclusion that the noncompetition agreement's unlimited geographical scope to be reasonable.
  2. Broad Geographic Limitations May be Unreasonable. The geographic scope of In other cases, the courts have used their discretion to limit the geographical scope of an agreement to a rather small area. For example, in Robert Half Int’l, Inc v Van Steenis, 784 F Supp 1263 (ED Mich 1991), where the defendant provided the same services as his former employer, the court limited the geographical scope to a 50-mile radius of the former employer’s offices.
  3. The Duration of a Noncompete Agreement Must Be Reasonable. Similar to geography, the reasonableness of a time restriction in a noncompete agreement will depend upon the facts and circumstances involved. While each situation should be independently assessed, as a general rule of thumb, six months to a year will often be upheld as reasonable. But again, there is no science to this determination and there will often be circumstances that permit this time to be expanded.  

Closing Thoughts

Noncompete agreements involve an area of law that both employers and employees should not leave to chance because there are significant ramifications to both. Further, noncompete law is very specialized and often very fact intensive when it comes to the enforceability of a noncompete agreement and knowledge of how the law may apply to your particular situation or industry is critical for drafting an enforceable noncompete agreement.

In addition to the legal issues discussed above, drafting a noncompete agreement that is likely to be upheld requires careful attention to its practical application. For example, a noncompete agreement drafted too broadly that effectively eliminates an individual from being able to work in any capacity has little chance of being enforced. 

For more information about drafting enforceable noncompete agreements, please contact Jason Shinn. Also, see What Happens When a Noncompete Agreement is Violated? A Blueprint for Noncompete Litigation, for more information about enforcing or defending against a noncompete lawsuit. 

Proposed Legislation Introduced to Restrict the Enforceability of Noncompete Agreements

Contract Documents.jpg

Under Michigan law, noncompetition agreements (sometimes referred to as covenants not to compete or restrictive covenants) are generally enforceable as long as the restriction is reasonable as to subject matter, geographical scope, and duration.

But recently proposed legislation would significantly limit Michigan's noncompete law, which is found in Michigan's Antitrust Reform Act (MARA), MCL 445.771 et seq.

Specifically, the proposed noncompete amendment (S.B. 0786) reads as follows: 

An employer shall not require and a Court shall not enforce an agreement or covenant under this section as a condition of employment if the employer did not inform the employee of the requirement at or before the time of the initial offer of employment. 

This proposed amendment would apply only to agreements entered into after the effective date of the amendment.  

Criticisms of the Proposed Noncompete Legislation 

As proposed, both employers and employees should be concerned about limiting the enforcement of noncompete agreements. Consider for example the following: 

First, the proposed amendment is overly restrictive in that employers get one shot at the beginning of the employment relationship to obtain an enforceable noncompete agreement. This may lead employers to simply require noncompete agreements for all new hires, irrespective of the actual position. 

Second, the proposed noncompete legislation does not make any exceptions for situations where an employee is hired into one position not subject to a noncompete agreement but is later promoted within the company into a position that is covered by a noncompete agreement.

For example, a noncompete agreement may not be necessary for a person hired to simply perform administrative work/data processing in a sales office. But an employer would likely want that employee to agree to a noncompete agreement if he or she is later promoted to a sales position where there is direct access to customers, highly confidential pricing information, product or service development, customer databases, marketing information, etc.

Under this scenario and the proposed legislation, an employer may bypass internal promotions and look to hire a new employee who could then enter into the required noncompete agreement?

Improving the Proposed Amendment Noncompete Legislation  

The proposed noncompete legislation was introduced by Michigan Senators Tory RoccaSteven Bieda, and Rebekah Warren.

I spoke with a representative from Senator Rocca's office (who was very helpful and knowledgeable) about the motivation for the noncompete legislation. In sum, Senator Rocca's focus for proposing this amendment is to protect individual employees with little to no leverage after being hired who are then asked to enter into a noncompete agreement.  

But rather than handcuffing both employees and employers, I would rather see an amendment that simply specifies the consideration that is required for a noncompete agreement obtained post hire to be enforceable. 

In this regard, Michigan, like most jurisdictions, routinely enforce noncompetition agreement signed by newly hired employees because employment alone is sufficient consideration for the noncompetition commitment. 

But the enforceability of noncompete agreements entered into by individuals already employed and later asked to sign a noncompete agreement in exchange for only continued employment is not so clear under Michigan law.

This is because Michigan's highest court has not addressed this issue. And lower courts have done so only in unpublished opinions, which have have no precedential effect under the Michigan Court Rules (See MCR 7.215(C)(1)).

As to those unpublished opinions, Michigan Courts have concluded that continued employment is sufficient consideration to support the validity of a noncompetition agreement. See Camshaft Mach Co v Rose, No 114314 (Mar 7, 1990). Camshaft involved an at-will employee who was already employed and later was required to sign a noncompetition agreement. The employee received nothing other than continued employment in exchange for signing. One year later the employee resigned and joined a competitor in violation of the noncompete agreement, which resulted in litigation and eventual court opinion that the noncompete agreement was enforceable. 

Conclusion

Based on my experience in representing both employers and employees in noncompete legal issues, imposing an outright ban on enforcing noncompete agreements after the initial hire will not benefit either employers and employees. 

Instead, both sides would be better served with a clear delineation as to the circumstances of when a post hire noncompetition agreement will be enforceable. Regardless of whether it is legislatively determined that continued employment will be sufficient or if some other additional consideration will be required, e.g., a one time payment, a promotion, or other benefit, at least both employers and employees will have the certainty that is presently lacking under current Michigan noncompete jurisprudence.     

The proposed legislation has been referred to the Economic Development Committee and we will continue to monitor it. 

What Happens When a Noncompete Agreement is Violated? A Blueprint for Noncompete Litigation

Blueprints.jpgEmployers commonly require employees to execute noncompetition agreements (also referred to as covenants not to compete or restrictive covenants). Under Michigan law (MCL 445.774a), such agreements will be enforceable if reasonable.

In theory, an enforceable noncompete agreement generally places certain limitations on an employee's ability to work for a competitor or to start a competitive venture business following an employee's departure. But as the venerable Yogi Berra noted, "In theory there is no difference between theory and practice. In practice there is."

So setting theory aside, in "practice" what happens when an employee is in violation of a noncompetition agreement?

There are few right or wrong answers in terms of a proper response, just trade-offs between decisions and informed decisions. But the following are a few critical strategic issues that should be considered when it comes to drafting a strategy for litigating noncompete issues: 

Is the noncompete agreement enforceable?

Before taking any action against a former employee, the first question that needs to be answered is whether the noncompete agreement is enforceable. Otherwise, you could be exposing your company to liability. Consider, for example, former employers have been held liable for tortiously interfering with their former employee's new employment relationship by threatening litigation over an unenforceable non-compete agreement.

Should the new employer be sued?  

Assuming the noncompetition agreement is enforceable, the next question is who should be sued: the former employee, the new employer, or both? The answer to this question will depend on a number of considerations.

Reasons for not suing the new employer 

The new employer may not have notice of the noncompete agreement, which warrants against naming it in the lawsuit. Sending the new employer a copy of the non-compete agreement and advising that, if necessary, you intend to fully enforce your legal rights under the non-compete has several advantages:

  • Generally a new employer is not interested in "hiring a lawsuit" and its associated costs. Accordingly, it may voluntarily terminate the new hire to avoid both once it is educated about the noncompete agreement and subsequent violation by the former employee.
  • Providing notice also has value in that it concretely documents the new employer's knowledge of the non-compete agreement. Not only is such knowledge a likely element for your legal claim, it also puts you on better footing when asking a judge to award injunctive relief against the new employer (i.e., a temporary restraining order) by showing the new employer had actual knowledge of the noncompetition agreement that is being violated. This eliminates a compelling argument that judicial relief should not be awarded against the new employer because it was merely an "innocent bystander" caught in the crossfire between you and your former employee.
  • In addition to providing notice of the actual noncompete agreement, you should also put the new employer on notice that an evaluation of its preservation obligations is appropriate in response to a reasonable expectation of litigation. By providing such notice, you are laying the foundation for later obtaining sanctions if there is a failure to preserve information involved in the litigation. 

Another reason you may not want to sue the new employer is because an individual employee is unlikely to have sufficient financial resources to hire legal counsel to defend against the noncompete violation. But by suing the employer, you may make a "deep pocket" available in which to pay legal expenses or the new employer may have insurance that extends to the individual employee. 

Reasons to Sue both the Former Employee and New Employer

You may have "smoking gun" evidence, such as e-mails between the former employee and new employer showing that the new employer actively encouraged the individual to misappropriate your information with the intent to violate the non-compete agreement, which leaves you with little choice but to sue the new employer.

There may also be compelling business reasons for suing the new employer. For example, the new employer may be using your former employee (and likely his or her knowledge previously gained from your company) to move into your market or geographical region or to actively solicit your current employees and/or customers. Obviously these circumstances create compelling business and legal reasons to include the new employer in the litigation.

It is important, however, to make certain business justifications do not overshadow state or federal legal and ethical requirements for maintaining an action. Generally, speaking, a claim must be well grounded in fact and warranted by existing law. Failing to comply with these requirements may result in a range of sanctions for filing a legally frivolous claim.  

Conclusion

The reasonableness of a noncompete agreement is often subject to judicial interpretation. It is, therefore, absolutely essential when drafting noncompete agreements to understand the statutory requirements for an enforceable noncompete agreement. As noted above, these requirements focus on "reasonableness." 

And when it comes to noncompete litigation it is often more art than science where there are no fixed or mechanical responses for responding to a breached noncompete agreement. Instead, each set of circumstances has its own unique business and legal issues. Accordingly, a noncompete litigation strategy should be developed by considering the above issues and other relevant considerations with legal counsel and business stake-holders.

Recent Michigan Court Decision Highlights Weak Link in Enforcing Non-compete Agreement

Weak Link.jpgA recent Michigan Court of Appeals Opinion dealt a serious blow to the enforcement of noncompete agreements. The Opinion invalidated a common provision found in such agreements and it illustrates that courts will closely scrutinize noncompete agreements for any weak links that may limit or otherwise invalidate these agreements.  

Overview of Non-compete Agreements

Employers commonly require employees to enter into an agreement referred to as a covenant-not-to-compete, restrictive covenant, or simply a non-compete agreement as a means to protect the employer's reasonable competitive interests.

In the employment setting, these agreements generally require an employee to agree not to pursue a similar profession or line of work in competition against the employer. It is also common for a restrictive covenant to contain provisions that kick in when an employee leaves employment. Examples include restrictions on soliciting customers, hiring current employees, and to not use or disclose certain information of the former employer. 

Michigan has a specific statute that covers the enforceability of non-compete agreements between employers and employees. (MCL §445.774a). Under this statute, one requirement for a non-compete agreement to be enforceable is that it must be "reasonable as to its duration, geographical area, and the type of employment or line of business." 

Michigan Court Invalidates Non-compete Agreement Provision 

A common provision in non-compete agreements, however, was invalidated by a Michigan Court of Appeals panel. Specifically, in Teachout Sec Servs v Thomas (2010), the Court addressed the following provision: "Employee acknowledges that the covenants and agreements ... are reasonable and required for the reasonable protection of Teachout and its respective relationships to customers ..."

The Court concluded that this contractual stipulation as to the "reasonableness" of the contract terms between the employee and employer was not binding. The Court reached this decision despite acknowledging that under Michigan law it is presumed that contracts voluntarily entered into are legal, valid, and enforceable as written. Instead, the Court noted that non-compete agreements “are disfavored as restraints of commerce and are only enforceable to the extent they are reasonable." (p. 6). The Court reasoned that it was, therefore, appropriate to bypass the presumption that contracts are enforceable as written and look behind the curtain to determine for itself if the agreement was actually reasonable. The Court concluded that it was not, and invalidated the non-compete agreement.  

The Take Away

The Teachout Court, however, concluded that this contractual acknowledgement of reasonableness did not prevent the Court from playing "Monday morning quarterback" to determine for itself if the agreement was actually reasonable. In so doing, the Court agreed with the trial court's granting the defendant employees summary disposition, i.e., judgment in their favor.  

The Teachout decision addressed a number of important issues involving Michigan non-compete law, including the importance of strategy in pursuing these claims (I don't think the former employer helped its cause by suing the individuals under the circumstances, but give me a call and I'll share my two-cents on this point). But one key take-way for employers is that it should be assumed a non-compete agreement will be subject to "Monday morning quarterbacking" by a court to determine for itself if the agreement was actually reasonable.

It is, therefore, critical for employers to carefully review their non-compete agreements to make sure there are no weak links. In this regard, Michigan Courts will generally evaluate four aspects of the parties agreement to determine its enforceability:

  1. The employer’s reasonable competitive business interests;
  2. The duration of the limitation on competition;
  3. The geographic area in which the employee is restricted from competing; and
  4. The type of employment or line of business in which the employee is restricted from competing.

For employees, it is equally critical to understand what restrictions you are agreeing to by signing a non-compete agreement. Certainly in the current economic environment employees may have little choice but to accept a job with whatever conditions are attached to the position. But it is still important to understand the full-scope of those conditions and how they apply to your future career plans.