Proposed Legislation Introduced to Restrict the Enforceability of Noncompete Agreements

Posted by Jason Shinn on November 05, 2011

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 Rocca, Steven 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

Posted by Jason Shinn on July 12, 2011

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

Posted by Jason Shinn on April 13, 2011

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.