May 2, 2018

Fun and games with covenants not to compete

Posted in Employment Law by Gene Killian |

We had a case not long ago in which an employee of one of our clients went to work for a competitor.   (I’ll call the employee “Benedict Arnold,” or “Benedict” for short, and the new employer “Company B”.) The client learned that Benedict was trying to steal the client’s customers. Fortunately (the client thought), Benedict had signed a covenant not to compete. Being the great lawyers that we are, we asked the client to send us a copy. It turns out that, of all the employment contracts in the client’s files, one was missing a signature page, which had clearly been removed from the document. Guess which one? Our suspicions were later confirmed when Benedict got fired from Company B, and his manager at Company B found the missing signature page in Benedict’s desk. (Not smart, Benedict.) To Company B’s credit, they promptly forwarded the missing signature page to our client.

Benedict’s efforts to avoid his contractual obligations notwithstanding, here are a few things to remember about litigation between employers and former employees over covenants not to compete (and litigation in general).  At the risk of putting myself out of a job, litigation in any form is generally stupid. Usually, because of egos, “principle,” or tunnel vision, both sides refuse to value a case fairly, so they end up spending a ton of money, and everyone (except the lawyers) goes away unhappy.  Here’s the dirty little secret:  The only “justice” in the halls of justice generally takes place in the halls.

One key to avoiding this unhappy situation is communication. At the hiring stage, the company and the employee should specifically review any covenant not to compete together and make sure it’s understood, it’s fair, and both sides are comfortable with it.  Later, if and when an employee is leaving to go to a competitor, sit down and review contractual obligations one last time, instead of circling each other like wary predators. Be willing to be flexible and sensible about the application of covenants not to compete. Make sure both sides understand what the employee will be doing in his or her new job, and make sure that both sides agree on how the covenant not to compete will apply to the specific facts.  Remember, the word that you’re a fair employer gets around very quickly…and so does the opposite.

Let’s look at a couple of recent cases in which the parties, instead of working things out consensually, decided that the legal equivalent of a fistfight was the best option.

Medix Staffing Solutions v. Dumrauf, a decision from a Federal Court in Illinois (which you can read here), is funny on a couple of levels. First, the employer is a staffing company. You would think that a staffing company, which specializes in the hiring of employees, would be an expert in avoiding disputes over the terms of employment contracts. (Maybe they are, but they charged off into the meatgrinder of litigation on this one anyway.)  Second, you can tell from reading the opinion that the judge was annoyed at having to deal with the problem.  The allegedly competing ex-employee (Dumrauf) provided a sworn statement that he was relocating to Ohio from Arizona (where he worked for Medix) and was not performing any Arizona-related work. (The covenant not to compete had a geographic limitation of 50 miles from Medix’s Scottsdale, Arizona office.)  The Judge commented: “Medix is not satisfied with these assurances and believes that Dumrauf violated and continues to violate the covenant.  So this case goes on…)  That’s a judicial eyeroll.    

In Medix, in addition to having a reasonable geographic limitation, the covenant had a reasonable time period (18 months from the date of termination). The problem was that the covenant prevented Dumrauf from taking any position with any company that competed with Medix, or was engaged “directly or indirectly in the business of Medix,” subject to the geographic and time limitations.

When he left the company, Dumrauf informed HR and his supervisor that he was taking a position with a competitor, ProLink, overseeing its healthcare division. He said that his client interaction would be minimal, and that 90% of his work would be in Ohio and Kentucky.

Medix sued anyway, ostensibly because ProLink had an Arizona office within 50 miles of Medix’s Arizona office. Dumrauf argued that the covenant didn’t take into consideration the work that he would actually be doing for ProLink, and that the way the covenant was written, he’d be unable even to take a job as a janitor with any company involved in the staffing business.

The Court dismissed the case (and refused to modify the covenant to make it more palatable), writing in part: “[T]he covenant clearly would prevent Dumrauf from taking any number of more plausible roles [than that of a janitor] at another industry player, no matter how far removed from actual competition with Medix.  Such a prohibition is unenforceable.”  The Court further noted: “[W]here [a case] involves a covenant not to compete whose provisions are so broad as to be a ban on competition per se, courts should refuse to enforce or modify the agreement.” 

Well, THAT was worth a bucket of legal fees…

Which is not to say that Courts will never make their presence felt with respect to restrictive covenants.  In another case closer to my firm’s home, ADP, LLC v. Halpin (which you can read here), a Federal Court sitting in New Jersey sanctioned a former employee of ADP, LLC for violating a Court Order temporarily enforcing a covenant not to compete.

The Court had entered an Order barring the former employees from soliciting ADP’s existing clients, and also from soliciting ADP’s prospective clients, until the legal issues could be worked out.  (Interestingly, the covenant arose when the employees had clicked on a computer screen to obtain a stock award bonus, and the screen required them to confirm that they had read and agreed to the non-compete as a condition of continued employment.   Be careful what you click!) 

But a former employee, Halpin, refused to abide by the terms of the Order. The Court noted, for example: “On at least one occasion, Halpin admits that an…inside sales representative told him that one of the named companies was Plaintiff’s client but Halpin proceeded to meet with that company anyway.”  Halpin argued that he had “substantially complied” with the Order, whatever that means.

The Court disagreed. (By the way, the next time you go to the supermarket, try walking out after paying for only half of your groceries, and then contending that you “substantially complied” with the bill.  See what happens.)

Interestingly, ADP did not seek money sanctions from Halpin; it only wanted the Court to enter an Order commanding the former employees to stop violating the previous Order. But the Court wasn’t in a generous mood, and imposed a $1000 fine on Halpin.  The Court also said that it would impose an additional fine of $1000 against Halpin for every future violation until the end of the litigation. More painfully, the Court held Halpin liable for ADP’s legal fees.  Ouch.

The bottom line here, though, is that honest communication can often avoid serious problems. Management and departing employees should really do everything possible to avoid winding up in Court. It’s usually a gigantic waste of money.  When I was a kid, my grandmother would say to me: “Use your head for something other than a hat rack.”   It’s good advice.