High Tech Noncompete Agreements; Anachronism Under Siege

This article by Stuart Adams appeared in Louisville Computer News February, 2000

Noncompete agreements have been a source of strategy, control, frustration, revenge, and litigation for years. They have been the topic of conversation around the highly polished and elaborate conference tables in the board rooms of powerful companies, as well as in start-ups, where the talk may be around the kitchen table. A recent judicial decision by a Federal court in New York could change how we look at these agreements for technology companies. More on that later, but first some background.

Noncompete agreements have been very, very good to me. That’s because I’m a lawyer. I’ve drawn up hundreds for my corporate clients and gotten in the habit of collecting good or unique language from those I’ve seen in 25 years of practice. I’ve also litigated many "to the death." This is also great for lawyers.

There also seems to be an endless supply of both employees calling to see if they can get out of one, as well as employers asking to have one drawn up or to improve on one they have recently had struck down in court. So, you might ask, why am I writing an article proposing that we change the law on noncompete agreements in this area. The reason is that I hate them, as I generally see them applied to talented young, but inexperienced professionals in a wide variety of fields. Even worse, since most of my corporate practice has gravitated to the representation of start-up e-commerce and high-tech companies, I honestly believe they are causing a "brain drain" in this area. This is absolute "death" to the espoused goal of our local civic and economic development leaders, who believe, as I do, that we have the present potential to create a sort of Midwest haven for high-tech companies.

There is definitely a place for a reasonable, well written noncompete agreement. On the other hand, if we lure talented people to talk to our local companies and they are interested in the job, we often find we lose them to another location. More than once, this has been because they are savvy enough to be unwilling to destroy their career by signing a "traditional" local style noncompete agreement.

For those few readers who have never had the delight of reading this sort of agreement (which I have occasionally found is the case with my clients, even thought they had clearly signed one) it is typically in the form of a written document submitted to a potential employee at the time of employment. It is sometimes part of an employment agreement, but could just as easily be a "freestanding" document that may be "forced" upon the employee years after the initial hiring.

A typical noncompete agreement, if there is such a thing, provides that the employee will not engage in any activity, after departure from employment with the current employer, which would be deemed to be in competition with the employer. The agreement will also typically give some definition to what the employer does, therefore defining what competition is or is not. Additionally, it will be limited perhaps to a term of a few months, up to several years, and will have some geographic limitation. Typically the departing employee will be free to compete with the former employer outside of the geographic noncompete territory, or even within the territory after the time period expires. Some courts, in specific situations, will engage in a "blue pencil" revision of an overbroad agreement, so as to enforce it, but, for instance, for a shorter period of time, or in a smaller geographic area.

Many of these agreements will contain additional provisions. Some will provide for a perpetual nondisclosure of the employer’s trade secrets (which do not necessarily follow the definitional guidelines of the local statutory version of the Uniform Trade Secrets Act) or other "protected" information of the employer. Some may also contain "noninterference" language, which prohibits employees from encouraging other employees to leave to join the original departing employee in competitive activities with the original employer. Typically these agreements prohibit both direct and indirect competitive activities, such as a consultant to a competitor, or substantial investor in a competitor.

These days such an agreement will typically be deemed "more" enforceable, the smaller the geographic area and the shorter the time period of the prohibition. A finite and direct connection between specific provisions of the noncompete prohibition and the strength of the employer’s relationship with specific, sensitive, and perhaps exclusive, clients, the better. They traditionally are more often upheld, if negotiated as part of the sale of a business, where the departing owner is paid separate consideration for not competing with the buyer after the sale. Conversely, the longer the term and geographic range of the prohibition, the more likely the agreement will be deemed unenforceable.

In early judicial decisions in the United States, agreements in restraint of trade or having a tendency to destroy or restrict competition were held to be void on the ground that they were contrary to public policy. Later cases held that "an agreement in restraint of trade is reasonable if, on consideration and circumstances of the particular case, the restriction is such only as to afford fair protection to the interests of the covenantee and is not so large as to interfere with the public interests or impose undue hardship on the party restricted."

Many early case provided that unless the noncompete agreement was signed when the employee was hired or was accompanied by additional and separate compensation, it was invalid because there was a lack of "mutuality" or consideration passing in both directions. Later cases, however, have often held, and particularly with local jurisdictions, that as long as an employer keeps an employee on for a reasonable time after the noncompete agreement is signed, it can be enforced, even if it is imposed on the employee long after date of hire, and without any additional consideration.

On an average of at least a couple of calls a week, I am asked, are these things really enforceable? My lawyer back home told me they were no good," etc. While that may be true "back home" it generally is not true locally. Almost as often, I am told, "gee, I signed that thing, but I knew it couldn’t be enforced, so I figured, what the heck, I’ll sign it because I needed the job." I always hate to be the one to break the bad news, so I often suggest they get a second, local opinion if they don’t believe me when I tell they these agreements are routinely enforced around here. Not that that’s a good thing.

To add even more confusion to the situation, there is not only a difference in how and to what extent noncompete agreements are enforced around the country, but there are also various differences in how they are even enforced in the same city. In the Louisville metropolitan area, for instance, if you sue in federal court, you may get one result while getting another if the suit is in state court. This is true even if the federal court is applying state law on the subject. Go a few hundred yards across the Ohio River to Southern Indiana, and you have a new set of judicial decisions.

Additionally, there are other exceptions to the general rule of enforceability. Perhaps, because of some very good attorneys on the side of medical practitioners, the theory that limiting the ability of "highly skilled" or "uniquely talented" physicians to practice their trade in competition with their former medical partners is still against "public policy," may be more successful in court than with one in, say, the janitorial services industry. Lawyers have their own ethics problems with trying to limit their clients’ access to departing members of "the firm." In other states various professions, such as accountants, engineers and others, may very well also be accorded disparate treatment by statutes or judicial decisions.

Some companies have very well drafted noncompete agreements which they rarely, if ever, try to enforce. Some have horribly overreaching agreements which exceed the bounds of reasonableness in the marketplace or the courthouse, but they still sue everybody who leaves.

Often, this is not a reasonable effort by a company to protect its trade secrets and protectable information. Many times it is a blatant power play. The employer knows that by hiring all the young talent it can, and getting this talent to sign a strongly worded noncompete agreement with the promise of a long and lucrative career with the company, it can fire the employee whenever it wants, and run them out of the marketplace with noncompete litigation.

Typically these noncompete agreement suits are combined with other claims, such as that the employee took a Rolodex or other such alleged "trade secret," even though such customer address lists usually are not held to qualify as a trade secret. Additionally, claims that the departed employee is "unfairly" competing will often also work their way into the litigation.

In a "classic" case, the departed employee, as first notice that "there may be a problem," is served with a summons and restraining order, which the employer’s attorney has already obtained without a full hearing. This restraining order will prohibit the employee from doing anything in "competition" with the former employer, and may impose other restrictions which keep the employee from earning a living, until such time as he or she can hire their own lawyer, and get the employer back into court to "dissolve" the restraining order, thus putting off the major battle on the merits of the case until another day. The definition of "competition" as well as the identity of who is or is not a "client" may very well be up for grabs.

If the employee loses this first real battle, the war may already be over. The employee will often either start to run short on money, or be forced to move outside of the prohibited competition area, thus making the defense more difficult and expensive. Meanwhile, the employer keeps on making money in something of a contractually imposed vacuum. Score another one for the employer, except that eventually they get such a reputation for such conduct, they find they inexplicably have trouble hiring new talent. Score a loss for the employer and the community.

In October of 1999, a federal judge in New York crafted a decision which The National Law Journal, for one, called a "wake up-call to technology companies and their counsel." The case was Earthweb vs. Schlack, and is available online in full text version. Get some paper ready if you want to print out the Adobe format text, because it runs over 40 pages.

The case involves an employer, Earthweb, which provides online services and products to businesses, and Mark Schlack, who was one of several vice presidents, and was in charge of "content" on the company’s website. When Schlack resigned less than a year after date of hire, he accepted employment with ITworld.com, which furnishes information technology print-based data. Earthweb, of course, sued Schlack, alleging violation of the noncompete agreement, and sought a restraining order to keep him from working for ITworld.com. There was apparently no evidence that Schlack had misappropriated trade secrets from nor solicited clients of Earthweb.

In order to obtain a restraining order a party must prove that it will suffer "irreparable injury." Injury is not typically irreparable, if it can be remedied with money damages. The trail judge in Earthweb acknowledged that "irreparable injury may be presumed if a trade secret has been misappropriated. A trade secret, once lost, is lost forever; its loss cannot be measured in money damages." Looks bad for Schlack at this point, doesn’t it?

The court then went on, however, to discuss the" imperceptible shift in bargaining power that necessarily occurs upon the commencement of an employment relationship marked by the execution of a confidentiality agreement," and opined that "the risk of litigation alone may have a chilling effect on the employee." The court found that the collective impact of various provisions of the "at-will" employment contract was to "indenture the employee to Earthweb."

Although the court’s opinion contains much of the classic defense case law language, such as: "powerful considerations of public policy which militate against sanctioning the loss of a man’s livelihood..." the following passage is part of the "wake-up call." The judge in Earthweb stated that the one year noncompete (typically well within the reasonable time frame of most legal precedents on the subject), was "too long given the dynamic nature of this industry, its lack of geographic borders, and Schlack’s former cutting-edge position with Earthweb, where his success depended on keeping abreast of daily changes in content in the Internet."

Citing a 1997 New York case, DoubleClick vs. Henderson, the Earthweb judge commented that, given the speed at which the Internet industry apparently changes, the defendant’s knowledge of his former employer’s business would likely lose its value before a year was up, so that the intended effect of injunctive relief would have evaporated. The traditionally enforceable one year noncompete was the equivalent of a lifetime in the information technology industry in the Internet environment, and something the court would neither enforce according to its terms, nor "blue pencil."

This case should not necessarily give immediate comfort to local IT professionals nor to anyone in other industries in New York, let alone in this region. The impact of the case is fairly local to the jurisdiction in which it was rendered, and to the industry involved in the litigation. Most, if not all of these cases, turn on the specific combination of facts presented. Generalities, including the ones I have made above, must be compared with the law of specific jurisdictions and facts in individual cases. Nonetheless, Earthweb may mark another link in the chain of evolution of the law of noncompete agreements in the United States. In order to stop the "brain drain," it is, perhaps, something we could and should compel legislatively, rather than waiting for years for the local courts to buck prior local case from this region, which may be safer precedents.

Departing employees can take some steps to reduce the likelihood of being sued for trade secret misappropriation:

Keep an itemization (and consider obtaining a witness) to be able to prove exactly what company material you did leave when you departed, including Rolodex, customer files, bid information, pricing data, software, hardware, etc. You might even go so far, if you have a company laptop or use your own personal computer for the job, to have a neutral witness to the deletion of company data and programs from the machine, unless the employer has a different procedure or requirement. Don’t do this without checking with the appropriate person in the chain of command, because the employer might charge that you intentionally destroyed the only copy of critical company work product or data belonging to their clients. Obviously the argument could also be made that you made backups you didn’t delete or destroy, but at least it’s a thought, and can be effective if staged properly.

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