Indiana Court of Appeals Decision Signals Change in State’s Restrictive Covenant Law
On April 15, 2019, the Indiana Court of Appeals issued a ruling that significantly developed restrictive covenant law in two areas: whether courts may reform contracts (as opposed to blue-penciling them) and whether non-solicitation provisions can include prospective customers.
In Heraeus Medical, LLC, et al. v. Zimmer, Inc. et al., the court of appeals—apparently for the first time—reformed an overbroad restriction rather than merely blue-penciling it. The court also clarified that non-solicitation provisions may include prospective customers, a category that practitioners had long considered to be off-limits.
Zimmer had exclusive distribution rights for Heraeus’s bone cements. When that deal ended, Zimmer employee Robert Kolbe and others joined Heraeus to work in sales. Kolbe’s restrictive covenant with Zimmer included the following provision prohibiting the solicitation of customers or active prospects, among other restrictive covenants: “[e]mployee will not, directly or indirectly, (i) provide, sell or market; (ii) assist in the provision, selling or marketing of; or (iii) attempt to provide, sell or market any Competing Products to any of Company’s Customers or Active Prospects in the Restricted Territory.” A key phrase in the definition of “active prospect” was that it meant a person or entity “to whom, at any time during the six (6) months immediately preceding the termination of Employee’s employment with Company, Employee had (i) any marketing or sales contact on behalf of Company and/or ii) access to, or gained knowledge of, any Confidential Information concerning Company’s business prospects with such Active Prospect.”
The agreement also included the following employee non-solicitation provision:
Employee will not employ, solicit for employment, or advise any other person or entity to employ or solicit for employment, any individual employed by Company at the time of Employee’s separation from Company employment, or otherwise induce or entice any such employee to leave his/her employment with Company to work for, consult with, provide services to, or lend assistance to any Competing Organization.
The period of the restrictions was 18 months.
In addition, the Kolbe agreement contained the following provision: “The parties agree that any court interpreting the provisions of this Agreement shall have the authority, if necessary, to reform any such provision to make it enforceable under applicable law.”
The trial court issued a preliminary injunction against Kolbe, enjoining him from, among other things:
soliciting anyone working for Zimmer as of November 3, 2017, or enticing them to leave their jobs with Zimmer to work for Heraeus; and
selling to or contacting any Zimmer customers Kolbe had sold to in his final two years of employment or any active prospects to whom he had marketed Zimmer products in his last six months of employment.
The Court of Appeals addressed those two key issues, among others.
New Contract Reformation Approach
The issue of whether to blue-pencil or reform the contract arose with the covenant not to solicit Zimmer’s employees. The appeals court agreed with Heraeus that Zimmer “[had] not shown that it [had] a legitimate protectable interest in its entire workforce, which includes many employees who would not have access to or possess any knowledge that would give a competitor an unfair advantage.”
Rather than invalidate the entire employee non-solicitation provision, the court noted that the “parties specifically agreed that [the court had] the authority ‘to reform any [unreasonable] provision to make it enforceable under applicable law’” (quoting the agreement).
The court then remanded the case so the trial court could narrow the preliminary injunction on employee non-solicitation to “those employees in which the company has a legitimate protectable interest.” The court did not elaborate on who those employees were.
The court did not explain its departure from what it called the “general rule” that courts may not create a reasonable restriction under the guide of interpretation. It also did not explain how its ruling was in accord with case law instructing courts not to rewrite contracts and instead only blue-pencil, or excise, overbroad language.
The ruling now allows a trial court to rewrite an overbroad provision if the contract at issue contains a provision giving that authority to the court, as many contracts do. Employers may want to consider including such provisions in restrictive covenants, and practitioners could request that relief in the event a court finds a restrictive covenant to be unenforceable and overbroad.
Prospective Customers and Reasonable Non-solicitation Provisions
Zimmer argued that covenants not to solicit prospective customers are overbroad and unenforceable as a matter of law. The court rejected that argument, saying there was an “absence of any Indiana authority that prospective customers cannot ever be a protectable interest.”
The court then found the particular non-solicitation ban for prospective customers to be reasonable because it included only “active prospects,” not all potential customers, and it had a limited duration (a six-month lookback period). As a result, the court affirmed the preliminary injunction pertaining to the ban on soliciting prospective customers.
This clarification of Indiana law is significant. Employers can likely have greater confidence in prospective customer non-solicitation provisions if (1) an employee had contact with or knew confidential information about the prospects and (2) the time periods are reasonable.
The deadline to file any motion to reconsider or petition to transfer has passed, so this decision stands. Below are a few key takeaways from this decision.
As a result of this opinion, Indiana courts may now reform contracts. The court reformed or rewrote an overbroad provision based on contract language giving it that authority, rather than limit any changes to blue penciling (merely excising language). If a contract includes a provision authorizing a court to reform any unreasonable restriction, this case now authorizes a court to do so. Employers might consider including such reformation provisions in restrictive covenants. Practitioners may want to specifically request reformation in the event a court finds a client’s restrictive covenant to be unenforceable and overbroad.
In addition, the court’s decision shows that non-solicitation bans may include prospective customers. The court clarified that a prohibition on soliciting prospective customers with whom an employee had contact is reasonable. This clarified the state of the law and allows agreements to be more restrictive. Employers can be more confident in non-solicitation provisions for prospective customers if an employee had contact with them or had confidential information about them, and if the restricted period is reasonable.
American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc.
The next opportunity for the Indiana Supreme Court to weigh in on restrictive covenant law is in the case American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc., No.
18S-PL-00437. The Indiana Court of Appeals issued its decision in that case on November 30, 2016. The Indiana Supreme Court accepted transfer, vacating the decision. That case addresses several issues: irreparable harm, reasonable restrictions, laches, and enforceability of extension clauses. The Indiana Supreme Court heard oral argument on October 4, 2018, and a decision remains pending.
Indiana employers will likely want to review their restrictive covenants to ensure they have language authorizing a court to reform an overbroad contract provision. Practitioners can now request and rely on that power, rather than falling back on the limited blue pencil doctrine. Employers can also better protect their prospective customers with non-solicitation provisions as long as the employee had contact with the prospects and the restricted period is reasonable.