The US First, Fifth, and Sixth Circuits Render Recent Decisions That Analyze the Enforceability of Restrictive Covenants in Employment Agreements, Teaching Employers Some Valuable Lessons
Three recent appellate court decisions teach employers some valuable lessons when drafting employment agreements that contain restrictive covenants.
In TLS Management and Marketing Services, LLC v. Rodríguez-Toledo, et al., No. 19-1104 (1st Cir. Jul. 21, 2020), the US Court of Appeals for the First Circuit analyzed the enforceability of a non-disclosure agreement as well as whether a former employee misappropriated alleged trade secrets. The First Circuit recognized that although they may not specifically prohibit an employee from entering into competition with a former employer, overbroad non-disclosure agreements “raise the same policy concerns about restraining competition as non-compete clauses where . . . they have the effect of preventing the defendant from competing with the plaintiff.”
The First Circuit identified three areas wherein a non-disclosure agreement can be impermissibly overbroad and can operate functionally as a facially invalid non-compete restriction. First, an employer’s interest in protecting information does not extend to prohibiting the employee from using general knowledge that the employee has acquired. If a non-disclosure agreement reaches that far, it may be considered overbroad and invalid. Second, a non-disclosure agreement is invalid when it prohibits disclosure of information that “is not in fact confidential” because it is public knowledge. And third, the First Circuit instructed that a non-disclosure agreement is overbroad when it extends to information properly provided to a defendant by third-party sources. Because of the “astounding breadth” of the non-disclosure agreement at issue in the case before the First Circuit, as well as its “lack of any meaningful limitation” on the information protected by the non-disclosure agreement, the First Circuit held that it unlawfully restricted the former employee’s freedom to compete.
In Calhoun v. Jack Doheny Companies, Inc., No. 20-20068 (5th Cir. Aug. 7, 2020), a former sales representative entered into an employment agreement with a Texas employer whereby he agreed not to “become engaged by, or aid, assist, own, operate or have any financial interest” in any industrial utility vehicle business for two years after his employment ended. Upon learning that the sales representative had received employment from a competitor, the former employer filed suit and sought emergency injunctive relief.
A problem existed, however, for the former employer. The lower court determined that, as written, the non-compete provision would likely be found unenforceable because it was overbroad in geographic or temporal scope. Critically, the lower court ruled that the non-compete provision could not be reformed at the preliminary-injunction stage of the parties’ litigation, and instead could be reformed only after a full trial, which likely would result in a long delay. On appeal, the US Court of Appeals for the Fifth Circuit disagreed with the former employee’s argument that reformation of a non-compete provision is a remedy available only after a final trial. On remand, the Fifth Circuit ordered the lower court to squarely address whether reformation would render the non-compete provision reasonable and impose no greater restraint than necessary to protect the former employer’s business interest.
Lastly, in Down-Lite International, Inc. v. Chad Altbaier, et al., No. 20-3354 (6th Cir. Jul. 28, 2020), the US Court of Appeals for the Sixth Circuit weighed in on a dispute between an Ohio employer and a California-based employee. The employer initiated suit in Ohio before the employee could do so in California. The race to the courthouse proved important, as the case centered on the enforceability of a choice-of-law provision that called for application of Ohio law notwithstanding “California’s hostility towards covenants not to compete.”
The Sixth Circuit honored the choice-of-law provision because the employee could not demonstrate that California had a “materially greater interest” in the dispute than Ohio. The Sixth Circuit reasoned that while “California has a meaningful interest in protecting its resident from [the Ohio employer’s] desire to restrict competitive conduct,” such interest was not “materially greater than Ohio’s interest in protecting one of its closely held businesses operating in the global economy.”
Employers can learn several important lessons from these three decisions. First, non-disclosure agreements should be narrowly drafted and, if possible, should specifically identify, with as much detail as possible, the trade secrets or confidential information that the employer has an interest in protecting. Second, employers should include language in non-compete provisions that permit reformation in the event a restriction is found to be overbroad, and such reformation language should specifically state that reformation is available in connection with requests for emergency injunctive relief. Lastly, employers should always consider including choice-of-law and choice-of-venue provisions in employment agreements and should be aware that, in the event a breach of the agreement is uncovered, acting quickly to file suit in the chosen forum is important to ensure that the desired law governs the dispute.