Employer v. Employer: Litigation over Non-Competes
In today’s "information economy", an employer’s competitive edge is often contained in its knowledge, processes, trade secrets, customer contacts, and similar information which it must share with its employees. For this reason, employers increasingly seek to protect such proprietary information from unauthorized use or disclosure by present or former employees.
Similarly, in many businesses, the recruitment and development of uniquely skilled employees has become the key to success. Internet, software, and some sales and marketing firms provide examples. These firms have a strong interest in retaining key employees. They need to protect their talent from raids by their competitors.
The purpose of this paper is to set out the various legal options available to protect the intellectual and informational assets deposited with a business’ employees. We will review the advantages and disadvantages of each option, with a special focus on the most common and effective of these options, the non-compete agreement ("non-competes"). By understanding the legal issues involved, employers can maximize their legal protection and minimize their legal liabilities when they face employer versus employer litigation over non-competes and trade secrets.
Legal Options Available.
There are two sources of legal protection for proprietary information entrusted to employees. These are contract protections [“Contract Protections”], and statutory and common law protections [“Legal Protections”]. Contract Protections require an agreement (contract) between the employer and employee granting the protection. For this reason, Contract Protections will be discussed first. Then, we will review the Legal Protections available in the event that the employer has no contract with the employee, or the existing Contract Protections are unenforceable or inadequate.
A variety of Contract Protections are available in Kentucky, Indiana, Ohio, and Tennessee, as well as most other states. These various protections, however, have different legal and practical advantages and disadvantages that should be considered in developing a comprehensive strategy to protect an employer's interest. These are described below.
Under a confidentiality agreement, an employee agrees not to use or disclose confidential or proprietor information without the employer's authorization. Confidentiality agreements offers several advantages. They are valid in all fifty states. Few employees object to signing confidentiality agreements. There is no requirement that any limitation be placed upon how long a confidentiality agreement may last, or over what geographic range it is enforceable. Employees may be legally bound to a confidentiality agreement not only after their employment terminates but forever into the future, and anywhere they may go.
Confidentiality agreements, however, have limitations. The ability to sue an employee after he or she has improperly used or disclosed a trade secret or other confidential information is a weak remedy at best. Not only is the "cat already out of the bag," but the employer may never be able to prove that a suspected disclosure has actually occurred. The persons with the best evidence, and sometimes with the only evidence, as to whether a confidentiality agreement has been violated, are the employee subject to the agreement and the person or firm that benefited from its breach. These parties will almost certainly deny that any violation occurred.
Some employers have sought to expand the protections of a confidentiality agreement by using a legal theory known as "inevitable disclosure." Inevitable disclosure argues that an employee who is bound by a confidentiality agreement should be legally forbidden to go to work for a competitor who would benefit from the use or disclosure of the confidential information protected by the agreement. For example, a salesperson who is bound to keep confidential the identity of his/her employer's customers should not be permitted to join a competing firm on the theory that the temptation would be irresistible to use his/her former employer's customer information for the benefit of his or her new employer.
The inevitable disclosure theory, however, has not found broad acceptance in the courts. Furthermore, it can backfire. Bridgestone/Firestone suffered a large verdict in Indiana when a court determined that it had wrongfully obtained an injunction against an employee from working for a competitor under the inevitable disclosure theory. The employee testified that he did not use or disclose his former employer's confidential information. As in the Firestone case, it may be difficult for the former employer to rebut such testimony.
This means that the confidentiality agreement is, often, merely the first step in protecting an employer’s proprietary information. For example, where an employer desires to keep an employee from using confidential information about its customers to, later, solicit those customers on behalf of a new employer, the employer should seek an agreement expressly prohibiting such solicitation, in addition to confidentiality agreement. This is known as a non-solicitation agreement.
A non-solicitation agreement is a contract in which the employee expressly agrees that he/she will not solicit the customers and/or employees of his/her present employer on behalf of any future employer. Non-solicitation agreements have the advantage of directly controlling the prohibited conduct and not merely the use or disclosure of information. If an employee leaves his/her employer, joins a competitor, then solicits the former employer's customers on behalf of the competitor, the contract is violated, regardless of whether any confidential information was used or disclosed. Similarly, if an employee has agreed not to solicit his/her fellow employees on behalf of another, then the employee joins a competitor and talks other employees into also defecting to the competitor, an agreement not to solicit employees has been violated. Non- solicitation agreements leave little doubt about the conduct forbidden by the agreement.
Non-solicitation agreements, however, also have distinct disadvantages. Like confidentiality agreements, violations can be difficult to prove. Many employers are reluctant to involve their customers in a dispute with a former employee. With the customer already at risk because their contact person with the company has joined a competitor, the employer must think twice about beginning to cross-examine its customer about whether it is being solicited by the former employee on behalf of a competitor. A salesperson may not directly call upon his/her former employer's customers, but, nevertheless, may secretly identify these customers so that his/her new employer can simply send a different sales person to do the soliciting.
Issues can also arise as to whether a customer’s change of vendors, or an employee’s change of jobs, is the result of contact from the employee bound by a non-solicitation agreement or wholly independent of that employee. The need to prove “who solicited who” is often a problem in the enforcement of non-solicitation agreements. To address this weakness, most employers should consider obtaining a non-compete agreement.
Non-compete agreements ("non-competes") are the most thorough tool for protecting an employer from future competitive injury at the hands of its employees. A non-compete forbids the employee to work for, or in any way assist, any competitor of the employer. Such a broad prohibition solves a multitude of practical problems. The employer need not prove that the employee has used any confidential or proprietary information to the detriment of his/her former employer. Yet, the employer is protected from having its confidential information used for the benefit of a competitor. Its former employees cannot work for a competitor.
Furthermore, the employer need not prove that the employee has solicited anyone. Yet, there is little danger that former employees will solicit customers, or fellow employees, away from the employer. The former employees will, themselves, be bound not to work for any competitor. Among the most important practical advantages of a non-compete agreement, however, is its ability to help the employer prevent competitive harm before it occurs.
Most courts understand that money damages are usually inadequate to remedy the wrongful conduct of an employee who uses confidential information, and/or personal contacts, gained from a former employer to compete against that employer. For this reason, courts are often willing to order ("enjoin") employees not to engage in activities prohibited by agreements with their former employers. Yet, by the time an employer learns of, and obtains a court order against, a former employee's violation of a confidentiality or non-solicitation agreement much of the competitive damage may have been done.
With a non-compete agreement, however, the employer can seek an injunction as soon as the employee goes to work for the competitor. This creates the best opportunity to stop an employee from disclosing confidential information or using advantages, gained from his/her former employer, to compete against his/her former employer. From the employer's standpoint, a non-compete presents the "best of all worlds."
The many practical advantages of a non-compete, however, must be balanced against severe legal restrictions many courts place on non-compete agreements. Unlike virtually every other contract between consenting adults, it is not enough to have the agreement of both the employer and the employee in order to have an enforceable agreement. You must also have the court’s agreement. Courts in every state in America will refuse to enforce a covenant not to compete if the court believes that the covenant is unreasonable. In most states, courts primarily examine the reasonableness of non-competes in terms of the duration of time that the employee will be forbidden to compete with his/her former employer, and the geographic territory over which the employee will be forbidden to work for a competitor. The reasonableness of the non-compete is viewed in light of the employer’s business interest that the noncompete is designed to protect.
For example, an employer whose business operates only within the Lexington geographic area is unlikely to be able to obtain judicial enforcement of a covenant preventing a former employee from competing anywhere in the Commonwealth of Kentucky. An employer who competes nationwide, on the other hand, may be able to obtain enforcement of a covenant forbidding its national sales manager to work for a competitor anywhere in the United States. Restrictions on the duration of time that a non-compete can last are somewhat more arbitrary. Nevertheless, the reasonableness of the duration of a non-compete is also tied to the business interest protected by the non-compete.
All of this interjects broad uncertainty into the enforcement of almost every non-compete agreement. As individual states, and individual judges, each determine what they consider to be "reasonable," the result is that judicial decisions are made on a case-by-case, state-by-state, and even judge-by-judge basis. A covenant of the same duration and geographic reach may be enforceable under the facts of one case, but not under another. It may be enforceable in one state, but not in another. It may be enforced by one judge, but not another.
Many judges have strong prejudices about non-competition agreements. Some believe that an employee ought to abide by his/her word. Such judges tend to broadly construe the "reasonableness" standard since the employee agreed to the covenant not to compete as written. Other judges feel strongly that employees should not be restricted in their ability to earn a living or change jobs. These judges construe the "reasonableness" standard narrowly, looking for any excuse to set aside a covenant not to compete.
The limits upon enforceability of covenants not to compete are also applied to non-solicitation agreements. Non-solicitation agreements also must be reasonable in duration and geographic scope. Because the application of a non-solicitation agreement is limited to customers (and sometimes identified prospective customers), however, some courts permit such a "customer restriction" to be substituted for a geographic restriction. See, Higdon Food Service v. Walker & Kesterson Meat Co., 641 S.W.2d 750 (Ky. 1982). For example, a salesperson may be forbidden to solicit from his/her former employer's customers for a two-year period anywhere in the United States. Such a covenant is likely to be held “reasonable,” despite the nationwide reach of the non-compete, since the salesperson is free to solicit among every business that is not already a customer (or an already identified prospective customer) his/her past employer.
Enforcement of Non-Compete Agreements In Kentucky.
Kentucky recognizes a variety of business interests as justifying a non-compete. These include protection from business competition, protection from employee raiding, and protection from former employees using or disclosing confidential information or business contacts for the benefit of a competitor. See, E.G., Higdon Food Service v. Walker & Kesterson Meat Company, 641 S.W.2d 750 (Ky. 1982); Central Adjustment Bureau v. Ingram Assoc., 622 S.W.2d 681 (Ky. Ct. App. 1981); Hammons v. Big Sandy Claims Service, 567 S.W.2d 313 (Ky. Ct. App. 1978); Hall v. Willard & Woolsey, P.S.C., 471 S.W.2d 316 (Ky. Ct. App. 1971).
In order for a covenant not to compete to be enforceable, however, it must be "reasonable in scope," in light of the purpose for which the employer is using the covenant. Hall v. Willard & Woolsey, P.S.C., 471 S.W.2d 316, 317 (Ky. Ct. App. 1971). The most succinct explanation for how Kentucky courts apply the "reasonableness" standard is found in a case involving competing credit bureaus. Kentucky's Court of Appeals explained:
"It has be held in Kentucky that an agreement and restraint of trade (non-compete) is reasonable if, on consideration of the circumstances of the particular case, the restriction is such as only to afford fair protection to the interest of the covenantee [employer], and is not so large as to interfere with the public interest, or impose undue hardship on the party restricted [the employee].”
Central Adjustment Bureau v. Ingram Assoc., 622 S.W.2d 681, 685 (Ky. Ct. App. 1981), citing Hammons v. Big Sandy Claim Service, 567 S.W.2d 313 (Ky. Ct. App. 1978).
Kentucky is not overtly hostile to non-compete agreements. The Kentucky Court of Appeals has explained: "The policy of this state is to enforce them [non-competes] unless very serious inequities would result.” Lareau v. O'Nan, 355 S.W.2d 679, 681 (Ky. Ct. App. 1962). Whether "serious inequities would result," of course, depends upon the facts of each case. Nevertheless, a review of Kentucky court decisions does provide guidance on the time and geographic restrictions that Kentucky courts will find to be reasonable and those that will be found to be unreasonable.
In virtually every case, a one-year restriction on competition has been held to be reasonable. OVRS Acquisition Corp. v. Community Health Services, Inc., 657 N.E.2d 117, 123 (Ind. Ct. App. 1995) (applied Kentucky substantive law); Hammons v. Big Sandy Claim Service, 567 S.W.2d 313 (Ky. Ct. App. 1978); Davey Tree Expert Co. v. Ackelbain, 25 S.W.2d 62 (Ky. 1930). Under some circumstances, however, Kentucky courts have approved covenants not to compete that extended for up to six years. Bradford v. Billington, 299 S.W.2d 601, 603 (1957). This case involved a non-compete agreement between two physicians. The court relied heavily on the fact that the parties were two intelligent men who held roughly equal bargaining power. The court observed: "There is no question here of an employer exacting an unconscionable bargain from an employee dependent on selling his services for a livelihood." Id. at 604.
Further, the Bradford court noted that the "geographic" limitation in this six-year covenant was only for a single county. Had the geographic region been broader, the six-year duration of the covenant might not have been enforced. A more recent case approved a five-year restrictive covenant among public accountants. This provides another example of the sophistication of the parties and a comparatively small geographic limit (50 miles) justifying a long duration for the non-compete agreement. White v. Sullivan, 667 S.W.2d 305 Ky. Ct. App. 1983).
In considering the geographic reach of a non-compete agreement, a Kentucky court has approved a covenant with a geographic reach of a 200-mile radius. The 200-mile radius had to be measured, however, from the office where the particular employee worked for the employer. A 200-mile radius from “any territory serviced by the employer at the time of the time of the employee's termination” was held to be overly broad and unenforceable. Hammons v. Big Sandy Claim Service, 567 S.W.2d 313 (Ky. Ct. App. 1978).
The author has obtained a ruling from a Louisville trial court upholding a covenant with worldwide geographic reach. Yet, the employee was the former sales manager for North America, and he attended annual sales meetings in Europe and Asia with his fellow sales managers from around the globe. Worldwide product development and marketing strategies were discussed at these meetings, and the employer was a worldwide software company with only one other global competitor. Under these circumstances, the Kentucky trial court determined that a worldwide geographic "limitation" was reasonable in light of the employer's legitimate business interest. Under most circumstances, however, some geographic limitation will be required to obtain judicial enforcement of a non-compete. Calhoun v. Everman, 242 S.W.2d 100 (1951).
The most important aspect of enforcement of non-competes in Kentucky, however, is the response of Kentucky courts when they determine that a non-compete is unreasonable. Kentucky is among many other states whose courts will enforce a non-compete to the extent that it is reasonable, rather than invalidate an “unreasonable” agreement. This practice known as "blue penciling" enables an employer to obtain some benefit from its non-compete agreement, even if the court finds the agreement, as written, to be unreasonable. Hammons v. Big Sandy Claim Service, 567 S.W.2d 313 (Ky. Ct. App. 1978). Where a covenant contains no geographic or time limitation, however, Kentucky courts will not write the parties’ agreement for them. The non-compete will simply be set aside. Calhoun v. Everman, 242 S.W.2d 100 (1951).
If an employer has failed to obtain contractual protections, there are, nevertheless, some protections for trade secrets created by statute and common law.
Prior to 1990, Kentucky used ordinary tort theories to protect "trade secrets" from misappropriation.1 In 1990, however, Kentucky adopted the Uniform Trade Secrets Act ("UTSA"), KRS §§365.880-900. This legislation largely preempts the existing tort theories. KRS §365.892 provides that the UTSA, "replaces conflicting tort, restitutionary, and other law of [Kentucky] providing civil remedies for misappropriation of a trade secret." Specifically exempted from this preemption are:
(a) contractual remedies, whether or not based upon misappropriation of a trade secret;
(b) other civil remedies that are not based upon misappropriation of a trade secret, or
(c) criminal remedies, whether or not based upon misappropriation of a trade secret.
There are no Kentucky cases interpreting the UTSA, so it is impossible to say, definitively, what effect KRS §365.892 has on the Kentucky common law protecting trade secrets. The statute's plain language, and other non-Kentucky cases, indicate, however, that aside from contractual claims, civil relief for the misappropriation of trade secrets is available only through the UTSA.2
A caution to the "preemption" issue is that, until Kentucky courts flesh out the parameters of the UTSA, an employer should continue to assert traditional misappropriation legal theories. For example, should a misappropriated "process" be deemed not a trade secret under the UTSA, an action for breach of a duty of trust, confidentiality, or corporate responsibility might still be viable. See, Aero Drapery, supra.
Under the UTSA, a "misappropriation" of a trade secret includes, an "[a]cquisition of a trade secret of another by a person who knows or who has reason to know that the trade secret was acquired by improper means;" or the "use of a trade secret of another without express or implied consent by a person who . . . knew or had reason to know that his knowledge of the trade secret was . . . [a]cquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or [d]erived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use. . . ." KRS 365.880(2). Accordingly, in the event a competitor hires away an employee, the employer should give notice to the competitor that the employee is under a duty to maintain the secrecy of any confidential information obtained while employed by the employer, to ensure protection under the UTSA.
As stated above, the UTSA does not affect contractual or criminal remedies for the misappropriation of trade secrets. Non-competition agreements and confidentiality agreements are enforceable in addition to the UTSA.
In Kentucky, there is no specific criminal prohibition against the theft of trade secrets. Nevertheless, the statutory definition of "property" protected by Kentucky's "theft" laws includes "anything of value." KRS 514.010(6). While there are no Kentucky cases so holding, an argument could certainly be made that a trade secret has value, and therefore would be protected by Kentucky's "theft" laws.
Kentucky does provide a cause of action for interference with contractual relations or prospective contractual relations.3 In Steelvest, Inc. v. Scansteel Service Center, Inc., Ky., 807 S.W.2d 476, 487 (1991), the Kentucky's Supreme Court ruled:
"Under Kentucky law, tort liability exists for the interference with a known contractual relationship, if the interference is malicious or without justification, or is accomplished by some unlawful means such as fraud, deceit, or coercion."
Therefore, a competitor who induces, and/or knowingly encourages and benefits from, the breach of a confidentiality, non-solicitation, or non-compete agreement becomes liable to the employer whose contract was violated. In this way, an employer’s Legal Protections not only create a “safety net” to protect trade secrets in the absence of Contract Protections, they also expand Contract Protections to reach the employer’s competitors.
1. See Mid-States Enterprises, Inc. v. House, Ky., 403 S.W.2d 48 (1966) (plaintiff argued for breach of implied agreement and trust; the court deemed the action to be "fraudulent appropriation"); Aero Drapery of Kentucky, Inc. v. Engdahl, Ky., 507 S.W.2d 166 (1974) (breach of fiduciary duty); Progress Laundry Co. v. Hamilton, Ky., 270 S.W. 834, 835 (1925) ("neither a present nor former employee, or any other person confidentially obtaining the information, may appropriate to his own use, or the use of another, 'trade secrets' of his commercially engaged employer.").
2. See Hutchison v. KFC Corp., 809 F.Supp. 68 (D. Nev. 1992); ITT Schadow Inc. v. Stein, 7 U.S.P.Q. 2d 1348 (Minn. App. 1988); Micro Display Sys., Inc. v. Axtel, Inc., 699 F.Supp. 202 (D. Minn. 1988); Milgrim on Trade Secrets, Section 1.01[a], (1996); 2 Business Torts 17.05 at 17-91 (1989) states:
The framers of the Uniform Act did not intend for the Act to affect the rules of law governing contracts, including covenants not to compete or nondisclosure agreements. They did intend, however, to replace all the various tort, property, and quasi contract theories of recovery with a single statutory cause of action for "misappropriation." To achieve this end, it is essential that the Act preempt all other civil noncontractual causes of action to the extent that they provide or are based upon some legal protection for commercially valuable secret information.
This preemption must extend not only to causes of action pleaded under common law misappropriation theories but also to those pleaded under theories such as unfair competition, breach of an employee's duty of loyalty, breach of a fiduciary duty, unjust enrichment, or any other noncontractual theory under state law. It is obvious that Section 7 of the Uniform Act was intended to have this effect.