Can Filing for Bankruptcy Invalidate a Noncompete?

Guest post by Solomon B. Genet.

Debtors and their lawyers sometimes use a bankruptcy filing as an offensive tool. In a recent case, a debtor tried to use his prior bankruptcy to shed his non-compete obligations. While this attempt was not successful, non-compete practitioners should be aware of this effort.

In In re Capps, a July 26, 2018 decision from the District of Kansas Bankruptcy Court, the individual debtor sold his company and signed an employment agreement with the buyer, agreeing to a series of non-compete, non-solicit and confidentiality obligations. The debtor later filed for bankruptcy, and the buyer fired him soon thereafter.  The buyer then discovered that the debtor was breaching his restrictive covenants and brought an action for declaratory relief in the bankruptcy court seeking a finding that the bankruptcy process and discharge did not relieve him of these obligations.

Bankruptcy Judge Nugent agreed with the plaintiff-buyer and rejected the debtor’s arguments, reasoning that: (1) the debtor’s breaches of the restrictive covenants occurred post-bankruptcy, and gave rise to “equitable” (i.e., injunctive) relief and not “a right to payment,” so the debtor did not discharge any debts arising from the agreements; and (2) the restrictive covenants were not “executory” contracts (material obligations on both sides), and therefore could not be rejected through the bankruptcy process.

The Capps debtor was unsuccessful in shedding his obligations.  But—hypothetically—a strategic legal counselor could use the Capps debtor’s arguments in a case with more favorable facts (and perhaps different applicable law) to assist a person subject to a non-compete to obtain relief long before his contracted time-period for his non-compete obligations expired.

A copy of the opinion can be downloaded here.

Florida Supreme Court Issues Landmark Noncompete Opinion

It’s been a difficult week in Florida, as the state recovers from Hurricane Irma. But the storm did not deter the Florida Supreme Court from issuing what could be one of the most important opinions in the state’s history regarding Section 542.335, Florida Statutes, the statute governing restrictive covenants. I’m still dealing with hurricane-related issues as my office in Miami prepares to re-open tomorrow, which prevents me from relaying an in-depth analysis. But I wanted to pass along some key takeaways. A more comprehensive analysis will follow in the coming weeks.

This opinion, White v. Mederi Caretenders Visitng Services of Southeast Florida, LLC, resolves a District split on the issue of whether referral sources can constitute a legitimate business interest, a prerequisite under the statute. Referral sources are not included in the statute’s list of protectable business interests, but the statute prefaces that list with the words “includes, but is not limited to.”

I previously wrote about the divergent holdings on this issue. I argued that the Florida Supreme Court should give life to the statute’s “includes, but is not limited to” provision by ruling that referral sources can be a legitimate business interest. The opinion ended up mirroring my analysis, holding that “the subject statute protects a plethora of protected legitimate interests far beyond those listed in the subject statute.” Here are a few key points:

  • This opinion has far-reaching implications beyond cases involving referral sources. It makes clear that courts should engage in industry-specific, context-based analysis to determine whether the plaintiff has a legitimate business interest, regardless of whether that interest is listed in the statute:

The illustrative list guides courts in their interpretation of what types of non-enumerated business interests qualify as legitimate under Section 542.335. However, because the statue protects more business interests than those specifically listed, courts must necessarily engage in fact- and industry-specific determinations when construing non-enumerated interests.

  • The opinion repeatedly references industry-specific determinations. Lawyers attempting to enforce a restrictive covenant should consider what types of industry-specific evidence is necessary to justify the restrictive covenant.
  • The Court also emphasized the purpose of the statute: “preventing unfair competition by protecting critical business interests.” This focus on unfair competition may shift courts’ analysis towards a determination of the unfair advantage provided to the new employer. This was always a consideration on some level, but it may rise in prominence.
  • The opinion also contains language that will likely be cited by defendants: “For an employer to be entitled to protection, there must be special facts present over and above ordinary competition such that, absent a non-competition agreement, the employee will gain an unfair advantage in future competition with the employer.”
  • Lawyers drafting restrictive covenants under Florida law should consider whether it makes sense to include language in which the employee acknowledges the importance of the business interest at issue to the company, particularly when that interest is not enumerated in the statute.

This opinion may embolden companies looking to enforce restrictive covenants. I would not be surprised if this case leads to increased litigation involving alleged business interests outside those listed in the statute. More analysis to come.

A copy of the opinion can be downloaded here.

Florida Companies: Are Your Non-Competes Missing This Critical Provision?

Under Florida’s restrictive-covenant statute, Section 542.335(f), a restrictive covenant is only enforceable by a successor entity or third-party beneficiary if the agreement so provides. This provision can become very important following corporate merger or sale transactions. Or in the due-diligence period leading up to those transactions.

In a recent Florida case, Collier HMA Physician Mgmt, LLC v. Menichello, the plaintiff almost fell victim to this statutory requirement. A copy of the opinion can be downloaded here.

In this case, the plaintiff owns a healthcare business employing approximately 40 doctors. It also operates two hospitals and clinics. The defendant, a physician, previously worked for the plaintiff, where he signed a non-compete agreement prohibiting him from working for certain of the plaintiff’s competitors. After his departure, he accepted a position with one of those competitors, and the plaintiff filed suit.

The physician argued that a merger transaction involving the plaintiff’s corporate parent triggered the statutory provision above. Per the physician, since the agreement did not expressly provide for enforcement by successors, the merger invalidated the non-compete. The trial court agreed and granted summary judgment in the defendant’s favor.

The appellate court reversed. To reach that conclusion, it interpreted the term “successor” in the statute as “a corporation that, through amalgamation, consolidation, or other assumption of interests, is vested with the rights and duties of an earlier corporation.”

The court found that “the status of [the plaintiff] after the merger does not comport with the standard definition of a successor as it relates to corporations or other business entities.” In particular, there were several tiers of corporate entities between the plaintiff and the parent company that was subject to the merger. While the ownership of the ultimate parent company changed, “nothing about the corporate structure or ownership of [the plaintiff] was different after the merger”; it “continued in existence as a single member limited liability company.”

In the end, the plaintiff here was able to enforce its non-compete agreement. But all of this trouble could have been avoided. This leads to a very simple takeaway: when drafting restrictive covenants in Florida, include a provision allowing their enforcement by successors and assigns. Florida companies with existing restrictive-covenants should have a lawyer review them for compliance with this statute.

Similarly, anyone considering acquiring or merging with a company with Florida employees/independent contractors needs to have a lawyer review any restrictive covenants for this purpose.

The failure to include this provision could lead to all sorts of problems. For example, it could impede a later merger or sale of the company. But any Florida company can avoid these problems by having a lawyer conduct a simple review.

 

Florida’s Restrictive Covenant Statute: The Power of Presumption

Florida has one of the most employer-friendly restrictive-covenant statutes in the country, Section 542.335, Fla. Stat. For example, the statute prohibits judges from considering any hardship suffered by the person against whom enforcement is sought. The statute also contains a rebuttable presumption that a violation of an enforceable restrictive covenant creates irreparable injury. Yesterday, Florida’s Third District Court of Appeal (which covers Miami-Dade County) issued an opinion showing the power of this presumption. The opinion, in Allied Universal Corp. v. Given, can be downloaded here.

Allied manufactures and distributes water-treatment chemicals. Defendant Given worked as a regional sales manger for Allied and signed a non-compete agreement. As part of his employment, he received training regarding various aspects of Allied’s business. Given resigned from Allied to work for Univar, a company that competes with Allied. Allied filed suit and sought a temporary injunction, which the trial court denied on the grounds that Allied failed to show irreparable harm.

The appellate court focused on the rebuttable presumption of irreparable injury and described the evidence offered by Allied:

At the evidentiary hearing on the motion for temporary injunction, Allied presented unrebutted evidence of the existence of statutorily legitimate business interests to be protected and evidence that Given had substantial relationships with specific prospective or existing Allied customers. Allied’s president, Mr. Palmer, testified that his company had trained Given, over the course of Given’s six-year employment, in its manufacturing and production techniques, marketing strategies, and confidential pricing strategies. In addition, Given had knowledge of existing and prospective customers, and had been sent to several trade meetings to cultivate these contacts.

Thus, the court concluded that Allied had successfully shifted the burden to Given to establish the absence of irreparable injury. But Given “failed to present any such evidence.”

Interestingly, Given argued that because he had not yet begun actively working for Univar, he had not breached the noncompete and no damages were incurred. But he admitted that if he were not enjoined, he would start working for Univar. The court rejected this argument, noting that “the only focus at the preliminary injunction stage is to maintain longstanding relationships and preserve the company’s goodwill.” In the future, plaintiffs can use this language to highlight the need to maintain the status quo.

Given Florida’s employer-friendly restrictive-covenant statute, noncompete and related agreements are powerful tools for Florida companies seeking to protect trade secrets and proprietary information. Cases like Allied show how this statute makes it easier for an employer to obtain an injunction prohibiting violations of a restrictive covenant.

Are We Headed for a Landmark Florida Supreme Court Non-Compete Case?

A few months ago, I wrote about a Florida appellate case holding that referral sources qualify as legitimate business interests under Florida’s restrictive covenant statute (Section 542.335, Fla. Stat.). On New Year’s Eve, a different Florida appellate court disagreed, setting up a possible appeal to Florida’s Supreme Court.

In Hiles v. Americare Home Therapy, Inc.Florida’s 5th District Court of Appeals overturned in part a temporary injunction entered against the former employee of a home healthcare company, who had allegedly violated a non-compete agreement. (The case I discussed in my earlier post also involved the home healthcare industry.) The injunction was based on the company’s claimed need to prevent the former employee from soliciting referral sources.

Under the Florida statue, a restrictive covenant is only enforceable if supported by a legitimate business interest. Here, the appellate court held that referral sources are not legitimate business interests.

The court relied on one of the legitimate business interests listed in the statute: “substantial relationships with specific prospective or existing customers, patients, or clients.” Since referral sources are not specific customers or potential customers, this court found that they are not legitimate business interests.

This is faulty logic, since the statute makes clear that the list of legitimate business interests in non-exclusive: “The term ‘legitimate business interest’ includes, but is not limited to” the enumerated items, including substantial relationships with customers.

In the home healthcare industry, it certainly sounds like referral sources are very important to business success. This is likely the case in a number of industries, where business is primarily generated through referral sources. In those industries, a company should be able to protect its referral sources through restrictive covenants.

Given the appellate-court split, there is at least a chance that the Florida Supreme Court will address this issue. If it does, the case could have far-reaching effects. The Florida Supreme Court could take this opportunity to address the definition of “legitimate business interest” under the statute, and clarify what types of legitimate business interests beyond those listed in the statute justify restrictive covenants. This could dramatically alter the way Florida treats restrictive covenants. Stay tuned.

Shark Tank and College Football Non-Competes

Two recent stories show why all companies should at least consider implementing non-compete agreements or other restrictive covenants.

First, here’s a link to a short interview with Shark Tank’s Robert Herjavec, talking about his first company. Unbeknown to Robert, his sales manager had set up a side business, to which he funneled half of Robert’s customers. Robert only found out because another employee broke down and told him during her exit interview.

Robert finishes the interview with good advice: “The minute you hire the first employee, you have to be careful.”

We don’t know if the sales manager had signed a non-compete or non-solicitation agreement. Such an agreement could have given Robert far better legal options.

Also, Robert trusted that his employees would be loyal. While it’s obviously good to trust your employees, it’s far better to trust and also have them sign appropriate restrictive covenants.

I also read about how an assistant coach of the Arkansas Razorbacks football team left for the University of Georgia. Bret Bielema, Arkansas’ head coach, was not happy. Apparently, his recently hired coaches signed non-compete agreements that prohibited them for coaching for other SEC schools. But the coach who had left had been hired earlier, and he did not have a non-compete.

Of course, Arkansas should have had its coaches sign non-competes from the outset. And once they decided to require new coaches to sign one, they should have at least attempted to have the older coaches sign as well.

These stories show how non-compete agreements can have value across diverse industries. It’s worth speaking with an attorney to figure out whether your company can benefit from implementing restrictive covenants, or improving existing agreements.

 

Florida Loves Non-Compete Agreements

Florida’s restrictive-covenant statute, Section 542.335, is one of the most employer-friendly in the country. A recent case from Florida’s Fourth District Court of Appeal, Transunion Risk and Alternative Data Solutions, Inc. v. Reilly, shows how this statute favors an employer trying to enforce a restrictive covenant against a former employee. A copy of the opinion can be downloaded below.

This opinion is short on facts, but the plaintiff sued the defendant for violating a non-compete agreement and sought a temporary injunction. At the injunction hearing, the trial court ruled in the defendant’s favor after the plaintiff finished its case in chief, before the defendant put on any evidence.

The appellate court reversed. First, it looked at the likelihood of irreparable injury, citing the statute’s presumption of irreparable injury that arises when the plaintiff shows a violation of an enforceable restrictive covenant. Here, the appellate court reversed because the defendant did not present evidence:

As the trial court’s ruling was issued before Reilly presented any evidence, Reilly could not have met his burden of presenting evidence overcoming the presumption.

This doesn’t sound right. A defendant should have the right to rebut this presumption simply by cross-examining the plaintiff’s witnesses. That’s what the trial court apparently thought happened here. But the presumption so strongly favors the plaintiff that this appellate court was unwilling to allow the defendant to rebut it without putting on affirmative evidence.

The trial court also concluded that the plaintiff had an adequate remedy at law. But the appellate court reversed this finding, noting that even when a plaintiff has suffered actual money damages,

the continued breach of a non-compete agreement threatens a former employer’s goodwill and relationships with its customers, and nothing short of an injunction would prevent this loss.

This finding essentially eliminates the adequate-remedy-at-law prong of the injunction analysis in restrictive-covenant cases.

Finally, the appellate court reversed the trial court’s finding that the plaintiff had not demonstrated a substantial likelihood of success on the merits. On this point, the appellate court relied on the trial court’s “implied finding” that the defendant violated a restrictive covenant. So once a court finds that the defendant breached, the plaintiff has automatically shown a substantial likelihood of success.

This case shows how Florida’s restrictive-covenant statute provides employers with the upper hand in litigation. As a result, these agreements are a very effective tool for protecting proprietary information and trade secrets. All Florida companies should consult with an attorney to determine whether to implement these types of agreements.

Transunion Risk and Alternative Data Solutions, Inc. v. Reilly

“Just Doin Blow and Erasing Evidence”

As the Defend Trade Secrets Act—which would create a federal cause of action for trade-secrets theft—makes its way through Congress, critics have focused on the proposed statute’s ex parte seizure provision. In a nutshell, the statute would allow for the entry of ex parte orders to seize specifically identified repositories of evidence that are at risk of destruction.

I’ve responded to these criticisms multiple times before (see here, here, and here). The statutory protections (e.g., the party subject to the order is entitled to a hearing within 7 days) combined with federal judges’ reluctance to issue ex parte orders are, in my view, sufficient to prevent abuse.

Meanwhile, the threat of evidence destruction is real. A recent case shows how far defendants can go to allegedly destroy evidence of trade-secrets theft.

As described in Law360, a radio-controlled-vehicle company sued several former employees for violating restrictive covenants and misappropriating trade secrets, among other claims. The plaintiff filed a motion seeking sanctions against the defendants for destroying evidence.

According to the plaintiff, the defendants destroyed “scores of emails, texts, and documents that described their scheme to start at least one rival toy car and boat business.”

One of the defendants—who sounds like a real winner—apparently sent a text message talking about how he expected to get served with the complaint, saying “That’s what I’m trying to deal with now so I can’t go out, just doin blow and erasing evidence.”

In misappropriation cases, the evidence is almost always in electronic form. And it’s way too easy for defendants to destroy this evidence. While a plaintiff could seek sanctions (as the plaintiff here is seeking against the guy “doin blow”), a plaintiff would almost always rather have the actual smoking gun proving misappropriation.

The ex parte seizure provision is a powerful tool that may allow companies to preserve critical evidence.

Trade Secrets Best Practices: Exit Interviews

This is the next in a series of posts addressing best practices for protecting trade secrets and proprietary information. Today’s topic: exit interviews, which can be a powerful tool to avoid, or at least anticipate, unwanted disclosure.

An exit interview is exactly what it sounds like. When an employee is leaving your company, you have someone meet with him to discuss various aspects of his departure. There are several goals: remind the employee of his legal obligations; make sure he has returned all company information, documents, and devices; and gather intelligence about his next job to determine the risk of unwanted disclosure.

The key is to have a set process that is automatically followed each time an employee leaves. Depending on the size and structure of your company, a single person or department should be responsible for conducting the interviews. That person should work from a checklist that includes all topics that must be discussed. To develop this process, consult with an attorney who specializes in trade-secrets issues who can help customize it to fit your company’s needs.

The checklist should include, at a minimum, the following:

Review of restrictive covenants and related agreements: Give the employee copies of any agreements he signed and remind him of specific noncompete, nonsolicitation, nondisclosure, and related obligations.

Review of non-contractual legal obligations: Remind the employee of his ongoing legal obligations to, for example, keep certain information confidential. The applicable laws vary state-by-state, so make sure to consult with an attorney familiar with your state’s laws.

Review inventory of all company devices: Hopefully, you are keeping an inventory of all company devices issued to the employee. Go through this inventory and make sure he has returned all of these devices.

Company information and documents: Ask whether the employee has any hard-copy documents or electronically stored information on his personal computer, devices, and storage medium. If he does, give a set date for him to return or destroy the documents/information.

Sign acknowledgment: Have the employee sign an acknowledgment form that confirms he is aware of his legal obligations, has returned all company devices, and returned or destroyed all company documents/information.

Gather information: Ask the employee where he will be working next, and in what capacity. Also make sure you have the employee’s updated contact information.

Additionally, prior to the interview, you should work with your IT department to see if the departing employee recently accessed or used trade-secret information, particularly in an out-of-the-ordinary manner. If so, consult with an attorney, since it may be advisable to address this issue with the employee during the exit interview.

Often, this process will allow you to handicap the risk that the departing employee will illegally use your trade secrets and proprietary information. For example, be wary of an employee who refuses to tell you where he will be working next. Or an employee who refuses to attend the exit interview. In cases where you suspect something is amiss, consult with an attorney right away, since time is of the essence in these cases.

Again, there is no one-size-fits-all approach to exit interviews. Speak with with an attorney to develop the process that best fits your company’s needs.

Best Practices for Protecting Trade Secrets: Categories of Employee Contracts

This is the first in a series of posts addressing best practices for protecting trade secrets. I’m starting with employee/independent contractor contracts, which are one of the most important and effective ways to protect proprietary information.

Contracts are critical for multiple reasons. First, they inform your employees of their legal responsibilities. Second, it’s generally easier to prosecute a breach-of-contract claim instead of relying solely on a trade-secrets misappropriation claim. Third, a competitor that hires your former employee may be more likely to cut ties with that employee when presented with a cease-and-desist letter attaching a contract. Finally, requiring these types of agreements can help you win a misappropriation case, since their existence bolsters the argument that you reasonably protected your trade secrets (a prerequisite to establishing a trade secret under the Uniform Trade Secrets Act).

There are three general categories of contractual protections: confidentiality/nondisclosure, nonsolicitation, and noncompete. Remember that the law applicable to these contracts varies widely from state-to-state, so you need to consult with an attorney who can make sure your agreements comply with and will be enforced under the applicable law.

Confidentiality/NDA

This is the lowest level of contractual protection. It’s also the easiest to implement, since employees are less likely to push back when asked to sign a NDA. From a best-practices perspective, it’s worth at least considering whether to require that all employees sign a NDA. Even low-level employees may have access to some proprietary information. The trick is drafting the language in a way that best defines what precisely needs to be kept confidential. In particular, you need to decide whether to define “confidential information” broadly vs. specifically. Each comes with benefits and risks. Speak with a lawyer who can learn about your unique situation to determine what language best suits your business.

Nonsolicitation Agreements

A nonsolicitation agreement prohibits your employee from soliciting some or all of your current or prospective customers and/or employees once she leaves your company, for a certain period of time. These contracts offer an intermediate level protection, more than a NDA but not as much as a noncompete. It’s best to have all employees with access to proprietary customer information, or who have relationships with prospective/actual customers, sign a nonsolicitation agreement. Again, consult with an attorney who can help craft the scope of the restrictions to your company, based on the applicable law.

Noncompete Agreements

These agreements offer the highest level of protection, since they prohibit your employee from working for your competitors or in your industry, within a certain area and for a certain amount of time. Recently, there has been media coverage of corporate overuse of noncompete agreements. For example, Jimmy Johns took a lot of heat for having its sandwich makers sign noncompete agreements. This type of practice can turn off a judge.

There’s no question that noncompete agreements can be a powerful tool for protecting your proprietary information. But you should consider only requiring that key employees sign a noncompete agreement. The other contracts above may be sufficient to protect against misappropriation by lower-level employees.

You also need to think about the noncompete’s temporal and geographic scope. Depending on the law in your state, an overbroad agreement may not be enforceable. In Florida, where judges are required to narrow an overbroad agreement, I’ve seen judges soured towards employers that overreached when drafting the agreement. Generally, it’s best to limit the agreement the area in which you can prove you compete. An attorney can work with you to determine the proper scope.

Procedure

Deciding to require some or all of the above agreements, and having an attorney draft the agreements, is only the first step. Next, you need to make sure the agreements are actually signed and dated. Then, you need to make sure the signed agreements are properly maintained. You would not believe how often companies forget to have an employee sign or date the agreement. Or how often I’ve seen a company struggle to find the signed agreement when it became necessary to enforce it.

The key is to develop a protocol that can be repeated for each new employee. When the decision is made to hire a new employee, a designated person should be responsible for creating a checklist of all documents that she needs to sign. Of course, the checklist may be different for each employee. Either the person who creates the checklist or another designated person needs to be responsible for making sure all items on the list are actually completed. I recommend including on the checklist the signing, dating, and filing of all required contracts. The responsible person should sign the checklist once everything has been completed, and the checklist should be filed along with the signed documents.

If the contracts are to be signed electronically, your IT people need to set up the software so it will not allow a signature unless all mandatory clickwrap “boxes” are checked. If you are old school and the contracts are manually signed, I recommend keeping an electronic copy along with the original.

In future posts, I’ll discuss specific contractual provisions that should be included in these agreements, as well as best practices for contractual protections when dealing with third parties, like vendors, consultants, and joint-venture partners.

 

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