A breach of a restrictive covenant agreement containing a non-compete, confidentiality or non-solicitation provision can result in the dissemination of company trade secrets, loss of customers, and damage to a company’s goodwill. Similar claims may arise in employee lift-out cases, or when there has been the sale and purchase of a business or professional practice. To stem the damage or likely risk of harm, most aggrieved employers will file a breach of contract suit and initially request emergency “injunctive” relief, via a “temporary restraining order” which can be granted ex parte on demonstrated need without a trial, and a “preliminary injunction” that can only issue after a hearing.
Following a phone call from a client reporting a breach by a current or former employee, we often find ourselves up late at night preparing injunction papers for filing the next day. The goal is to quickly convince the court that our employer client has sufficient grounds to issue a TRO that precludes any further actual or inevitable breach. Such an order allows us and the client a period of time, usually just a few days, to gather additional facts in anticipate of a preliminary injunction hearing and or to engage in settlement discussions with the defendant.
Focusing on New York for the sake of simplicity (Injunction law, or put in a more scholarly way, the law of provisional remedies, is fairly consistent from state to state), Rule 6301 of New York Civil Practice Law and Rules, states as follows:
A preliminary injunction may be granted in any action where it appears that the defendant threatens or is about to do, or is doing or procuring or suffering to be done, an act in violation of the plaintiff’s rights respecting the subject of the action, and tending to render the judgment ineffectual.
A preliminary injunction can only issue, however, after a hearing. A TRO, on the other hand can issue immediately. Pursuant to CPLR 6313:
If, on a motion for a preliminary injunction, the plaintiff shall show that immediate and irreparable injury, loss or damage will result unless the defendant is restrained before a hearing can be had, a temporary restraining order may granted without notice. Upon granting a temporary restraining order, the court shall set the hearing for the preliminary injunction at the earliest possible time….
To obtain an injunction, a movant-the plaintiff-must convince the court of three things: (1) a probability of success on the merits, meaning that the plaintiff has enough evidence to convince a judge that the defendant has breached or his about to breach (as opposed to proof positive); (2) that the plaintiff will suffer irreparable harm absent an injunction, think: disclosure of the formula for Pepsi Cola; and (3) a balancing of the equities favoring the injunction. This latter test requires the court to weigh the harm that each party will suffer with and without injunctive relief. For example, precluding a salesperson with a non-compete from earning a living on one hand versus protecting his former employer from the harm caused by unfair competition.
Restrictive covenant injunction litigation is a strong and effective tool. It stops the offender in his or her tracks and sends the message to the defendant and existing employees, that breach will not be tolerated and that the employer is prepared to act and throw resources at defending its interests. Given the exigent circumstances, the litigation tends to be fast and intense but generally of limited duration. The good news is that if there is evidence of theft of trade secrets, the improper use of those secrets, or interference with client relationships there will often be relief.
When a court determines that a non-compete agreement is overly broad and unenforceable as written, that may not be the end of the story. A distinct minority of states will refuse to enforce the entirety of a non-compete agreement that the court deems unreasonable, a practice sometimes referred to as “all or nothing enforcement.” However, the majority of courts will still try to enforce the agreement if they can correct its flaws. Certain courts will rewrite parts of the contract to make it reasonable, a policy referred to as “judicial reformation.” In addition to, or instead of judicial reformation, some jurisdictions employ “blue penciling,” a practice where courts will strike the offending language from the agreement.
New York Courts will modify a non-compete clause when an employer can demonstrate that, among other factors, it sought the agreement in good faith. See BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999). To establish good faith, an employer must show that it did not use coercion to form the agreement and that it designed the non-compete to protect a legitimate business interest, like trade secrets or client confidentiality. New York Courts, however, are hesitant to reform non-compete agreements due to a presumption against restraints on competition, stating that “our economy is premised on the competition engendered by the uninhibited flow of services, talent and ideas.” See Reed, Roberts Associates, Inc. v. Strauman, 386 N.Y.S.2d 677, 680 (1976). New York Courts have also noted that non-compete agreements are only enforceable to the extent they are reasonable, but that “the formulation of reasonableness may vary with the context and type of restriction imposed.” Id. at 679. If an employer is clearly taking advantage of its employees by using superior bargaining power in negotiating its contracts, a New York Court may find that the non-compete is entirely unenforceable under such circumstances and refused to engage in blue pencilling. See Scott, Stackrow & Co., C.P.A’s, P.C. v. Skavina, 9 A.D.3d 805, 807-08 (3d Dep’t 2004).
New Jersey Courts may modify or blue pencil a non-compete agreement to the extent reasonable under the circumstances. See Solari Industries, Inc. v. Malady, 264 A.2d 53 (1970). An employer is entitled to enforce an overly broad noncompetitive agreement if the agreement “is reasonably necessary to protect their legitimate interests, will cause no undue hardship on the defendant [employee], and will not impair the public interest.” Id. at 61. Furthermore, New Jersey courts have held that a non-compete agreement may be reduced in geographic scope for appropriate reasons such as the potential adverse impact on the public of an unduly broad geographic scope of coverage in a physician’s non-compete agreement. Cmty. Hosp. Group, Inc. v. More, 183 N.J. 36 (2005).
Litigation arising out of employment contracts that contain non-compete, non-disclosure/trade secret, no employee raiding or non-solicitation of customer provisions often involve high stakes, including the protection of trade secrets, the ability to practice one’s trade, the elimination of a competitor, or maintaining key client relationships. Businesses have long sought to guard against unfair competition and to protect their trade secrets and market share. Regardless of whether it was in 1414 in Dyer’s Case, where, in the first recorded restrictive covenant case, an English court refused a master’s request to preclude his apprentice from practicing his trade in London for 2 years following the end of his apprenticeship or today in New York where courts are willing to enforce a restrictive covenant agreement if reasonable in time and geographic scope, and necessary to protect the employer’s legitimate interests.
The litigation is fast and furious for the parties often get one bite at the apple to quickly secure an emergency injunction or to prevent its issuance. This, before a judge who may
appreciate the necessity for such relief , but nevertheless looks upon restrictive covenants, just as courts did in the 1400’s, with great skepticism because they can act as a restraint on trade and the free flow of ideas. Crafting and arguing a restrictive covenant case requires skill and experience, as failure can mean a loss of employment. On the employer side, decades of hard work and financial investment can be quickly undone by misappropriation of a database or the raiding of a company’s staff by a knowledgeable ex-employee.
Generally restrictive covenants are designed to protect against a company’s “legitimate business interests” including its proprietary information, trade secrets, and client relationships from unfair competition or misappropriation. Enforcement may lie in a claim for breach of contract, tort or both.
by an employer, compensation and staffing policies
Generally, time is of the essence in order to bring an immediate halt to the dissemination of trade secret or the loss of a client, thus a complaint and a motion for emergency injunctive relief, with or without notice to the other side is filed in a court of competent jurisdiction. In time, a complaint is often preceded by a cease and desist letter to the offending party.
What is the Inevitable Disclosure Doctrine?
Under the inevitable disclosure doctrine, courts may enjoin a former employee from working in a specific job if doing so would inevitably lead to the disclosure of his former employer’s trade secrets. Courts following the inevitable disclosure doctrine most often apply it where a former employee with knowledge of his former employer’s trade secrets moves to a competitor and takes a job with duties so similar to his former position that the court finds that he cannot perform his new duties without using his former employer’s trade secrets. Because such disclosure is “inevitable,” the former employer need not sit and wait until there is actual or threatened use of the trade secrets before the former employer takes legal action.
PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995) is the seminal case that discusses inevitable disclosure. In PepsiCo, PepsiCo sought to enjoin a former high-level managerial employee, Redmond, from accepting the position of “Vice President – Field Operations for Gatorade” with PepsiCo’s competitor, Quaker Oats. PepsiCo and Quaker Oats were in fierce competition, especially in the “sports drink” and “new age” drinks markets. At that time, Quaker Oats held the market niche with its sports drink Gatorade, and PepsiCo had just introduced its Gatorade rival, “All Sport.” Quaker Oats also had the lead in the new age drink market. Redmond had signed a confidentiality agreement with PepsiCo but had not entered into any non-competition agreement.
At the preliminary injunction hearing, PepsiCo presented evidence that Redmond, who worked for PepsiCo for ten years, had access to and intimate knowledge of PepsiCo’s financial goals and its strategic planning for the upcoming year. Thus, although Redmond had signed a confidentiality agreement stating he would not disclose confidential information, PepsiCo argued that Redmond inevitably would disclose the trade secrets and confidential information to Quaker in his new position. The Seventh Circuit agreed with the PepsiCo’s position that:
“Redmond cannot help but rely on [PepsiCo’s] trade secrets as he helps plot Gatorade and Snapple’s new course, and that these secrets will enable Quaker to achieve a substantial advantage by knowing exactly how [PepsiCo] will price, distribute, and market its sport drinks and new agedrinks and being able to respond strategically.”
Accordingly, the Seventh Circuit affirmed the district court order preliminarily enjoining Redmond from taking his position at Quaker Oats and permanently preventing him from disclosing PepsiCo’s trade secrets.
Application of the Doctrine
The inevitable disclosure doctrine has not been universally adopted. Whether or not the employer can successfully seek an injunction under the inevitable disclosure doctrine depends on which state has jurisdiction over the dispute. State acceptance and interpretation of the doctrine has been varied and inconsistent, with some states even flatly rejecting the doctrine. We examine the current state of the inevitable disclosure doctrine in California, Connecticut, New Jersey and New York below.
New York has been viewing the inevitable disclosure doctrine with increasing disfavor.
Last year, in Janus et Ciet v. Andrew Kahnke,the Southern District of New York rejected the use of the “inevitable disclosure” doctrine as a basis for an independent cause of action. No. 12 Civ. 7201, 2013 WL 5405543 (S.D.N.Y. Aug. 29, 2013). The case was brought by Janus, a provider of high-end residential and commercial furnishings, against its former employee, Andrew Kahnke, a sales manager in one of its showrooms who was subject to a confidentiality agreement but no restrictive covenants. Janus commenced an action for inevitable disclosure of trade secrets and sought a permanent injunction barring Kahnke from disclosing any of Janus’ trade secrets or confidential information and from working for his new employer in any area where they are direct competitors, but notably did not allege breach of the confidentiality agreement or any actual misappropriation.
After exploring New York precedent, the Court acknowledged the possible validity of the inevitable disclosure doctrine, but rejected the idea that the doctrine could constitute an independent cause of action without allegations of wrongdoing. In dismissing Janus’s complaint, the Court stated that it refused “to countenance the imposition of an unlimited, unbargained-for restrictive covenant on Mr. Kahnke based on threadbare allegations,” because such a result was against “‘well entrenched state public policy considerations disfavor[ing] such agreements.’”
California has a strong public policy favoring employee mobility and generally rejects any type of restrictive covenant. Consistent with its public policy, the California Court of Appeal summarily rejected the inevitable disclosure doctrine in Schlage Lock Co. v. Whyte, 101 Cal. App. 4th 1443 (Cal. Ct. App. 4th Dist. 2002) (holding that it is “contrary to California law and policy, since it creates an after-the-fact covenant not to compete that restricts employees’ mobility.”).
Connecticut has applied the doctrine of inevitable disclosure to non-compete agreements, even where there is no bad faith on the former employee’s part. In Aetna Retirement Services, Inc. v. Hug, the Superior Court of Connecticut granted an injunction against an employee despite that employee’s “unimpeachable integrity.” No. CV970479974S, 1997 WL 396212 (Conn. Super. Ct. Jun. 18, 1997). The Aetna court found a one year non-competition agreement to be reasonable because the employee had access to and knowledge of confidential information that may not be protected by a non-disclosure agreement. The employee’s unimpeachable integrity and honesty was irrelevant since his “decisions, contributions, and strategic insights cannot help but be informed by the framework and knowledge he gained in his employment at Aetna.”
National Starch and Chemical Corp. v. Parker Chemical Corp. has been cited as setting forth New Jersey’s position on the inevitable disclosure doctrine. 219 N.J. Super. 158 (N.J. Super. Ct. App. Div. 1987). In National Starch, the appellate court held that despite the lack of bad faith by a former employee, his former employer was entitled to a preliminary injunction to prevent the disclosure of alleged trade secrets. The former employee was “intimately associated with the development of many sophisticated, highly technical envelope adhesives,” and his knowledge of his former employer’s products was “admittedly sufficiently detailed and extensive that he [could] duplicate certain formulas from memory.” Although the former employee had signed a confidentiality agreement and only 5% of his new work would be related to envelope adhesives, the court still upheld the preliminary injunction because there was “sufficient likelihood of ‘inevitable disclosure,” and that the circumstances justified “more than a ‘mere suspicion”’ of threatened irreparable harm.
Since National Starch,at least one New Jersey court has discussed the limits of the inevitable disclosure doctrine. In SCS Healthcare Marketing, LLC v. Allergan USA, Inc., the Bergen County Chancery Court evaluated an independent cause of action for inevitable disclosure in a motion to dismiss. C-268-12 (N.J. Super. Ct. Ch. Div. Dec. 7, 2012). The court dismissed the claim for inevitable disclosure, finding that New Jersey does not recognize inevitable disclosure as an independent cause of action. The court went on to clarify that where the doctrine of inevitable disclosure has been discussed (such as in National Starch), it has only been considered a factor for injunctive relief.
On January 9, 2012, New Jersey Governor Chris Christie signed the New Jersey Trade Secrets Act (NJTSA) into law. The statute expressly states that “actual or threatened misappropriation may be enjoined,” perhaps indicating that New Jersey may prohibit or limit claims based merely on “inevitable disclosure” of trade secrets. Since the enactment of the NJTSA, it remains to be seen whether the adoption of the NJTSA will alter New Jersey’s stance on the doctrine.
 We note that the SCS Healthcare decision rejecting inevitable disclosure as an independent cause of action did not analyze the issue under the lens of the newly adopted NJTSA.
As courts historically have disfavored broad restraints on competition, judges tend to strictly scrutinize restrictive covenants when employers seek to enforce them. See BDO Seidman v. Hirshberg, 93 N.Y.22d 382, 389 (N.Y. 1999).
For a quarter of a century, courts in New York adhered to the standard set by Reed, Roberts Assoc. v. Strauman, 40 N.Y.2d 303, 307-08 (N.Y. 1976), which balanced two policy considerations: protecting an individual’s ability to earn a living and the reasonable interests of employers. Because restrictive covenants are subject to an overriding standard of reasonableness, they “will only be subject to specific enforcement to the extent that they are reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee.” Id. Legitimate interests of the employer, according to the Reed, Roberts court, would include the protection of trade secrets or confidential information, or preventing competition when “an employee’s services are unique or extraordinary.” Id. at 308.
While attempting to remain faithful to the Reed, Roberts standard, two more recent cases refined restrictive covenant analysis for the new millennium. BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 388 (1999), and Ticor Title Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), led the way in defining how state and federal courts in New York would analyze, apply, and enforce restrictive covenants.
BDO Seidman concerned a restrictive agreement between the accounting firm BDO and Hirshberg, a manager in its Buffalo office. BDO Seidman, 93 N.Y.2d at 387. When BDO promoted Hirshberg to manager, it had required him to agree to compensate BDO for losses and damages in the event that he left the company and “served any former client of BDO’s Buffalo office” within 18 months. Id. at 387. After Hirshberg terminated his employment, the company sued, claiming damages because of 100 clients allegedly lost to Hirshberg. Id. at 388. The Court of Appeals of New York devised a three-prong test to determine whether a non-compete was reasonable in time and scope and warranted specific enforcement. Id. First, it could be no greater than required for the protection of the legitimate interest of the employer. Id. Second, the agreement could not “impose undue hardship on the employee.” Id. 388-389. Finally, the agreement would be null if “injurious to the public.” Id. at 389.
The BDO Seidman court found that the covenant at issue was reasonable because it only applied for eighteen months and only in the city where Hirshberg worked for BDO. However, while on the one hand it was legitimate for BDO to restrain a former employee from soliciting and taking clients that “BDO enabled [Hirshberg] to acquire through his performance of accounting services for the firm’s clientele during the course of his employment,” and for which he was compensated, BDO could not prevent its ex-employee from soliciting clients with whom he did not develop a relationship “through assignments to perform direct, substantive accounting services.” Id. at 391-392. Going forward then, employers have not been able to enforce those aspects of restrictive covenants which prevent ex-employees from doing business with the employer’s former clients that the employees acquired themselves (without the help of the business) or with whom the employee did not have a previous relationship. See id. at 393.
BDO Seidman v. Hirshberg was also significant because it embraced the concept of partial enforcement. Id. at 393. That is, the court rejected a rule that would nullify entire non-compete agreements because one clause or section was too broad or against public policy. Id. at 394. Therefore, post-BDO Seidman, a court could simply alter the terms of the restrictive covenant to make it more fair and reasonable under the circumstances, e.g., reducing the terms of a non-compete from one year to three months.
Some courts, however, have resisted the BDO Seidman standard of partial enforcement where the agreements were truly over-the-top. For example, in Scott, Stackrow & Co., C.P.A.’s, P.C. v. Skavina, 9 A.D.3d 805, 807, 780 N.Y.S.2d 675 (N.Y. App. 2004), a restrictive covenant that had no geographic limitations and sought to prevent the defendant “from soliciting or performing work for any client of the employer,” not just those clients with whom the employee had worked at her former employer, was found to be overly broad. Furthermore, the employer had acted anti-competitively by requiring the defendant to sign the agreement when it hired her and sign another one later as a condition of continued employment. Id. at 807. She did not enjoy any additional benefits in exchange for signing the agreement, and had to sign it again even after the BDO Seidman court placed limits on restrictive covenants. Id. at 808.
Ticor Tile Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), was a pivotal Second Circuit case, which held that an employee’s special relationships with his or her clients can be considered a unique service that warrants enforcement of a restrictive covenant. The court explained that when analyzing these agreements, trial courts should inquire into the “employee’s relationship to the employer’s business to ascertain whether his or her services and value to that operation may be said to be unique, special or extraordinary,” not just analyze the employees abilities in a vacuum. Id. at 65. Thus, a title insurance company was able to enforce a restrictive covenant against a former salesman because of the unique services that salesman had provided. The court reasoned that because “the costs and terms of title insurance are fixed by law, competition for business relies more heavily on personal relationships.” Id. at 71.
Despite Ticor Title’s holding, there are limits to what can be considered unique or special services. For example, it was unreasonable to enforce a restrictive covenant that would bar a conference organizer for two years from offering to any employer similar to her former employer anywhere in the world because “[a] conference organizer—who coordinates hotels, caterers, and printers and who makes about $50,000 a year—does not provide the ‘special, unique, or extraordinary’ services that would justify injunctive relief.” AM Medica Communications Group v. Kilgallen, 90 Fed. App’x 10, 11 (2d Cir. 2003).
The employee choice doctrine is a rare exception to the rule that courts will stringently analyze restrictive covenants. It “applies in cases where an employer conditions receipt of postemployment benefits upon compliance with a restrictive covenant.” Morris v. Schroder Capital Mgt. Int’l, 7 N.Y.3d 616, 620-21, 859 N.E.2d 503 (N.Y. 2006). That means that if an employee can choose between not competing and forfeiting rights to postemployment benefits (e.g., severance) by competing, the agreement is per se reasonable, since it an assumes the departing employee is making an informed decision. Id. at 621. In these cases, as long as the employee has terminated his employment voluntarily, courts will not scrutinize these agreements for reasonableness. Id.
Ultimately, a court’s decision to enforce a restrictive covenant will usually depend on the specific facts of the case. In particular, courts will analyze the industry, the employer, the bargaining situation leading to the agreement, and, most crucially, the terms of the agreement itself. While courts may find these agreements reasonable in many situations, those employers who overreach or try to place restraints that are too broad will lose their ability to restrain departing employees from competing, soliciting clients, or raiding coworkers. Crafters of these agreements must seek to balance the rights of a company to protect its legitimate business interests and the rights of an individual to seek work and earn a living.