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DTCI: The limits of what’s reasonable

June 3, 2015

 

murphy-hannesson-dtci-mug By Hannesson I. Murphy

A practitioner’s guide to the enforceability of restrictive covenants in Indiana

Employment attorneys who routinely litigate the enforcement of restrictive covenants know the following fact pattern all too well.

• A trusted employee leaves her job to work for a competitor.

• The employee knows the company’s confidential information, and her employer fears that she will divulge all these secrets to the competitor.

• The employer wants to stop her from working for the competitor.

What follows depends on (1) what restrictions, if any, the employee agreed to during her employment and (2) whether those restrictions are enforceable. Unlike some states that prohibit the enforcement of restrictive covenants, Indiana will enforce them – albeit reluctantly – if narrowly tailored and reasonable.

But the law is always changing. Last year, the Indiana Court of Appeals issued a decision in Clark’s Sales & Service, Inc. v. Smith, 4 N.E.3d 772 (Ind. Ct. App. 2014), which contained some subtle – but potentially significant – changes to Indiana’s enforcement of restrictive covenants. This article will analyze the current state of Indiana law and some of the pitfalls that practitioners and employers face when trying to enforce restrictive covenants.

A. The restrictive covenant spectrum

Restrictive covenants come in a variety of shapes and sizes, ranging from no restrictions at all to completely prohibiting an employee from working for a competitor in a specific field.

1. The law of the jungle

On one end of the spectrum is no contractual restrictions at all. This is the law of the jungle and affords employers few options for stopping employees from working for a competitor. At best, the employer might be able to claim the misappropriation of trade secrets; however, this approach contains several substantive hurdles.

First and foremost is whether the information at issue actually constitutes a trade secret. Under Indiana law, a trade secret (1) is information that derives independent economic value from not being generally known or readily ascertainable through proper means and (2) is the subject of reasonable efforts to keep its secret. I.C. § 24-2-3-2. As a result, many things commonly viewed by employers as secret (personnel information and payroll, bookkeeping records, marketing strategies) are unlikely to qualify as trade secrets because the information provides no economic value as do unique manufacturing methods and practices or formulas. In the same vein, if there are no adequate protections to keep the trade secret information actually secret (such as password-protected electronic databases), the information may not meet the requisite definition.

Of course, showing that information is a trade secret is just the first hurdle. Next, the employer has to show that the information was misappropriated and that an injunction is warranted. This necessarily requires that improper means (i.e., theft, fraud, bribery, industrial espionage) were used to acquire knowledge of the trade secret.

2. Confidentiality agreements

The next point on the spectrum is the confidentiality agreement. These agreements typically safeguard proprietary information that otherwise would not be considered trade secrets. They also enable employers to sue faithless employees for breach and potentially recover damages. While such agreements generally are not subject to the same onerous standards as a noncompete agreement, they still are considered restraints on trade. Bodemer v. Swanel Beverage, Inc., 884 F. Supp. 2d 717, 736, 2012 WL 3138097 (N.D. Ind. 2012) (holding that confidentiality agreement, although entitled to more lenient review than a noncompete, was unenforceable because it could be used to bar employee’s use of general knowledge and skills in future employment); Harper/Love Adhesives Corp. v. Van Witzenberg, 2008 WL 740362, at *9 (N.D. Ind. Mar. 17, 2008) (enforcing nondisclosure provision but not noncompete).

3. Nonsolicitation of employees

These provisions bar a separated employee from soliciting her former colleagues to leave the company and work for a competitor. These provisions generally are enforceable in Indiana. Deich-Keibler v. Bank One, 2005 WL 2428210, at *7 (S.D. Ind. Sept. 30, 2005), aff’d, 243 Fed. Appx. 164, 2007 WL 1827260 (7th Cir. 2007).

4. Nonsolicitation of customers

These provisions block separated employees from contacting customers (and usually prospective customers) of an employer. Whereas nonsolicitation-of-employee provisions are usually uncontroversial, these provisions are regarded in the same manner as noncompetition covenants and are held to the same stringent standards. See Clark’s, 4 N.E.3d at 772.

5. Noncompetition covenants

On the far end of the spectrum is the noncompetition covenant (perhaps the gold-standard for ensuring that a faithless employee does not work for a competitor). Given the inherent harshness associated with the provision – preventing someone from working – it has been the most controversial and is the subject of most of the litigation regarding restrictive covenants.

B. Indiana law on restrictive covenants

Indiana, like most states, does not favor restraints on trade. Licocci v. Cardinal Assocs., Inc., 445 N.E.2d 556 (Ind. 1983). Public policy prohibits unnecessary interference with a person’s calling and livelihood. Wagler Excavating Corp. v. McKibben Constr., Inc., 679 N.E.2d 155 (Ind. Ct. App. 1997). As such, Indiana courts will construe these covenants strictly against employers. Licocci, 445 N.E.2d at 556. To be enforceable, a restrictive covenant must be reasonable. Central Indiana Podiatry, P.C. v. Krueger, 882 N.E.2d 723 (Ind. 2008). This means that the employer must show that “the former employee has gained a unique competitive advantage or ability to harm the employer” before it can seek the protection of such a covenant. Hahn v. Drees, Perugini & Co., 581 N.E.2d 457, 459 (Ind. Ct. App. 1991). The employer must establish that it has a legitimate interest to be protected by the agreement and that the restrictions are reasonable as to time, activities and geographic area.

1. Legitimate protectable interests

First out of the gate, an employer must show a good reason for asking employees to sign the restrictive covenant. A “legitimate protectable interest” is an advantage possessed by an employer that would be unfair for an employee to use after the end of the employment relationship in competition with the employer. Coates v. Heat Wagons, Inc., 942 N.E.2d 905 (Ind. Ct. App. 2011). Trade secrets and goodwill – the advantageous familiarity and personal contact that employees derive from dealing with an employer’s customers – are recognized as legitimate, protectable interests. Liococci, 445 N.E.2d at 561-62. By contrast, general knowledge, information or skills gained by the employee in the course of employment are not regarded as protectable interests. Buffkin v. Glacier Group, 997 N.E.2d 1 (Ind. Ct. App. 2013) (holding that the accumulated knowledge of a sales recruiter concerning the company’s recruiting practices and how contracts were to be written were not, in themselves, legitimate protectable interests).

2. Time

For the most part, restrictions of three years or less are regarded as enforceable in Indiana. Titus v. Rheitone, 758 N.E.2d 85 (Ind. Ct. App. 2001) (three years); Washel v. Bryant, 770 N.E.2d 902 (Ind. Ct. App. 2002) (two years). Longer restrictions also may be reasonable, but this will depend on whether the facts warrant such restrictions. Mayne v. O’Bannon Pub. Co., Inc., 990 N.E.2d 525 (Ind. Ct. App. 2013) (upholding five-year restriction where employee had worked for decades in the industry and also several years with the company).

3. Activities

Indiana courts regard as overbroad and unreasonable agreements that prevent an employee from working for a competitor in any capacity. In Buffkin, an agreement that prohibited an employee from working “in any way with any business that competes” with the employer was struck down. 997 N.E.2d at 14. The rationale is that the expansive scope of such provisions would restrict the employee’s ability to work. Id. at 15. Such provisions would prevent an employee with knowledge of a company’s information technology practices from working for a competitor in an unrelated capacity (sales, accounting, or even as a janitor).

4. Geography

The reasonableness of an agreement’s geographic scope similarly depends on the interest of the employer that the restriction serves. Krueger, 882 N.E.2d at 729. Krueger involved a physician who was barred from competing against his practice group within a geographic area that included 14 Indiana counties, any county where the group maintained an office, or any county adjacent to those counties. The Indiana Supreme Court regarded this as unenforceable because it included counties in which the physician did not practice. Id. The court reasoned that a noncompetition agreement justified by the development of goodwill must be limited to the area in which the employer had customer contact, and since the physician at issue had no contact with patients in certain counties, the restriction was overbroad. Id. See also Buffkin, 997 N.E.2d at 15 (holding that geographic area encompassing the entire United States was unreasonable since this was an area larger than that in which the employer conducted business).

C. The Clark’s case

Clark’s involved a longtime salesman for an appliance retailer. 4 N.E.3d at 776. He was party to a noncompete that barred him in any capacity for a period of two years from:

• soliciting or calling on anyone who had been a customer of the company at any point in time during his employment;

• working for a competitor in any state where the company does business; in Marion County or any county contiguous to Marion County; in any county in Indiana where the company has at least one customer; in the state of Indiana; or within a 50-mile radius of the company’s principal office. Id.

After the employee resigned and went to work for a competitor, the employer filed suit to enforce the noncompete and sought injunctive relief. Id. at 777. The trial court rejected the employer’s claims and struck down the noncompete as unreasonable. This decision was affirmed in full by the Court of Appeals. Id. at 778-80.

The Court of Appeals took issue with several parts of the agreement. First, the court believed that the restriction on soliciting customers was overbroad because it prohibited the employee from calling anyone who had been a customer at any point in time during his employment, including customers with whom he may have had no contact. Id. at 781-82.

Second, the court viewed the scope of activities as too broad because it went beyond his old sales job and prohibited him from engaging in any service that the company offered but which he himself never performed. Id. at 782.

Third, the court viewed the geographic restriction as unreasonable. While the court believed that a 50-mile radius might be reasonable given the nature of the sales services he provided, the problem was with the way the provision was worded: It was in addition to and not a limitation of the much more expansive geographic restrictions that preceded it. Id. at 783. The court refused to apply the “blue pencil doctrine” to salvage the geographic restriction. Id. at 784-87.

This last holding may be of most concern for Indiana employers. The blue-pencil doctrine has long allowed courts to excise unreasonable restrictions in order to uphold restrictive covenants if the provisions are readily divisible and the reasonable parts clearly can be separated from the unreasonable ones. Krueger, 882 N.E.2d at 730. The Clark’s court believed that excising provisions to make the language enforceable would have to be extensive and would change the meaning of entire paragraphs. Clark’s, 4 N.E.3d at 784-87. Since it could not easily redact the challenged language, the court refused to enforce the noncompete agreement. Id.

D. Conclusion

Clark’s is a stark reminder of the uphill battle Indiana employers face when seeking to enforce restrictive covenants. Nevertheless, the case also provides some useful lessons. Blanket prohibitions barring employment with a competitor in any capacity should be discarded. Customer-contact restrictions that span an employee’s entire tenure should be narrowed to current customers. Subsections, subparagraphs or other devices should be used to separate restrictions concerning geography and scope of activities so that even if some are culled, the survivors can still support an enforceable restriction. Indeed, this can be seen to good effect in the post-Clark’s case of Moss v. Progressive Design Apparel, Inc., 20 N.E.3d 604 (Ind. Ct. App. 2014), which affirmed the blue-penciling of a nonsolicitation of customers restriction and enforced the surviving clause, which was limited to current customers. In short, the enforcement of restrictive covenants in Indiana is far from dead, but practitioners and employers need to be aware of developing changes to ensure that the covenants they draft and employ are worth the time and money they have invested.•

Mr. Murphy is a partner in the Indianapolis office of Barnes & Thornburg and chairs the Employment Law Section of DTCI. The opinions expressed in this article are those of the author.

 

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