IT Recruiting Firm’s Non-Compete and Trade Secrets Claims Against Former Employees Fail – ND IL (Part I of II)

In Instant Technology, LLC v. DeFazio, 2014 WL 1759184, the Northern District of Illinois examines Illinois non-compete law, trade secrets rules and a slew of business torts in the context of a heated battle between rival recruiting firms and some of their key employees.  This article distills the case’s key restrictive covenant principles.  Part II of the post will summarize the court’s ruling on the plaintiff’s trade secrets, tortious interference, and civil conspiracy claims.

The plaintiff staffing firm sued several former employees and their current employer – a rival recruiter – for violating restrictive covenants contained in their employment contracts and for disclosing the plaintiff’s trade secrets in connection with their current position with the competing firm.  Plaintiff sued when it found out that the defendants had contacted some of plaintiff’s clients and job placement candidates in violation of their non-compete and non-solicitation provisions.  After a several-day bench trial and hearing testimony from almost 20 witnesses, the Court ruled in the defendants’ favor on all of the plaintiff’s claims.

Illinois Non-Compete Rules

The Court found that the defendants’ non-compete provisions were unenforceable because they lacked consideration and because the plaintiff couldn’t establish a legitimate business interest to be protected by the non-competes.  Under Illinois law, when assessing a restrictive covenant (here, a “non-compete”), the court looks to whether (1) the covenant is ancillary to a valid contract, and (2) whether it’s supported by consideration.  Consideration to support a non-compete is lacking if an employee can be fired the minute after he signs it and will only have adequate consideration only if, after signing the covenant, the employee remains employed for a substantial period of time – defined as two years or more of continued employment. See Fifield v. Premier Dealer Services, Inc. 2013 IL App (1st) 120327.

Aside from requiring at least two years of continuous employment, a valid non-compete has to be “reasonable.”  The reasonableness of a non-compete turns on whether it (1) is no greater than necessary to protect a legitimate business interest of the employer; (2) the non-compete doesn’t impose an undue hardship on the employee; and (3) it’s not injurious to the public. 

A legitimate business interest will usually exist where (a) the employee has access to the employer’s confidential trade information; and (b) the employee is tampering with the employer’s established customer relationships.  Other factors a court considers when determining whether an employer has a legitimate business interest include (i) the “near-permanence” of customer relationships; (ii) whether the employee’s acquired the employer’s confidential information; and (iii) the non-compete’s time and space restrictions.

Near-permanency (of customer relationships) depends on the nature of the business involved.   Businesses that engender customer loyalty and that offer specialized, unique services have a better chance of establishing a near-permanent client relationship than do companies whose services are more generic and disposable.   An industry marked by high turnover or one in which customers uses many vendors – like the recruiting business (or a large corporation that uses regional law firms) – will not meet the near-permanence criterion.

Under these guideposts, the Court invalidated the former employees’ non-competes.  First, several of the employees didn’t work the requisite two years to support the non-competes: they lacked consideration.  In finding the non-competes substantively unreasonable, the Court noted that the staffing industry is mercurial and subject to “massive turnover.”  The recruiting industry also uses elemental (read: not secret) sales techniques like cold calls to make sales and identify potential prospects.

And while maintaining workforce stability can be a legitimate business interest (as the plaintiff argued), where an industry is subject to rampant turnover – with frequent employee departures and terminations – the workforce stability argument fails.  The Court held that enforcing the defendants’ non-competes wasn’t likely to enhance the plaintiff’s workforce stability given the high turnover in the recruiting business and its basic, non-specialized sales techniques (cold-calling, e.g.).

Afterwords: Instant Technology is significant and instructive for its expansive analysis of Illinois non-compete principles, its validation of the two-year employment rule announced in Fifield (see http://paulporvaznik.com/fifield-case-two-years-of-continous-employment-sufficient-consideration-to-enforce-employee-restrictive-covenants/1261) and its discussion of the legitimate business interest non-compete clause prong.  The case illustrates that with a business that is historically subject to high turnover and that utilizes direct selling techniques, it will be hard for an employer to establish near-permanence with its customers ad, by extension, difficult to show a legitimate and protectable business interest.

 

Medical Practice Break-Up Spawns Non-Compete Dispute

imageThe bitter breakup of a medical practice provides the setting for the Illinois Fifth District to consider the scope of a non-compete clause and how it impacts a minority shareholder’s buy-out rights.

Gingrich v. Midkiff, 2014 IL App (5th) 120332-U presents a dispute between two former partners in a medical corporation.  At the medical practice’s inception – in the late 1990s – the parties signed a stock purchase agreement that contained a 5-year/20-mile non-compete provision (the “Non-Compete”).

The Non-Compete only applied in two situations: (1) if a shareholder withdrew from the practice after giving the required written notice; or (2) where a shareholder was expelled from the practice.  The parties’ relationship quickly soured and in 2002, a decade-long cycle of litigation between the two doctors ensued.

The 2002 Lawsuit

A 2002 lawsuit between the parties culminated in the plaintiff buying defendant’s stock in the medical corporation.  The court in the 2002 case didn’t rule on whether the Non-Compete was enforceable.

The 2007 (and current) Lawsuit

In the 2007 case, plaintiff sued defendant alleging the defendant violated the Non-Compete by going to work for a rival practice within 20 miles of plaintiff’s office. 

The trial court dismissed.  It held that the Non-Compete didn’t apply because defendant didn’t withdraw and wasn’t expelled from the medical corporation.  Plaintiff appealed.

Ruling: Affirmed.

Reasoning:

The court rejected plaintiff’s law of the case (LOTC) argument.  The LOTC doctrine prevents relitigation of an issue of fact or law previously decided in the same case.  ¶ 14.  Its purpose is to avoid repetitive litigation of the same issues and to foster finality and consistency in litigation.  LOTC reflects the court’s preference to generally not reopen previously decided issues.

Here, there was no adjudication of the Non-Compete in the 2002 case.  The core issue litigated in that first suit was the valuation of defendant’s shares and whether plaintiff served a proper election to purchase those shares.

Since the cardinal issues in the 2002 and 2007 Lawsuits substantively differed, LOTC didn’t prevent defendant from challenging the Non-Compete in the 2007 case. ¶¶  17-19.

The court also found the Non-Compete wasn’t enforceable.  In Illinois, noncompetition clauses in the medical services context are heavily scrutinized and only validated where they have reasonable time and space limits.

¶¶ 22-24.

Finding the Non-Compete unambiguous, the Court held that the 5 year/20-mile strictures attached in only two circumstances: where a shareholder either (1) withdrew or (2) was expelled from the practice.  Here, defendant  didn’t withdraw and she wasn’t expelled.  As a result, the Non-Compete didn’t prevent the defendant from practicing within twenty miles of plaintiff’s office.  ¶¶ 25-29.

Afterwords: Clarity in contract drafting is critical.  The case illustrates that a Court won’t strain to find ambiguity where contract language is facially clear.  Gingrich also illustrates that a restrictive covenant will be construed in favor of permitting, instead of stifling, competition.  In hindsight, the plaintiff should have made it clear that if a shareholder departed the medical practice for any reason: whether voluntary, forced, or after a buy-out, the non-compete would still govern.

 

 

 

Facebook Announcement Doesn’t Equal Improper Client Solicitation: Mass. Court

In Invidia v. DiFonzo, 30 Mass. L.Rptr 390 (2012), a hair salon sued a former stylist for breaching a non-compete and non-solicitation clause in her employment agreement.  The Court examined whether the new employer’s posting a job change on defendant’s Facebook page and “friending” former clients was improper solicitation.

The employment contract contained a non-compete spanning two years and 10 miles and a two-year non-solicitation clause.  After she resigned, the defendant went to work for a competing salon less than two miles away.  Her new employer then posted an announcement on its Facebook page, promoting defendant’s new affiliation with the competing salon. 

The plaintiff saw the Facebook activity and sued.  The Court denied the request for injunctive relief because plaintiff failed to show a likelihood of success on the merits or irreparable harm.

Rules/Reasoning:

A preliminary injunction plaintiff must show (1) likelihood of success on the merits; (2) irreparable harm if the injunction is denied; and (3) the risk of irreparable harm to the movant outweighs similar risk of harm to the opposing party.  *2. 

Massachusetts courts scrutinize non-competition agreements because they often result from unequal bargaining power.  A covenant not to compete is enforceable only if it’s necessary to protect a legitimate business interest, is reasonably limited in time and space, and supported by the public interest.  *4.

The Non-Compete Provision

The salon plaintiff failed to show that it was likely to succeed on the merits on the noncompete because it was questionable whether a two-year/10-mile restriction was necessary to protect plaintiff’s interest and because plaintiff failed to show that its “legitimate business interest” – the goodwill which plaintiff claimed it lost – belonged entirely to plaintiff.  *5.  

The Court noted that in the hairdressing business, goodwill often belongs to the individual stylist rather than the salon.  That is, customers likely patronize a salon for a specific hairdresser; not because they like the salon itself. 

The Court also found the plaintiff failed to show irreparable harm, since plaintiff could clearly quantify its damages.  The Court pointed out that plaintiff offered evidence of the number of clients that it lost since defendant left (90) and the average dollar amount spent ($87.16) by each lost client.  This militated against a finding of irreparable harm.  *5.

The Non-Solicitation Clause

Turning to the non-solicitation clause, the Court found that the Facebook announcement of defendant’s affiliation with the new salon (by that salon) did not equate to active solicitation.*5.  

Nor did the defendant’s sending  friend requests to eight clients of plaintiff amount to a breach of the non-solicitation provision. 

The employer did however have some circumstantial evidence in support of its solicitation argument.  It offered documents at the injunction hearing that demonstrated that some 90 salon clients had cancelled (without rescheduling) appointments in the two-plus months since defendant’s departure. *6.  Yet the Court wasn’t prepared to find this a breach of the anti-solicitation provision.  The Court stressed that no current or former clients testified that defendant contacted them and solicited their business.

Take-aways: A third party’s passive Facebook posting and direct Facebook friends requests are not enough to establish solicitation for preliminary injunction purposes.  Instead, there must be direct evidence of active solicitation to merit injunctive relief.