U.S. Supreme Court Rules That Arbitrators, Rather Than Courts, Determine The Enforceability Of Non-Compete Covenants In Arbitrable Agreements

Because non-compete agreements are governed by state law, it is rare that the U.S. Supreme Court issues a ruling affecting such contracts. This week’s decision in Nitro-Lift Technologies, L.L.C. v. Howard, 568 U.S. __ (2012)(decided Nov. 26, 2012), however, announces a rule of which non-compete disputants and their counsel nationwide must necessarily take notice.

The Court held that when a non-compete agreement contains an arbitration clause that is subject to the Federal Arbitration Act (FAA), 9 U.S.C. §1 et seq., “it is for the arbitrator to decide in the first instance whether the covenants not to compete are valid as a matter of applicable state law.” Id. (citing Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 445-6 (2006)).  In so holding, the Court vacated an Oklahoma Supreme Court decision that declared the non-compete agreements to be against Oklahoma public policy and thus void and unenforceable.

The Court based its decision on the FAA’s “national policy favoring arbitration” and on the established rule of law that “when parties commit to arbitrate contractual disputes, . . . attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself, are to be resolved ‘by the arbitrator in the first instance, not by a federal or state court.’” Id. (quoting Preston v. Ferrer, 552 U.S. 346,349(2008)).  The Court also cited the supremacy clause from the US. Constitution, Article VI, cl. 2.

BURR POINTThis decision goes in the “win” column for employers everywhere (except those who hire employees with non-competes), because it removes the ability of an employee to obtain relief in the court system when an employer seeks to avail itself of an arbitration clause in connection with the enforcement of a non-compete covenant.  The ruling makes a definite difference in jurisdictions in which the governing law often results in Courts voiding or modifying non-compete agreements for overbreadth.  Arbitrators have much more latitude than trial courts in how they apply the law (and arbitrator’s decisions are extremely difficult to get overturned) and are thus much less likely to void a non-compete covenant that was agreed upon by the parties.

How Public Interest May Limit Enforcement of a Non-Compete Agreement

Though non-compete agreements are generally disfavored in Tennessee as a restraint on trade, courts will enforce them if the employer has a legitimate business interest to protect and the time and territorial limits are reasonable.  Courts strictly construe non-compete agreements in favor of the employee and may revise the terms the agreement when necessary to balance the interests of the employee and employer.

Like other contracts, however, non-compete agreements which implicate important public policy issues are even more strictly construed and may be unenforceable.

In 2005, the Tennessee Supreme Court held non-compete agreements which restrict a physician’s ability to practice medicine are unenforceable.  The Court decision’s was based on a belief that having a greater number of physicians practicing in a community benefits the public by providing greater access to health care.  Also, increased competition for patients tends to improve the quality of care and keep costs affordable.  Further, a person has the right to choose his or her physician and to continue an on-going professional relationship with that physician.  Enforcing a non-compete agreement would impair or even deny the patient’s rights altogether.

Though the Tennessee Supreme Court’s 2005 decision was overturned by the Tennessee Legislature (see James Haltom’s discussion in his April 25, 2012 post discussing the most recent amendments to the physician non-compete law effective January 1, 2012), it is a good example of how the public interest in professional services may render a non-compete agreement unenforceable.  Other states continue to hold that a physician’s practice may not be limited by a non-compete agreement.

Another area in which courts have long held non-compete agreements are unenforceable is legal services.  In 1991 the Tennessee Supreme Court held a law firm’s deferred compensation plan which was contingent on the departing attorney not practicing law was a non-compete agreement.  In holding the non-compete agreement was unenforceable, the Tennessee Supreme Court stated that, “[t]he practice of law is a profession, not a business, that clients are not merchandise, and that lawyers are not tradesmen.”

As in the Tennessee Supreme Court’s 2005 related to physicians, the Tennessee Supreme Court in 1991 found that non-compete agreements restricting an attorney’s ability to practice law also harms the public good.  These cases demonstrate that there are professional services which benefit the public at large and are viewed differently than other business transactions.

The cases in which a non-compete agreement is unenforceable because it harms the public good are few.  The focus is primarily on whether the terms of the non-compete agreement are reasonable.  However, in drafting non-compete agreements, employers should keep in mind that in some instances the post-employment restrictions placed on a former employee could be construed as implicating important public policy issues which may render the non-compete agreement unenforceable.

Please contact any member of Burr & Forman’s Non-Compete and Trade Secrets team members with any questions you may have regarding non-compete and trade secrets issues.

DuPont Wins the Battle Over Kevlar . . . But Has It Won the War?

After being slammed with a verdict of $919.9 million against it in September 2011, South Korean-based Kolon Industries suffered its second whammy in August when the United States District Court for the Eastern District of Virginia enjoined it from production of its Heracron aramid fiber line, a competitor to DuPont’s Kevlar aramid fiber line, on the basis of misappropriation of DuPont’s trade secrets.

The District Court’s rulings were the products of litigation instituted by DuPont against Kolon in February 2009, wherein DuPont alleged that Kolon stole trade secrets and confidential information about Kevlar, DuPont’s aramid fiber developed in the 1960s and used in military and first responder protective gear.  More specifically, the suit urged that Michael Mitchell, a former DuPont employee who had worked as a Kevlar marketing executive, stole the trade secrets and passed them along to Kolon when he became employed therewith.  (Side bar: the F.B.I. investigated, Mitchell plead guilty, and he ultimately was sentenced to 18 months in prison).  Kolon denied any wrongdoing.

Following the massive damages award to DuPont in September 2011, DuPont announced that it would press forward with an effort to secure injunctive relief prohibiting Kolon from profiting further from having stolen DuPont’s trade secrets

After being slammed with a verdict of $919.9 million against it in September 2011, South Korean-based Kolon Industries suffered its second whammy in August when the United States District Court for the Eastern District of Virginia enjoined it from production of its Heracron aramid fiber line, a competitor to DuPont’s Kevlar aramid fiber line, on the basis of misappropriation of DuPont’s trade secrets.

The District Court’s rulings were the products of litigation instituted by DuPont against Kolon in February 2009 in E.I. Dupont de Nemours and Company v. Kolon Industries, Inc., No. 3:09-cv-00058 (E.D. Va. Feb. 3, 2009), wherein DuPont alleged that Kolon stole trade secrets and confidential information about Kevlar, DuPont’s aramid fiber developed in the 1960s and used in military and first responder protective gear.  More specifically, the suit urged that Michael Mitchell, a former DuPont employee who had worked as a Kevlar marketing executive, stole the trade secrets and passed them along to Kolon when he became employed therewith.  (Side bar: the F.B.I. investigated, Mitchell plead guilty, and he ultimately was sentenced to 18 months in prison).  Kolon denied any wrongdoing.

Following the massive damages award to DuPont in September 2011, DuPont announced that it would press forward with an effort to secure injunctive relief prohibiting Kolon from profiting further from having stolen DuPont’s trade secrets.

And so it was.  On August 30, 2012, the District Court entered an Order requiring Kolon to return DuPont’s trade secrets by October 1, 2012, prohibiting Kolon’s use of DuPont’s trade secrets permanently, and enjoining Kolon from producing or selling any para-aramid fiber products worldwide for twenty years. In so doing, the Court stated that Kolon showed a “complete disregard for DuPont’s trade secret rights and a disregard for the law that protects such secrets,” further noting that Kolon engaged in stealing DuPont’s trade secrets as “a matter of corporate policy.”  Not surprisingly, Kolon voiced its disapproval of the injunction’s issuance and immediately moved to stay the order pending the appeal of the jury verdict, which was granted by the Fourth Circuit Court of Appeals.

Shortly thereafter, the federal government announced on October 18, 2012 an indictment in United States v. Kolon Industries, Inc., No. 3:12-Cr-137 (E.D. Va. Aug. 21, 2012), charging Kolon with theft of DuPont’s trade secrets, conspiracy, and obstruction of justice, and five of its executives with conspiracy and obstruction of justice, contending that Kolon engaged in a multi-year campaign to recuirt DuPont employees to Kolon for purposes of obtaining Kevlar-related trade secrets.  The United States Department of Justice is attempting to seize $226 million from Kolon, allegedly representing the proceeds of the sale of Heracron fiber from 2006 to June 2012, plus over $300,000 in payments allegedly made to former DuPont employees to provide trade secret information.  If found guilty, the Kolon executives face up to 30 years in prison, and both the executives and Kolon would face millions of dollars in fines. U.S. Attorney Neil MacBride, in discussing the indictment, stated that it “should indicate that industrial espionage is not a business strategy and will not be tolerated by the United States Department of Justice.”

As Kolon has been found liable for civil violations and charged with criminal action related to its alleged trade secret theft from DuPont, DuPont has won the battle.  However, since Kolon has now appealed the civil matter and will contest the criminal action, has DuPont won the war? We will have to wait and see.

If you would like additional information on non-compete agreements or trade secrets law, please contact one of the Burr & Forman Non-Compete & Trade Secrets team members.

Does Bird’s Eye View Render Executive Non-Compete Unenforceable?

So here’s a good one for employers to ponder.  Let’s say you have an executive subject to a valid and seemingly enforceable non-compete agreement.  Because the agreement concerns an executive, we would normally presume that a court is likely to strictly read the terms of a non-compete agreement and enforce it accordingly.  Well, the Second Circuit Court of Appeals recently affirmed a decision that an executive whose level of seniority limited his knowledge of the details rendered him not subject to the terms of his otherwise-valid non-compete agreement.

In the typical case, an employee with specific knowledge – let’s use the example of an engineer – enters into a non-compete agreement that states, for instance, that he will not work for a competitor within the same geographic area of his current job responsibilities for one year after his departure, regardless of the reason for his departure.  If the agreement is otherwise enforceable, a Florida court would typically view the above-described restriction as valid.  After all, the engineer has specific knowledge the details of which could, in theory at least, give a competitor an advantage over the former employer.

Taking this analysis one step further, however, led at least one court to determine that the senior executive was so far removed from the mundane specifics of the actual work product, he was actually no longer subject to the non-compete agreement he voluntarily executed.  Which brings us to IBM v. Visentin, 2011 WL 672025 (SDNY 2011), aff’d 437 Fed Appx 53 (2d Cir. 2011).  I’ll keep the facts short, although the somewhat unique nature of the facts obviously resulted in a seemingly unexpected opinion.  Visentin worked at IBM, very successfully, for over a quarter of a century.  So successfully, in fact, that at the time he departed IBM for competitor Hewlett Packard he was in charge of a multi-billion dollar business unit.  He had executed a non-compete with a one year work restriction that on its face appeared to encompass his prospective employment with Hewlett Packard.  The agreement Visentin executed included a relatively standard three-year look-back stating that the agreement only pertained to those areas of IBM’s business in which Visentin worked in the three years prior to his departure.

When Visentin left, IBM sued, seeking injunctive relief based on Visentin’s alleged violation of the non-compete described above.  The federal district court denied the motion for a preliminary injunction.  (In cases to enforce non-compete agreements, denial of the preliminary injunction usually ends the dispute… unless the former employer appeals.)  IBM appealed, only to have the 2nd Circuit Court of Appeal affirm the lower court’s ruling.

While the denial of the preliminary injunction motion in Visentin presents a unique situation due to Visentin’s high level executive position, the district court’s lengthy holding contains some valuable insight in the analysis of non-compete issues.  Among the points raised was that the high level of the former employee’s position allowed him a supervisory capacity (he was a manager of a business line with expertise in making operations “efficient”), and yet insulated him from the specific technological goings-on and to detailed data potentially protected as a trade secret.  So in essence, because he maintained a bird’s-eye view of operations, rather than a position with direct creative input or a position “on the line,” he was insulated from information that would negate his former employer’s presumed competitive advantage.

The district court opinion went even further, at one point discussing that among known competitors with significant resources, the open flow of intelligence in the marketplace rendered the probability of harmful disclosure somewhat remote (if even possible).  Also interesting was the emphasis that success on a motion for preliminary injunction was challenging in the absence of known instances of disclosures of detailed information that clearly violated the non-compete agreement, or detailed information that the employee’s new position would require improper disclosure.  Given the bird’s-eye view Visentin had over the IBM business unit, pointing out specific instances of wrongful disclosures proved difficult.

So where does that leave employers seeking to enforce these agreements?  Certainly in Florida, there a many instances in which the courts uphold these agreements.  What is important to keep in mind, however, is the necessity of providing either enough detail in your non-compete/non-disclosure agreement to make enforcement easier, or to allege with enough specificity the actual information or trade secrets the disclosure of which could cause actual harm.  The case discussed in this article also points out that despite possible factual similarities, each non-compete rests on its own merits and brings to the dispute its own facts.  It is the nature of the information the employer seeks to protect and the factual circumstances surrounding the former employee’s duties and experience that will form the foundation of any successful argument regarding enforcement.

This is the part where I counsel you to get counsel.  Better yet, make sure you get counsel familiar with these issues.

Author Peter C. Vilmos, Esq. works in the Orlando office of Burr & Forman LLP, 407-540-6600.  Contact Peter or any attorney in Burr & Forman’s Non-Compete and Trade Secrets group for more information or for further inquiries.