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August 6, 2014

Drafting Enforceable Non-solicitation Agreements

Significant time, money and resources often goes into developing client relationships. To protect these relationships, more companies are requiring managers and other employees who have significant contact with clients to sign non-solicitation agreements.

However, requiring an employee to sign a non-solicitation agreement and being able to enforce that agreement are two completely different matters. Customer non-solicitation agreements, like traditional non-compete agreements, are considered restraints on trade, and thus most courts, including those in Delaware, will enforce them only if they are “reasonable.”

Courts will traditionally assess the reasonableness of a non-solicitation agreement by evaluating the scope of the restriction as it relates to three factors: 1) the employer’s interest in protecting its business; 2) the employee’s right to work and earn a living; and 3) the public’s interest in free trade and competition. What follows are four points to consider when drafting a non-solicitation agreement under Delaware law.

Be Clear About What You Are Trying to Protect

The most widely recognized protectable interest is the goodwill a business has cultivated with its customers. Delaware courts recognize that a company has an interest in protecting its client relationships against misappropriation by departing employees. This is particularly true where the employee had significant personal contact with the clients.

But employers often overlook a second interest that merits protection. Courts have recognized that companies have a right to protect their confidential information by prohibiting former employees from soliciting clients. In these instances, courts may restrict a former employee from soliciting business from customers even if that employee had no direct contact, so long as the employee gained significant knowledge or understanding of those customers during his or her employment.

An important consideration for this rule is that the information must be of such confidential nature it would give the former employee (and his new employer) and unfair competitive advantage. As a general rule, confidential information would not include general knowledge or skills the employee acquired during his employment or information that is available to the public through other sources.

Set a Reasonable Time Period

In order to be enforced, non-solicitation agreements must have a reasonable time limit. This is often interpreted to be a period no longer than that which is needed for the company to rebuild its customer relationships. The determination of whether a time period is reasonable is fact specific and must be examined on a case-by-case basis.

In some instances, it may be that a period of several months is reasonable for a company to put a new employee on the job and demonstrate his/her effectiveness to the customers. If the selling or servicing of the relationship is relatively complex, a longer period may be justified.

Courts in Delaware have in general presumed that restrictions of two years or less are reasonable, unless circumstances demonstrate otherwise. Longer periods may be necessary to protect the business, particularly if the former employee had access to confidential information which could provide a competitor with an unfair competitive advantage for many years following the employee’s departure.

Avoid the "I Didn't Solicit Them; They Called Me" Defense

A common defense invoked by former employees accused of violating a non-solicitation agreement is that they did not “solicit” the customer. In many cases, an agreement will prohibit employees from "soliciting" customers without defining the term "solicit." In such instances, courts typically defer to the common meaning of the term "solicit" as defined in dictionaries, and will take into account public policy considerations.

Employers can avoid the potential for uncertainty by defining the term "solicit" or by specifying in the agreement that a former employee may not accept business from the employer's customers. Many jurisdictions, but not all, will enforce non-solicitation agreements that prohibit the former employee from “accepting business” from certain clients.

Consider a Liquidated Damages Provision

Finally, institutions should consider including a remedy of liquidated damages against former employees who improperly solicit customers. It is usually easier to sue a former employee for money than obtain injunctive relief from a court, and the potential for a significant award of damages may make the employee think twice about poaching clients. A liquidated damages provision also can make it easier to calculate monetary losses, which are often difficult to quantify at trial.

In order for a liquidated damages provision to be enforceable, it must set forth a reasonable estimate of the monetary loss likely to be suffered, yet relate to an injury incapable of accurate estimate. Reasonable estimates of damages might include the fees or payments made by the solicited customer to the former employer during a certain time frame.

February 17, 2012

Protecting Trade Secrets In Delaware

Employers frequently confront the problem of theft or misappropriation of trade secrets and confidential, proprietary information by departing employees. While employers have an arsenal of legal weapons at their disposal to protect their most valuable business assets, it is critical that they take proactive steps to protect against the disclosure of important business information and prevent unfair competition. From a practical standpoint, failure to implement basic security measures makes it easier for an unethical employee or competitor to misappropriate confidential business information. From a legal perspective, absent efforts to preserve the secrecy of such information and avoid unfair competition, a court is unlikely to respond favorably to an employer request for relief.Delaware

Trade Secret Protection

Delaware, like most states, has enacted the "Uniform Trade Secrets Act" providing employers with legal protection for trade secret information even in the absence of contractual agreements with employees. While many people may believe that "trade secret" status is only afforded to scientific data such as the formula for Coke, in reality, trade secret protection is available for a much broader array of information. The statutory definition for a trade secret is "information" that "derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use." To be protected by the statute, the information must be "the subject of efforts that are reasonable under the circumstances to maintain its secrecy."

Trade secret protection is available to business information other than scientific data such as formulas and chemical compounds. The Uniform Trade Secrets Act specifically extends protection to a "compilation," "program," "method," "technique," or "process" that has independent economic value to a company arising from its secrecy.

Customer lists may be subject to trade secret protection if the employer expended substantial resources and time in developing information that is not generally known to the public or competitors. Further, even if the customer list itself is not trade secret, information the employer compiled as part of its marketing efforts may be protected. For example, the courts have found that a "rankings report" kept by company sales representatives concerning the amount of sales to clients and ranking the company's customers by sales volume is sensitive financial information that may be subject to trade secret protection. Likewise, while an idea such as linking a savings program to an affinity group may not be a trade secret, the means by which such a program is implemented may be.

Even if business information does not meet the definition of a "trade secret," it still may be confidential, proprietary information subject to other legal protections.

Computer Fraud Act

Employers have a potentially powerful weapon to combat improper access and misappropriation of electronic data and information stored on a computer. We are all familiar with cases in which an unethical employee downloads company electronic information to a thumb drive for later use and/or sends such information via email to his or her personal computer in preparation for leaving employment and competing with their employer. The federal Computer Fraud and Abuse Act ("CFAA") may be used to hold employees liable both civilly and criminally for such misconduct. Although the CFAA was originally passed to target computer "hackers", not disloyal employees, some courts have applied the statute to employee misconduct. The CFAA also has criminal provisions. For example, former news anchor, Larry Mendete, plead guilty under the CFAA to intentionally accessing the private email account of his former co-anchor, Alycia Lane.

Delaware has a state counterpart to the CFAA.  The Misuse of Computer System Information Statute, 11 Del. C. § 935 et seq., makes it a crime to knowingly access a computer system without authorization. The statute prohibits not only the unauthorized copy and disclosure of electronic data, but the knowing deletion of data from a computer system.  The statute also has a civil component to this law which allows an aggrieved party to bring an action in the Delaware Court of Chancery for injunctive relief, restitution, treble damages, and attorneys' fees.  For more information see our earlier blog post on this statute.

Common Law Claims

There are many other legal claims that the company may assert to protect its business assets if an employee improperly uses or discloses its confidential, proprietary, or trade secret information. Employees who are given access to such information may be treated as fiduciaries with a duty of loyalty to protect it from disclosure during their employment. A competitor who knowingly participates in improper disclosure may be charged with "aiding or abetting" a breach of fiduciary duty or illegally participating in a civil conspiracy. In addition, a competitor who unfairly competes through the acquisition and intended use of such information may be sued for tortious inference with contract or business relations.

Contractual Protections

Aside from statutory and common law protections, there are contractual safeguards available to help employers stop the inappropriate disclosure of the business information and prevent unfair competition. At a minimum, all employers should consider requiring key employees who have access to confidential, proprietary, and trade secret information to sign Confidentiality and Non-Disclosure Agreements. A company may legally require employees who have access to confidential, proprietary information to sign such an agreement. If drafted properly, such agreements have "teeth" when enforcement action is necessary. Confidentiality agreements may provide not only for emergency injunctive relief, but also for an award of damages from the improper disclosure of company information. Importantly, in appropriate circumstances, Delaware courts will enforce a provision in a confidentiality agreement providing that an individual who violates its terms is subject to paying the company's attorneys' fees and costs in bringing enforcement action.

For certain classes of employees, employers should consider broader contractual protections beyond a simple confidentiality agreement. Employees in sales and marketing or high-level management positions may be in a position to seriously damage the company's business if they leave to work for a competitor. A non-competition agreement or restrictive covenant is valid and enforceable in Delaware so long as the agreement is not overly broad and is necessary to protect the company's legitimate economic interests.

Delaware courts will generally enforce a non-competition agreement that is reasonable in geographic and temporal scope. The non-competition agreement must contain a geographic restriction tied to the areas where the company does business and where the employee works to establish that the Company has a legitimate business interest in restricting competition in those locations. Delaware courts, like most courts throughout the United States, also require that the restriction against competition have a reasonable time limit. Typically, a Delaware court will find a two-year restriction to be reasonable.

Since enforcement of a non-competition agreement prohibits an employee from working in a specified field in competition with his or her former employer, courts are careful to balance the equities. The court will consider the employer's reasonable business needs versus the impact of the enforcement of such agreements on an individual's ability to earn a livelihood. Upon a showing of a need for such relief, however, courts will enforce non-competition agreements and may even issue an order prohibiting a former employee from working for a competitor.

An alternative to a non-competition agreement is a "non-solicitation" agreement. Non-solicitation agreements are narrower than non-competition agreements. A non-solicitation agreement restricts a former employee from soliciting a company's clients or customers. Like a non-competition agreement, a non-solicitation agreement must include a reasonable time limit. Instead of a geographic limitation, however, a non-solicitation agreement may restrict an employee from solicitation or business dealings with certain customers such as those with whom the employee had direct contact or about whom the employee received confidential information. Non-solicitation clauses may also include potential customers or prospects. Of course, as with other contractual provisions, careful drafting is necessary to ensure the enforceability of such contractual restraints.

In appropriate cases, employers may include confidentiality, non-competition, and non-solicitation clauses in the same agreement. As a rule of thumb, the need for such protections and the likelihood of successful enforcement increases with the amount of access an employee has to valuable business information and his or her level in the organization. In addition, employee misconduct, such as misappropriation of a customer list or other sensitive information, increases the likelihood that a court will award relief to the employer.

Posted by Barry M. Willoughby
March 28, 2011

Court of Chancery Indicates It May Strike - Not Reform—Overly Broad Non-Compete Clause

When enforcing covenants not to compete, Delaware has long been viewed as a “reformation” state – meaning that when faced with an overbroad covenant, Delaware law allows the court to reduce the scope of the covenant and enforce it to the extent that the court deems reasonable. This view has developed among the lower courts in a number of decisions, but has never been fully addressed by the Delaware Supreme Court.chancerylogo60

However, as we noted in an earlier article, it is important to make certain the restrictive covenant you draft is reasonable both in its scope and duration. Employers should not count on a court to "reform" a poorly drafted restrictive covenant that is overly broad or vague. A recent case from the Court of Chancery demonstrates why.

In the case of Delaware Elevator, Inc. v. John Williams, No. 5596-VCL (Del. Ch. March 16, 2011), the plaintiff-employer sued its former employee alleging a violation of the employee’s non-competition agreement. Because the employee admitted that he had engaged in conduct that violated the terms of the non-competition agreement, the only question before the Court was whether the non-competition agreement was overly broad, and therefore unenforceable.

The non-competition agreement at issue had both a non-competition and a non-solicitation provision, each of which restricted the employee’s conduct for 3 years after he left his employment. The non-competition provision prohibited the employee from competing with the employer within 100 miles of its Newark, Delaware office. Under the non-solicitation provision, the employee was prohibited from soliciting any customer who had been a current or prospective client of the employer during the last 6 months of the employee’s employment.

The employee resigned his position with the employer in 2010. Shortly thereafter, the employer discovered that he was competing within 100 miles of the Newark Office, and that he was using a customer list that he developed while he was employed by the employer. When the employee refused to cease and desist, the employer brought suit, seeking to enjoin his violation of the agreement.

The non-competition agreement included a Maryland choice-of-law provision, so the Court’s analysis was conducted under Maryland law. After determining that the 3-year, 100-mile restriction was overly broad, the Court was faced with the question of whether to strike or reform the provision. The Court concluded that Maryland law required reformation under the blue pencil rule. However, the Court declared that it would have handled the question differently under Delaware law.

The Court stated that reformation of overly broad contracts puts an employer in a no-lose situation. If the agreement will be enforced to some lesser extent even if overly broad, an employer has no incentive to draft a reasonable provision in the first place. The Court also noted that for every employee who challenged the provision, others would choose not to, thereby harming consumers and interfering with labor and product markets.

The Court was further troubled by the disparity in bargaining power between low and mid-level employees and their employer. Where such employees are involved, the Court noted, there is no real choice as to whether to sign the non-competition agreement. Moreover, even if there were a choice, most employees do not have the savvy or access to legal advice to bargain effectively. As a result, the Court noted that Delaware law might require that an unreasonable restrictive covenant be struck in its entirety.

While the Court’s statements regarding Delaware law are dicta, they provide a strong indication that overly broad restrictive covenants might not be enforced in any manner by the Delaware Court of Chancery. As a result, employers should exercise caution when drafting non-competition agreements. These agreements should consider, among other things, (1) the employee’s relative position within the company, (2) the extent of the employee’s business-related contacts, (3) the employee’s establishment within the field of business and the surrounding community, and (4) the realistic possibility of relocating or working outside of the geographical scope of the restrictive covenant. As an employee’s position within the company and access to customers and trade secrets increases, so does the employer’s ability to restrict his competition and solicitation of current and prospective customers.

By Scott Holt and Lauren Moak

February 11, 2011

Court Doesn’t Buy Sellers’ Effort To Get Out Of Noncompete Agreement

A purchaser of a business often require the seller to agree to a non-compete agreement as part of the sale terms.   This not only has tax benefits (the agreement can be considered an acquired intangible asset and and amortized for tax purposes), but it can protect the buyer from future competitive activities of the seller in the same marketplace.

Delaware courts have tended to enforce noncompetition agreements arising out of the sale of a business.  Sale transactions are normally conducted at arms-length, and the courts are reluctant to strike down noncompete provisions that were negotiated as part of the sale price.  A recent case decided in the Delaware Superior Court adhered to this view.

In O’Leary v. Telecom Resources Service, LLC et al., the plaintiffs sold their telecommunications business to Telecom Resources – a wholly owned subsidiary of NAL Worldwide.   As part of the sale, both the asset purchase agreement and the plaintiffs’ employment contracts with the buyer contained noncompete provisions.  After the plaintiffs were terminated from employment (for allegedly operating several competing business ventures), they sued Telecom Resources seeking, among other things, a declaration that the noncompete provisions were unenforceable.

The plaintiffs made several arguments, including (1) the noncompete was not designed to protect legitimate business interests, (2) it was not reasonably limited in both geography and duration, and (3) that defendants had breach the underlying agreements.  The applicable language of the noncompete provided that the plaintiffs were barred from rendering services for “any entity competitive with the Business of [Telecom Resources] anywhere in the United States for a period of four (4) years from the closing date of [the sale].”

Plaintiffs first argued that the noncompete provision did not protect a legitimate interest, because Telecom Resources was not in operation.  The Court disagreed, noting that while Telecom Resources might not have been in operation, its owner NAL Worldwide was in operation, and that it had rights to enforce the noncompete.

The court also rejected plaintiffs’ argument that the 4 year restriction was too long, noting that Delaware court have upheld as reasonable non-compete provisions for the sale of a business for as long as 10 years.  The court also rejected the plaintiffs’ argument that the nationwide prohibition on competition was overbroad.  The court found that the plaintiffs’ business operated on a nationwide basis before and after the sale, and that both plaintiffs acknowledged the national scope of the business in the agreements. 

Finally, the court noted that the restrictions were reasonable especially considering the benefits the plaintiffs received from the sale.  The sale price was $1,000,000, and both plaintiffs received executive positions with six-figure salaries in exchange for the agreement not to compete.  The court observed that “Delaware courts are strongly in favor of enforcement of contracts freely entered into by the parties, and the Court will only set aside the agreement ‘upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than the freedom of contract.’” (citing Libeau v. Fox, 880 A.2d 1056 (Del. Ch. 2005).

O’Leary v. Telecom Resources Service, LLC et al., No. 10C-03-108-JOH (Del. Super. Jan. 14, 2011)

June 8, 2010

Chancery Court Utilizes Two-Step Analysis for Enforcement of Non-Competes

The Delaware Court of Chancery generally employs a two-step analysis to determine the enforceability of a covenant not to compete in the employment context. The first step of the analysis is a question of basic contract law. The Court looks to whether there was mutual assent between the parties, whether adequate consideration was exchanged, and whether a material breach of the other party excuses performance.

Assuming that the covenant is valid under ordinary contract principles, the Court then determines whether four additional, covenant-specific conditions are satisfied. First, the temporal restrictions of the covenant must be reasonable in scope and duration. Second, the geographical limitations (if any) must be reasonable. Third, the covenant must advance a legitimate economic interest of the employer at the time enforcement is requested.

Fourth, the covenant must survive a balance of the equities test. Here, the Court looks to the harm likely to be caused to each party should their position be unsuccessful. The Court then balances the harms to ensure that no one party will suffer unfairly. This fourth condition is grounded in the equitable nature of the injunctive remedy being sought. As a result, a covenant not to compete may be valid but may not be specifically enforceable in the circumstances presented at the time of the application for enforcement.