NONCOMPETE LITIGATION LESSONS FROM THE TENTH CIRCUIT

Thursday, 25 October 2018 19:07 Written by  Patricia Collins


Reprinted with permission from the August 18th, 2018 issue of The Legal Intelligencer. (c) 2018 ALM Media Properties. Further duplication without permission is prohibited.

A recent case from the United States District Court for the Tenth Circuit, First American Title Insurance Company, et al. v. Northwest Title Insurance Agency, et al., no. 17-4086, illustrates nicely the complicated issues faced in noncompete litigation, and the risks a good agreement can prevent.  Although the case arose in the United States District Court for the District of Utah, the issues confronted and legal principles cited arise frequently under Pennsylvania law.

The individual defendants were employed by First American Title Insurance Company, and had signed various restrictive covenants of one year in duration.  All individual defendants were subject to a code of ethics and employee handbook that required employees to use office equipment for company business only, and barred outside activity competing with First American.  First American Title Company acquired the stock of First American Title Insurance Company pursuant to a Stock Purchase Agreement.  Defendant Smith created defendant Northwest Title Insurance Company, and then quit his job with First American.  The day after Smith resigned defendants Carrell and Williams resigned and all individual defendants took positions at Northwest Title Insurance Company, along with twenty-five other employees over the next two weeks.  Litigation ensued, and defendants suffered a large jury award at trial.

Lesson 1:  File petitions for preliminary injunction early, and make sure to have a tolling provision in the agreement.  

The First American District Court denied the plaintiff’s motion for a preliminary injunction after a hearing, finding that there was no irreparable harm.  Notably, the individual defendants resigned in March of 2015, and their restrictive covenants, which did not contain tolling provisions, terminated in March of 2016.  Plaintiffs filed the petition for preliminary injunction in January of 2016, with only two months remaining on the restrictive covenants, and the motion was not heard until September 2016.    The case then proceeded to a trial, resulting in the appeal addressed by the Tenth Circuit.  An injunctive order entered early in a case tends to change the dynamic of a case going forward, providing opportunities for sanctions and contempt motions, and an incentive to settlement.  Certainly, defendants enjoyed an early victory that rendered this case solely about damages. Indeed, this may well have been the strategy:  part of the court’s reasoning on the preliminary injunction was that most of the damage had already been done, in light of the quick transfer of customers and employees.  

A preliminary injunction is only powerful when filed early, and it might be worth considering foregoing the motion in certain circumstances, where the tactical advantages of early filing are lost.  Most importantly, a tolling provision in the document might have changed the outcome:  drafters must include a provision that extends the duration of the restrictive covenant where the employee is in breach.  

Lesson 2:    A jury will likely accept clear, specific evidence of the defendants’ ill-gotten gains.

The First American jury awarded a total of $2,725,000.00 in damages.  The plaintiffs’ expert testified that lost profits between March of 2015 and December 2015 (no explanation is provided as to why this date was used) amounted to $2,067,000.00, and that lost profits over ten years would exceed $14 Million.  The jury award reflects that the jury did not put much weight on the concept of future lost profits.  But, the jury did award profits that plaintiffs could show they actually lost, and, presumably, defendants actually gained.  Damages in restrictive covenant cases are often difficult to quantify in a way that does not appear speculative.  The jury here seemed to accept completely the expert’s conclusion regarding actual lost profits, and seemed inclined to require the defendants to disgorge its ill-gotten gains.  The Tenth Circuit affirmed the jury award, finding it reasonable given the evidence in the case.  

Lesson 3:  New employers, although not parties to restrictive covenants, bear a great deal of risk in noncompete litigation.  

The jury divided the $2,725,000.00 among the defendants.  The jury apportioned $1,000,000 of the damages to Northwest for its tortious interferences with contracts.  The jury apportioned $50,000 in damages to two of the three individual defendants.  The jury then apportioned $500,000 against the perceived ringleader defendant for breach of contract, $600,000 for breach of fiduciary duty, and $525,000 for tortious interference with contracts.  Thus, the jury found the new employer and the ringleader liable for the bulk of the damages.  While it is true, in this case, that the new employer was owned by the individual defendants, the fact remains that employers will not avoid liability when hiring employees who are subject to restrictive covenants.  In fact, employees who have signed restrictive covenants risk their new enterprise if they found it in disregard of those obligations.  Tellingly, the jury awarded $500,000 in punitive damages against Northwest.  In this case, new employers’ aggressive approach to the agreements, and First American’s employees and customers was punished by the jury.  The Tenth Circuit affirmed the jury’s apportionment of damages.  


Lesson 4:  Corporate changes present an opportunity for defendants, and both the agreement and transactional documents should mitigate the risks of challenges.  

The First American entities underwent a stock purchase that defendants attempted to use to challenge the enforceability of the restrictive covenants.  The district court found, and the Tenth Circuit affirmed (interestingly, citing Pennsylvania law), that the agreements remained enforceable despite the change in stock ownership.  The First American entities had properly protected the enforceability of those agreements as part of the stock transaction.  The issue of what happens with restrictive covenants in the event of a corporate transaction is a complicated one.  The restrictive covenant itself, and the transaction documents need to address the issue.  Of course, no amount of proper documentation will likely prevent a defendant from raising the issue in  litigation.  

Lesson 5:    Attorney’s Fees dictate strategy.  

The First American court awarded plaintiffs’ attorneys fees of nearly $2.9 Million.  Despite the fact that the fees exceeded the jury award, the Tenth Circuit affirmed the award and found it reasonable.  The drafting lesson is, of course, that the agreement should contain an attorneys’ fees provision, in all cases, but the strategy lesson is more complicated.  Along the way, a reasonable settlement strategy must well have looked like the jury’s damage award, and would have cost defendants considerably less than $2.9 Million in fees, plus their own fees.  Noncompete litigation will always be expensive:  it will essentially require two trials (the injunction hearing and the damages trial), experts, motion practice with regard to discovery from customers and clients, and complicated legal issues relating to enforceability.  Where the agreement contains an attorney’s fees provision, it can dramatically change the economics of a settlement strategy.  

The Tenth Circuit’s affirmance in full of the district court’s decision for the First American Plaintiffs provides an interesting roadmap of what a victory looks like for an employer with a valid restrictive covenant in place.  Drafters and litigators alike will benefit from a review of the Tenth Circuit’s opinion.  

Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on employment, commercial litigation and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com.

Patricia Collins

Patricia Collins

Patty has been practicing law since 1996 in the areas of Employment Law, Health Care and Litigation, with extensive experience in advising employers and health care providers as well as complex litigation in federal and state courts. Patty’s knowledge of employment law includes the Employee Retirement Income Security Act; federal and state employment discrimination laws, and employment contracts and wage claims.

To view Patricia Collins' full profile, click here.

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