By Patricia C. Collins, Esquire
Reprinted with permission from December 12, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Propeties. Further duplication without permission is prohibited.
Increasingly, employers and their attorneys meet resistance when seeking to enforce covenants not to compete. States such as Georgia and California continue to refuse to honor those restrictions. Even in states that recognize the validity of such agreements, Courts can restrict the geographic or temporal scope of the agreement, refuse to find sufficient irreparable harm to permit the entry of a temporary or preliminary injunction, or find other equitable grounds to refuse to enforce the covenant not to compete. Employers do have a back-up plan, however. Recent cases illustrate that the court will enforce agreements not to solicit customers and clients after termination. These cases also illustrate that courts will look to the nature of the contacts with clients or employees to determine if there is a breach of a non-solicitation provision.
In Corporate Technologies Inc. v. Harnett, the United States Court of Appeals for the First Circuit affirmed the district court’s grant of a preliminary injunction against a former employee of Corporate Technologies Inc. and his new employer. The preliminary injunction restricted the employee from doing business with certain customers of Corporate Technologies with whom he worked during his employment, and required the new employer to withdraw bids which the employee prepared during his employment with the new employer. The First Circuit court noted that the district court was specifically applying the non-solicitation and not the non-compete provisions of the agreement. Accordingly, both courts engaged in a discussion of the applicable requirements for the entry of a preliminary injunction (which are the same under Massachusetts and Pennsylvania law). Notably, the First Circuit did not engage in a discussion of the reasonableness of the geographic or temporal scope of the agreement, or whether the employer had a “protectable interest” served by the non-solicitation provision. The district court found that the employee breached the non-solicitation provisions of the agreement, and the First Circuit affirmed the grant of the preliminary injunction.
By Thomas P. Donnelly, Esquire, Reprinted with permission from October 11, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.
Senior Judge Anita Brody of the United States District Court for the Eastern District of Pennsylvania recently presided over a non- jury trial in the matter of Lehman Brothers Holdings, Inc. v. Gateway Funding Diversified Mortgage Services, L.P. Judge Brody is expected to render a decision in the coming weeks. Lehman Brothers represents the first occasion for the District Court to consider the legal principal of de facto merger under Pennsylvania law following the Pennsylvania Supreme Court’s landmark decision in Fizzano Brothers Concrete Products, Inc. v. XLN, Inc., 42 A.3d 951 (Pa. 2012). In Fizzano Brothers, the Supreme Court substantially modified the application of the de facto merger doctrine allowing trial courts far greater flexibility in the application of the doctrine to a broader set of facts.
Before Fizzano Brothers, Pennsylvania courts were constrained to a mechanical application of four elements: (1) continuation of the enterprise of the seller corporation; (2) continuity of shareholders; (3) cessation of ordinary business operations on the part of the selling entity; and (4) assumption of those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations. In practical application, the “continuity of shareholders” requirement was nearly impossible to satisfy where sophisticated business people with legal representation structured the transaction as a sale of assets to a new entity. Consequently, mechanical application of the continuity of shareholders element was the stumbling block in the de facto merger analysis.
The Fizzano Brothers court substantially modified the analysis by discarding the mechanical application of continuity of shareholders. Citing public policy and recognizing the sophistication of business transactions in the current climate, the court ruled that “where the underlying cause of action is rooted in a cause of action that invokes important public policy goals, the continuity of ownership prong may be relaxed.” Fizzano Brothers, 42 A.3d at 966. The question of successor liability should first be viewed in light of “whether, for all intents and purposes, a merger has or has not occurred between two or more corporations, although not accomplished under the statutory procedure.” Id. at 969.
The Supreme Court went on to hold that the shareholders of the predecessor company were no longer required to become shareholders of the successor to meet the requirements of de facto merger. The court concluded such a holding would be “incongruous” with provisions of the Pennsylvania Business Corporation Law stating; “because a de facto merger analysis tasks a court with determining whether, for all intents and purposes, a merger or consolidation of corporations has occurred, even though the statutory procedure had not been used, the continuity of ownership prong of the de facto merger analysis certainly may not be more restrictive than the relevant elements of a statutory merger as contemplated by our legislature.” Id. at 968.
The court then adopted a more flexible approach. After Fizzano Brothers, cases rooted in breach of contract and express warranty no longer require strict transfer of ownership. Rather, the de facto merger doctrine now requires “’some sort of’ proof of continuity of ownership or stockholder interest. . . . However, such proof is not restricted to mere evidence of an exchange of assets from one corporation for shares in a successor corporation.” Id. at 969 (internal citations omitted).
The Fizzano Brothers factors are at issue in Lehman Brothers Holdings, Inc. v. Gateway Funding where Lehman Brothers raised claims of successor liability relating to indemnification agreements with Gateway’s alleged predecessor. At trial, evidence was admitted indicating that Gateway had specifically and intentionally purchased all assets that were necessary to the continuation of the mortgage origination business formerly conducted by the predecessor. Such evidence included direct testimony on the part of Gateway’s management team that the acquisition was designed to acquire not only the current “pipeline” of loans in progress, but also the potential for continued loan origination. Contemporaneously, Gateway also undertook to acquire debt obligations owed by the predecessor which were necessary to loan origination including securing warehouse lines of credit utilized to temporarily fund mortgage loans until sold on the secondary market. Finally, documents related to the transaction reflected the intention that the business operations of the predecessor entity were to be “wound down”. In that regard, restrictions against competition imposed upon the former principals of the predecessor, now Gateway employees, were permitted to “compete” only for the purpose of effectuating that wind-down.
While evidence was admitted as to each element of the de facto merger doctrine, continuity of ownership was specifically contested. The transaction at issue was characterized by the buyer and seller as an asset transaction with no stock transfers. However, the four shareholders of the predecessor entity were provided compensation in a variety of ways which Lehman Brothers argued were illustrative of ownership. The four shareholders received employment agreements with Gateway which included substantial severance benefits, a right to share in the profits of the same operations as had been conducted by the predecessor, and cash considerations. One former shareholder indicated the cash component was paid, at least in part, as a result of his equity position in the predecessor.
In contrast, Gateway argued that the four shareholders were valuable and experienced revenue generating employees with corresponding compensation arrangements following the acquisition. Objectively, the four shareholders of the predecessor were not granted stock in the acquiring entity. Further, although certain of the agreements between the four shareholders and Gateway referenced the shareholder’s equity stake in the predecessor, no provision for consideration set forth in the language of the agreements was expressly tied to that equity position.
The Lehman Brothers trial is the first test of the new more relaxed application of the continuity of ownership prong of the de facto merger analysis. Judge Brody’s decision will provide guidance to both transactional practitioners in structuring transactions where liabilities may remain post-closing, and to litigators when faced with claims against a defunct entity where assets were transferred leaving a hollow shell.
The author served as local trial counsel to Lehman Brothers Holdings, Inc.
By William T. MacMinn, Esquire Reprinted with permission from August 13, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.
But He Asked Me First!
Is that a good defense to an alleged breach of a non-solicitation agreement? In a recent decision a Pennsylvania trial court said that it was.
In Marino, Robinson & Associates, Inc. v. Robinson, 2013 Pa. Dist. & Cnty. Dec LEXIS 18 (Jan 2013) Judge Wettick of the Allegheny County Court of Common Pleas entered summary judgment dismissing the case against Defendant who allegedly violated a non-solicitation clause. Plaintiff acquired Defendant’s accounting practice. The contract signed by the parties included clauses prohibiting Defendant from competing with the Plaintiff or soliciting any of her former clients. The non-compete was not implicated in the case because, while the Defendant provided competing accounting services, she did so outside of the geographic limits imposed by the covenant. However, she provided those services to several of her former clients, each of whom unilaterally approached her and asked her to continue on as their accountant. Plaintiff alleged that by providing services to these former clients, the Defendant violated the non-solicitation clause of the contract which prohibited Defendant from “Solicit(ing) in any manner any past clients … for a period of ten (10) years from closing”. The Court, following cases decided in other states, agreed with the Defendant that she was not required to turn away former clients who, unsolicited, approached her to request that she provide services. The Court held that solicitation required conduct on the part of the Defendant designed to awaken or incite the desired action in the former client. Where, as in this case, the former client approached the Defendant unilaterally, the Defendant did not violate the non-solicitation clause.
A similar result obtained in Meyer-Chatfield v. Century Bus. Servicing, Inc., 732 F. Supp. 2d 514, 517-518 (E.D. Pa. 2010) where the Court decided that the meaning of the word “solicit” was not ambiguous and applied the parole evidence rule to bar evidence regarding the meaning of the term. In Meyer-Chatfield, Plaintiff’s Vice-President of Sales and Marketing left his employment with Plaintiff and accepted a similar position with Defendant. An agreement, which included non-solicitation provisions, was negotiated between the parties. Shortly thereafter the parties engaged in negotiations for the acquisition of Plaintiff by Defendant. Those negotiations failed. Subsequently (and after he was terminated by Plaintiff) one of Plaintiff’s sales persons accepted employment with Defendant and took with him other employees (who were part of his sales team) with the result that several significant customers of the Plaintiff eventually began doing business with Defendant. Plaintiff brought suit alleging violation of the non-solicit provisions in the solicitation of both the employees and the customers.
The language at issue prohibited the direct or indirect “…solicit(ation) of any of Plaintiff's employees, agents, representatives, strategic partnerships, [or] affiliations.” The contract did not define the word “solicit.” The Court looked to the common meaning of the term, citing the Black's Law Dictionary definition:
"To appeal for something; to apply to for obtaining something; to ask earnestly; to ask for the purpose of receiving; to endeavor to obtain by asking or pleading; to entreat, implore, or importune; to make petition to; to plead for; to try to obtain; and though the word implies a serious request, it requires no particular degree of importunity, entreaty, imploration, or supplication. To awake or incite to action by acts or conduct intended to and calculated to incite the act of giving. The term implies personal petition and importunity addressed to a particular individual to do some particular thing."
The Court also cited the Webster’s definition of the word: “to entreat, importune . . . to endeavor to obtain by asking or pleading . . . to urge.”
The issue before the Court was whether the word “solicit” was ambiguous permitting parole evidence of its meaning. In holding that it was not, the Court reviewed Akron Pest Control v. Radar Exterminating Co., Inc. 216 Ga. App. 495, 455 S.E.2d 601 (Ga. App. 1995), in which the Court held that an agreement “not to solicit, either directly or indirectly, any current or past customers” requires more than “[m]erely accepting business [to] constitute a solicitation of that business.” A party is not required to turn away uninvited contacts of former customers. The Court also cited Maintenance Co. v. West, 39 Cal. 2d 198, 246 P.2d 11 (Cal. 1952) in which it was held that neither the act of informing former customers of one’s change of employment, nor the discussion of business upon the invitation of the former customer constitutes solicitation. Finding no ambiguity, the Court prohibited testimony regarding the parties’ understanding of the term.
It seems clear that the Court will apply the ordinary meaning of the word “solicit” which has been repeatedly found to require some overt act of entreaty on the part of the former employee designed to induce the former customer to action. Responding to an uninvited inquiry from a former customer, even where that inquiry is for the purpose of discussing business, and where that inquiry ultimately results in doing business with that former customer, will not be sufficient to support a finding of a breach of a non-solicitation agreement. Of course, doing business with a former customer may well violate the provisions of a non-compete clause and, in such cases, the Courts have not been reluctant to enforce such provisions. Although research has found no cases directly on point, the reasoning of the cases suggests that advertisements or social media posts informing the general public or one’s social media circle of new employment circumstances would also not constitute the type of targeted action required to support a finding that a non-solicitation agreement has been breached.
By Patricia C. Collins, Esquire Reprinted with permission from June 14, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.
It is a reality of litigation that the facts of a case can change in significant ways between the filing of the complaint and trial, but litigants do not always amend pleadings to address these changes. A recent decision by the United States Court of Appeals for the Third Circuit offers incentive to amend in those situations. In West Run Student Housing Associates, LLC v. Huntington National Bank, 7 F.3d 165 (3d Cir. 2013), the Third Circuit held that averments in a complaint that is later amended do not amount to judicial admissions.
The procedural posture of the West Run case is not unique. The plaintiff filed a complaint alleging, inter alia, a breach of contract. The plaintiff claimed that the defendant bank breached its agreement to provide financing for a housing project. The contract required the bank to provide the financing if plaintiff sold the requisite number of housing units. The original complaint included averments regarding the number of units sold, and those numbers were not sufficient to trigger the financing requirement. Defendant moved to dismiss the original complaint, and plaintiff, not unexpectedly, amended. The amended complaint did not contain averments regarding the number of housing units sold.
Predictably, the defendant again moved to dismiss, alleging that the averments contained in the original complaint were judicial admissions, that is, admissions that cannot later be contradicted by a party, which barred the breach of contract claim. The district court agreed and dismissed the claim.
The Third Circuit disagreed. The Court found that an amended pleading supersedes an original pleading, and parties are free to correct inaccuracies in pleadings by amendment. The Court noted that the original pleading is of no effect unless the amended complaint specifically refers to or adopts the original pleading. In this way, the amended pleading results in “withdrawal by amendment” of the judicial admission.
Reprinted with permission from April 5, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties.
Further duplication without permission is prohibited.
The Pennsylvania Supreme Court is set to hear argument on April 10, 2013 regarding the scope of the work product doctrine and the discovery of materials contained in a testifying expert’s file on April 10, 2013. The specific issue on appeal is whether Pennsylvania Rule of Civil Procedure 4003.3 provides absolute work product protection for all communications between a party’s counsel and its testifying trial expert. The decision may provide clarity and guidance to litigation counsel facing an otherwise clouded issue.
In Barrick v. Holy Spirit Hospital, 32 A. 3d. 800 (Pa. Super. 2011), the trial court was faced with a subpoena directed to a medical provider who was both a treating physician and an expert retained for the purpose of offering trial testimony. The trial court, after an in camera inspection, ordered the enforcement of the subpoena and the disclosure of communications between the expert and the Plaintiff’s counsel. Plaintiff appealed, arguing the application of the work product doctrine under Pennsylvania Rule of Civil Procedure 4003.3 and trial preparation materials under Rule 4003.5 protected the communications from disclosure.
Why does it seem to take so long to solve simple problems? For years litigators have had to resort to the use of the cumbersome and needlessly expensive procedures to compel the attendance of a witness in interstate litigation pending in state court. The problem arises, of course, where the testimony of a witness located in Pennsylvania is needed in connection with litigation pending in another state, or when the witness is located out of state and his testimony is needed in connection with a Pennsylvania case.
In 2007, the National Conference of Commissioners on Uniform State Laws promulgated the Interstate Depositions and Discovery Act (the “Act”) which simplified the entire process. In October 2012 the Act was adopted in Pennsylvania and became effective December 24. It is codified at 42 Pa.C.S. § 5331.
The Act requires the Prothonotary to issue a Pennsylvania subpoena, upon the submission of a foreign subpoena. The Pennsylvania subpoena must incorporate the terms used in the foreign subpoena and provide the names and contact information for all counsel of record and unrepresented parties in the foreign proceeding. Service and enforcement of the subpoena are governed by the Pennsylvania Rules of Civil Procedure.
Need to subpoena a witness in another state for a Pennsylvania case? If the witness is located in any of the thirty two states and territories that have adopted the Act, the procedure is just as simple. Issue a Pennsylvania subpoena; send it to your local counsel on the ground in the discovery state and off you go. The Act is the law in Alabama, Arizona, California, Colorado, Delaware, District of Columbia, Georgia, Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Mississippi, Montana, Nevada, New Mexico, New York, North Carolina, North Dakota, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, U.S. Virgin Islands, Utah, Vermont, Virginia, Washington. It is on the legislative agenda in New Jersey.
That’s all there is to it! In the words of the Commission:
The Act requires minimal judicial oversight and eliminates the need for obtaining a commission or local counsel in the discovery state, letters rogatory, or the filing of a miscellaneous action during the discovery phase of litigation. Discovery authorized by the subpoena is to comply with the rules of state in which it occurs. Furthermore, motions to quash, enforce, or modify a subpoena issued pursuant to the Act shall be brought in and governed by the rules the discovery state.
The solution is so simple one wonders why it took so long to come up with it and, once the Act became available, why it took five years to enact it in Pennsylvania? Enact it we have and litigators, their clients and the Courts will benefit from its simplicity.
Restrictions against competition are frequently included in employment agreements and agreements for the sale of business assets or stock. The restriction against competition is designed to secure a time period for the employer or buyer of business assets, as the case may be, during which the employer/buyer is free from competition for a departed employee or seller so as to facilitate the transition and better protect their own business assets and customer relationships. If properly drafted and implemented, restrictions against competition are enforceable under Pennsylvania law.
The primary method of enforcement in the event of breach is a preliminary injunction in equity. In order to prevail on a petition for preliminary injunction, a petitioner must demonstrate several factors including (1) the need to prevent irreparable harm which cannot be compensated by money damages, (2) that more harm will result from the denial of the preliminary injunction than from granting same, (3) that the injunction will restore the parties to the status quo, (4) the likelihood of success on the merits, (5) that the injunction is designed to abate the offending activity, and (6) that the injunction will not negatively impact public policy. In most cases the issues of likelihood of success on the merits and irreparable harm incapable of compensation with money damages represent the contested issues.
In Bucks County, the petition for preliminary injunction must be accompanied by a verified complaint and an order for hearing. The petition is often, though not always, heard by the initial pre-trial judge assigned to the case at the time of filing. Court administration reviews all petitions for preliminary injunction and assigns the presiding judge, courtroom and date for evidence to be taken. The order for hearing is an essential aspect of the petition; without it, no hearing will be scheduled.
The petitioner in any injunction matter bears a heavy burden. Adequate evidence as to the need for enforcement of the covenant, the potential irreparable harm and right to relief must be presented. Because the entry of injunctive relief is an extraordinary remedy, the evidence must be clear and persuasive. In employment and business asset transfer cases, the language of the restriction in the applicable agreements must be constrained to those aspects of competition which are reasonably necessary for the protection of the employer/buyer. For example, a covenant which is overbroad in terms of geography, time or scope will not be enforced.
Preliminary injunctive relief may be acquired in the Bucks County Court of Common Pleas if supported by the underlying agreement and if properly perfected under the practices and procedures employed in the County.
Employment agreements, especially those for key employees which include non-competition terms, must be carefully drafted. What should they include? Here are eight (what’s magic about ten?) musts:
1. Define the Restrictions. The non-compete should, first and foremost, clearly define the prohibited zone by industry segment, by geography and by time. Because these covenants are disfavored in the law (certainly by every trial court which I’ve ever asked to enforce one of these agreements) employers must leave no doubt about the restrictions and be able to tie each to an identifiable protectable interest. The covenants are not enforceable unless they are required to protect such interests, and then only to the extent the restrictions are reasonable.
2. Protectable interest? Courts will not enforce these covenants unless the employer has an interest which can only be protected by the restriction. Eliminating competition is not a protectable interest but, for example, protecting customer relationships is. Consider how the particular employee could hurt your business and tailor the restrictions to provide protection in those areas.
3. Reasonable? A covenant prohibiting competition anywhere in the country is not likely to be enforced where the employee’s relationships were confined to one state or region of the country. Such a broad restriction would likely be found to be unreasonable. Similarly, temporal restriction should be limited to the time required to give the employer’s new representative time to meet and solidify relationships with the customers.
4. Don’t forget to protect your people. A well drafted employment agreement will include provisions which prohibit the employee from inducing your employees to move to the new employer. Losing one key employee is bad enough; losing three or four may be catastrophic.
5. What happens if the employer sells the business? Unless the covenant can be assigned, it is lost and the employee is free to compete. Restrictive covenants are important assets of the business. Absent assignability, the value of those assets is lost if the business is sold.
6. A tolling provision? It may take some time for an employer to learn that a former employee has violated the covenant. Litigation to stop that violation takes more time. A well drafted document will include a tolling provision which stops the clock from running while the employee is in breach.
7. Protect confidential information. The employment agreement should protect confidential information and trade secrets. Employees are often privy to sensitive information which is necessary to do their job. When they leave employment, that information should stay behind. Make sure that the employment agreement provides that confidential information and trade secrets will not be “used or disclosed” after the sale. Define confidential information as broadly as possible, but keep in mind that it does not include information known to the public or easily discoverable.
8. Make violation risky. The former employee must know that if he chooses to violate, it will cost him. The tolling language, mentioned above is one way to get that point across. Another is to provide for recovery of attorney’s fees if the restrictive covenants are violated and enforcement litigation results.
There is a large body of state specific law surrounding the interpretation and enforcement of these agreements. Make sure the attorney who you engage is experienced in this area of the law.
In a recent case that may not bode well for the enforcement of noncompete agreements in Pennsylvania and New Jersey, the Virginia Supreme Court reversed twenty years of Virginia precedent relating to noncompetes, agreements pursuant to which an employee agrees not to compete with an employer for a period of time after the termination of employment. Until this recently, Pennsylvania, New Jersey and Virginia had similar laws relating to noncompetes. Historically, courts in all states have not looked favorably on such agreements, and have used various tools to limit or deny enforcement of noncompetes. Prior to the court’s decision in Home Paramount Pest Control v. Shaffer, the law in Virginia was similar to Pennsylvania law: a Court could re-write overbroad noncompete agreements so that the document was consistent with the employer’s protectable interests. In Home Paramount Pest Control, the court stated that it would no longer re-write such provisions, and that it was free to refuse to enforce a noncompete that was overly restrictive.
The former employee in Home Paramount Pest Control signed a noncompete agreement that prohibited him from competing with his former employer’s fumigation business in any manner, in any geographic area where he worked for Home Paramount Pest Control for a period of two years after his termination. Prior to this case, it was well settled that if the court found the restrictions of the noncompete broad, it could rewrite the document and enforce more reasonable provisions. The court generally exercised its re-writing power to limit the geographic or temporal scope of the document, or to find that specific conduct did not violate a noncompete if the employer could not articulate a protectable interest in prohibiting the conduct, even where the clear language of the agreement prohibited the competitive conduct. Generally speaking, “protectable interest” means that the employer has provided something to the employee that it has the right to protect, such as access to trade secrets, or specialized training. If the restriction on future employment did not match a protectable interest, the court would not enforce the restriction.
In Virginia at least, this is no longer the case. The Virginia Supreme Court noted that it had “incrementally clarified” the law relating to noncompetes so dramatically over the past two decades that it was free to find the noncompete unenforceable in this case. Most interestingly, the court focused on language that lawyers generally believe is good drafting. The agreement in question contained a list of prohibited activities designed to address every conceivable kind of competition, as well as the ubiquitous “in any capacity whatsoever” catch-all for good measure. The court found that the employer could not articulate a protectable interest that would justify such a sweeping prohibition. Specifically, the court was looking for a nexus between the employee’s job duties, and the prohibitions imposed by the noncompete.
In the good old days, the court would simply have revised the agreement to remove whatever restrictions were too broad, such as the “in any capacity whatsoever” language. Or, the court may have found that there was no protectable interest in prohibiting the employee from engaging in his current employment. But the Virginia Supreme Court refused to do so, noting that incremental changes in the law required a different result. I will not bore the reader with the court’s very interesting discussion of how the doctrine of stare decisis applies to the case, except to note that the court recognized its decision as a departure from well-settled law.
While this case does not apply in Pennsylvania or New Jersey, many states have seriously limited the enforceability of noncompetes. We are making sure to discuss these issues with our clients, and draft noncompetes as narrowly as possible. We are also thinking creatively about other solutions to the problem of competition, trade secrets and specialized training, such as non-solicitation provisions. The Virginia Supreme Court has given us new reasons to draft carefully.