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Five HR Errors That Can Invalidate a Non-Compete Agreement

Enforcement by employers of non-competition agreements against former employees can be made even more difficult when HR fails to catch these simple errors.

Friday, December 12, 2014
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Non-competition agreements are increasingly prevalent in today's business world, but they remain disfavored under most states' jurisprudence because they may impinge, sometimes drastically, on an individual's ability to earn a living.

Enforcement by employers of non-competition agreements against former employees can be an uphill battle in the best of circumstances - even when they are narrowly drafted to protect the employers' legitimate business interests, and are reasonable in terms of geographic scope and duration.

So imagine the frustration of employers if a non-compete covenant which otherwise might stand a good chance of being enforced is torpedoed by a simple error made months-or years-earlier in the employer's human resources department, which invalidates the restriction and prevents its enforcement.

The following are examples of these sorts of errors reported in court decisions, in which the individual is able to walk away from a non-compete provision-scot-free and on a technicality, as it were. Perhaps more than anything, these cases show that implementation of human resources best practices and even just a little more attention to detail can go a long way.

1. Re-Hiring a Terminated Employee without Executing a New Non-Compete

If an employee is terminated, but then re-hired within a short period of time, the employer should not assume that a non-compete agreement in effect during the first period of employment will remain in effect during the second period of employment. For example, in a case in Indiana, Nightingale Home Healthcare, Inc. v. Helmuth, No. 29A04-1403-PL-121 (Ind. App. Aug 28, 2014), an employee signed a two-year post-employment non-compete agreement in 2008, and then was fired on October 16, 2009 for allegedly substandard work. The employee was re-hired only 10 days later, and continued working until March 2012, when he was fired again. He immediately took a job at a competitor, which would have been in violation of his non-compete obligations. When the plaintiff attempted to enforce the non-compete agreement, however, the court held that the two-year non-compete period began to run when his initial employment was terminated, and it had expired by October 16, 2011.

A similar decision was rendered with respect to an employee in a New Jersey case, Truong LLC v. Tran, No. A15752-1171 (N.J. App. Div. Jan. 9, 2013). There, the individual left work at a nail salon and opened a competing nail salon, violating a two-year non-compete agreement that she had signed. When the nail salon sought to enforce the agreement in court, however, the individual successfully defended herself by pointing out that previously she had ceased to be an employee of the nail salon for four months. Since the two year non-compete restriction began to run at that break in service (during which time she was not paid nor expected to return), it had already expired.

The important lesson from these cases is that when employers re-hire individuals who had been subject to a non-compete, they need to have the individual agree in writing to a new non-compete agreement in connection with the new employment.

2. Not Confirming Whether the Individual Actually Has Signed the Non-Compete

When an employer asks an individual to agree to a non-compete restriction, the individual may take time before signing it in order to think it over and/or consult an attorney. In such circumstances, an employer must follow through and make sure it actually gets the agreement signed by the employee (or at least gets some sort of written or electronic acknowledgement from the employee that he or she is bound by the restriction). Down the road, an employer will have a difficult time enforcing a non-compete agreement if it is unable to produce a copy of the agreement actually signed or acknowledged by the individual employee.

In Workflow Solutions v. Lewis, 77 Va. Cir. 334 (Va. Cir. Ct. City of Norfolk Dec. 12, 2008), an employee resigned under contentious circumstances. He was persuaded to return to the employer for a six month period, with an option to continue as an at-will employee, provided that he signed a non-compete. He returned to work for the employer for several years, but never actually signed the non-compete. When the employee resigned again, the employer sued to compel him to execute the non-compete agreement. The court refused to grant such belated relief. See also New Hanover Rent-A-Car, Inc. v. Martinez, 525 S.E.2d 487 (N.C. App. 2000), which held that a former employer had little likelihood of success on the merits of its breach of covenant claim in light of a finding that the former employee had not signed the covenant.

3. Failing to Have a Corporate Representative Sign the Non-Compete

It can also be a problem if the employer fails to sign a non-compete agreement. For example, in Holloway v. Dekkers, No. 05-10-01132-CV (Tex. Ct. App. Sept. 18. 2012) a Texas appellate court ruled that a one-year employment agreement that was not signed by the employer fell within the statute of frauds and was therefore unenforceable. The case involved a breach of contract claim by the employee after he was terminated just a couple of months into his employment, not an attempt by the employer to enforce a non-compete agreement. If, however, the agreement had included a non-compete agreement of, say, two years, and the employer sought to enforce it against the individual, it would have been unable to do so because the employment agreement was invalid under the statute of frauds (i.e., was not able to be performed within one year, and was unsigned by a party (the employer)).

In United States Risk Management, L.L.C. v. Day, 73 So.3d 1100 (La. App. Ct. 2011),  an individual challenged a non-compete agreement because the agreement did not contain a handwritten signature of any representative of the employer but only a typed signature of a principal of the employer. The appeals court did not invalidate the agreement on summary judgment, but remanded the case for further proceedings to determine whether the parties intended that the agreement would become effective only upon the agreement being signed by hand by both parties.

In either of these cases the lack of the employer's written signature might have proved dispositive on whether a non-compete would be enforced. It is good practice for employers to make sure all non-compete agreements with their employees are countersigned by an officer of the employer, and are not just placed into its personnel files after the employee has signed it.

4. Transferring the Employee to a Different Entity without Continuing the Non-Compete

Sometimes, for various reasons, an employer may transfer an individual employee to the employer's subsidiary, to an entity resulting from a merger, or some other corporate affiliate. The employment relationship thus is no longer between the individual and the erstwhile employer, but rather between the individual and the affiliate or other entity. If that individual was subject to a non-compete restriction with the original employer, that obligation may not automatically follow the individual to the new employment relationship.

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Can the employer simply assign its rights under the non-compete restriction to the affiliate or entity?

Whether a particular restrictive covenant is assignable, or was effectively assigned, depends on the language of the contract, the law of the applicable jurisdiction, and the circumstances of the case.

If there is no clause in the non-compete agreement providing for assignment, a new non-compete agreement may be necessary, or at least an acknowledgement from the individual that he or she still agrees to the non-compete restriction being applied to the new employment relationship. See Guy Carpenter & Co. v. John B. Collins & Assocs., No. 05-1623 (JRT/FLN), 2006 U.S. Dist. LEXIS 61765 (D. Minn. Aug. 29, 2006), in which the court held that, by their terms, two employees' non-solicitation agreements signed with their original employer did not transfer to their new employment relationship with a different entity after a merger. See also Ascencea, L.L.C. v. Zisook, No. 08-5339 (DRD), 2011 U.S. Dist. LEXIS 36786 (D.N.J. Apr. 5, 2011) (absent a merger agreement, stock purchase agreement, assignment of rights, or other evidence signifying transfer of all corporate assets and liabilities, alleged successor cannot enforce non-compete agreements of predecessor).

5. Breaching the Non-Compete Agreement

Finally, a unilateral material breach by an employer of an agreement containing a non-compete provision can doom later efforts by the employer to enforce that provision. This category of error may be made by management more often than human resources, but is problematic in either case. For example, in Smith-Scharff Paper Co., Inc. v. Blum, 813 S.W.2d 27 (Mo. Ct. App. 1991), an individual was hired at a salary of $2500 per month until he would be able to reach "sales representative status." Four months later, however, the employer unilaterally changed the individual's compensation to straight commissions. The court found this change to be a breach of the contract by the employer, and refused to enforce the contract's non-compete provision.

Indeed, courts may find that a modification of pay structure, change in the employee's title, or some other change to the employment relationship may indicate that the employee has entered into a new employment relationship with the employer, thereby voiding the original non-compete agreement. See Rent-A-PC, Inc. v. March, No. 13-10978-GAO (D. Mass. May 28, 2013) (refusing to issue preliminary injunction against former employees who experienced "material changes" in their employment including change of job duties, authority and compensation).

Such changes to the employment relationship should not be proposed or made without full consideration of their consequences on the individual's existing non-compete obligations.

In summary, employers and their HR professionals should spend the time needed to verify and execute all paperwork and formalities with respect to their valued employees whom they wish to be bound by non-competition restrictive covenants. If those formalities are not performed properly, the employer may fail in later efforts to enforce its non-compete to protect both its confidential information and customer relationships.

David J. Clark is senior counsel in the litigation and labor and employment practices in the New York office of Epstein Becker Green.

 

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