E-Newsletter

April 2008

Recent Developments: Covenants Not To Compete

Mark A. Johnson, Esq.
maj@kclegal.com

Are you sure that a court would enforce the covenants not to compete that you rely on to protect your company's intellectual capital?

Courts generally construe covenants not to compete (often referred to as non-compete agreements) in favor of the employee. To be enforceable, a covenant must: (1) be necessary to protect the employer; (2) provide a reasonable time limit; (3) provide a reasonable territorial limit (for which a customer restriction can sometimes substitute); (4) not be harsh to the employee; and (5) not be contrary to public policy. Time and territorial limits must be no greater than necessary. If any part of a covenant not to compete is invalid, the entire agreement is unenforceable.

Because the courts highly scrutinize covenants not to compete, employers must draft these agreements as narrowly as reasonably possible. Two recent Wisconsin cases highlight additional issues to watch.

Divisibility

In late February 2008, the Wisconsin Supreme Court agreed to review the Court of Appeals' decision in Star Direct Inc. v. Del Pra. The agreement in Star Direct had two clauses. The "customer clause" prohibited the employee from interfering with or enticing away customers of the employer for twenty-four months after termination. The "business clause" prohibited the employee from engaging in a business that was substantially similar to the business of the employer for twenty-four months after termination within a specific geographic region.

This restriction also prohibited the employee from distributing products the employer did not distribute. Therefore, the Court of Appeals concluded that the business clause was not reasonably necessary to protect the employer's interests and was unenforceable.

The Court of Appeals went on to conclude the business and customer clauses were indivisible and, therefore, because one was unenforceable, both clauses were unenforceable.

One could argue that the Court of Appeals' decision makes it difficult to determine when separate clauses could ever be considered divisible. The Supreme Court will have the opportunity to review procedures dealing with the issue of divisibility and provide employers guidance on how to determine when clauses are divisible.

Extending Time Periods

In the second case, H&R Block Enterprises, Inc. v. Swenson, the agreement contained a non-solicitation clause and a non-competition clause. Each clause prohibited certain activity for a period of two years following termination of employment with the extension clause "such period to be extended by any periods of violation."

The Court of Appeals in H&R Block concluded that the text extending the time period of the covenant by the period of a violation rendered the clauses unenforceable. The Court noted that an employee would not be able to determine how long a violation had lasted. For example, if an employee solicited one customer in violation of the agreement, would that equal a one day violation? Additionally, there could be legitimate disputes over whether certain conduct violated the agreement. As a result, the clauses did not have fixed time limits that an employee could use in advance to determine how long the clauses applied. The extension clauses thus rendered both clauses unenforceable, even if they would have been otherwise enforceable. H&R Block has appealed the Court of Appeals' decision to the Wisconsin Supreme Court.

The law governing non-compete agreements continues to develop. Employers should periodically review the agreements that they use to keep them current with the law.

For more information about covenants not to compete or other employment law issues, contact educational services at (414)988-8400.