Today we will learn about non-compete clauses by examining the case of Data Management versus Greene. Non-compete clauses are increasingly relevant in our economy. The extent to which they should be enforced is the subject of our lesson today. Before we turn to the facts of the case, let's talk a bit about non-compete clauses. A non-compete clause, or covenant not to compete, is a provision under which an employee agrees not to enter into, or start a similar professional trade in competition against his or her employer. Why might an employer want their employee to sign a non-compete clause? Well, the main reason is that, employers may be concerned that their employee might reveal confidential information, trade secrets, or marketing strategies. Employees of course, sign non-compete clauses because it's a condition of employment for at least some employers. In cases where employees have some leverage, they might sign a non-compete clause in exchange for a higher salary or benefits of some kind from the employer. Employees might be willing to give up the freedom of working for a competitor, in order to get a good job that might provide them with some extra training, or hands on experience. But a non-compete clause that's too broad, either in its temporal or geographic scope, might prevent an employee from finding any alternative employment in their chosen field. The Facts in Data Management verses Greene are simple, defendants and employees Greene and Van Camp signed a covenant not to compete, against plaintiff, an employer, Data Management in Alaska for five years following their terminations. Shortly after their terminations, defendants began to compete with the plaintiffs, who sought injunctive relief. The trial court granted a preliminary injunction, and then summary judgment in favor of defendants. The ensuing court, clarified the law to be applied and remanded the case. There are two main issues in this case, the first is whether the covenant was overbroad and therefore against public policy. The second, is whether the covenant, as a result of its overbreadth is completely unenforceable. On the first question of whether the covenant was overbroad and therefore against public policy, the court answered yes. Under English common law, overbroad covenants not to compete, were unenforceable under the public policy doctrine. In effect, preventing covenants that are overbroad sets a ceiling or a cap on their length. Covenants not to compete, must be reasonable with regard to both their length, and their geographic scope. There is a mandatory ceiling on this scope. In this diagram, you can think of there being a mandatory ceiling on the maximum duration of the covenant, and not to compete. The court finds that the covenant not to compete for five years goes beyond this cap, and goes into the noncontractable zone. This immutable ceiling is similar to the treatment of unconscionably high markups, and the treatment of unconscionably high liquidated damages amounts, that operate as penalties. In these other contexts, the law also places mandatory caps on the markups, or the price, or on the size of liquidated damages. But the default rules are very different in these different contexts. The default duration of a covenant not to compete is zero years. If you leave out a covenant, then there is no duration, you can immediately compete. But the default price is a reasonable price, not a zero price, and a default damages are expectation not zero damages. So, from these examples, you can see that contract law, can not only decide what a default rule is, but it can also limit the alternatives to the default, which the parties can choose by putting on ceilings, or floors, and or somehow limiting what other options they go for. Why is the mandatory ceiling imposed here? Well, one reason is that restraints against Labor race 13th Amendment type concerns. Recall that the 13th Amendment bans slavery and involuntary servitude in the United States. One argument is that the covenant not to compete are unconstitutional restraints on people's ability to provide their labor in an open marketplace. We also don't want a former employee to become a word of the state. If employees are laid off and can't find another job because of the covenant not to compete, they might have to rely on Social Security payments or welfare payments of one type or another. This means the rest of society picks up the tab for the non-compete. Generally, when you see a mandatory limitation on freedom of contract, you should ask whether the limitation can be justified in terms of externalities, or paternalism concerns. You can argue that both are in play here. After the court has found the covenant to be overbroad, it must address the second question. What to do with the contract? The court opted to reasonably alter the covenant to make it enforceable. The court has three main approaches to a covenant that is overly broad, that goes beyond the mandatory ceiling. First, the court can choose not to enforce the contract at all. This court does not like this approach, because it "May produce unduly harsh results." But you might argue that, we want harsh results for deterrence purposes. To deter employers from putting in overbroad covenants not to compete, the court's tone reflects its attitude about the nature of the employers and maybe the employee's behavior. This may be a context where employers actually know the law and the risk of overbreadth. Second, the court can use the blue pencil test. The blue pencil allows alterations only by the deletion of specific words in the covenant. The court rejects this approach, because it's too dependent on the language that the parties happen to use. The blue pencil rule is a very mechanical rule, but because some courts rely on it, the parties might consider fallback language indicating that the covenant will be enforced for the longest period possible. So, a party might say, a covenant might read,"This covenant last for five years or for the longest period allowed by law." The blue pencil rule arose because courts are disinclined to rewrite contracts to add in their own language into it. With a blue pencil rule, courts don't have to write any new words, they just have to strike offending words. Sometimes a crafty court might be able to strike a word or even just a digit. For instance, a 10 year non-compete clause, might become a one year non-compete clause by striking the number zero. The last approach, the one adopted by the court in Greene, is the reformulation of the contract to a reasonable brand. In this case, the court adopts this approach, unless the contract was not drafted in good faith. If it was drafted in bad faith, the contract wouldn't be enforced altogether. When parties violate a mandatory limitation, there are two generic legal responses. First, the law can substitute the provision that comes closest to what the parties contracted for. That result as depicted in this slide by moving the parties to a covenant just below the mandatory cap. Alternatively, the law can punish one or both of the contractors for violating the mandatory limitation. That result is depicted in this slide by moving the parties to a covenant with zero duration. It's a poor length with regard to an employer's preferences, than what the employer might have been able to contract for. Non-compete clauses also appear in the sale of a business. Well, why would a buyer and seller of a business want a non-compete clause? Usually, the vendor of a business will promise not to compete with the purchaser to ensure the value of the business being sold. For instance, suppose that Robert sells Sally his bakery, Sally will likely demand that Robert sign a non-compete to not open up a new bakery next door, because that would undermine most of the value of the bakery Sally just bought. The covenant not to compete has been the source of prolific litigation. Ohio court once wrote that "there is so much authority on non-compete, that it can be compared to a sea that will drown the legal researcher." US jurisdictions approach non-compete clauses differently. While the majority of US states recognize and enforce various forms of non-compete agreements, a few such as California show great hostility toward the enforcement of covenants not to compete. In general, courts focus upon two aspects of a covenant, whether it protects some legitimate interest of the promisee, and whether it's reasonable in scope. When it comes to the sale of a business, courts tend to be more favorably disposed toward covenants that are ancillary to the sale of a business, than toward those that restrict an employee's competitive activities. A covenant ancillary to the sale of a business is usually seen as protective of the goodwill being sold. With respect to the employees covenant, where the party does not have a special or unique skill, the usual attempt is protect by precluding the use of trade secrets, confidential information, customer lists, and the like. The reasonableness test deals primarily with the area and types of companies covered, as well as the duration of the Covenant. It is here that efforts are frequently made as in the instant case, to convince a court that the excessive part should be excised leaving intact that which is reasonable both as with regard to space and time. Efforts are thus made to sever or divide the legal portion from the portion which is illegal. The geographic scope is increasingly problematic, because in the Internet age, many manufacturers find themselves competing online with producers from anywhere in the world. In summary, a non-compete clause or covenant not to compete, often appears in an employment contract or a sale of a business. Non-compete clauses cannot be overbroad and against public policy. If they are overbroad, a court may choose to not enforce the clause entirely, delete certain provisions using the blue pencil rule, or reformulate the contract to what would be reasonable. Reformulation is often the preferred approach, because it's not overly harsh, and is very flexible.
