Noncompete Restriction Against Owning Stock Not Necessarily Unenforceable

When the Virginia Supreme Court decided Home Paramount Pest Control Companies v. Justin Shaffer five years ago, it stressed the importance of the “function” consideration in analyzing the enforceability of non-compete agreements. To be enforceable, the court held, a noncompete agreement should not purport to restrict the employee from engaging in activities having nothing to do with the tasks performed for the former employer. The court found particularly troublesome the fact that the noncompete at issue in the Home Paramount case barred the former employee from “engaging even indirectly…in the pest control business, even as a passive stockholder of a publicly traded international conglomerate with a pest control subsidiary.” What legitimate business interest would an employer have in preventing its former employees from owning stock in its competitors if the employee was not actually engaging in competitive activities? The court couldn’t identity any, so it held the noncompete was overly broad and therefore unenforceable. Since Home Paramount was decided, noncompete agreements containing restrictions against owning stock are being scrutinized more carefully. But a case decided by the Eastern District of Virginia a few weeks ago shows that such noncompete agreements will not necessarily be declared unenforceable.

The case was between Hair Club for Men, LLC, and its former employee, Lailuma Ehson, and her new company, Illusion Day Spa, LLC. Hair Club is in the business of hair replacement and hair therapies. Ehson worked at its Tysons Corner location from 2011 until 2015. When she took the job, she signed a “Confidentiality, Non-Solicitation and Non-Compete Agreement.” The noncompete clause prevented Ehson from engaging in the business of hair replacement or becoming interested in such business, directly or indirectly, “as an individual, partner, stockholder, director, officer, clerk, principal, agent, employee, or in any other relation or capacity whatsoever…”

In October 2014, while she was still a Hair Club employee, Ehson opened a salon called Illusion Day Spa just over 15 miles away from Hair Club’s Tysons Corner location. A few months before she quit, she began providing hair replacement services at her new company. She contacted at least 27 Hair Club clients to inform them about her competing business. She admitted to forming a competing business in violation of the terms of her noncompete, but argued that the noncompete was overly broad and thus enforceable. Despite the inclusion of the restriction against owning stock, the court found the noncompete was no greater than necessary to B&O_RR_common_stockprotect the employer’s legitimate business interests, and entered summary judgment in Hair Club’s favor with respect to this aspect of its breach-of-contract claim.

The court first observed that Hair Club had a legitimate business interest in protecting its customer contacts. It noted that having access to an employer’s confidential information can make a noncompete restriction more reasonable. Here, the court essentially recognized that the noncompete agreement arguably failed the so-called “janitor test” in that it “prevents Ehson from working for a potential competitor of Hair Club in any capacity.” Nevertheless, due to the narrow focus of Hair Club’s business and the access of Ehson to significant proprietary information (including clients’ specifications, Hair Club’s hair replacement techniques, and pricing information), the court found the noncompete restriction to be reasonable.

“Because Hair Club only provides one kind of service, in practice this provision only prohibits Ehson from working in some role which would compete with Hair Club,” the court reasoned. The court was also persuaded by the fact that “hair replacement services” was a very narrow business scope, leaving Ehson free to provide other types of hair styling or salon services. (Illusion Day Spa apparently offers 60 other services besides hair replacement).

The opinion does not actually address directly whether the restriction against owning stock is overly broad. Ehson had pointed out in her brief that the “clause is so broad that it restricts Ms. Ehson from even holding stock in a company that provides hair replacement services,” but cited only a 2002 circuit-court case from Roanoke in support of that argument. In any event, the court was clearly aware of the restriction but not persuaded that its inclusion should render the entire noncompete clause unenforceable.

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