Articles Posted in Noncompetition Agreements

Under Federal Rule of Evidence 802, hearsay evidence is generally not admissible in court. In preliminary injunction proceedings, however, the rules of evidence don’t necessarily apply. Here in the Fourth Circuit, courts relax evidentiary rules when faced with motions for preliminary injunctive relief, mostly due to practical considerations such as the exigent nature of the proceeding and the unavailability of a detailed factual record at the very outset of the case. There is some disagreement among federal circuit courts on this issue, but here in Virginia, “district courts may look to, and indeed in appropriate circumstances rely on, hearsay or other inadmissible evidence when deciding whether a preliminary injunction is warranted.” (See G.G. ex rel. Grimm v. Gloucester Cty. Sch. Bd., 822 F.3d 709, 725 (4th Cir. 2016), vacated on other grounds, 137 S. Ct. 1239 (2017)). Failure to consider hearsay evidence at preliminary injunction proceedings may even be deemed an abuse of discretion.

Relying on hearsay evidence is exactly what the district court did when it granted the plaintiff’s motion for a temporary restraining order and/or preliminary injunction in the case of Edward D. Jones & Co. v. Samuel (Ed) Clyburn, Jr., a non-solicitation case filed in the Roanoke Division of the Western District of Virginia. Here’s what happened, according to the facts recited in the opinion:

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Noncompete agreements are typically found in employment agreements between employers and their employees. But that’s not the only place these clauses are found. Sometimes you’ll have two sophisticated companies of roughly equal bargaining power who, for whatever reason, wish to enter into a binding agreement placing restrictions on the one of the entity’s ability to compete with the other. Perhaps one company has acquired or merged with another and needs to ensure that the target company’s former officers and directors don’t immediately form a competing business and take their old clients with them. Or perhaps, as was the case recently in the dispute between wood-flooring contractors Lumber Liquidators and Cabinets To Go, two businesses with overlapping ownership simply seek to reach an agreement to reduce competition and minimize the sharing of confidential information. The important thing to note is that most of the reasons Virginia courts disfavor noncompete agreements have to do with fairness to the employee and do not apply when the two contracting parties are both businesses. Therefore, courts are much more likely to enforce noncompete agreements found in a business-to-business context than in an employment setting.

The basic facts of Lumber Liquidators v. Cabinets To Go are as follows. About 10 years ago, hardwood flooring retailer Lumber Liquidators learned that its Chairman and largest shareholder, Thomas D. Sullivan, was also involved in the ownership and operation of Cabinets To Go, which sold kitchen and bath fixtures and building supplies. Concerned that Sullivan might divert business opportunities or confidential business information over to Cabinets To Go, Lumber Liquidators entered into a number of agreements with Cabinets To Go. Among the agreements formed between the companies was a pair of “reciprocal restrictive covenants” in which Cabinets To Go agreed not to engage in the sale of hardwood flooring anywhere in the world during the term of the agreement and a period of two years thereafter. Lumber Liquidators similarly agreed not to sell kitchen cabinets.

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Once upon a time, courts would routinely dismiss non-compete lawsuits brought by businesses against their former employees if the agreements at issue appeared to impose an unreasonable burden on the employee’s ability to earn a living. The rules of the game changed a bit back in 2013 when the Virginia Supreme Court decided Assurance Data v. Malyevac, where it held that in most cases, even if the agreement appears overly broad on its face, the employer should be given an opportunity to prove that for its particular business model, it has a legitimate business interest in restricting a particular employee’s ability to compete with it for the length of time and in the geographic area specified in the agreement. Proving reasonableness is often easier said than done.

For a noncompete to be enforceable in Virginia, it has to be worded so that its restrictions (a) are no greater than necessary to protect the employer’s legitimate business interests, (b) are not unduly harsh or oppressive in limiting the employee’s ability to earn a living, and (c) are reasonable considering sound public policy. It’s up to the employer to produce evidence sufficient to demonstrate each of these elements. As reasoned by the Assurance Data court, “restraints on competition are neither enforceable nor unenforceable in a factual vacuum.” A recent decision out of Fairfax County Circuit Court demonstrates how this can play out in the real world.

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When the Virginia Supreme Court decided Assurance Data v. Malyevac a few years ago, most employment lawyers speculated that although Virginia law no longer permitted most non-compete cases to be disposed of summarily on demurrer, a procedural mechanism known as the “plea in bar” could still be used by defendants intent on challenging the enforceability of their noncompete agreements. Assurance Data held that “restraints on competition are neither enforceable nor unenforceable in a factual vacuum” and that evidence is ordinarily required to perform the analysis. Unlike demurrers, pleas in bar allow for the presentation of evidence, so it would seem that the plea in bar would be an appropriate way to dispute a noncompete. A new decision from the Circuit Court of Fairfax County agrees with this approach.

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The best way to predict whether a particular noncompete clause will be deemed enforceable in a Virginia court is to read about how similar clauses have been treated by those same courts. No two cases are exactly alike, but non-compete agreements tend to incorporate similar language (mostly for the reason that lawyers don’t like to re-invent the wheel and do a lot of cutting and pasting from prior agreements when drafting such contracts for their clients). Back in November 2017, I wrote about O’Sullivan Films v. Neaves, in which the court held that it would be premature to rule on the enforceability of a noncompete clause without hearing evidence. Since then, the parties presented evidence to the court and the court reached a decision, so I thought it would be a good time to revisit the case here on the blog.

In its latest opinion, the court (the Western District of Virginia, Harrisonburg Division) doesn’t make any new law, but its ruling can serve as a guide to how courts are likely to interpret and apply in the future noncompetes using language similar to the language at issue in the O’Sullivan Films case. Here’s what the noncompete in that case said:

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It happens to every business eventually. A rogue employee defects to a competitor and immediately starts soliciting the former employer’s customers and clients, using the former employer’s trade secrets or other confidential commercial information against it. Although non-compete and non-solicitation agreements are generally disfavored in Virginia, most Virginia judges nevertheless recognize that employers have a legitimate business interest in protecting themselves from competition by former employees who possess sensitive information and will, in appropriate circumstances, compel former employees to honor their contractual commitments. This blog post provides a brief overview of the process involved in obtaining such relief from the legal system, divided into two basic steps.

Step One: Write an enforceable noncompete agreement.

The most common mistake employers make in their efforts to prevent unfair competition is to present their employees with overbroad, overreaching employment agreements. Many businesses, knowing that 99% of new employees will sign whatever piece of paper you put in front of them, cannot resist the temptation to draft their noncompete agreements in a way that is completely one-sided in favor of the employer. They might draft agreements that prohibit the employee from contacting any of its customers for 10 years after leaving the company, or that prohibit former employees from taking any kind of job within a 500-mile radius of the employer’s office. When an employer goes too far in its efforts to secure loyalty by forcing its employees to sign unreasonable contracts, those efforts can backfire by causing the contracts to become unenforceable as a matter of law.

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Restrictive covenants in employment agreements (e.g., noncompete and nonsolicitation clauses) are enforceable in Virginia if they are (1) narrowly drawn to protect the employer’s legitimate business interests, (2) not unduly burdensome on the employee’s ability to earn a living, and (3) are not against public policy. There was once a time when litigation brought to enforce noncompete and nonsolicitation agreements would be routinely dismissed at the outset of a case based on a finding that one of these elements was lacking. For example, a noncompete provision restricting a former employee from taking a similar job with a nearby competitor for five years might have been quickly dismissed based on the judge’s quick determination that five years is simply too long.

This changed with the 2013 Virginia Supreme Court decision in Assurance Data, Inc. v. Malyevac. There, the court pointed out that every case is different, and held that an employer seeking to enforce a restrictive covenant must be given the opportunity to present evidence demonstrating reasonableness. Since this decision, some judges–like Fairfax County Circuit Court Judge John M. Tran–have opined that in appropriate cases, courts can still dismiss noncompete cases without an evidentiary hearing, such as when an employer fails to even proffer a legitimate business interest. Others hold that Assurance Data forecloses facial attacks on restrictive covenants. This appears to be the more common interpretation of the case.

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The “janitor test” isn’t the only hypothetical scenario that, when applied to a non-compete agreement governed by Virginia law, can render the contract unenforceable. In NVR, Inc. v. David Nelson, the federal court in Alexandria imagined a number of hypothetical situations when struggling to interpret an ambiguous geographic limitation in a noncompete agreement. When some of those hypotheticals resulted in an unreasonable restriction, the court decided the noncompete was overly broad and therefore unenforceable.

Noncompete agreements are disfavored in Virginia because they restrain free trade. For this reason, if such an agreement is ambiguous, it will be construed in favor of the employee. Before a court will enforce the agreement, the employer will have to demonstrate that the restraint is no greater than necessary to protect a legitimate business interest; that it is not unduly harsh or oppressive in curtailing the employee’s ability to earn a livelihood; and that the terms are reasonable in light of sound public policy. Courts examine reasonableness primarily by looking at three factors: function (i.e., the activity being restricted), geographic scope (the area in which the restriction applies), and duration.

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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…”

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In Virginia, independent contractors can be held to noncompete agreements to the same extent as regular employees. But beware. A Fairfax County Circuit Court judge decided last month that all bets are off if the “independent contractor” should really have been classified as an employee. Although the Virginia Supreme Court has not yet spoken on the subject, Judge John M. Tran crafted a lengthy, well-reasoned opinion in Reading and Language Learning Center v. Sturgill holding that misclassifying employees as independent contractors violates Virginia public policy and is grounds for voiding the contract–including its noncompete and nonsolicitation provisions–even if the misclassification is unintentional. In other words, reasoned Judge Tran, independent contractors will only be bound by noncompete agreements if they have been properly classified as independent contractors.

Reading and Language Learning Center (“RLLC”) is a speech therapy practice that provides services to people with speech, language, or reading disorders. In 2014, Charlotte Sturgill was a recent graduate of a master’s program in speech-language pathology. To obtain her license and certification, Sturgill was required to complete a supervised clinical fellowship, which she arranged to do with RLLC. RLLC hired her with an agreement titled “Agreement between Private Practitioner and Independent Practitioner” which classified Sturgill as an independent contractor and contained the following non-compete clause:

RLLC and the Consultant agree not to employ any contracted employee or contract with any current client of the Other for a period of two (2) years after the expiration of the contract between RLLC and the Consultant.

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