Colorado Non-Compete Law Blog : Denver Non-Compete Lawyer & Attorney : Dan Warden : Bond & Morris Law Firm : Adams County, Brighton, Aurora, Bow Mar, Lakeside

In a recent decision, Phoenix Capital, Inc. v. Dowell, the Colorado Court of Appeals appeared to establish a "bright line" rule for determining the duration of an employee's obligations under a non-compete. The trial court had ruled that the non-solicit provisions were only enforceable for the period set forth in the provision itself (that is, one year from the employee's termination).  On appeal, however, the employer argued that the non-compete should be extended beyond the one year period. 

The Court of Appeals rejected the employer's argument and held that any injunctive relief based on a restrictive covenant must be "co-extensive" with the terms of the contract. In other words, a one year non-compete could not be extended beyond the one year period. 

A different conclusion was reached earlier this summer in a decision that how reveals how the scope of injunctive relief is often determined by a judge's effort to provide a "fair" decision. In Xantrex Technology v. Advanced Energy Industries, Judge Daniels on the federal bench was presented with a series of difficult issues but he eventually ruled that the employee was bound by a non-compete. Judge Daniels granted the employer's motion for preliminary injunction and ordered the employee not to work for certain companies in accordance with the non-compete. 

Judge Daniels also ordered, however, that the "clock" for the duration of the non-compete should start on the date that the injunction was issued, not on the date of the employee's termination. This ruling was entered even though the non-compete itself stated that the non-compete was for one year following the termination of the employee's employment.

Based on the decision in Xantrex Technology, it may be possible, although difficult, for an employer to argue that a non-compete should be extended past the date set forth in the non-compete. On the other hand, the ruling in Phoenix Capital may lead employers to be more creative in drafting non-compete obligations. Employers may, for example, draft non-competes to provide that the duration of the non-compete will be extended if the employee violates the non-compete.

Any such efforts at creative drafting will face its own challenges. In a 2007 decision, for example, the Wisconsin Court of Appeals held that a provision extending the duration of the non-compete for any period of violation was unenforceable. 

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There has long been a debate about whether non-competes stifle the formation of new tech companies and inhibit the growth of a region's economy.

This debate has been particularly heated in New England where several prominent members of the venture capital community have urged that non-competes should be abolished. Several panel discussions have been conducted in Boston during which those opposing the enforcement of non-competes have argued that the Massachusetts tech economy has fared poorly in competition with California because of the two states' differing  laws on non-competes. In Massachusetts, non competes are generally enforced and in California, non-competes are generally not enforced. 

Non-compete opponents have argued that each successful tech company creates or "breeds" new companies with a multiplier effect as time passes. Non-competes, according to this argument, dampen or limit this growth because those seeking to form a new company will move to a state like California to start a new company and avoid the application of a non-compete. A proposal to alter Massachusetts non-compete law apparently has been prepared and submitted to the Massachusetts Governor. 

A new study by two economists, Covenants Not to Compete, Labor Mobility, and Industry Dynamics, analyzed the rise of tech jobs and companies along Route 128 in Boston in the 1950s and 1960s and the region's subsequent slow down relative to the Silicon Valley in the 1970s and 1980s. Using a mathematical model to compare growth in the two areas, the economists conclude that non-competes can help a region get established but limit its growth in the long run. This study was published in the Journal of Economics & Management Strategy, Vol.17, Issue 3, pp. 581-606 Fall 2008. (I haven't been able to locate the study on the internet but it appears as if you can order a copy for a fee from the Social Studies Research Network). 

In Colorado, there doesn't appear to be a ground swell of support for adopting the California model for non-competes. Nonetheless, the ongoing debate in Massachusetts demonstrates how things may change. 

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A recent decision from the Third Circuit illustrates the price an employee can pay for violating a temporary restraining order precluding competition with a former employer.

In the fall of 2006, a federal district court in Pennsylvania granted the employer's motion for a temporary restraining order pending a hearing on the employer's motion for preliminary injunction. Several months later, the district court granted the motion for preliminary injunction. Applying Colorado law in accordance with the choice of law provision in the employee's employment agreement, the court found that the employee's non-compete was enforceable because the non-compete fell within two of the exceptions to Colorado's general rule barring enforcement of non-competes. The court found that the employee's agreement was a "contract for the protection of trade secrets"  and that the employee was an executive or manager.

In its Order granting the motion for preliminary injunction, the court also found that, despite its entry of a temporary restraining order several months earlier, the employee had performed services for a "handful" of former clients. Later, in an unreported order, the district court found the employee in contempt and awarded the employer over $130,000 in attorneys fees and over $180,000 in lost revenue. 

In a decision issued earlier this month, the Third Circuit in AMG National Trust Bank v. Ries was faced with the employee's appeal of the order granting the preliminary injunction and the order imposing sanctions. The Third Circuit affirmed the award of the preliminary injunction with little hesitation, but the sanctions presented a more difficult issue. The Third Circuit ultimately affirmed the award of attorneys fees but remanded the issue of lost revenue with instructions that the district court reconsider its order after a final determination of the merits of the case. 

Even though the employee won a minor victory in the Third Circuit when the court ruled that the award of lost revenue should be reconsidered, the Third Circuit decision provides a valuable lesson for employees faced with a temporary restraining order. In AMG National Bank, it appears as if the employee only performed services for a few former clients who contacted him. Nonetheless, the employee was held in contempt and damages were awarded against him. Any employee, or employer for that matter, needs to understand and comply with any order issued by a court considering a non-compete. Damages can and will be awarded for the violation of a court order. In addition, an employee's violation of a court order will cast the employee in a negative light, damage the employee's credibility and lead to the enforcement of the disputed non-compete.  

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In recent years, employees in several states have attempted to assert claims for wrongful discharge when their employment was terminated after they refused to sign non-compete agreements. Typically, these employees have argued that their termination for refusing to sign the non-compete constituted a wrongful discharge in violation of public policy. The Supreme Courts in New Jersey, Oregon, Vermont and Wisconsin have rejected these claims and affirmed the right of employers to terminate employees for refusing to sign a non-compete. These courts generally have reasoned that non-competes do not sufficiently implicate public policy to alter the fundamental nature of an at-will employment relationship. California, on the other hand, has recognized that a wrongful discharge claim may be asserted. 

This split in authority certainly suggests that the viability of any claim for wrongful discharge will depend on a state's public policy toward non-competes. California's strong policy against the enforcement of non-competes played a large role in the decision to recognize a claim for wrongful discharge for the termination of employment based on the refusal to sign a non-compete.

Colorado's state appellate courts have not squarely faced this question. In 1990, a federal district court, in Colorado, however, concluded that a claim for relief for wrongful discharge did not exist for an employee who was terminated after refusing to sign a non-compete, despite Colorado's statute voiding any non-compete which does not fall within one of the statutory exceptions. The court noted that it was not the role of a federal court to effect a dramatic shift in a state's common law.  

Since that decision, Colorado has continued to develop the claim for wrongful discharge in violation of public policy. That claim requires the employee generally to show that the employer directed the employee to perform an illegal act or that the employer prohibited the employee from performing a public duty. This showing would need to be made by any employee seeking to establish a claim for wrongful termination based on the refusal to sign a non-compete.

Even if an employer may terminated an employee for refusing to sign a non-compete, that does not mean that any non-compete signed by the employee is enforceable. Any non-compete would need to be considered in light of Colorado's statute generally voiding non-competes. In addition, these decisions do not resolve whether a court would decline to enforce a non-compete signed by an existing employee for lack of consideration. 

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Perhaps because they are more familiar with the law in other states or perhaps because they don't think that non-competes are "fair", many non-lawyers in Colorado believe that non-competes are rarely enforced. Or they think that they can take a risk and breach a non-compete because damages won't be awarded.  Those errors can lead to costly decisions as demonstrated by Judge Blackburn's decision on July 21, 2008 in Tax Services of America v. Mitchell.

In Tax Services, Judge Blackburn of the federal district court in Colorado found that one of the defendants had signed a non-compete when she sold a tax preparation business known as Qwik Tax. The other defendants signed non-competes when they were employed by the purchaser of the business. Despite these non-competes, the three defendants opened an office of "Kwik Tax Service" within 135 feet of the purchaser's business. Defendants then prepared many tax returns for the purchaser's customers, effectively stealing the purchaser's business. The purchaser's business dropped precipitously once "Kwik Tax" opened while Kwik Tax's revenue increased "exponentially during the same period". 

Judge Blackburn not only entered injunctive relief against the defendants precluding them from breaching the non-compete, he also awarded damages to the purchaser for lost profits. Judge Blackburn also awarded over $370,000 in attorneys fees and costs against the defendants. 

Judge Blackburn's decision should serve as a warning to anyone who considers breaching a non-compete, especially a non-compete which arises out of the sale of a business. Courts are favorably inclined to enforce non-competes arising out of purchase agreements for businesses and damages will be awarded if a purchaser can prove its damages were caused by the competing business. 

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In a long awaited, but unsurprising, decision, the California Supreme Court in Raymond Edward II v. Arthur Andersen LLP has rejected the use of most non-compete agreements. Arthur Andersen had argued that Section 16600 of the California Civil Code,  which generally voids any agreement limiting competition, only prohibited "broad agreements" that prevent a person from engaging entirely in his chosen business.  Agreements that did not have this broad effect, but merely regulated some aspect of post-employment conduct, were enforceable, according to Arthur Andersen. 

The California Supreme Court rejected this approach as it declined to adopt recent Ninth Circuit decisions that suggested that there was a "narrow restraint" exception that allowed companies to use non-competes if the agreements only restricted a small or limited part of their employees' future ability to work. 

The Raymond Edwards decision, however, left unresolved one major issue. In a footnote, the court expressly declined to address the applicability of the "so-called trade secret exception to section 16600". Accordingly, it may be possible for an employer in California to,  among other things, preclude a former employee from soliciting customers by claiming that its customer list is a trade secret. 

This decision may be important for Colorado employers with California employees and even for Colorado employees of a California employer. The enforceability of any non-compete may depend solely on which state's law is applied, which makes any choice-of-law provision and venue selection clause especially important when the two states have an interest in resolving the enforceability of any non-compete. Even with a choice of law provision, the conflict in the approaches taken by Colorado and California may spur a race to the courthouse. Either state's courts may decline to enforce a choice of law that bears on such an important public policy of the state.

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A recent Kansas case highlights the unique rules in Colorado governing non-competes for physicians. 

Kansas, like many other states, allows reasonable non-competes to be enforced against physicians. In Wichita Clinic v. Louis, a physician challenged the enforcement of a non-compete and argued, among other things, that her non-compete was unreasonable and contrary to public policy. In its June 13, 2008 decision, however, the Kansas Supreme Court held that the three year, county-wide, restrictive covenant was enforceable. In addition, the court ruled that a liquidated damage provision, requiring payment of 25% of all earnings collected over three years, was not an improper penalty.  

A different ruling would be entered by any Colorado court faced with these facts. In 1982, Colorado added a new subsection to its non-compete statute, C.R.S. 8-2-113, which was specifically directed to agreements which restrict the right of a physician to practice medicine. This subsection voids any such physician non-compete. There is an exception, however, that allows for the recovery of damages reasonably related to the injury suffered.. 

In Colorado, as a result, any trial court would decline to enforce the kind of non-compete presented in Wichita Clinic. In addition, a Colorado court would not award damages unless the conditions set forth in the statute were satisfied.  

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