Damages Awarded for Breach Prior to Modification of Non-compete Agreement

Posted on October 26, 2009 by Dan Warden

Damages may be awarded for breach of a non-compete agreement even if the agreement is  modified after the breach occurs, according to the recent First Circuit decision in Astro-Med v. Nihon Kohden. 

In Astro-Med, the trial court modified the scope and range of the prohibited conduct set forth in the non-compete when it issued a preliminary injunction. Instead of North America and Europe, the trial court limited the prohibited conduct to a specific state and a limited subset of customers.  Such limitation was consistent with Rhode Island law which disfavors non-compete agreements -- as Colorado law does. Later, at trial, damages were awarded for breach of the modified non-compete. The opinion isn't clear, but presumably the breach and resulting damages occurred prior to the preliminary injunction.  

On appeal, defendants sought to have the damage award vacated as they argued that the non-compete was not enforceable until it had been modified by the district court.  In the words of the First Circuit, defendants were seeking the application of the "one free breach" rule, which would bar damages for breach of a non-compete if the non-compete was subsequently modified by a court. At first blush, this argument seems plausible. As the First Circuit noted: "We have no quarrel with the defendant's general contention that under the partial enforcement rule, an overly broad noncompetition provision cannot be enforced until it is modified, a proposition that seems self-evident". 

The First Circuit rejected defendants' argument, however, as it reasoned that the one free breach rule "would eviscerate all but the most narrowly tailored non-competition agreements, since a modification of any term of the provision would justify a breach of all its terms".   

This case raises some perplexing issues. The First Circuit may be right that employees should not be able to enjoy the benefits associated with the "one free breach" rule. On the other hand, there may be situations where it would be unfair to ask employees to anticipate whether and how an unreasonable restraint will be construed. And, in those situations, a court may not be inclined to award damages against a former employee when the employee guesses wrong about how the restrictions in a non-compete should be enforced. 

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Damages For Lost Profits Awarded

Posted on October 25, 2009 by Dan Warden

Profits lost on specific orders are recoverable for breach of a non-compete agreement, according to the recent Tenth Circuit decision in Southwest Stainless v. Sappington.

Oklahoma law was applied to determine that the non-compete was enforceable. As a result, the trial court's reasoning about why the non-compete was enforceable has limited value for a case governed by Colorado law. Oklahoma's non-compete statute differs from Colorado's. Nonetheless, the Tenth Circuit's damages analysis may provide guidance in Colorado cases. 

In Sappington, the trial court rejected the plaintiff's claim for "general lost profits"; that is, plaintiff's claim for lost profits on all the business done by its former employees' new employer. Other jurisdictions have similarly concluded that damages should not be measured by the benefit to the party in breach. The trial court awarded damages, however, on two contracts where there was evidence that the former employees' breach of their non-compete had caused damages.

On appeal, the defendants challenged the ruling that lost profit damages were recoverable on the two contracts at issue. The former employees argued that any breach of their non-competes had not caused damages to their former employer because the plaintiff had not shown exactly what the defendants had done or how the damages had resulted. The Tenth Circuit rejected this evidentiary argument with little difficulty, as it noted that Oklahoma law provided that a causal connection could be proved by circumstantial evidence.  

While the decision is not surprising, it does include lessons for both employees and employers. Employees subject to non-competes should recognize that there are times when damages have been awarded for the breach of a non-compete. Employers should recognize, on the other hand, that their case for damages may depend on showing how the employee's conduct caused it to incur damages. It is often not enough for a former employer to show that the new employer of its former employee has been successful.

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