Labor and Employment Update - Winter 2008

COURT FINDS NON-COMPETITION AGREEMENT TO BE UNENFORCEABLE

Non-competition a nd non-solicitation agreements have long been used by employers seeking stability and consistency in the workplace as well as the ability to prevent former employees from becoming direct competitors with them.  These agreements, however, face ever increasing scrutiny as courts seek to balance the tension created by an employer’s interest in continuity and employee loyalty on the one hand and an employee’s interest in freedom and mobility on the other.  

In the United States, most courts that have considered the validity and enforceability of non-competition agreements have upheld the agreements with varying limitations.  Generally, a non-competition clause will be enforceable if it is reasonably limited in time, scope and geographic area – that is to say that the protection sought is no broader than is necessary to protect the employer’s business and not so restrictive as to prevent a former employee from earning a living.  Yet, courts often adopt the narrowest interpretation of such agreements and resolve ambiguities in favor of the employee.  

For example, a Wisconsin court recently ruled in H & R Block Eastern Enterprises, Inc. v. Swenson that non-competition and non-solicitation clauses were entirely void due to language that allowed the employer to extend the duration of the restrictive covenants “by any period(s) of violations.” In affirming the grant of summary judgment against the employer, the appeals court determined that the language contained in the agreements was unreasonable because the existence and duration of any extension of the agreed upon restrictive covenants could not be predicted by the employee with any certainty.

Defendant Mary Swenson and five other individuals worked for H&R Block as tax preparers.  Each of the employees had more than 10 years of experience and had executed employment contracts that included non-competition and non-solicitation provisions as follows:

11.  Non-Competition Covenant. Associate covenants that for two (2) years following the voluntary or involuntary termination of Associate’s employment (such period to be extended by any period(s) of violation), Associate shall not, directly or indirectly, provide any of the following services to any of the Company’s Clients: (1) prepare tax returns, (2) file tax returns electronically, or (3) provide bookkeeping or any other alternative or additional service that the Company provides within the Associate’s district of employment. 

12.  Non-Solicitation Covenant. Associate covenants that for two (2) years following the voluntary or involuntary termination of Associate’s employment (such period to be extended by any period(s) of violation), Associate shall not directly or indirectly solicit or divert the Company’s Clients or otherwise interfere with the Company’s continuing relationships with its clients. Company Clients are those defined in Section 11.

Less than one year after leaving H&R Block, two of the defendants started a new business and hired the other four former H&R Block employees.  H&R Block brought suit alleging that all the former employees breached the restrictive clauses in their contracts and that two tortiously interfered with those clauses in the contracts of the other four employees and seeking injunctive relief and damages. The former employees filed a counterclaim alleging that H&R Block continued to use their names for trade purposes without their permission in violation of their right to privacy under Wisconsin Law.

The circuit court granted summary judgment in favor of the former employees, finding that a two-year limitation was more than necessary to protect H&R Block’s interests and that with the extension permitted in addition to the two years the duration was plainly invalid.  On appeal, H&R Block unsuccessfully argued that the extension provision did not make the restrictive covenant unreasonable because the effect was to restrain the former employees for a total of only two years, and if two years is reasonable, then the extension for a violation to make up a total of two years is reasonable as well. 

The appellate court determined that the extension provision made the duration of the restraints unreasonable for two reasons.  First, the contract language did not allow a former employee to know how long an extension, if any, would be for particular conduct.  The court found that if it accepted H&R Block’s proposed construction, it is unclear how the extension provision would be applied in the context of providing tax and bookkeeping services.  Second, an employee will not know from the plain language of the agreement whether particular conduct violates the clauses. Therefore, the court held that the effect of the extension provision was to create a restriction that was not fixed and definite in duration and was contingent upon outcomes the employee cannot predict.

Most important, however, was the court’s finding that “[a]n employer is by no means entitled to an extension simply because there has been a breach” of a restrictive covenant.  The court reasoned that extensions were remedies to be permitted and applied within a court’s sound discretion; taking into account factors such as the circumstances of the breach, the effect on the employer, and the inadequacy of monetary damages. 

In light of this decision, employers would be well served to review the restrictive covenants contained in their employment contracts to be certain that they are narrowly tailored to protect a legitimate business interest.  The enforceability of such agreements, as always, will vary by state and by the specific circumstances. 

PRE-EMPLOYMENT BACKGROUND CHECKS

Conducting a pre-employment background investigation, although not a complete defense, is one way to mitigate your exposure to negligent hiring lawsuits. Regardless of whether your company currently conducts pre-employment background checks, or whether you consider implementing them, there are several important rules employers must know and follow. 

First, your company should have a written policy that informs applicants/employees that your company screens applicants with a uniform background check.  The policy should also identify some or all of the types of investigations that might be done.  This could include credit reports, criminal records checks, drug testing, or other investigations depending on the level and sensitivity of the position. Regardless, the policy should state that the information the employer gathers is kept confidential and maintained in a way that a limited amount of employees have access to that information. 

An employer engaged in pre-employment background investigations must have solid knowledge of federal law in addition to a host of state laws.  For example, the Fair Credit Reporting Act (“FCRA”) requires an employer using a credit report, or any investigative consumer report, obtained from a third-party agency and used in any way to determine the employability of a particular applicant, to:

Inform, by clear and conspicuous written disclosure, the applicant (or current employee) that the company may obtain a consumer report;

Obtain written authorization from the applicant to gather the report (in advance of obtaining the report);

Certify that disclosure was made in accordance with the FCRA and that the information is not going to be used to violate any state or federal laws; and

Certify that a copy of the report and a summary of the applicant’s rights will be provided if an adverse decision is based on the report. 

If the employer makes an adverse decision, based in any way on the consumer credit report, the employer must give the person the name, address and toll free telephone number of the reporting agency.  The employer must state that the credit reporting agency did not make the adverse decision.  The employer must alert the person that he/she may obtain a free copy of the report within a certain time period and must also notify the person that he/she may dispute the completeness and accuracy of the report.  (These rules change slightly if the employer owns or is otherwise affiliated with the agency that conducts the investigation.)

The ADA, among other requirements, prohibits an employer from gathering any medical information about disabilities from an applicant before making them a conditional employment offer.  Furthermore, the Civil Rights Act, Bankruptcy Code, Employee Polygraph Protection Act and Educational Rights and Privacy Act each prohibit using certain types of information in the company’s pre-employment investigation and decision process. 

Conclusion

An effective pre-employment investigation process will assist an employer in identifying solid employees and cultivating long lasting, trusting relationships with these employees.  Several state and federal laws obligate employers to conduct their investigations responsibly.  Employers must make all required disclosures, maintain confidentiality and establish a uniform policy for conducting these investigations.  There are significant consequences for employers that do not conduct pre-employment investigations in compliance with applicable laws and their pre-employment screening policy.  

FMLA AMENDED TO COVER FAMILY MEMBERS OF MILITARY PERSONNEL; PROPOSED AMENDMENTS TO FMLA REGULATIONS ARE ISSUED

On January 28, 2008, the National Defense Authorization Act (“NDAA”) was signed into law, which includes provisions modifying the scope of the federal Family and Medical Leave Act (“FMLA”) to cover leaves taken by family members of military service personnel.

Under the newly amended FMLA provisions, FMLA-covered employers must provide:

Up to 12 weeks of FMLA leave during any 12 month period to employees who experience a “qualifying exigency” arising out of the active military duty (or notice of impending call or order to active duty) of an employee’s spouse, parent or child.  The term “qualifying exigency” is not defined by the statute, and the Secretary of Labor is directed to issue a regulation determining the scope of this provision.

Up to 26 weeks of FMLA leave during a single 12 month period to employees who are the spouse, parent, child or next of kin (defined as the nearest blood relative) of a service member who is undergoing medical treatment, recuperation or therapy or who is otherwise on outpatient status or on the temporary disability retired list for a serious injury or illness that renders him/her unable to perform his military duties.

Although the U.S. Department of Labor (“DOL”) has not yet issued governing regulations regarding these new kinds of military-related leave, the DOL is “encouraging” employers to provide “qualifying exigency” leave in accordance with the statutory amendment (despite the absence of language defining what a qualifying exigency is).  The DOL is requiring employers to comply immediately with the 26-week unpaid leave for the care of a wounded service member.

At the same time, the DOL has announced extensive proposed revisions to its FMLA regulations, which were issued for public comment on February 11, 2008.  Among the proposed revisions are:

Regulations addressing what kind of “break in service” will be permitted in determining whether an employee is FMLA-eligible (such as up to a 5-year break for persons who have been absent for work due to military leave);

Regulations defining what is meant by “continuing treatment” and “periodic” treatment (in terms of frequency of medical visits);

Regulations addressing how to count intermittent leave taken during overtime hours;

Regulations addressing when releases of FMLA claims will be permitted without court or DOL approval;

Regulations addressing medical certifications, including the employee’s ability to remedy incomplete medical certification forms and the employer’s right to clarify and/or authenticate medical certification information, in conjunction with HIPAA requirements; and

Revisions will be made to the DOL’s standard FMLA forms.

It should be noted that these proposed revisions are not final, as the DOL is currently seeking review and comment.

The Labor and Employment Group represents and counsels employers in all aspects of the employment relationship, including EEO litigation, union avoidance, negotiations, arbitrations, executive compensation, corporate transactions, and non-competition/non-solicitation agreements, as well as compliance with federal and state laws such as the Family and Medical Leave Act, the Americans with Disabilities Act, the Health Insurance Portability and Accountability Act, the Fair Labor Standards Act and the Occupational Safety and Health Act.

This document is published for the purpose of informing clients and friends of Klehr Harrison about developments in the areas of labor, employment and benefits, and should not be construed as providing legal advice on any specific matter. For more information about this publication or Klehr Harrison, contact Charles A. Ercole, Chair of the Labor and Employment Group, at (215) 569-4282 or visit the firm’s Web site at www.klehr.com