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Antitrust and Trade Regulation Developments 

Published: June, 2006

Submission: June, 2006

 



Lessons in Using Employee Non-Compete Agreements An increasing number of companies are requiring their employees (new and existing) to sign so-called “non-compete” agreements. Many of these agreements prohibit employees from working for their employer’s competitors for a period of time after the termination of employment. Some are less restrictive—prohibiting former employees from performing certain duties or dealing with the former employer’s customers. Despite their widespread use, courts do not treat non-compete agreements like most other commercial contracts and automatically enforce them. Many employers mistakenly assume that a boilerplate non-compete will protect their interests. However, the states which permit non-competes require that they be reasonable in terms of duration, geographic coverage and activities covered. For example, in Michigan (which banned all non-competes until 1985), the statute governing non-competes states that such agreements must: (1) “protect[ ] an employer’s reasonable competitive business interests . . . ;” (2) “be reasonable as to… duration;” (3) be reasonable as to “geographical area;” and (4) be reasonable as to “the type of employment or line of business.” Michigan Compiled Laws §445.774a. Furthermore, employers cannot assume that courts will judicially rewrite (i.e., “blue pencil”) broad boilerplate non-competes to make them enforceable. Some states which prohibit blue penciling will completely invalidate non-competes found to be overly broad. Even in states, like Michigan, where blue penciling is permitted, courts are not required to do it and often invalidate broad boilerplate non-competes. Moreover, broad boilerplate non-competes often complicate the process of obtaining a preliminary injunction, an expedited pretrial order seeking to enforce non-competes, and the most common “battleground.” Judges ruling on preliminary injunctions are required to “balance the equities,” determine whether the employer will suffer “irreparable harm” unless the non-compete is enforced and make an expedited judgment on the likelihood of ultimate success at trial. Having a narrowly tailored non-compete, along with demonstrable evidence of violation, harm and reasonableness, will significantly improve the chances of success on a preliminary injunction. Given the above fact-intensive “tests,” and the inescapable fact that different jurisdictions, and even judges within the same jurisdiction, have differing views on non-competes, it is difficult (or, at the very least, unwise) to advise an employer or an employee in advance about the likelihood that a court will enforce any non-compete agreement. A few general lessons, however, can be distilled from the cases involving non-competes. Lesson 1: “Non-Compete” is a Misnomer. It is inimical to our free market economy (and the antitrust laws) to use non-competes merely to insulate an employer from future competition by a former employee. Non-competes are permissible to protect against unfair competition. This reflects the requirement that a non-compete protect only a “reasonable competitive business interest.” Unfair competition occurs when, for example, a former employee uses secret or proprietary information (e.g., pricing and profit data, engineering and production information, customer data or marketing plans) to take business away from a former employer. Therefore, employers must carefully determine which employees will be in a position to unfairly harm them after they leave and determine which activities could cause such harm. Not every employee has access to the type of information that warrants protection by a non-compete. Non-compete agreements should also spell out in as much detail as possible what information the employee will have access to and the harm which could befall the employer if that information were used by a competitor. All too often, employers use “boilerplate” agreements with vague descriptions of possible access to “secret” information. Such recitations are often useless in court and could actually disadvantage an employer seeking to enforce a non-compete agreement. Lesson 2: Once You Decide What is Worth Protecting . . . Protect It. Do not assume that non-competes are a panacea for protecting secret information. If employers have competitively sensitive information that merits protection with non-compete agreements, they must also take affirmative steps to ensure that such information remains confidential. Otherwise, a departing employee may claim that the agreement is no longer protecting a reasonable competitive business interest. For example, if an employer seeking to protect a customer list has knowingly permitted other departing employees to walk out the door with the list, a court may conclude that there is nothing to protect. In a recent case, a court denied injunctive relief where a high-level executive, after indicating his likely resignation, was permitted to access his computer and attend high-level planning, financial and sales meetings. The court concluded that these actions “significantly undermine [the company’s] claim of substantial harm” if the former employee violated the non-compete. The same vulnerability exists if an employer seeks to protect customer or financial information that is accessible to a large number of employees (through, for example, a computer system without adequate password protection). Accordingly, employers should, among other things, clearly mark confidential information as “Confidential,” limit the number of employees with access to such information, store documents containing such information in locked cabinets or offices, tighten computer access to confidential information through the use of passwords, clearly set forth confidentiality policies have confidentiality policies clearly set forth in corporate manuals, reinforce confidentiality procedures in employee meetings and immediately shut off access to trade secret information upon discovery of an employee’s intent to resign. Such procedures make it far easier to graphically demonstrate in court why a non-compete should be enforced. Lesson 3: Don’t Be Greedy. Non-competes are enforceable only if they are “reasonable” in terms of the geographic area covered and the time limitation. Courts generally frown upon extremely broad non-competes. While courts are permitted to scale back the scope of such agreements, they are likely to go further than an employer would desire, or refuse to enforce the agreement altogether. Thus, it is best to limit the agreements to the minimum time period and geographic area necessary to protect the employer’s interests. The geographic area and time restrictions in non-competes should be tied directly to the business interests being protected. For example, a non-compete for a salesperson responsible for a specific geographic territory should be limited to that territory. A non-compete for a professional with an office-based practice should roughly correspond to the service area of the particular office. On the other hand, non-competes for very high-level executives of national or international businesses may, in some circumstances, justifiably cover the United States or the world. An increasingly popular alternative to approximating a “reasonable” geographic area is to prohibit a former employee from soliciting certain customers, wherever they are located. Many courts recognize such restrictions as being more reasonable because they do not prevent the former employee from pursuing a livelihood. Determining a time limitation for non-competes can be more difficult. A reasonable time limitation should match the “useful life” of the information sought to be protected. For example, if designs for a particular part will be used for three years, three years would likely be a reasonable limitation. On the other hand, if the information relates to pricing and profit information in a market-driven industry, where prices change every month or so, arguably the reasonable time limitation would be only a month or two. Far too many businesses wrongly assume that non-competes are treated like most other contracts and what is on a piece of paper signed by two parties will be enforced. Following these simple rules should greatly improve the chances that your non-compete agreement will hold up if tested in court. Appeals Court Rules that Exclusive Dealing Arrangement Constituted Unlawful Monopolization The U.S. Court of Appeals for the Third Circuit, in reversing a trial court decision, handed the U. S. Department of Justice Antitrust Division a substantial victory against the number one competitor in the artificial teeth market in the United States. U.S. v. Dentsply International, Inc. (3d. Cir. No. 99-00005). In its case, the Justice Department alleged that Dentsply, which had in excess of 75% of the artificial teeth market in the U.S., unlawfully monopolized that market, in violation of section 2 of the Sherman Act, 15 U.S.C. §2, through its use of exclusive contracts with dealers. These contracts provided that Dentsply dealers “may not add further tooth lines to their product offering.” As a result of the contracts, none of the major dealers gave up the popular Dentsply teeth to take on a competing line. The Third Circuit reversed the trial court’s dismissal of the monopolization claim. The trial court reasoned that the dealer contracts did not exclude effective competition because some other dealers (without contracts) were available and manufacturers could make direct sales to laboratories. Moreover, the trial court concluded that Dentsply dealers were not charged monopoly-level prices and were free to leave the network at any time. The Third Circuit disagreed. It first concluded that Dentsply had a monopoly-level market share. Absent other pertinent factors, according to the court, a share significantly larger than 55% is the first step in proving monopoly power. Other factors include the size and strength of competing firms, pricing trends, industry practices and the ability of consumers to substitute comparable goods. The Court of Appeals found that Dentsply possessed monopoly power, given its high market share, the absence of strong competition and the inability of consumers to substitute for artificial teeth. The Third Circuit also determined that direct sales to laboratories “have not been a practical alternative for most manufacturers.” It observed that the overwhelming majority of sales were made through dealers, likely because of the lower costs of selling through dealers, as opposed to direct sales to numerous laboratories. The competitors that attempted direct sales to laboratories had attained only miniscule market shares and provided no realistic competitive threat to Dentsply’s monopoly position. Dentsply, according to the court, had “effectively choked off the market for artificial teeth, leaving only a small sliver for competitors.” Although a rival could theoretically convince a dealer to buy its products and drop the Dentsply line, that had not occurred. The court, giving great weight to testimony by former Dentsply managers, concluded that the contracts were designed to “block competitive distribution points, not allow competition to achieve toeholds in dealers; tie up dealers;–[and] not free up key players.” The appeals court also rejected the district court’s finding that the absence of monopoly-level pricing mitigated against finding a section 2 violation. Although Dentsply’s prices were not necessarily at monopoly levels, the evidence in the record indicated that it set prices with little concern for its competitors’ prices—for example, not reducing its prices when competitors elected not to follow its price increases. Moreover, when monopoly power has been acquire or maintained through improper means, the fact that it has not been used to extract a monopoly price is not a defense for a monopolist. While exclusive dealing requirements are often employed in competitive markets, Dentsply shows that these exclusivity requirements could present significant antitrust risks for manufacturers with high shares in certain markets with limited effective distribution channels. Sixth Circuit Refuses to Dismiss Direct Purchasers’ Price Discrimination Claims Against Cigarette Manufacturers The Sixth Circuit recently affirmed a lower court decision granting summary judgment on Robinson-Patman (price discrimination) claims against cigarette manufacturers brought by indirect purchasers and refusing to grant summary judgment on Robinson-Patman claims by operators of direct purchasing vending machines. Lewis v. Philip Morris, Inc., 6th Cir., No. 01-6174-6502. In sustaining certain of these claims, the Sixth Circuit applied a highly forgiving view of the evidence needed to satisfy the requirement of discrimination in price and other terms to competing purchasers. Plaintiffs alleged that Philip Morris violated the Robinson-Patman Act by offering lower prices and better promotional services to convenience stores, mini-marts and gas stations for cigarettes than were offered to cigarette vending machine companies. Beginning in 1998, Philip Morris instituted programs for these venues that provided price promotions, product promotions and incentive programs, as well as a payment for each pack of cigarettes sold (provided that the customer received an equal discount). These terms were not offered to vending machine operators. Section 2(a) of the Robinson-Patman Act prohibits price discrimination only if there are two or more consummated sales of commodities of like grade and quality made at discriminatory prices by the same seller to two or more competing purchasers. Sections 2(d) and (e) of the Act prohibits discrimination in the provision of promotional services and payments for such services made available to competing purchasers who buy for resale. These services include, for example, advertising, catalogues, demonstration models, display cabinets, special packaging and monetary awards paid to clerks or salesmen to promote particular products. In order to bring a Robinson-Patman case, the plaintiff must be a direct purchaser or a customer. A divided panel of the Sixth Circuit upheld summary judgment dismissing the section 2(a) claims. The court first dismissed claims of eight of the ten plaintiffs because they purchased cigarettes through a wholesaler. The court held that these indirect purchasers lacked standing under the Robinson-Patman Act unless the seller substantially controlled the sale by the wholesalers to the indirect purchasers. The court also rejected their section 2(d) and (e) claims. Although the Supreme Court in F.T.C. v. Fred Meyer, 390 U.S. 341 (1968) extended standing to retailers who purchased through wholesalers and competed with direct buyers, the Sixth Circuit held that Fred Meyer reflected the underlying concern that a chain retailer would take advantage of smaller retailers who bought through wholesalers. The court refused to extend this analysis to the instant case, at least where supplier Philip Morris did not control the sales of the wholesalers so extensively as to imply a circumvention of the Robinson-Patman Act by selling through “dummy” wholesalers. The court also ruled that the remaining direct purchasing vending machine operators had standing under sections 2(a), (d) and (e) because they did in fact compete with the convenience stores, mini-marts and gas stations. The court found sufficient evidence of such competition, even though the plaintiffs did not provide a detailed analysis of price elasticity (i.e., whether the vending machine prices or demand were influenced by changes in the stores’ prices). The court stated that, “although such a study would be helpful, competition can be shown in other ways…” The court credited testimony by two expert witnesses that smokers purchase cigarettes both from convenience stores and vending machines, that “some people purchased cigarettes from both” convenience stores and vending machines, and that a price difference will cause vending machines to lose business to convenient stores selling cigarettes for less. Several vending machine operators also testified that they were forced to remove their vending machines due to lost sales after customers continued to leave their premises to purchase cigarettes at nearby convenience stores. The Sixth Circuit’s decision indicates anecdotal evidence of customer leakage could support the competitive harm element of a Robinson-Patman claim, even if the purchasers were functionally different or were located in different areas. Under this test, for example, a retail store that also sells through the internet may be deemed to compete, for Robinson-Patman purposes, with stores thousands of miles away. Hog Producer Pays $2 Million Fine for Violating Premerger Notification Rules The U.S. Department of Justice recently settled a lawsuit against Smithfield Foods, Inc., the nation’s largest hog producer and pork packer, alleging that Smithfield violated the premerger notification and waiting period requirements of the Hart-Scott-Rodino Act of 1976 (“HSR”). HSR requires the parties to many transactions valued currently at $53.1 million or more to file premerger notifications with the Federal Trade Commission and the U.S. Department of Justice, and observe a waiting period of 30 days (or less if early termination is granted) prior to consummation. According to the Complaint, Smithfield twice violated HSR when it acquired more than the then-effective threshold $50 million of stock in its competitor, IBP Inc., without filing a premerger notification. Smithfield claimed that its stock acquisition was exempt from HSR filing under the “solely for purpose of investment” exemption. The Department of Justice rejected that claim, asserting that the exemption did not apply because Smithfield was actively considering merging with IBP at the time it made its acquisition. Smithfield agreed to settle the suit, paying a $2 million civil penalty. This settlement, but one of a string of recent multi-million dollar settlements with accused HSR violators, reinforces the Department’s warning that it will aggressively pursue HSR violations. These costly settlements underscore the importance of paying close attention to HSR requirements in transactions that result in the acquiring party’s holding anywhere close to $53.1 million of the assets or voting securities of the acquired party, even if no competitive issues are present.

 


 

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