Vol. 82, No. 11, November 2009
On July 14, 2009, the Wisconsin Supreme Court issued its decision in Star Direct v. Dal Pra,1 which marks the beginning of a new chapter in Wisconsin’s treatment of restrictive covenants – agreements that limit the competitive activities of current or former employees and agents. The five-member majority, in an opinion authored by Justice Gableman, exhibited an unprecedented degree of solicitude for such agreements and substantially enhanced the ability of employers to enforce them. In addition to examining and commenting on the substantive law developments introduced by Star Direct, this article considers and critiques two analytical tools used by the majority in articulating the court’s new approach to assessing the enforceability of restrictive covenants.
The Analytical Foundation for Considering the Enforceability of Restrictive Covenants
More than a half-century ago, the Wisconsin Legislature adopted Wis. Stat. section 103.465 to overrule the Wisconsin Supreme Court’s decision in Fullerton Lumber Co. v. Torborg,2 which held that courts have the power to reform or “blue-pencil” restrictive covenants by ignoring unreasonable, and therefore unenforceable, provisions and enforcing them to the extent the court deems reasonable. That statute provides as follows:
“A covenant by an assistant, servant or agent not to compete with his or her employer or principal during the term of the employment or agency, or after the termination of that employment or agency, within a specified territory and during a specified time is lawful and enforceable only if the restrictions imposed are reasonably necessary for the protection of the employer or principal. Any covenant, described in this subsection, imposing an unreasonable restraint is illegal, void and unenforceable even as to any part of the covenant or performance that would be a reasonable restraint.”
The court subsequently explained that the statute served the public policy of enhancing employee mobility by limiting the effect of unreasonable covenants.3 This statutory purpose was enhanced by including language that minimized the in terrorem effect of such agreements.4 By codifying a requirement that such restrictions’ purpose and scope be reasonable and declaring that “an unreasonable restraint is illegal, void and unenforceable even as to any part of the covenant or performance that would be a reasonable restraint,” the legislature created a disincentive to overreaching in the drafting of these agreements and consequently reduced their in terrorem effect.
Greater certainty in assessing the likely enforceability of restrictive covenants permits all affected parties – the former employer, its former employee, and the prospective or subsequent employer – to make rational decisions concerning matters potentially affected by those agreements. Greater certainty about the likely enforceability of restrictive covenants also serves the public policy underlying section 103.465 by enhancing employee mobility. The constraint on employee mobility is one fundamental reason for the disfavor with which Wisconsin law views such contracts.5
Bradden C. Backer, U.W. 1981, is a partner in Albrecht Backer Labor and Employment Law S.C., with offices in Milwaukee and Madison, a firm that focuses on representing businesses in employment and labor matters, including in noncompete and other restrictive-covenant-agreement matters. His last article on restrictive covenants appeared in the February 2002 Wisconsin Lawyer. The author thanks Jeremy P. Levinson, Shannon A. Allen, and Matthew W. O’Neill of Friebert, Finerty & St. John S.C. for their editorial assistance and U.W. law student Suzanne Glitsch for research assistance.
The five-factor test for determining the reasonableness of restrictive covenants – agreed on by both the majority and the dissent in Star Direct6 – is historically linked to the statutory mandate of section 103.465. Only two years after enactment of the statute, the court stated that a restrictive covenant will not be enforceable unless it 1) is necessary to protect the employer;7 2) provides a reasonable time limit; 3) provides a reasonable territorial limit; 4) is not “harsh or oppressive to the employee”; and 5) is not contrary to public policy.8 This standard has been repeated like a mantra ever since.
The following court-created guidelines for construing the enforceability of restrictive covenants also are grounded in the statute,9 and they, individually and collectively, constitute the equivalent of a “raised judicial eyebrow” respecting the enforceability of such contracts: Employers have the burden of proof in establishing the enforceability of restrictive covenants.10 These restrictions are “viewed with suspicion”11 – indeed, they are “prima facie suspect.”12 Restrictive covenants also must “withstand close scrutiny to pass legal muster as being reasonable; they will not be construed to extend beyond their proper import or further than the language of the contract absolutely requires; they are to be construed in favor of the employee.”13 As will be discussed below, the holding and analysis of Star Direct appear to be at odds with the long-standing five-factor test and these interpretive directives.
Background of the Star Direct Dispute
Star Direct engaged in the business of distributing various products to customers consisting of convenience stores, service stations, truck stops, and travel centers.14 Dal Pra was employed as one of the company’s route salespersons,15 a position that the court deemed central to the company’s business model.16 His employment was conditioned on his accepting an agreement that contained three distinct restrictive covenants that limited his competition for 24 months following the termination of his employment:17 1) a customer clause, which restricted his solicitation of, and competition for, current customers of the company, and past customers that had terminated their relationship with the company during the year before Dal Pra’s termination and that he had serviced, dealt with, or obtained knowledge about during his employment;18 2) a business clause, essentially a noncompete provision;19 and 3) a confidentiality clause, which restricted the use or disclosure of “all information or knowledge, disclosed or otherwise obtained by him during his employment….”20
The customer clause, the provision of greatest analytical interest, read as follows:
“[F]or twenty-four (24) months, [sic] after termination of Employee’s employment with Employer, Employee shall not interfere with, or endeavor to entice away from Employer any person, firm, corporation, partnership or entity of any kind whatsoever which is a customer of Employer CB Distributors or which was a customer of Employer or CB Distributors within a period of time of one year prior to the termination of Employee’s employment with Employer, for which Employee performed services or otherwise dealt with on behalf of Employer or relative to which Employee obtained special knowledge as a result of his position with Employer; and Employee shall not approach any such customer or past customer for any such purpose or knowingly cooperate with the taking of any such action by any other person, firm, corporation, or entity of any kind.”21
The court characterized this restriction as a prohibition against “interfering with or attempting to entice away: (1) current customers of Star Direct that Dal Pra serviced, dealt with, or obtained special knowledge about during his employment, and (2) those who were customers during the year prior to Dal Pra’s termination (‘past customers’) whom Dal Pra serviced, dealt with, or obtained special knowledge about during his employment.”22
After roughly four years, Dal Pra quit his job and established his own distribution company.23 This business allegedly competed with Star Direct in a manner that violated both the business clause and the customer clause. Star Direct sued Dal Pra, seeking both injunctive relief and damages.24 Presented with cross-motions for summary judgment, the circuit court denied the employer’s motion and granted Dal Pra’s, concluding that each of the three restrictive covenants was both unenforceable and indivisible from the others.25
In an unpublished opinion, the court of appeals concluded that the business clause was unenforceable and was indivisible from the customer clause and that the indivisibility of the clauses rendered the customer clause unenforceable. The court of appeals did not analyze the enforceability of the customer clause, apart from its fatal and indivisible link to the business clause, or either the enforceability of the confidentiality clause or its indivisibility respecting the other restrictive covenants.26
Supreme Court Holding
The Wisconsin Supreme Court reversed the court of appeals and remanded the case to the circuit court for further proceedings. The five-
justice majority27 rejected all challenges to the enforceability of the customer clause and the confidentiality clause.28 The court agreed that the business clause was unreasonably overbroad and unenforceable because it barred engaging in noncompetitive, as well as competitive, enterprises.29 Finding this clause divisible from the other two, the court concluded that the unreasonableness of the business clause had no effect on the enforceability of the customer clause and the confidentiality clause.30
In reaching this result, the court made five specific substantive clarifications – or in some cases, arguably changes – to Wisconsin’s law respecting restrictive covenant agreements. The court: 1) recognized for the first time that an employer has an interest in restricting competition from a former employee for its past customers – at least those customers that have recently ended their ties with the employer;31 2) validated restrictions against competition for the business of current customers with whom an employee has had no contact, so long as that employee has obtained special knowledge about the customer or, perhaps, mere knowledge about the former employer;32 3) enforced a restrictive covenant not required of all similarly situated employees;33 4) concluded that the unenforceability of a restrictive covenant will have no effect on the enforceability of other restrictive covenants, provided that they are divisible;34 and 5) articulated a refined, or arguably new, test regarding the divisibility of distinct restrictive covenants.35
Perhaps as significantly, the court articulated a far more supportive approach to considering the enforceability of these agreements:
“One of the running themes in this case is how broadly or narrowly to read restrictive covenants. As discussed earlier, it is true that we read restrictive covenants in favor of the employee. But this does not mean we make an effort to read a clause unreasonably in order to find the clause unreasonable and unenforceable against the employee. Though they are disfavored at law, our task is still to rightly and fairly interpret non-compete agreements as contracts.”36
As will be discussed in greater detail below, the court’s holdings and approach appear to be inconsistent with the long-standing test and rules for determining the enforceability of such agreements. Indeed, the court’s overall approach appears to substantially set aside the hostility with which such anticompetitive provisions have been viewed by Wisconsin courts.
The Enforceability of Restrictions on Competition for Past Customers
The circuit court rejected the enforceability of the Star Direct customer clause because it prohibited competition respecting businesses that had ceased to do business with Dal Pra’s employer.37 The restriction explicitly included past customers of Star Direct, albeit those who had done business with it in the year preceding the termination of Dal Pra’s employment.38
Acknowledging that “[n]o Wisconsin case has explicitly addressed or affirmed an employer’s interest in customers who have recently chosen to cease doing business with the employer,”39 the court concluded that “Star Direct does have an interest in prohibiting the solicitation of its recent past customers.”40 The court stressed the existence of an employer’s “general interest in winning back the business of its recent past customers.”41 The court also recognized an employer’s interest in protecting itself against the competitive advantage possessed by a former employee in knowing the employer’s business, for example, “prices, pricing strategies, proprietary marketing techniques, and profit margins,”42 its customers’ “specific needs and product desires,”43 and the employee’s “relationship history with them.”44
The court declined to opine on “how much time must pass between a customer placing an order and a route salesperson’s termination before the employer no longer has a legitimate protectable interest in that customer. Our holding today under the facts of this case is that the interim of one year is not too long.”45 And having placed great emphasis on an employer’s particular interest in restricting competition from route salespersons,46 the court left uncertainty about the applicability of its conclusion that an employer had a protectable interest in proscribing competition for past clients in a business model that, unlike Star Direct’s, does not rely on route salespersons.
The court relied on two decisions in which courts, without comment, did not strike down nonsolicitation provisions that, the Star Direct court observed, may have extended to include past customers. Neither of these decisions, however, actually addressed that issue.47 A critique of using “silent” decisions as precedent in this manner is discussed below.
The court’s explanation for its conclusion that employers have a protectable interest in restricting solicitation of their former customers is troubling. First, the employer interests cited by the court to justify this restriction appear to be far more tenuous than those recognized as justifying a nonsolicitation covenant in the case of current customers. The court acknowledged that, under the terms of the customer clause, the salesperson might have had no recent, or indeed any, “relationship history” with the past customer.48 Rather, the court concluded that restriction on the solicitation of past customers was justified by presumed employee “special knowledge” about a former employer’s operations or the former customers. This justification, however, begs the question about whether this “special knowledge” exists and actually confers a competitive advantage that justifies the restriction.
In addition, the court’s reliance on a presumed, generalized employer interest in restricting competition to enhance the opportunity to win back recent past customers appears to be inconsistent with the critical attitude toward restrictive covenants that underlies section 103.465 and the long-standing precedent that places a heavy burden on employers seeking to justify such restrictions.49 Acknowledging that “an employer’s prospects of rekindling customer relationships fade considerably” with time, the court nonetheless concluded, without justification or precedential support, that “an employer is entitled to an opportunity to recoup the considerable investment of resources it made in developing and fostering customer relationships and business opportunities that were active as recent as one year prior to the employee’s termination.”50 The actual prospects for success in winning back former customers could range from zero to some greater, but unknown, possibility. In explaining the reasonableness of this restriction, the court even assumed that “past customers may have chosen to take their business elsewhere temporarily….”51Each of these assumptions appear inconsistent with the “hostility” with which courts have been directed to view such restraints on trade.
This unknown and speculative employer interest in winning back past customers highlights another issue concerning the court’s analysis: Star Direct was relieved of any obligation to prove that its interest was real. Indeed, the court’s presumption that employers have interests that justify restrictions on competition for recent past customers appears to have truncated the established enforceability analysis by foreclosing a factual inquiry into the actual strength of the employer’s interest in the restriction against competition. The court arguably created an irrebuttable presumption of an employer interest in restricting competition for its recent past customers. If so, the holding appears to be a departure from Wisconsin Supreme Court precedent requiring a factual inquiry into the strength of employer interests implicated by assertions of special employee knowledge.52
Finally, in reaching this conclusion, the court appeared to ignore the five-factor test articulated in Slutsky as well as its long-standing ancillary rules.
The Permissibility of Restricting Customers with Whom the Employee had no Recent Contact
Relying on Equity Enterprises, Inc. v. Milosch,53 Dal Pra maintained that the nonsolicitation restriction was unreasonable because it “prohibits interference with customers with whom [he] may not have been in contact for years.”54 The court rejected this argument, because “[e]ven if Mr. Dal Pra was not the recent servicer of a customer he would still have some relationship with that customer, important knowledge about that customer or maybe most significantly, special knowledge about Star Direct’s business and methods.”55 Milosch, the majority observed, concerned a customer nonsolicitation provision that lacked any requirement of recent contact between former employee and customer.56
Like the court’s analysis of the restriction against solicitation of past customers, the most troubling aspect of this justification is the assumed and hypothetical nature of the asserted employer interest. For example, neither the text of the Star Direct customer clause nor the majority’s holding clearly require that the special knowledge – which is the linchpin of the court’s response to the challenge to this aspect of the customer clause – had been recently obtained by the employee or provided him with a real competitive advantage. Rather, the contact and special knowledge of the former employee is assumed to confer a competitive advantage in all cases. Indeed, the court’s holding appears to have relieved employers of any burden of proof on this critical factual matter.
The court’s analysis of this challenge did not address the situation in which the employee had no special knowledge; such knowledge was presumed to exist in the case of all past and current customers, irrespective of when the employee last obtained that knowledge or had contact with that customer.57 Likewise, the court did not address the enforceability of a customer nonsolicitation restriction when there was neither special knowledge nor any recent contact between the former employee and the customer.
The Significance of Inconsistency in Obtaining Restrictive Covenants
The court rejected this final challenge to the enforceability of the customer clause by noting that, since Star Direct’s acquisition by its current owners in 2002, it had consistently required execution of restrictive covenant agreements by all new employees. Under these circumstances, the court observed that “we are untroubled by the fact that not every salesperson signed a non-
The Alleged Overbreadth of the Confidentiality Clause
Although Dal Pra did not challenge the confidentiality clause, the circuit court deemed it to be overly broad and unenforceable “because it barred Dal Pra from using or disclosing any information.”59 Justice Gableman disagreed, reasoning that “[a]ll of the enumerated examples of protected information in the confidentiality clause are of a proprietary nature,” and that “[t]he only reasonable construction of the clause considered in its totality is that it prohibits Dal Pra’s use of confidential information of the type identified in the examples – information of a confidential and sensitive nature that, if made public or used by Dal Pra, would be deleterious to Star Direct’s business.”60
Despite this pronouncement, the court’s holding is difficult to reconcile with general rules of contract construction, as well as those formulated for the interpretation of restrictive covenants. The clause imposed a confidentiality obligation on “any information or knowledge, known, disclosed or otherwise obtained by [the employee] during his employment….”61 The court’s reliance on the clause’s examples to limit the sweeping definition of confidential information seems counterintuitive and inconsistent with the language used in the definition.62 Moreover, the examples of “any information” are preceded by the language “including but not limited to….” The court’s analysis appeared to give these words no effect.63 This entire strained approach accordingly seems at odds with the majority’s declaration that, notwithstanding the disfavor with which restrictive covenants are viewed, “[the court’s] task is still to rightly and fairly interpret non-compete agreements as contracts.”64
The court’s holding also appears to call into question the 50-year mandate that restrictive covenants are to be construed in favor of the employee65and the more recently articulated canon of construction that such provisions should not to be construed “beyond their proper import.”66 Anticipating such objections, the majority commented as follows: “[I]t is true that we read restrictive covenants in favor of the employee. But this does not mean we make an effort to read a clause unreasonably in order to find the clause unreasonable and unenforceable against the employee.”67
The Issue of (In)Divisibility
Star Direct effected a major clarification, perhaps even a profound change, in Wisconsin’s approach to issues concerning the divisibility or indivisibility of multiple restrictive covenants. A background concerning this concept is essential to understanding and assessing the court’s ruling.
The indivisibility concept is the logical corollary of the policy balance reflected in the all-reasonable-or-nothing public policy underlying section 103.465. An invalid restrictive covenant that is indivisible from a valid restrictive covenant must be fatal to the enforceability of both, if the statute’s language and underlying public policy are to be given effect.68 A more far-reaching application of this public policy would extend this principle to divisible restrictive covenants.
The Wisconsin Supreme Court first enunciated this principle in Streiff v. American Family Mutual Insurance Co., withholding comment on the effect of an unenforceable restrictive covenant on an otherwise reasonable, divisible provision. The contract in Streiff contained two provisions – paragraph 5h, which contained customer nonsolicitation and noncompete provisions, and paragraph 5i, which contained another restrictive covenant and provided for forfeiture of extended earnings if the former employee breached either restrictive covenant. The Streiff court held that an unenforceable restrictive covenant precluded the enforcement of another, otherwise reasonable, indivisible restrictive covenant. Accordingly, it refused to consider giving effect to an arguably reasonable restrictive covenant when the agreement contained another covenant that contained no reasonable activity, duration, and territorial limits. This approach, the Streiff court explained, would act as a deterrent to employers who “fashion ominous covenants which affect the mobility of employees because of their in terrorem effect on employees who respect contractual obligations and their effect on competitors who do not wish to risk legal difficulties.”69
The Streiff court then offered the supreme court’s first discussion about distinguishing between indivisible and divisible restrictive covenants. The court concluded that the provisions were “not distinct, mutually exclusive, independent provisions that come into play in totally different fact situations so that they are divisible.”70 The court also stressed that that “they govern several similar activities,” and it deemed the provisions “intertwined,” indivisible and, therefore unenforceable.71
Star Direct and (In)Divisibility
The Star Direct court offered four observations about Streiff that laid the groundwork for limiting its holding. First, the court correctly characterized Streiff as leaving open the question of the effect of an unreasonable restrictive covenant on another otherwise reasonable restrictive covenant in the context of divisible provisions. It then commented that Streiff “was not purporting to decide whether Wis. Stat. § 103.465 overruled the common law distinction between divisible and indivisible contracts, or just blue-penciling of indivisible contracts as was done in Torberg.”72Second, it commented that “[n]owhere does Streiff purport to establish a comprehensive test or set of factors to be analyzed for determining whether restrictive covenants are indivisible.”73Third, the Star Direct court pronounced “that we believe the legislative history and text of the statute did not eliminate or modify the common law rules on divisibility,” thus concluding that “[t]he statute’s prescriptions … apply to any ‘covenant,’ not to the entire contract.”74Fourth, it characterized the indivisibility conclusion reached in Streiff as “premised primarily on the fact that the provisions were intertwined via their textual link,” rather than the overlapping subject matter of the restrictive covenant provisions.75 This latter approach to defining divisibility was most clearly articulated in Mutual Service Casualty Insurance Co. v. Brass,76 in which the court of appeals interpreted Streiff’s divisibility test as turning on whether the provisions “govern several similar types of activities and establish several time and geographic restraints.” Deeming this an “expansive rendering” of Streiff, the Star Direct court overruled Brass’s articulation of the divisibility test.77
The court then announced its own divisibility test:
“The foundational inquiry for determining whether a covenant is divisible is whether, if the reasonable portion is stricken, the other provision or provisions may be understood and independently enforced. This inquiry will be fact-intensive and depend on the totality of the circumstances. In the context of multiple non-compete provisions in a contract, indivisibility will usually be seen by an intertwining, or inextricable link, between the various provisions via a textual reference such that one provision cannot be read or interpreted without reference to the other. Restrictive covenants are divisible when the contract contains different covenants supporting different interests that can be independently read and enforced.”78
Although at first glance the court’s test has the advantage of comparative clarity, the test fails to achieve that objective when examined closely. Qualifying the textual focus of the test with the unexplained term “usually” creates uncertainty about when this approach to resolving the question of divisibility applies and magnifies that uncertainty by failing to articulate the alternative approach that should be applied when that formulation is inappropriate. In addition, the reference in the last sentence of the court’s divisibility test formulation to “different interests” served by multiple restrictive covenants arguably resurrects the Brass approach, which the majority explicitly rejected.
Moreover, strict adherence to the pure “textual focus” test (perhaps) articulated by the Star Direct court is arguably inconsistent with the public policy underlying section 103.465, which is to discourage employer over-reaching in the drafting of restrictive covenant agreements.79 Assuming competent drafting, the pure textual-focus test will dramatically limit the number of agreements whose multiple restrictive covenants are deemed indivisible. Employees will be confronted with contracts that contain overlapping layers of restrictive covenant restrictions, and they should assume, in light of Star Direct, that the unenforceability of any one or more such restrictions may well leave the remaining restraints intact and enforceable.
Critique of the Court’s Analytical Tools
Two analytical tools the court used warrant consideration. The first – its citation of precedent that was silent about the propositions for which it was cited – drew the condemnation of Justice Bradley and Chief Justice Abrahamson in the former’s separate opinion. Among the criticisms the justices directed at what they described as this “new interpretive tool of appellate analysis created today by the majority” was that it was “contrary to precedent [and] principles of judicial restraint and makes no sense.”80
The persuasiveness of this criticism is most easily observed by reviewing the majority’s response, which acknowledged that “[t]he dissent’s arguments against such an interpretive approach are strong.”81 The majority then offered a puzzling justification for its use of this analytical tool: “We explicitly state that these cases do not settle the matter. The cases in fact do show both that courts and litigants have not flagged the implicit asserted interest in past customers, and that this sort of provision is not really all that unique.”82 One can fairly question the value and propriety of the citation of precedent in this manner for the sole purpose of demonstrating what the parties in prior cases chose not to argue.
The second disturbing aspect of the majority’s analysis is its overall failure to actually apply the half-century-old test for determining such provisions’ enforceability and the long-standing rules for assessing these restraints against competition. Although acknowledging the five-factor test in its introductory remarks, the majority never actually applied it in assessing the enforceability of the challenged restrictive covenants. Similarly, the majority invoked the long-standing principles of construction applied to such contracts, merely to dismiss them as secondary to an implicitly distinct and overriding obligation of construing the contract “rightly and fairly.”
Star Direct announces a new era of tolerance for restrictions against competition. Whether one is comforted or disturbed by this policy result,83 there is little doubt that the court’s reasoning is troubling both for its obvious tension with precedent and the public policy underlying section 103.465 and for its apparent departure from “fundamental principles of judicial restraint.”84 Evidencing a fundamental shift in assessing the enforceability of such agreements, Star Direct grants drafters and lower courts a blank check in expanding the scope and effect of these contracts.