Employers who would like to make their covenants not to compete more restrictive may have gained false confidence from a recent Wisconsin Court of Appeals decision whose result was counter to existing case law. In August 2012, in Key Railroad Development LLC v. Guido, the court of appeals appeared to expand the scope of customers that an employer can prohibit a former employee from doing business with through use of a covenant not to compete or noncompetition agreement.1 The court upheld a provision prohibiting a former employee from attempting to solicit any of the employer’s customers with whom the former employee had had any contact at any time during his employment.2
J. Nels Bjorkquist, U.W. 2001, focuses his practice on management-side employment law, appellate advocacy, and commercial litigation at Mawicke & Goisman S.C., Milwaukee.
This decision may tempt employers to severely limit employees’ postemployment activities by revising their covenants not to compete to prohibit employees from competing for any customers with whom they ever dealt. Employers and their counsel should resist this temptation, however, because Key Railroad conflicts with established Wisconsin law. As a result, such a prohibition could invalidate all protections contained in the covenant not to compete and jeopardize related covenants, such as nondisclosure covenants, if they are indivisible from the covenant not to compete.
Notably, the covenant in Key Railroad would likely have been invalidated as unreasonable and overbroad had the employee prevented the court of appeals’ admitted confusion by citing the controlling law in his brief. Thus, the case stands as a cautionary tale to all attorneys, even those who do not practice employment law: To avoid confused or incorrect outcomes, support your arguments with clear citations to the controlling law on dispositive issues.
The pre-Key Railroad Law on Covenants Not to Compete
“Restrictive covenants in Wisconsin are prima facie suspect as restraints of trade that are disfavored at law, and must withstand close scrutiny as to their reasonableness.”3 The burden to prove a covenant’s reasonableness is on the employer (or principal) seeking to enforce a noncompetition or nondisclosure covenant against a former employee (or agent), under the following five criteria:
1) The covenant must be reasonably necessary for the protection of the employer’s legitimate interests (for example, prohibiting only unfair competitive activities).
2) The covenant must restrict the employee for only a reasonable period (for example, typically two years or less).
3) The covenant must restrict activities only within a reasonable zone (for example, restricting activities within the geographic area in which the employer or employee conducted business, or restricting activities with customers with whom the employee recently dealt or about whom the employee learned nonpublic information during the employment).
4) The covenant must not be harsh or oppressive to the employee (that is, it must permit the employee to earn a livelihood).
5) The covenant must not be contrary to public policy (that is, it must not unduly impede the mobility of workers or deprive the community of the only provider of a much-needed service).4
The Key Railroad decision hinged on the first and third of these criteria and focused on which customers and for whose business the employee could properly be restricted from soliciting and competing.
Section 103.465 of the Wisconsin Statutes and ample case law provide that any employment-related restrictive covenant that is unreasonable with respect to any of these five criteria is unenforceable in its entirety.5 Wisconsin courts have been barred from rewriting unreasonably harsh employment covenants to make them enforceable – a practice known as “blue-penciling” – since adoption of Wis. Stat. section 103.465 in 1957.6 An unenforceable covenant not to compete may invalidate otherwise reasonable covenants – for example, a nondisclosure agreement or a nonsolicitation agreement – if the covenants are indivisible as a result of intertwined text or other inextricable links.7
New Case Conflicts with Existing Law
Employers drafting or revising restrictive covenants should not rely on the unpublished Key Railroad decision because it conflicts with at least one published court of appeals decision, Equity Enterprises Inc. v. Milosch, in which the court held that an employer must narrowly define which customers it has a legitimate interest in protecting from competition.8 The Milosch court held that the employer could not prohibit a former employee from competing for all customers with whom he had contact at any time during his 15-year employment because such an unlimited look-back period is “unreasonable,” “invalid,” and “not reasonably necessary to protect the [employer’s] legitimate business interests.”9
The court of appeals cited this portion of Milosch with approval in 2009 in Techworks LLC v. Wille, in which the court approved a two-year look-back period regarding customers for whom the employee could not compete.10 The Wisconsin Supreme Court signaled its approval of Milosch’s invalidation of the unlimited look-back period in its most recent opinion regarding covenants not to compete, Star Direct Inc. v. Dal Pra.11 Thus, Key Railroad is in direct conflict with Milosch and is unsupported by Techworks and Star Direct.
Employee Confused the Court by Not Citing Controlling Law
Guido’s brief to the court of appeals contained two sentences in which he implied that the one-year restriction would be extended indefinitely into the past so as to bar him from soliciting any customer with whom he ever had any contact at any time while employed by his previous employer.12 The Milosch court specifically rejected enforcement of restrictive covenants that contain such unlimited look-back periods because an employer is not entitled to protection from competition by former employees for the business of customers who may have long ago transferred their business to competitors.13 Guido, however, failed to cite Milosch, Techworks, or Star Direct for this proposition, instead citing Milosch on a separate topic elsewhere in his brief to the court of appeals.14
The court of appeals apparently mistook Guido as suggesting that an unlimited look-back period would extend the one-year restriction of the covenant not to compete indefinitely into the future.15 The court wrote: “It is not entirely clear what Guido is arguing, but this is our best attempt at comprehending it.”16
Rather than understanding Guido to be arguing that the covenant’s unlimited look-back period was retrospectively indefinite, the court interpreted his argument to be that the covenant was indefinite as to the duration of its future application, so it issued a clipped rebuke: “The one-year prohibition commences when he leaves employment, and terminates one year later. There is nothing indefinite about it.”17 This remark indicates the court did not appreciate the point the employee appears to have attempted to raise regarding the look-back period. As a result, the court did not address Milosch’s bar against prohibiting former employees from soliciting any customers with whom they had ever dealt at any point in the past as an employee.18
Issues to Consider When Drafting Restrictive Covenants
(Excerpted from Peter Albrecht et al., 3 Wisconsin Employment Law ch. 15 (State Bar of Wisconsin PINNACLE 5th ed. 2013) (forthcoming))
Section 103.465 of the Wisconsin Statutes and associated case law govern restrictive covenants, also known as noncompetition agreements or nondisclosure agreements, and identify specific requirements for enforceability. To draft enforceable restrictive covenants, attorneys must consider and address each of these requirements.
1) The covenant must be reasonably necessary to protect the employer’s legitimate interests. The two most common employer interests are protecting goodwill the employer has developed with customers or clients and protecting confidential information. The first interest applies when the employee has developed rapport with the employer’s customers, leading the customers to associate their goodwill toward the enterprise more with the employee than the employer. The second interest applies when the employee has access to competitively significant confidential information. Employers should determine which of these interests, or both, apply to each employee and tailor the restrictive covenant to protect the interest or interests as narrowly as possible.
2) The covenant must restrict the employee for only a reasonable period. A restrictive covenant that does not contain a time limitation is unreasonable per se. There are no other bright-line rules as to the reasonableness of a time limitation; however, two years has emerged as a rule of thumb for drafters. Employers should consider the reasonableness of any time limitation in light of the interest justifying the restriction. For example, it may be hard to justify a restriction premised on customer contacts that lasts longer than the employee’s actual term of employment. However, a restriction based on access to confidential information may reasonably last as long as the information remains confidential.
3) The covenant must restrict activities only within a reasonable zone. When a restrictive covenant is based on customer contacts, the restriction may be limited to a specific geographic region or group of customers, a specific activity, or both. A geographic restriction extending further than the territory actually served by the former employee will likely be found unreasonable. Furthermore, if an employee serves customers throughout a large region like the state or country, a restriction based on customer contacts likely must be limited to the specific customers the employee serves or a very limited set of potential customers. A restriction on specific activities should apply only to competitive activities, and not to all employment activities within the geographic region. This would unduly limit the employee’s ability to seek other work in the area.
When a restrictive covenant is based on access to confidential information, which is highly mobile, a geographical restriction may not be required. If the restriction is based on access to confidential information about customers, the employee may reasonably be restricted from contact with all the employer’s customers, rather than just those customers with whom the employee has developed a relationship.
4) The covenant must not be harsh or oppressive to the employee. This factor focuses on whether and to what extent the restriction inhibits the employee’s ability to pursue a livelihood. The reasonableness of a particular restrictive covenant may depend on the employee’s age, education, and physical condition. Even if justified from the employer’s perspective, a restriction should not effectively prohibit the employee from using his or her particular skills in any other employment.
5) The restrictive covenant must not be contrary to public policy. This occurs most often when a restriction creates a shortage of certain employees or of a certain kind of service in an area. This is especially relevant to particular occupations, such as doctors or lawyers, where a person’s interest in unfettered choice of service providers is particularly important.
Because courts may review restrictive covenants with varying degrees of hostility, it is important that an employer and its attorney carefully consider the purpose of the covenants and narrowly tailor them to meet the employer’s needs. This will increase the likelihood that the covenant will be enforced and protect the employer’s business interests after an employee separation.
For additional information on restrictive covenants, including noncompetition agreements and nondisclosure agreements, see Peter Albrecht et al., 3 Wisconsin Employment Law ch. 15 (State Bar of Wisconsin PINNACLE 5th ed. 2013) (forthcoming in June). This book is available in print or online through Books UnBound. Annotated sample restrictive covenant provisions, based on appendix 15A of Wisconsin Employment Law, are available for download as a Wisconsin Lawyer WebXtra.
Turning Possible Victory into Certain Defeat
The employee’s failure to clearly call the court’s attention to the controlling case law on this issue not only confused the court but also likely changed the outcome of the case. The court noted that Guido’s failure to “develop any legitimate argument” contradicting Key Railroad Development’s lengthy discussion of the restrictive covenant’s alleged reasonableness resulted in a concession on the issue of enforceability.19
Had the employee cited and quoted the relevant portion of the Milosch decision in his brief, however, the court might have invalidated the entire covenant not to compete pursuant to Wis. Stat. section 103.465. Instead, the court became confused, admitted that it was guessing (probably incorrectly, it turns out) as to what the employee’s legal argument was, and issued a decision that unwittingly conflicts with its decision in Milosch.
As a result of this confusion, the court of appeals reversed the summary judgment entered by the circuit court in favor of Guido and remanded the case to the circuit court for determination of whether he violated the covenant not to compete.20 Although the circuit court had previously found the restrictive covenant to be enforceable, it also found that Key Railroad Development could not avoid dismissal in favor of Guido because it had not provided sufficient evidence to create an issue of material fact on whether Guido had violated the covenant.21 The court of appeals agreed that the covenant was enforceable but reversed and remanded for further proceedings concerning the alleged violations.22
Guido did not move for reconsideration or file a petition for review by the Wisconsin Supreme Court, so the unpublished decision of the court of appeals stands. Pursuant to the remand, the circuit court reopened the case, and the CCAP docket reveals that the parties remain in contentious litigation, replete with discovery disputes, regarding whether Guido violated the restrictive covenants.
Employers Should not Rely on Court’s Confused Decision in Key Railroad
Because of the troubling conflict between the Milosch and Key Railroad decisions, employers should not rely on Key Railroad when drafting or evaluating covenants not to compete. The court of appeals does not have the authority to reverse its prior decisions; only the Wisconsin Supreme Court has that power.23 Therefore, the conflict between the decisions in Key Railroad, Milosch, and Techworks makes the issue of unlimited customer-contact look-back periods in covenants not to compete fertile ground for law development or clarification by the Wisconsin Supreme Court beyond the Star Direct court’s implied approval of Milosch. The Key Railroad court’s admitted confusion as to Guido’s argument and the direct conflict between Key Railroad and Milosch each weaken the value of the unpublished Key Railroad decision if employers rely on it when negotiating, drafting, or evaluating covenants not to compete that contain similar language.24
Lessons Learned from Key Railroad
The Key Railroad decision provides several cautionary lessons to employers and their counsel.
Wisconsin Law Regarding Restrictive Covenants is Nuanced and Complex. Employers should rely on experienced counsel to draft covenants not to compete, nonsolicitation agreements, and nondisclosure agreements. Counsel advising employers need to ensure they are up to date on the law regarding restrictive covenants. Employers who draft their own restrictive covenants or use any one-size-fits-all agreement from the Internet risk having the courts throw out the entire agreement, thereby allowing former employees to engage in unfair competition with impunity.25
In-house counsel for national corporations that use a standardized covenant not to compete with respect to Wisconsin employees should ensure that the covenant is modified to comply with Wisconsin law. Noncompliant covenants should be revised, but employers must ensure existing employees are given consideration beyond continued employment in exchange for executing the revised covenants.26
Do Not Confuse the Court. The Key Railroad case stands as a practical reminder that necessary and reasonable protections can be lost if the court is confused by one of the parties. Employers and employees should 1) know the law; and 2) clearly state both their positions and their supporting authority so the court need not guess what the parties’ positions are. Haste makes waste, and the Key Railroad case shows that any simple oversight in a brief, such as not addressing an opponent’s argument or failing to cite a dispositive authority in the proper context and consequently confusing the court, can turn a deserved victory into a surprise defeat.
Half a Loaf is Better than None. Generally, covenants not to compete should bar former employees from competing for the business of the employer’s recent customers and those customers and prospects with whom the former employee recently dealt or about whom the employee learned information not publicly available.27 If properly challenged by an employee who cites the controlling case law, overbroad covenants with restrictions not reasonably necessary for the protection of the employer’s legitimate protectable interests will be invalidated in total.28
Employers, therefore, should err in favor of using less restrictive covenants not to compete. Doing so minimizes both the chance of the covenant being challenged in court and the risk of a judge throwing out all the restrictions and permitting former employees to openly compete for the employer’s customers.
1 See Key R.R. Dev. LLC v. Guido, No. 2011AP2073, 2012 WL 3176422 (Wis. Ct. App. Aug. 7, 2012) (unpublished opinion not citable per section 809.23(3)). The Key Railroad case involved several employees and a variety of legal issues. This analysis focuses on the most interesting issue involving just one of the defendants. For a comprehensive overview of the facts and issues in the case, please refer to the court’s decision.
2 Id. ¶¶ 14-16.
3 Star Direct Inc. v. Dal Pra, 2009 WI 76, ¶ 20, 319 Wis. 2d 274, 767 N.W.2d 898.
4 Id. ¶¶ 20-21; Techworks LLC v. Wille, 2009 WI App 101, ¶¶ 9-14, 318 Wis. 2d 488, 770 N.W.2d 727.
5 See, e.g., Star Direct, 2009 WI 76, ¶ 21, 319 Wis. 2d 274.
6 Id. ¶ 65. Covenants not to compete incidental to the sale of a business interest, however, are not subject to the exacting scrutiny of Wis. Stat. section 103.465, and therefore courts continue to blue-pencil and enforce them to the extent they are reasonable. See, e.g., Reiman Assocs. Inc. v. R/A Adver. Inc., 102 Wis. 2d 305, 309-10, 306 N.W.2d 292 (Ct. App. 1981).
7 Star Direct, 2009 WI 76, ¶¶ 65-78, 319 Wis. 2d 274.
8 See Equity Enters. Inc. v. Milosch, 2001 WI App 186, ¶ 15 n.4, 247 Wis. 2d 172, 633 N.W.2d 662.
10 Techworks, 2009 WI App 101, ¶ 10, 318 Wis. 2d 488.
11 Star Direct, 2009 WI 76, ¶¶ 40, 43-44, 319 Wis. 2d 274.
12 Resp’t Response Br., Key R.R., at 24.
13 Milosch, 2001 WI App 186, ¶ 15 n.4, 247 Wis. 2d 172.
14 Resp’t Response Br., Key R.R., at 23.
15 Key R.R., No. 2011AP2073, ¶ 15 n.7.
16 Id. ¶ 15.
18 Milosch, 2001 WI App 186, ¶ 15 n.4, 247 Wis. 2d 172.
19 Key R.R. Dev., No. 2011AP2073, ¶ 16 (citing Charolais Breeding Ranches Ltd. v. FPC Secs. Corp., 90 Wis. 2d 97, 109, 279 N.W.2d 493 (Ct. App. 1979) (deeming unrefuted arguments conceded)).
20 Id. ¶ 1.
21 Id. ¶ 6.
22 Id. ¶¶ 20-25.
23 Cook v. Cook, 208 Wis. 2d 166, 189, 560 N.W.2d 246 (1997).
24 Because the unpublished Key Railroad decision was issued per curiam, Wis. Stat. section 809.23(3)(b) prohibits parties from citing it even as persuasive authority during litigation or appeals. The real danger presented by Key Railroad, therefore, is its capacity to lull unwary employers or their counsel into drafting unenforceable restrictive covenants or overestimating the enforceability of covenants already in place.
25See, e.g., Wis. Stat. § 103.465.
26See, e.g., NBZ Inc. v. Pilarski, 185 Wis. 2d 827, 839, 520 N.W.2d 93 (Ct. App. 1994).
27See, e.g., Star Direct, 2009 WI 76, ¶¶ 39, 41, 319 Wis. 2d 174.
28Id. ¶¶ 20-21; Wis. Stat. § 103.465.