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Non-Competes, Stock Agreements & Escape Clauses – A Recent Case from the NDNY

A recent decision out of the Northern District of New York is a fantastic example of the thorough, methodical process all courts should bring to the analysis of non-compete claims.  The decision also provides a wealth of useful information about defending non-compete claims under New York law.  Let’s take a look:

Two companies, DS Parent, Inc. and Davis-Standard, LLC (collectively “Davis”) build and sell “converting and extrusion machines, including liquid coating equipment.”  The liquid coating process goes something like this:  A “substrate” (paper, film, fabric, etc.) is unrolled, treated with certain liquids, dried and rolled up again.  It is then used as coating for any number of different products.  The treated substrates, basically the laminates, are used in everything from plastic packaging to certain fabrics to stop signs.

In 1987, Donald Teich first began working as a salesman for a Davis predecessor.  Over the next sixteen years, Teich worked as a salesman, a district sales manager and a vice president of the company’s liquid coating division before ultimately returning to sales. In 2012, DS parent acquired Davis-Standard.  At that time, Teich signed an employment agreement (“Employment Agreement”) that contained the following provisions:   (1) a non-compete provision prohibiting Teich from working for a domestic competitor for two years in the event he resigned or was terminated for cause (2) a two-year non-solicitation clause and (3) a non-disclosure provision.   The Employment Agreement also contained an escape clause that released Teich from his non-compete if the company “reduced its efforts in the liquid coating markets” by  “1) Ending or severely reducing its participation in trade shows, conferences, trade print advertising, website, etc.; or 2) Permanently allocating existing liquid coating resources to other product areas.”

In addition to the Employment Agreement, Teich signed certain other agreements when he exercised his option to purchase Davis’ stock.  Specifically, Teich signed a joinder agreement and a participation election form, pursuant to which he agreed to be bound by a Stockholder Agreement (“Stock Agreement).  The Stock Agreement, which Teich never even saw, also contained restrictive covenants including a one-year non-compete provision and a one-year non-solicitation clause.

On November 14, 2013, Teich resigned from Davis.  A week later, he informed the Company that he had accepted a position as Vice President of Sales for SAM North America, LLC, a competitor in the liquid coating business.  The next day, Teich filed a complaint in New York state court seeking a declaratory judgment holding the restrictive covenants contained in the Employment and Stock Agreements were unenforceable.  Davis removed the case to the Northern District of New York, filed claims against Teich for breach of the Stock agreement and also initiated a separate action in Connecticut, pursuant to a forum selection clause, for breach of the Employment Agreement.  The parties then stipulated to dismissing the Connecticut action and agreed to litigate everything in the NDNY.  Davis filed an Amended Complaint for breach of both Agreements and then sought both a temporary restraining order and a preliminary injunction.  Initially, the court entered a TRO, which enjoined Teich from working for SAM or any other competitors, soliciting Davis’ customers or using any of the Company’s trade secrets or confidential information.

Which Non-Compete Agreement Governs?

Both the Employment Agreement and the Stock Agreement contained non-compete provisions.  Recall that the Employment Agreement also contained an escape clause that released Teich from his non-compete obligations if the Company scaled back its liquid coating business.  In contrast, the Stock Agreement did not provide an escape clause.

As expected, Teich argued that the Employment Agreement applied and that under that Agreement he was released from his non-compete obligations.  As it turned out, Davis has dramatically reduced its “trade print advertising” and permanently allocated liquid coating resources to other product areas, and these actions potentially triggered the escape clause.

In contrast, Davis argued the Stock Agreement and its non-compete restrictions applied and that the Stock Agreement contained no such release.  Teich countered with a wealth of record evidence establishing that (1) the Company had issued certain internal communications that recognized confusion over the Stock Agreement’s terms and attempted to clarify those terms (2) the Company had indicated that stock plan participants would be required to execute “the Company’s standard form employment agreement” that contained a 2-year non-compete clause (3) the Company recognized, in writing, that the standard two-year non-compete restriction from the Employment Agreement applied (4) the Company recognized, in writing, that certain employees had already executed that standard agreement.  At the same time, the non-compete provision in the Stock Agreement was buried in a section labeled “Joinder to Stock Agreement” that focused on the transfer and sale of stock.  Even the Court noted that the provision could have easily been overlooked.  And, perhaps more importantly, Teich never saw the Stock Agreement—he signed other agreements that made him a party to the Stock Agreement but never signed that Agreement itself.

Teich argued that all of this amounted to a mutual mistake:  Both Teich and the Company were operating on the premise that the only binding non-compete provision was the one contained in the Employment Agreement.  Davis, of course, countered that it was not mistaken, that it knew about the non-compete provision in the Stock Agreement and that it expected that provision to govern.  This argument strains credulity, given all of the examples of corporate communications in which Davis referenced the non-compete in the Employment Agreement as the required non-compete for stock plan participation.  But that doesn’t matter:  Ultimately, the Court held there was no need for Teich to establish mutual mistake because he had demonstrated unilateral mistake.   Teich submitted unrebutted evidence establishing that he was operating under the first non-compete agreement when he signed the stock plan participation forms.  Teich never saw the Stock Agreement.  Teich also provided evidence that the Company was aware of his mistake:  Teich and Davis had just recently engaged in negotiations over his Employment Agreement, which Teich refused to sign without the aforementioned escape clause.  In short, the Court concluded, “Davis had reason to know that Teich was unaware that he was agreeing to be bound by the Stock Agreement’s non-compete, which contained no release.”  The upshot of all of this:  The Company took advantage of a Teich’s unilateral mistake.  Teich likely will be able to rescind the Stock Agreement or reform it to remove its non-compete provision.

As a result, the Employment Agreement governs.  And because the Company scaled back certain aspects of its liquid coating business, it is likely that Teich has been released from his non-compete obligations.  Based on that alone, the Company has no likelihood of success on the merits and is not entitled to an injunction.  But the Court does not stop there:  It proceeds to run through the entire restraint of trade analysis and conclude that, even if Teich were bound by both Agreements, the restrictive covenants contained in those Agreements were unenforceable for lack of a protectable interest.

No Protectable Interest

Under New York law, non-compete agreements will only be enforced to the extent necessary (1) to prevent the employee’s solicitation or disclosure of trade secrets, (2) to prevent the employee’s release of confidential information regarding the employer’s customers, or (3) in those cases where the employee’s services to the employer are deemed special or unique.  Davis alleged it satisfied all three of these standards, but failed on each point.

First, Davis attempted to establish a protectable interest through a number of supposed trade secrets.   For example, Davis claimed that Teich had intimate knowledge of its technical processes and systems related to liquid coating equipment.  As expected, Davis put forward no actual evidence to bolster this claim.  In contrast, Teich presented expert evidence that all of the companies in the industry use the same liquid coating machinery and technology, which often is described in detail in technical white papers and industry publications.   Teich also established that where customers require specialized machinery, they – the customers – designed the machines themselves, using their own engineers, and companies like Davis merely carried out those specifications.

The rest of the Company’s trade secret allegations were similarly deficient:  Davis claimed Teich had access to the Company’s “strategic knowledge” about its business generally, future plans, opportunities for growth, strengths and weaknesses, etc.  Teich countered by presenting evidence that similar information was widely known throughout the industry.  The Court agreed, rejecting a claim of trade secrets based on high-level strategic plans and string-citing half-a-dozen cases that have held the same.  Davis took one last shot at the trade secret claim, arguing that certain bid and pricing information constituted a trade secret.  But, again, this claim proved hollow:   The Court concluded that there appeared to be a general lack of bid and price secrecy both internally at Davis and in the industry at large, and that such information was likely of limited utility to competitors.

Having failed to establish the existence of any trade secrets, Davis moved on to customer relationships.  Davis argued that the non-compete agreement(s) were necessary to protect the Company’s “special and unique relationships” with its clients.   Once again, Davis was long on hyperbole and short on specifics.  Davis proffered no evidence of special customers relationships.  Further, information about the customers and their requirements (e.g. a customer’s requirements for a certain liquid coating machine) could not be considered confidential information that belonged to Davis.  Instead, that information belonged to the customers.

Davis took one last shot at establishing a legitimate business interest by arguing, in passing, that Teich was a unique employee who possessed a “unique set of skills.” As with all of Davis’ other arguments, the Court shot this one down:  Under New York law, “unique employees” have generally been found to include musicians, pro athletes, actors and other individuals who possess such unique qualities.   A liquid coating equipment salesman simply is not in that league.

The Court ran through the remaining preliminary injunction factors, concluded that Davis had not come anywhere close to meeting its burden, and denied the Plaintiff’s motion for an injunction.  Some things to takeaway:

(1)   The Judge – Judge Kahn (and his clerks) should be commended for such a thorough, well-reasoned opinion.  I don’t say that because I defend non-compete cases.  I say that because this order is truly outstanding.  Sometimes nuanced issues get swept under the rug— not in this case.  The Court dealt with every possible issue and did so in a fair, principled manner.

(2)   New York Law – Non-compete agreements are governed by state law.  Throughout the country, there is tremendous variation in the law of non-competes from one state to the next.  For instance, in many states (certainly in Florida) confidential information (whether customer-related or otherwise) can satisfy the legitimate business interest.  But in New York, as this decision makes clear, non-customer confidential information is not sufficient.  Instead, if we’re not dealing with customer information, then the confidential information at issue must rise to the level of a trade secret in order to justify enforcement of a non-compete agreement. This factor is extremely significant and raises numerous issues on both the drafting/negotiation front (e.g. fight for a more favorable governing law) and the litigation front (fight the choice of law fight if at all plausible).  In the end, when it comes to non-compete issues, choice of law is critically important.

(3)   Employment Agreement vs. Stock Agreements:  Both sides (both those in-house lawyers drafting non-compete agreements and those lawyers who defend these cases) can learn something from this situation:  For those in-house lawyers or corporate counsel:  Do a thorough review of all employee contracts.  That includes not only standard employment agreements, but also stock agreements and ERISA-related agreements.  If you have a non-compete agreement in your basic employment agreement, make sure that this agreement is standard across all of your employee contracts.  And if you’re an attorney defending these agreements, always investigate the possibility that other agreements exists:  When you do client intake, ask the client for anything he or she signed— whether it’s an employment agreement, stock agreement, ERISA participation agreement or otherwise.  As your client’s lawyer, you should always be familiar with every single contract or agreement they signed.  Sometimes those agreements will help your case and sometimes they may hurt your case, but you are always better off knowing.

The case is DS Parent, Inc. and Davis-Standard, LLC v. Teich et. al., 2014 WL 546358 (N.D.N.Y. Feb. 10, 2014).  Hat tip to Menter, Rudin & Trivelpiece, P.C. and Bond Schoeneck who defended the case and, from the looks of it, did an outstanding job.

Jonathan Pollard is a trial lawyer and litigator based in Fort Lauderdale, Florida.  He focuses his practice on competition, particularly cases involving non-compete, trade secret and antitrust disputes and represents clients in Florida and throughout the country.  He is licensed in all Florida federal and state courts and routinely represents clients in Fort Lauderdale, Miami, West Palm Beach, Fort Myers, Tampa, Orlando, Jacksonville, and beyond.  His office can be reached at 954-332-2380954-332-2380/ 954-332-2380

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