August 25, 2017

Limitation on Blue-Pencil Doctrine?

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A recent Indiana case refused to apply the blue-pencil doctrine to make enforceable an otherwise overbroad restrictive covenant provision. Clark’s Sales and Service, Inc. v. Smith and Ferguson Enterprises, Inc., 4 N.E.3d 772 (Ind.Ct.App. 2014). The former employee worked at an appliance store for 14 years.  He signed a noncompetition agreement. During the 14 years, the employee had access to the employer’s customers, including secret and confidential information regarding customers.

The court stated that the employer must first show that it has a legitimate interest to be protected by the noncompetition agreement, and the employer bears the burden to show that the agreement is reasonable in scope as to time, activities and geographic area restricted.

To demonstrate a legitimate protectable interest, an employer must show some reason why it would be unfair to allow the employee to compete with the former employer, and the employee should be enjoined only if he has gained some advantage at the employer’s expense which would not be available to the general public. In industries where personal contact between the employee and the customer is especially important due to the similarity in product offered by competitors, the advantage acquired through the employee’s representative contact with the customer is part of the employer’s goodwill, regardless of whether the employee has access to confidential information. The court held that the employer had a legitimate, protectable interest, due to the employee’s contact with customers and the employer’s effort to build goodwill with its business accounts and referral network of home builders, remodelers and kitchen designers, and that such contact is not available to a person in the general public.

The restrictive covenant prevented the former employee from providing “services competitive to those offered by [the former employer] or those provided by [the former employee] on behalf of [the former employer]” to anyone who was a customer of the former employer during the term of the employee’s employment. The court held that present customers are a protectable interest of an employer; however, a contract prohibiting contact with any past or prospective customers, no matter how much time has elapsed since their patronage has ceased, was vague and too broad. Accordingly, the court found the restrictive covenant to be overbroad and unreasonable.

Further, the court found the restrictive covenant to be overly broad because it prohibited the former employee from offering any services competitive to any service provided by the former employer. For instance, the restrictive covenant as written would prohibit the former inside appliance salesman from performing maintenance, repair, delivery, ordering or pricing services, to anyone who was a customer during his 14-year employment. The court held this restriction was too broad.

Further, the court found that the geographic restriction, restricting the former employee from working for any other entity providing services competitive in Marion County, any county contiguous to Marion County, any county in Indiana in which the employer has at least one customer, the State of Indiana, or within a 50-mile radius of the employer’s principal office, to be clearly overbroad and unreasonable. The court found that the geographic restriction was not divisible and was not clearly separated into parts, and was not written to include “severable terms.” As a result, the court found that it would not apply the blue-pencil doctrine to limit the geographic restriction to an enforceable area.

The Smith case elucidates the principle that restrictive covenants must be drafted very carefully and tailored to individual business needs. Due to an overbroad covenant, the Smith court denied the former employer’s injunction, the employee was permitted to work for a competitor.