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Restrictive Covenants May Not Protect Past Customers - Labor and Employment Law News

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Labor and Employment Law News


Posted on: Mar 10, 2015

By Dan Burke, Hoover Hull Turner LLP 

In cases recently decided by the Indiana Court of Appeals and the United States District Court for the Southern District of Indiana, employers have been barred from using non-solicitation agreements to preclude former employers from soliciting business from the employer’s past customers, including those with whom the former employee had contact.

In Clark’s Sales and Service v. Smith, the Indiana Court of Appeals held that an employer may not use a non-solicitation provision to preclude a former employee from soliciting business from the employer’s past customers. 4 N.E.3d 772, 781-82 (Ind. Ct. App. 2014). After working for Clark’s for approximately 14 years, Smith terminated his employment and went to work for a competitor. Id. at 775. During his employment with Clark’s, Smith signed an agreement, which provided that – for two years following his employment – he could not:

"Solicit or provide, or offer to solicit or provide, services competitive to those offered by [Clark’s], or those provided by [Smith] on behalf of [Clark’s], to any business account or customer of [Clark’s] who was a business account or customer of [Clark’s] during the term of [Smith’s] employment, including but not limited to any business account or customer serviced or contacted by [Smith], or for whom [Smith] had direct or indirect responsibility, on behalf of [Clark’s] within the 12-month period preceding the termination [of] [Smith’s] employment or about whom [Smith] obtained Confidential Information."

However, once employed by Clark’s competitor, Smith began soliciting and offering “to provide competitive services to business accounts and customers of Clark’s.” Id. at 778.

Clark’s responded with an action against Smith, seeking damages and preliminary injunctive relief. Id. The trial court denied Clark’s request for injunctive relief based on its conclusion that the non-solicitation provision, as written, would preclude Smith from seeking business from customers with whom he had no contact while with Clark’s. Id.

Clark’s appealed, and the Indiana Court of Appeals affirmed. The court began its analysis by noting that a non-competition agreement will only be enforceable if the employer establishes that the provision is reasonable. Id. at 790 (citing Cent. Indiana Podiatry, P.C. v. Krueger, 882 N.E.2d 723, 728-29 (Ind. 2009)). To establish that the provision is reasonable, the employer must first demonstrate that it has a legitimate business interest to be protected by the agreement. Id. If it clears this hurdle, the employer must then demonstrate that the restrictive covenant “is reasonable in scope as to the time, activities, and geographic area restricted.” Id.

The court concluded that Clark’s had a legitimate business interest to protect. Specifically, the court noted that an employer’s goodwill with its customers constituted a sufficient interest to warrant protection through a restrictive covenant. Id. at 781.

However, the court concluded that the non-solicitation provision was overly broad, and thus unenforceable, because it extended “to anyone who was a customer of Clark’s during Smith’s employment.” Id. The court reasoned that, by prohibiting Smith from soliciting business from Clark’s customers during the entire term of Smith’s employment, the non-solicitation provision would bar Smith from doing business from “someone who may have been a customer of Clark’s fourteen (14) years earlier and never returned to the business after the first time.” Id. Further, the court observed, this provision would prohibit Smith from dealing with customers with whom he had no prior dealings. Id.

Citing Seach v. Richards, Dieterle & Co., 439 N.E.2d 208, 213-14 (Ind. Ct. App. 1982), the court noted that “a contract prohibiting contact with any past or prospective customers, no matter how much time has elapsed since their patronage ceased, was vague and too broad.” Id. at 781-82. As such, the court affirmed “the trial court’s conclusion that Clark’s attempt to protect a customer base spanning the entire term of Smith’s employment is overly broad and unreasonable.” Id. at 782.

The court also found the restrictive covenant to be overly broad because it extended to activities unrelated to Smith’s services for Clark’s. Id. Specifically, the non-solicitation provision restricted Smith from offering any services competitive with “those offered by” Clark’s. Id. However, as the court noted, Smith worked as an “inside appliance salesman,” but the restrictive covenant would prohibit Smith “from performing maintenance, repair, delivery, ordering, or pricing services, just to name a few.” Id. To underscore the point, the court observed that, “assuming arguendo that Clark’s sold snacks or beverages within its showroom, Smith would be prohibited from selling snacks or beverages for a new employer because it would be a service competitive with those offered by Clark’s.” Id. The court concluded that, because the “services competitive” language would prevent Smith from engaging in “seemingly harmless conduct,” it was invalid and unenforceable. Id.

Judge Magnus-Stinson reached a similar result in Distributor Service, Inc. v. Stevenson, 16 F. Supp. 3d 964 (S.D. Ind. 2014). There, Distributor Service, Inc. (“DSI”), a seller of specialty building products, entered into a non-solicitation provision with Stevenson, DSI’s sales manager, which provided:

"[Stevenson] covenants and agrees that while employed by [DSI] and for a period of one (1) year after termination of such employment, whether the termination is voluntary or involuntary and regardless of the reason therefor, [Stevenson] will not without the express written authorization of the President of [DSI] engage in any of the following: … Soliciting or inducing, or attempting to solicit or induce, any customer or prospective customer of the Company with which [Stevenson] communicated while employed by [DSI], to purchase competitive products or services from a source other than [DSI], or to cease doing business with [DSI], or to curtail or limit such business. Id. at 975-76."

Citing the Indiana Court of Appeals’ decision in Clark’s, Judge Magnus-Stinson concluded that the non-solicitation provision was overly broad, and thus enforceable, because it extended to all customers with whom Stevenson had dealings through the entire term of his employment, which would be impossible to enforce. Id. at 976. Accordingly, Judge Magnus-Stinson entered summary judgment in favor of Stevenson. Id.

For more information, please contact Daniel K. Burke at dburke@hooverhullturner.com.

This post was written by Dan Burke of Hoover Hull Turner LLP. If you would like to submit content or write an article for the Labor & Employment Law Section page, please email Rachel Beachy at rbeachy@indybar.org.

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