By Kristopher N. Kazmierczak, Katz Korin Cunningham
It has become fairly commonplace for employers to include a clause in employment contracts that extends the time period for restrictive covenants, such as non-compete provisions, when a violation has occurred during the restrictive period. Frequently referred to as "tolling provisions," the intended effect of such provisions is to toll, or suspend, the time period restricting employment activity for an equal amount of time that the employee has failed to abide by the restrictive covenant. By doing so, the employer receives the intended benefit of its bargain to have a full and uninterrupted time period of an employee’s adherence to the restricted activity.
Tolling provisions serve a useful purpose in deterring and remedying violations of restrictive covenants. Oftentimes, it may take a few months before an employer discovers that an employee has been soliciting a customer or took a job with a competitor in violation of a restrictive covenant. Even then, it may be a few more months after initiating a lawsuit before a preliminary injunction is entered. By this time, the clock has ticked away on the restrictive covenant period and for covenants with a short period of six or twelve months the restriction could be close to expiring; despite the fact that the employee has been violating it since day one after his termination. In such instances, tolling provisions have enabled courts to extend the restrictive covenant period as an enforcement remedy for the breach and require the employee to not compete or solicit for the full intended restrictive time period. In turn, the presence of a tolling provision discourages departing employees from being tempted to violate a restrictive covenant with the hope of not being caught before the expiration of the restrictive covenant period.
In the past, Indiana courts have been open to enforcing tolling provisions as part of a preliminary injunction order with the view that it gives effect to the parties’ intention as expressed in the contract. The continued utility of tolling provisions at the preliminary injunction stage, however, was seriously called into question recently by the Indiana Court of Appeals in the opinion of Hannum Wagle & Cline Eng'g, Inc. v. Am. Consulting, Inc., 64 N.E.3d 863 (Ind. Ct. App. 2016).
In Hannum, the Court held that a tolling provision, in its present wording before the Court, may not be used to extend a non-competition covenant beyond its original restriction period at the preliminary injunction phase, regardless of proof of a violation. The employee in Hannum executed an employment agreement with a non-compete and non-solicitation clause. The restricted covenants were enforceable for 24 months. The employee resigned from his employer in May 2014. In March 2015, the employee’s former employer sued to enforce the employment agreement and sought a preliminary injunction. On December 11, 2015, 19 months after termination, the trial court entered a preliminary injunction finding a reasonable likelihood for success that the employee had breached the employment agreement. Thereafter, the employee moved to dissolve the preliminary injunction as of May 2016 because the original restrictive period of 24 months expired.
The former employer responded that the express terms of the tolling provision provided for an extension and also asserted that the doctrine of equitable estoppel applies to prohibit the employee from benefitting from his violation. The employment agreement contained the following extension clause in the case of a violation:
In the event Employee violates any of the non-competition covenants contained in this Section 9, the duration of all non-competition covenants (and the Restricted Time Period) shall automatically be extended by the length of time during which Employee was in violation of such covenant, including, but not limited to, an extension equal to the time period from the date of Employee's first violation until an injunction is entered enjoining such violation.
The employer argued that this agreement, which the employee voluntarily signed, contained a provision that tolled the time period by extending the non-compete by the amount of time from the employee’s first violation until the entry of an injunction. The trial court disagreed and dissolved the injunction finding that “Indiana law precluded the enforcement of agreements to extend the duration of non-compete provisions when a preliminary injunction had been entered.”
In affirming the trial court’s decision, the Court explained that the purpose of a preliminary injunction is to preserve the status quo and that meant returning the parties to their last uncontested position prior to the litigation. The Court determined that point to be before the employee breached the contract and hence its original terms would therefore apply to set the restrictive period for use at the preliminary injunction stage – not the extended term. The Court considered that any court-ordered extension would be appropriate only after a full examination of the case on the merits and final determination. Thus, according to the decision in Hannum a court presented with a similarly worded clause may not extend the restrictive period beyond its original terms as part of a preliminary injunction order. From a practical standpoint, an employer who does not catch a breaching employee right away, is delayed through litigation or discovers the earlier breach toward the end of the restrictive period will not get the full protection of the uninterrupted restriction period by virtue of preliminary injunctive relief.
Even under the precedent set out in the Hannum opinion, a court’s ability to apply a tolling provision at the preliminary injunction stage may not be altogether lost. With the use of differently worded contract terms, there seems to be room for argument to allow for the protection intended by a tolling provision even at the preliminary injunction phase. For instance, the Court in Hannum did not address whether a term that automatically extends the restrictive period for a specified number of months which is expressly triggered and imposed as a result of a trial court’s finding of a reasonable likelihood of success that a breach has occurred might pass muster. Regardless, given the impact of the holding in Hannum on the often-used tolling provision, good reason exists for employers to consider revisiting their employment contracts and developing alternative language to address the predicament exposed in enforcing restrictive covenants prior to a final decision on the merits.
If you would like to submit content or write an article for the Labor & Employment Law Section, please email Kara Sikorski at email@example.com.