Non-Competes and Other Restrictive Covenants—Alive and Kicking in Wisconsin

WDC Journal Edition: Summer 2016
By: Josh Johanningmeier, Godfrey & Kahn, S.C.

Restrictive covenant litigation may not neatly fit within the definition of a “defense” practice, yet nearly every defense lawyer in Wisconsin has likely had exposure to and experience litigating non-competes and other restrictive covenants, whether on the side of a former employer trying to enforce them, or a former employee asking a court to declare them invalid. Likewise, most Wisconsin judges have presided over restrictive covenant cases and have seen the law surrounding them change over the years. It is also possible that your firm occasionally counsels clients on restrictive covenants. No matter how your practice intersects with restrictive covenants, with two significant cases decided by the Wisconsin Supreme Court in less than a decade, you owe it to yourself and your clients to be aware of recent developments in this area of the law.

Rooted in preventing unfair competition, restrictive covenants take many forms. While non-competes are the most-frequently litigated, restrictive covenant litigation also includes non-solicitation and confidentiality agreements. Trade secret law creeps into the mix as well. The parameters of enforceability for each type of agreement have evolved through Wisconsin common law and statute for more than a century. It is helpful to understand the law’s development in order to appreciate its current state, as well as appreciate restrictive covenant agreements entered into at various times. This article will provide a century of condensed background, and then more detailed analysis, of two recent Wisconsin Supreme Court decisions which may re-level the playing field for restrictive covenant litigation.

The Early Years

At common law, restrictive covenants were analyzed as contractual restraints on trade, with the Wisconsin Supreme Court first analyzing employee restrictions (as opposed to restrictions incident to the sale of a business) in its 1911 Eureka Laundry decision.[i]

Declaring that it “perceive[d] no difference in principle” between restrictive covenants incident to the sale of a business and those that sought to protect a business from an employee, the supreme court conditioned validity on several factors: (1) the restriction’s reasonable necessity to fair protection of the employer’s business; (2) that the restriction not unreasonably limit the rights of the employee; (3) that the restriction not otherwise be contrary to public policy; and (4) that the restriction meet the requirements of enforceability as a contract.[ii] While courts have evaluated the public policy and reasonableness issues over the years, the supreme court quickly acknowledged that a promise of at-will employment was sufficient consideration for a restrictive covenant, even though such at-will employment could be terminated at any time after the covenant’s execution.[iii] As we will see later, at-will employment (and continued at-will employment) as consideration is key to the most recent legal development in this area.

The Evolution of Blue-Penciling

In the early years of judicial activity, so-called “blue-penciling” was the rule—i.e., reforming the terms of an agreement to what a reviewing court thought was reasonable. Two types of blue-penciling took place. First, there was acknowledgment and application of blue-penciling for divisible terms in a restrictive covenant.[iv] Thus, if a court could strike the language containing an unreasonable restraint and enforce the remaining reasonable restraints, a court could do so. Still, under that approach, if the terms of a restraint were indivisible, meaning the contract provided no basis to divide the restriction into reasonable and unreasonable portions, the entire covenant was void.

Then came Fullerton Lumber Co. v. Torborg, which introduced true blue-penciling, that is, the revision of even indivisible terms so that restrictions would be enforced to the extent deemed reasonable.[v] For example, a non-compete with a 10-year restriction could be found unreasonable, but a judge could decide that two years was reasonable and enjoin competition for two years. This level of judicial revision of contracts was not well-received.

The Legislature Steps In

In 1957, the Wisconsin Legislature, viewing Torborg as judicial overreach, stepped in and barred blue-penciling with its passage of Wis. Stat. § 103.465.[vi] The statute’s language has remained substantially unchanged in the nearly sixty years since its passage:

A covenant by an assistant, servant or agent not to compete with his or her employer or principal during the term of the employment or agency, or after the termination of that employment or agency, within a specified territory and during a specified time is lawful and enforceable only if the restrictions imposed are reasonably necessary for the protection of the employer or principal. Any covenant, described in this section, imposing an unreasonable restraint is illegal, void and unenforceable even as to any part of the covenant or performance that would be a reasonable restraint.[vii]

The statute’s proscription of blue-penciling led to several decades of restrictive covenant litigation marked by courts invalidating entire agreements where one or more provisions were deemed unreasonable.[viii] Case-by-case analyses by different courts naturally led to varying results, but the die was cast: restrictive covenants were generally disfavored and “regarded with suspicion” in Wisconsin.[ix]

Fact-specific determinations of “reasonable necessity” continued to examine the familiar factors of employer necessity, duration, territory, degree of harshness or oppressiveness, and public policy.[x] Along the way, several guiding principles emerged. For example, non-competes were acknowledged to require a specific duration and two years was endorsed as reasonable.[xi] Extensions of time limits based on “periods of violation,” however, were disallowed.[xii] And, while territorial restrictions were (and still are) reviewed based on the facts of each case, the absence of a geographic limit in favor of customer-based or other non-geographic boundaries is not necessarily fatal to enforcement.[xiii]

Star Direct and Divisibility

The tide began to turn when, in 2009, the Wisconsin Supreme Court decided Star Direct v. Dal Pra, re-inserting divisibility into the law of restrictive covenants.[xiv] Star Direct was a traditional route salesperson case where the employee entered into a restrictive covenant when his employer was acquired by Star Direct.

Star Direct distributed merchandise to convenience stores, and its principal sales strategy employed the use of route salespersons who were charged with developing long-term business and personal relationships with Star Direct's customers. Dal Pra worked for Star Direct for approximately four years, collected a 30-month bonus, and then quit to start a competing distribution company. Naturally, litigation ensued. The circuit court and the court of appeals ruled that the non-competition agreement was unenforceable. The supreme court reversed.

In addition to the divisibility analysis discussed more fully below, in overruling the lower courts, the supreme court pointed out that, while Wisconsin courts must interpret restrictive covenant agreements in favor of the employee, they must still interpret such agreements “reasonably” by “giving the words their plain meaning.” The court also ruled that there is, in fact, a protectable interest in shielding former customers from unfair competition by former employees. The court rejected Dal Pra’s argument that, because not all similarly situated employees of Star Direct had similar restrictive covenants, his was not enforceable.

The most important aspect of Star Direct, however, is its central holding that the existence of an unenforceable post-employment restrictive covenant does not render other, separate restrictive covenants contained in the same agreement unenforceable as long as the separate provisions may be understood and independently enforced. This is important in litigation because, when a non-compete agreement contains multiple restrictive covenants, as was the case in Star Direct, employees had long argued—based on Wis. Stat. § 103.465—that the existence of an unenforceable covenant rendered separate covenants unenforceable. The Star Direct court provided clear guidance on this issue, holding that one unenforceable covenant does not necessarily mean that other restrictive covenants are also unenforceable. The “foundational inquiry” is whether, if the unenforceable provision is stricken, the other provisions can be understood and independently enforced. In concluding that two of the three restrictive covenants contained in Dal Pra's non-compete agreement were divisible, and therefore enforceable, it is instructive to note that the supreme court placed special emphasis on the fact that the covenants were contained in separate paragraphs and did not contain any cross-references.

The supreme court supported its approval of divisibility by pointing out that Wis. Stat. § 103.465 itself, as well as its legislative history, did not modify the common law divisibility rules. Further, the statute applies to individual covenants, rather than entire employment contracts, and, thus, if an unreasonable portion of the contract was stricken, but remaining provisions could still be understood and independently enforced, it was proper to do so.

It is important to note, particularly because some commentators have added confusion to the issue, that divisibility as endorsed by the supreme court in Star Direct is not the same as Torborg blue-penciling. As explained above, with Torborg blue-penciling, an overbroad restriction would be judicially rewritten to a level that is enforceable, e.g., a 40-mile geographic restriction could be decreased to 20 miles if a judge felt that was the limit of reasonableness. Under divisibility, on the other hand, the 40-mile geographic restriction, if deemed overly broad, could lead to invalidation of that section (likely a non-compete) without invalidating other restrictions, such as non-solicitation or confidential information protections (assuming they would be valid on their own). Using the guidance from Star Direct, savvy trial lawyers (and restrictive covenant drafters) can now salvage some restrictions that otherwise might have fallen victim to the invalidation of an entire agreement.

Runzheimer and Consideration

In 2015, the Wisconsin Supreme Court clarified lawful consideration for non-competes in the Runzheimer case.[xv] The issue was whether forbearance of the right to terminate an at-will employee was lawful consideration for the employee’s agreement not to compete. The court held that it was.

The Runzheimer facts are useful to appreciate the breadth and limitations of the supreme court’s holding. In 2009, the employer required its at-will employees, including the defendant, to sign a restrictive covenant agreement or be terminated. The restrictive covenant included a two-year non-compete provision. The disclosure of confidential information and solicitation of work from the corporation’s customers were also limited by the restrictive covenant.

The defendant signed the agreement and remained with the company for another 29 months, until he was terminated and hired by a competitor. The employer filed suit against the ex-employee and his new employer to enforce the terms of the restrictive covenant agreement. The ex-employee and his new employer argued that the agreement was unenforceable because he did not receive anything in exchange for signing the restrictive covenant, except that he was permitted to continue his at-will employment. The circuit court agreed with the ex-employee and invalidated the restrictive covenant, ruling that an employer’s offer of continued at-will employment to support a non-compete with an existing employee was not sufficient consideration. The court of appeals certified the case to the supreme court.

The supreme court reversed the decision of the circuit court and determined that an employer could enforce a restrictive covenant signed by an employee even if the only consideration for that agreement was his or her continued at-will employment. Although the analysis could have ended there, the court continued on and asserted that it is of no consequence whether the duration of continued employment is expressly stated or whether the employment relationship, in fact, continues on for a period of time. Specifically, the court asserted that:

[A]n employer’s forbearance in exercising its right to terminate an at-will employee constitutes lawful consideration for signing a restrictive covenant.

Thus, continued at-will employment, without more (i.e., without additional monetary or non-monetary benefits), is now legally sufficient consideration.

The Runzheimer decision also included two important directives to employers and employees. First, under Wisconsin law, an at-will employee may bring a “wrongful discharge” claim if the discharge is contrary to “a fundamental and well-defined public policy as evidenced by existing law.” The court made clear that an employee who is terminated for failing to sign a restrictive covenant will not have a claim for wrongful discharge on that basis. As explained by the court, employers may respond to and reduce the risk of employees competing and taking business from the employer by requiring employees to sign reasonable restrictive covenants. Thus, employers may lawfully terminate an at-will employee for refusing to sign a restrictive covenant. Second, the court emphasized that employers remain subject to the long-standing principles of contract formation, such as fraudulent inducement and the covenant of good faith and fair dealing. Accordingly, employers may not misrepresent their intention to continue to employ the employee. An agreement signed by an employee who is terminated by the employer shortly thereafter could constitute a breach of the covenant of good faith and fair dealing, rendering the agreement unenforceable.

Conclusion

After a century of slow-but-steady development of restrictive covenant law squarely favoring employees and disfavoring enforcement of restrictions on their post-employment activities, the combination of Star Direct and Runzheimer has revitalized employers’ opportunities to protect themselves from unfair competition. Unsurprisingly, since Star Direct, many employers have revised their restrictive covenants to take advantage of divisibility. Now, with the ability to use continued at-will employment as consideration for new or revised restrictive covenants, even more employers will do so. New or revised agreements, drafted properly, will likely fit the Star Direct and Runzheimer framework.

This relatively rapid change, applied in many cases to litigation involving restrictive covenants which were drafted and executed before the supreme court clarified the law, will take some time to shake out. Older restrictive covenants that find their way into courtrooms will challenge trial lawyers and judges to determine, in cases where at least one covenant fails to pass muster, whether one or more remaining restrictions may be properly divided and salvaged to give the agreement a fair interpretation. Where continued at-will employment is offered as consideration by an employer attempting to enforce restrictive covenants, courts will still be faced with challenges based on the employer’s actual intent. In either case, and from either side of the “v”, notwithstanding recent clarification of the law, restrictive covenant litigation remains highly fact-specific and challenging for trial lawyers.


References


[i] Eureka Laundry Co. v. Long, 146 Wis. 205, 209, 131 N.W. 412 (1911); see also Cottington v. Swan, 128 Wis. 321, 107 N.W. 336 (1906) (enforcing restrictive covenant incident to sale of business).

[ii] Eureka Laundry Co., 146 Wis. at 209.

[iii] Wisconsin Ice & Coal Co. v. Lueth, 213 Wis. 42, 250 N.W. 819, 819-20 (1933).

[iv] General Bronze Corp. v. Schmeling, 208 Wis. 565, 243 N.W. 469 (1932).

[v] Fullerton Lumber Co. v. Torborg, 270 Wis. 133, 70 N.W.2d 585 (1955).

[vi] Chapter 444, Laws of 1957.

[vii] Wis. Stat. § 103.465 (2013-14) (emphasis added). The handful of changes to the statute’s language included revising “his employer” to the gender neutral “his or her employer,” 1995 Wis. Act 225, and revisions to language to make more specific reference to termination of employment, 1997 Wis. Act 253.

[viii] Heyde Cos. v. Dove Healthcare, LLC, 2002 WI 131, 258 Wis. 2d 28, 654 N.W.2d 830; NBZ, Inc. v. Pilarski, 185 Wis. 2d 827, 520 N.W.2d 93 (Ct. App. 1994); Wausau Med. Ctr., S.C. v. Asplund, 182 Wis. 2d 274, 514 N.W.2d 34 (Ct. App. 1994); Gary Van Zeeland Talent, Inc. v. Sandas, 84 Wis. 2d 202, 267 N.W.2d 242 (1978).

[ix] Henderson v. U.S. Bank, N.A., 615 F. Supp. 2d 804, 810 (E.D. Wis. 2009).

[x] Lakeside Oil Co. v. Slutzsky, 8 Wis. 2d 157, 163, 98 N.W.2d 415 (1959).

[xi] Techworks, LLC v. Wille, 2009 WI App 101, 318 Wis. 2d 488, 770 N.W.2d 727.

[xii] H&R Block Eastern Enters., Inc. v. Swenson, 2008 WI App 3, 307 Wis. 2d 390, 745 N.W.2d 421.

[xiii] Id.; Equity Enters. v. Milosch, 2001 WI App 186, 247 Wis. 2d 172, 633 N.W.2d 662; Rollins Burdick Hunter, Inc. v. Hamilton, 101 Wis. 2d 460, 304 N.W.2d 752 (1981).

[xiv] Star Direct Inc. v. Dal Pra, 2009 WI 76, 319 Wis. 2d 274, 767 N.W.2d 898.

[xv] Runzheimer Int’l, Ltd. v. Friedlen, 2015 WI 45, 362 Wis. 2d 100, 862 N.W.2d 879.