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Disintermediation, New Jersey Non-Compete Cases, Non-Compete Agreements, Non-Compete Appeals, staffing industry

Non-Competes & Disintermediation (Cutting Out the Middle Man) – A Recent Case from NJ

A recent case out of the District of New Jersey addresses disintermediation as a legitimate business interest in the non-compete context.   Disintermediation is just a technical term for cutting out the middle-man. Let’s take a look:

CarePoint Health Management Associates is a New Jersey hospital system. UpStream Healthcare Management Associates is a hospital management company and manages certain hospitals in the CarePoint system. HR Staffing Consultants is a New Jersey based healthcare staffing agency that provided employees to CarePoint over a period of several years.

Enter Richard Butts. In 2011, HR Staffing hired Butts as an employee, trained him and then placed him with CarePoint at Peninsula Heart and Vascular Services as Executive Director. Three years later, HR Staffing reassigned Butts to serve as Vice President of Cardiovascular Services for all CarePoint Hospitals. In connection with his new role, Butts signed a new employment agreement (“the Employment Agreement”). The Employment Agreement contained various restrictive covenants. Specifically, the Employment Agreement contained a non-compete provision that barred Butts from (1) providing services to any HR Staffing client (2) providing services to any other healthcare facility within a several county radius or (3) soliciting any of the company’s clients for a period of 1-year following his separation from HR Staffing.

In August 2014, HR Staffing and CarePoint negotiated a new staffing agreement (“the Staffing Agreement”). The Staffing Agreement provided – in relevant part – that CarePoint could directly hire any of its existing long-term placements without paying HR Staffing a fee or obtaining their further consent. Butts was one of these existing long-term placements.

In March 2015, Butts spoke with the owners of HR Staffing about the possibility of working directly for CarePoint.   Butts subsequently met with CarePoint to discuss direct employment.   During these discussions, Butts informed CarePoint that he was subject to a non-compete agreement with HR Staffing. CarePoint advised Butts that he should seek a waiver of those restrictions. A few weeks later, CarePoint offered Butts direct employment with the company without any mention of the non-compete issue. Butts then informed HR Staffing of the CarePoint offer and asked them for a waiver of his non-compete restrictions. HR Staffing refused.

Butts sat on the CarePoint offer for a few weeks, but ultimately chose to accept it. On May 1, 2015, he tendered his resignation to HR Staffing and informed the company that he intended to continue on in his role as Vice President of Cardiovascular Services at CarePoint. HR Staffing immediately sued. Interestingly, Upstream – the hospital management company – was also a plaintiff.

The crux of the case is whether or not the restrictive covenants contained in Butts’ Employment Agreement with HR Staffing are reasonable and enforceable.   If the restrictive covenants are not necessary to protect a legitimate business interest, then the agreement is an illegal restraint of trade.

Ultimately, the court found that the restrictions were reasonable and necessary to protect two legitimate business interests: confidentiality and disintermediation.   On the first, the court held that both HR Staffing and Upstream had given Butts access to business plans for possible joint ventures and information regarding new business opportunities.   In the court’s view, this information was confidential and Butts could have used this information in his new direct role at CarePoint and to the detriment of HR Staffing and Upstream. Now for the real issue: Disintermediation.

The court indicated that it could enforce the restrictive covenants based solely on confidential information, but made it clear that disintermediation was more compelling. Per the court: HR Staffing has a legitimate business interest in preventing disintermediation. HR Staffing invests in recruiting, training and placing its personnel. Those personnel remain employees of HR Staffing and are paid by HR Staffing even while they are working in various placements. Absent enforcement of this contractual protection, CarePoint or any other client could hire away personnel placed there by HR Staffing. This would basically destroy HR Staffing’s business model.

The vast majority of the Court’s analysis of disintermediation is simply an appeal to fairness and equity. Only after several pages does the Court attempt to re-cast disintermediation as a well-recognized legitimate business interest: customer relationships.   As the court sees it, CarePoint is HR Staffing’s customer. The non-compete provisions are necessary to protect the relationship between CarePoint and HR Staffing and to prevent Butts from “poaching” CarePoint.

The rest of the decision disposes of some technical arguments, then runs through the preliminary injunction factors. Notably, the court finds that HR Staffing and Upstream have made a sufficient showing of irreparable harm. First, Butts was exposed to confidential information belonging to HR Staffing and Upstream and could unfairly use that information in his new direct role at CarePoint.   And second, allowing Butts to remain at CarePoint would irreparably harm HR Staffing and Upstream via disintermediation.

The decision is a rather lazy one and not particularly compelling. Here’s why: Let’s start with the legitimate business interest.

Take confidential information. Butts technically was employed by HR Staffing but working in a CarePoint placement for several years. He was at CarePoint on a day-to-day basis. Given these dynamics, it is difficult to view Butts as a high-ranking corporate insider at HR Staffing who had access to the company’s top-secret plans. Even more compelling: If Butts had access to this information for years, all while he was working a placement at CarePoint, wouldn’t he have disclosed it already? He had thousands of opportunities to do so. Butts transitioning from being a placed employee to being a direct employee of CarePoint changes little. But the Court mentioned confidential information almost as a fallback. Confidential information is a well-recognized legitimate business interest. The Court used confidential information, and stressed that it could enforce the restrictive covenants based solely on this interest. It seems that the Court did this because it was concerned about basing its holding solely on disintermediation.

The court found a legitimate business interest in preventing disintermediation. It explains that holding in a fairly superficial analysis. Here, the problem is a conceptual one:

In the non-compete context, legitimate business interests are concrete things that need to be protected. For example: Confidential information, customer relationships, a company’s extraordinary investment in training or education, or corporate goodwill (among others). These are specific, discrete, identifiable interests.

“Preventing disintermediation” is not a legitimate business interest.   Instead, preventing disintermediation – like preventing unfair competition – is a goal or policy reason for enforcement of non-compete agreements. When courts find a legitimate business interest in preventing disintermediation, they are badly conflating the concept of an underlying legitimate business interest and the concept of a goal or policy reason.

The distinction is an important one: The legitimate business interest – the confidential or customer relationships – is what deserves protection. And by protecting that interest, the court prevents unfair competition (or disintermediation).   In hanging its hat on “preventing disintermediation”, the court skipped an important (and I believe necessary) step. Identifying the specific underlying interest forces courts to ground their holdings in facts.   Conversely, basing a holding on the need to prevent disintermediation allows courts to gloss over facts and focus on much squishier concepts like fairness.

The court should have grounded its “preventing disintermediation” holding the facts by linking it to some well-recognized interest (e.g. confidential information, customers, training). The court knew this and attempted to do this, but only half-heartedly. In its disintermediation analysis, the court attempted to tie disintermediation to customer relationships. But its argument on that point is non-sensical. Consider the following:

Protection of customer relationships can be a legitimate business interest. But in most states, not all customer relationships are protectable. Florida, for instance, uses the term “substantial” customer relationships. Many other states apply a similar framework. This makes sense based on market realities: Some customer relationships are special and therefore protectable. Other customer relationships are not. There are entire industries where the notion of a protectable customer relationship makes absolutely no sense because everything is public knowledge, business is awarded based on open bidding and competition is fierce. So if we are talking about protecting a customer relationship, then that relationship has to be a substantial one.

And here: HR Staffing and CarePoint were already involved in other, related litigation.   All of the parties previously had been involved in one joint venture, but CarePoint had terminated its involvement with that venture. And CarePoint had already notified HR Staffing that their Staffing Agreement would terminate in August 2015. The relationship between HR Staffing and CarePoint does not sound like a substantial, protectable one. It sounds like the relationship has already deteriorated.

But even assuming the relationship was substantial enough to deserve legal protection, the court fails to explain how Butts is threatening that relationship.   HR Staffing placed multiple long-term employees with CarePoint.   Butts is merely one of those employees. The Staffing Agreement between the companies explicitly grants CarePoint permission to direct hire certain of these long-term placements, including Butts. This suggests that the parties envisioned CarePoint occasionally direct-hiring certain of the placed employees, but continuing in their relationship together. The Court utterly fails to explain how CarePoint’s direct hire of Butts threatens the customer relationship. If the relationship was mutually beneficial, then CarePoint’s direct hire of Butts – which is permitted under the Staffing Agreement – should have had no impact on the relationship.

But the court doesn’t just say Butts was threatening that relationship. The court says Butts was “poaching” HR Staffing’s client, CarePoint. That simply makes no sense.

Even if “prevening disintermediation” (and the resulting unfairness) could justify enforcement of non-compete agreements in some cases, that logic simply does not work here. The fact that the Staffing Agreement permitted CarePoint to direct hire Butts makes any suggestion of unfairness ring hollow.

In my view, the Court’s reliance on other disintermediation cases is misplaced. Those cases have much different facts. Take Consultants & Designers v. Butler, 720 F 2d 1553 (11th Cir. 1983). Butler is an 11th Circuit case applying New Jersey law. In Butler, the court held that a non-compete agreement was enforceable to prevent disintermediation. But Butler had much different facts:

  • Bulter did not involve another (conflicting) contract that permitted direct hiring of the employees in question
  • Butler involved employees who were highly skilled, difficult to find technical workers. These employees were sourced on a national and even international level.
  • Butler involved a 90-day restriction.

Another consideration: Butler was decided 32 years ago. In light of current market realities and modern technology, is the harm the Butler court sought to prevent really comparable to the threatened harm in this case? I don’t think so. Ultimately, it is wrong to assume that because “preventing disintermediation” justifies enforcement of restrictive covenants in one case that the same principle necessarily holds true in other cases.

Considering all of the facts, here is what we really have: For years, HR Staffing made money from placing individuals at CarePoint. Those individuals worked at CarePoint on a day-to-day basis but technically remained employees of HR Staffing. HR Staffing and CarePoint had a Staffing Agreement that explicitly allowed CarePoint to direct hire certain individuals (including Butts) without any further approval or fees. The relationship between HR Staffing and CarePoint goes south. They cancel a joint venture and become involved in litigation. Then CarePoint hires Butts direct, but HR Staffing blocks this hire via a restraint contained in the Employment Agreement with Butts.   Where is the legitimate business interest? The claims about confidential information are fairly boilerplate and not compelling. Butts could have shared the allegedly confidential information with CarePoint at any time he was staffed there, but now it’s an emergency.   And customer relationships? Forget it. The relationship between HR Staffing and CarePoint had already deteriorated and was not protectable. Where is the unfairness? Remember, CarePoint had a contractual right to direct hire Butts.

Our entire system of competition law is based on the goal of protecting competition, not necessarily competitors. You will never find an antitrust case where the court is this concerned about a competitor or market participant. Instead, in antitrust cases, courts are concerned with technical requirements and market realities. It’s sort of a cold, hard, factual approach. But in non-compete cases, courts are policing the much more subjective concept of unfairness. This one is a bit too much fluff for me.  Apparently, it’s headed to the 3rd Circuit on appeal.

The case is HR Staffing Consultants, LLC v. Butts, 2015 WL 3492609 (D.N.J. June 2, 2015).

Jonathan Pollard is a trial lawyer and business litigation attorney based on Fort Lauderdale, Florida. He focuses his practice on competition law and has extensive experience litigating non-compete, trade secret and antitrust claims. He is licensed in all Florida federal and state courts and routinely represents clients in Miami, Fort Lauderdale, West Palm Beach, Fort Myers, Tampa, Orlando and Jacksonville. His office can be reached at 954-332-2380.

Discussion

4 thoughts on “Non-Competes & Disintermediation (Cutting Out the Middle Man) – A Recent Case from NJ

  1. The facts of this case strike me a quit similar to a standard real estate broker’s Listing Agreement where the Seller agrees that, for some period after the Listing Agreement expires, the Seller will not sell to any Buyer introduced to the Seller by the Broker during the term of the Listing Agreement. Those covenants are enforced on concepts of fairness which seem to apply equally in the employee placement industry.

    Posted by Bob Small | June 22, 2015, 9:21 am
  2. Bob, thanks for the comment. But this case presents a specific scenario that is much different. On one hand, HR Staffing had a restriction in its contract with Butts. On the other hand, HR Staffing’s contract with CarePoint explicitly permitted CarePoint to direct hire Butts. In my view, that renders any claim of unfairness pretty hollow.

    Posted by Jonathan Pollard | June 22, 2015, 11:31 am
    • Jonathan, I agree with you. In a case heard in early March a state judge here in Texas denied a requested temporary injunction in a remarkably similar case involving a staffing company seeking to use a non-compete to prevent a client from hiring two employees who had been on the staffing company’s payroll. The agreement between the staffing company and the client expressly allowed the client to hire staffing company employees, in some cases with payment of a fee and in some cases without. The employees’ principal argument, brushed off by the judge in the Butts case, was that the non-compete, being a contract in restraint of trade, had to be construed strictly against the employer and that its agreement that the client could hire the employees evidenced the employer’s intention and understanding that the non-compete did not prevent such a hire.

      Courts are conditioned to find ways to enforce contracts (hold people to their bargains); the normal rules of contract interpretation favor enforcement over refusal to enforce; and we are at a high “freedom of contract” point in the jurisprudential cycle, with the law-and-economics movement stressing the importance to overall economic well-being of courts enforcing private agreements. Those factors work together, don’t you think, to prevent many judges from giving non-competes the “strict scrutiny” that black-letter law says they should receive as restraints of trade?

      Posted by Steve | June 22, 2015, 2:43 pm
      • Steve- Such a fantastic, thoughtful comment. Thank you. I agree wholeheartedly. People (including many judges) view non-compete cases almost purely as contract cases. This is incorrect. Non-compete cases are – first and foremost – restraint or trade cases. Any non-compete agreement (or restraint of trade) has to be evaluated using two different lenses: The first lens is the antitrust/restraint of trade lens. The second is the contract lens. If analysis through the first lens (the antitrust lens) establishes that the restraint is unreasonable, then the contract is irrelevant (because it is unenforceable). As you note, courts far too often engage in a superficial analysis through the antitrust lens in order to reach the contract lens and enforce the contract.

        Posted by Jonathan Pollard | June 22, 2015, 2:51 pm

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