Eighth Circuit Weighs in on Assignment of Non-Competes

A recent case out of the United States Court of Appeals for the Eighth Circuit raises some interesting issues related to assignment of employee non-compete agreements.  Let’s take a look:

Brandon Tipton, Michael Gilbert and Steven Padgett all worked for Treadway Electric Company in Arkansas.  Treadway was a distributor of electrical supplies and equipment. As a condition of their employment, each of these individuals signed an agreement (“Employment Agreement”) that contained the following relevant language:

[I]f and when you leave Treadway’s employ, for whatever reason, you will not compete with Treadway or its subsidiaries by soliciting or accepting business from Treadway’s customers within your territory, as defined by Treadway Electric Company, for at least one (1) year after leaving; and … that you will not to solicit the employment of any Treadway representatives for at least one (1) year after leaving.

In December 2011, Irby Company – another electrical supply company – purchased certain of Treadway’s assets and was assigned all of Treadway’s contractual rights. In January 2012, Tipton, Gilbert and Padgett stopped working for Treadway. They each applied for jobs with Irby, went through a screening process and then were hired. Roughly a year later, Tipton began speaking with a competitor called Wholesale Electric Supply Company about possible job opportunities. On March 14, 2013, Tipton left Irby to go work for Wholesale. The next day, Gilbert and Padgett followed.

As expected, Irby sued for breach of the non-compete agreements, along with claims for breach of fiduciary duty, tortious interference and civil conspiracy. Ultimately, the Eastern District of Arkansas granted summary judgment in the defendant’s favor. The core of the District Court’s holding was that the defendants had not breached the express terms of their Employment Agreements: The restrictive covenants began running from the moment the employees stopped working at Treadway. The employees stopped working at Treadway in January 2012, when they became employees of Irby. As such, the 1-year restricted term had run by the time the employees left Irby to work for Wholesale in March 2013. In addition, the District Court also ruled that the non-compete was overbroad and unreasonable and that the restrictive covenants were not necessary to protect a legitimate interest. Let’s flesh this out a bit:

The District Court’s Holding 

Irby claimed that several of its customers had done business with Wholesale after the three employees jumped ship. The record indicated that those Irby customers – electrical contractors – were already doing business with Wholesale before the switch. In fact, it was undisputed that electrical contractors did business with multiple suppliers or vendors. Next, to the extent Irby had a customer list, that list was public knowledge. All of the customers at issue were electrical contractors. Any competitor could obtain a list of all licensed electricians in the State of Arkansas through the Department of Labor’s website. In short, the District Court held that the restricted term had expired, but that even if it had not expired, there was no legitimate basis for enforcing the restrictive covenants at issue. The District Court also held that the geographic restriction was overbroad, also rendering the restrictive covenants unenforceable.

The Eighth Circuit’s Analysis 

On Appeal, the Eighth Circuit completely disagreed, reversing and remanding the case for trial. The Eighth Circuit reached the exact opposite conclusion on virtually every point, holding (1) The restrictive covenants contained in the Employment Agreements had not expired and (2) There were questions of fact as to whether the restrictive covenants were reasonable and supported by a legitimate business interest.

The Assignment & Its Effect 

The District Court did not reach the issue of whether Arkansas law would permit the assignment of a non-compete agreement to a successor employer. Neither the Arkansas Supreme Court nor any Arkansas appellate courts have addressed the question. So the Eighth Circuit took up that issue and predicted that Arkansas would allow restrictive covenants to be assigned in the employment context. From there, the Court concluded that the non-compete agreements had been validly assigned to Irby as part of the asset sale. The asset purchase agreement did not expressly indicate which contracts Treadway was assigning to Irby. Instead, it merely indicated that certain contracts would be assigned. But that combined with testimony of Irby’s chief operating officer was enough to convince the Court that a valid assignment had taken place (or at least that the issue should go to a jury).

From there, the Court considered the legal effect of the assignment of the Employment Agreements. Recall: The District Court held that although Irby could enforce the Employment Agreements (having taken them by assignment), Irby could not materially alter the terms of those Agreements. The Agreements expressly provided that the restricted term began running “if and when you leave Treadyway’s employ, for whatever reason.” The employees all left Treadyway’s employ in January 2012, when they became employed by Irby. In reversing, the Eighth Circuit rejected this argument out of hand. Interestingly, the Eighth Circuit called out the District Court for “offer[ing] no legal support for this peculiar result.” The irony here is that the Eighth Circuit itself (1) cites no Arkansas law in favor of assignment of employee non-compete agreements because no such law exists and (2) cites no case law in support of its conclusion about how the assignment operates in this context.

On the Merits 

The second part of the Court’s holding is pretty straightforward: It concluded that a jury should decide whether the restrictive covenants at issue were reasonable and necessary to protect a legitimate interest.   I agree that the existence of a legitimate business interest is best left to a jury. But on reasonableness, the Eighth Circuit seems to have departed from (or at least ignored) binding Arkansas authority.

The restrictive covenants at issue prevented the employees from competing for “Treadway’s customers within [their] territory, as defined by Treadway.” The District Court held that this was overbroad because it did not specifically define the geographic territory and left that up to Treadway’s discretion. As such, the agreement was overbroad and unenforceable under Arkansas law. In reaching this conclusion, the District Court relied on HRR Arkansas, Inc. v. River City Contractors, Inc., 350 Ark. 420, 430 (2002). In HHR, the restricted territory was defined as within “ten (10) miles of 2824 Barrow Road, Little Rock, Arkansas, or such others established by [HRR]…”. The Arkansas Supreme Court found the non-compete overbroad and unenforceable because the “such others” language was ambiguous. As written, the company could designate a vast geographic territory at some future date with no assent from the employee.

In the instant case, the Eighth Circuit dismissed the District Court’s concerns about Treadway/Irby using an ambiguous geographic term that would later allow them to designate a vast territory without the employee’s assent. This was the Arkansas Supreme Court’s exact concern in HHR, and a concern that rendered the non-compete unreasonable and unenforceable. Surprisingly, the Eighth Circuit completely ignored HHR.   Instead, the Court found that the most reasonable reading of the non-compete resulted in a restricted territory based on where the employees actually worked. In the Court’s view, this was not overbroad enough to result in judgment on the pleadings. A jury could decide whether or not it was reasonable.

Some Final Observations

Regarding Assignment: The Eighth Circuit’s analysis is shoddy. Arkansas is fairly hostile to non-compete agreements. In spite of this, the Court decided that Arkansas would allow assignment of employee non-compete agreements. I can live with that part of the holding. The problem is the Court’s reasoning regarding the operation of that assignment.

The employees agreed for the restricted term to run for 1-year after they stopped being employed by Treadway, for whatever reason. This creates two problems. First, after the asset sale, the employees stopped working for Treadway. They then applied for new jobs at Irby, went through a screening process and were hired by Irby.

Even if Irby takes an assignment of the non-compete, Irby only gets to enforce that non-compete based on its written terms. Irby gets the right to restrict the employees from competing for 1 year after those employees left Treadway. The Eighth Circuit gives this analysis short shrift and disregards it as a “peculiar” result. But peculiar or not, it is technically the correct outcome. And either Treadway or Irby could have prevented this peculiar result. Treadway could have better drafted the original Employment Agreement. And Irby, knowing that the employees no longer worked for Treadway, could have required those employees to sign a new employment agreement.

What’s more, the language “for whatever reason” – if construed normally – seems to suggest that the 1-year begins running from the time employment with Treadway ends, regardless of the reason (including assignment).

On all of this, I direct you to Western Forms, Inc. v. Pickell, 308 F.3d 930, 933 (8th Cir. 2002). In Western Forms, albeit under Missouri law (which is more pro non-compete than Arkansas), the Eighth Circuit reached a very different conclusion: There, the restrictive covenants ran for a period of two years from the termination of “such employment.” The Court concluded that “such employment” referred to the employment that existed at the time the contract was signed. There, the employee was originally employed as a sales representative and his contract indicated he was being employed in that capacity. At some point, the employee was promoted to regional manager. The Court held that “such employment” as used in the contract ended when the employee stopped working as a sales representative and started working as a regional manager. As a result, the non-compete expired while he was still working or the company. The Eighth Circuit referred to this as a “strange result” and a product of (1) Western’s poor drafting and (2) Western’s failure to have the employee sign another employment agreement with new restrictive covenants.

So in Western, the Eighth Circuit was fine with a strange, but technically correct result. But in the case at bar, the Eighth Circuit contorted itself to reach a less peculiar, technically questionable outcome.

Regarding Everything Else:  The Eighth Circuit ignored pertinent Arkansas authority on a number of points of law, particularly on geographic scope.

There’s a good chance the Arkansas Supreme Court will weigh in at some future date and let us know whether the Eighth Circuit got this one right or wrong.

The case is Stuart C. Irby Co. v. Tipton, No. 14-1970, 2015 WL 4645766, at *1 (8th Cir. Aug. 6, 2015). And thank you to Stephen Fink at Thompson Knight in Dallas for bringing this case to my attention.

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.