Articles

TORTIOUS INTERFERENCE CLAIMS ARISING FROM VIOLATIONS OF RESTRICTIVE COVENANTS IN EMPLOYMENT AGREEMENTS

DELAWARE LAW

By: Thomas D. Rees, Esquire

I. WHAT ARE THE ELEMENTS OF A CLAIM FOR TORTIOUS INTERFERENCE IN THE CONTEXT OF RECRUITING OR HIRING AN EMPLOYEE WITH A RESTRICTIVE COVENANT (e.g., NON-COMPETE, NON-SOLICITATION, OR NON-DISCLOSURE)?

In Research and Trading Corp. v. Pfuhl, 1992 WL 345465 (Del. Ch.), the Court of Chancery for New Castle County set forth the elements of a cause of action for tortious interference:

1. a contract,
2. about which defendant knew,
3. an intentional act that is a significant factor in causing the breach of such contract,
4. without justification,
5. which causes injury.

Research and Trading Corp. v. Pfuhl, supra, at *14. In Research and Trading Corp. v. Pfuhl, the old employer, Research and Trading Corp. ("RTC"), sued each of three ex-employees for tortiously interfering in the other two ex-employees' restrictive covenants. RTC was engaged in the business of marketing safety devices designed to protect individuals required to work at heights, such as harnesses, body belts, and shock absorbing lanyards. The restrictive covenants prohibited selling or purchasing any products that competed with RTC's products to or from any entity with which the employee had dealt either directly or indirectly at RTC, for a period of 12 months after termination of employment. The 12-month restrictive covenant also prohibited employees from acting for any competitor of RTC to sell or buy any products which the employee had sold or bought for RTC at any time during his employment with RTC. Within weeks after leaving RTC, the three ex-employees formed a competing business, Safety and Technology Systems, Inc. ("STSI"), solicited RTC customers and suppliers, and conveyed negative information about RTC.

In Research and Trading Corp. v. Pfuhl, the Court dismissed the claim that the individual defendants had interfered with the other employees' restrictive covenants. The Court held that the plaintiff had "not shown that any act by one of the defendants was a significant factor in occasioning the breach of covenant by any other defendant." Research and Trading Corp. v. Pfuhl, supra. Nevertheless, the Court enforced the restrictive covenant by enjoining the defendants from contacting specified customers or distributors during the 12-month period. Research and Trading Corp. v. Pfuhl, 1993 WL 93369, *3 -*4 (Del. Ch.).

1. the existence of a valid business relationship or expectancy;
2. knowledge of the relationship or expectancy on the part of the interferer;
3. intentional interference that induces or causes a breach or termination of the relationship or expectancy; and
4. resulting damages to the party whose relationship or expectancy has been disrupted.

In Research and Trading Corp. v. Pfuhl, 1992 WL 345465 *14 (Del. Ch.), the Chancery Court of Delaware dealt with the old employer's claim that its ex-employees attempted to tortiously interfere with a relationship with a distributor. Such interference was prohibited under the restrictive covenant. The Court made an independent determination of whether tortious interference had taken place after having decided that the defendants had violated their restrictive covenants. The Court found that the plaintiff had suffered no injury from the attempted interference. The Court nevertheless enjoined any future interference for one year - the same period as the restrictive covenant. Research and Trading Corp. v. Pfuhl, supra.

II. TORTIOUS INTERFERENCE IN THE CONTEXT OF THE RESTRICTIVE COVENANT ITSELF

1. Invalidity or Unenforceability of the Restrictive Covenant

Under Delaware law, a restriction on competition will be enforceable only if the following requirements are met:

1. the duration is reasonably limited temporally;
2. the scope is reasonably limited geographically;
3. the purpose is to protect legitimate interests of the employer;
4. the operation of the restrictive covenant is such as to reasonably protect those interests.

No cases have been found that dealt with unenforceability of a restrictive covenant in the context of a tortious interference claim. However, in COPI of Delaware, Inc. v. Kelly, 1996 WL 633302, *5, *6 (Del. Ch.), aff'd sub nom. Smart Business Systems, Inc. v. COPI of Delaware, Inc., 707 A.2d 767 (Del. 1998), the Court of Chancery for New Castle County limited the extent of injunctive relief against a new employer for tortious interference. The plaintiff sought to enjoin the new employer "from interfering with COPI's business opportunities." The Court issued the injunction only to the extent that the new employer was using confidential, proprietary, and trade secret information appropriated from the old employer. The Court refused to issue a blanket injunction against dealing with COPI's customers although such relief might have been warranted under the restrictive covenant and the Court had earlier found the restrictive covenant to be enforceable against ex-employees.

2. Breach of Contract by the Former Employer

The former employer's breach of contract does not necessary excuse compliance with a restrictive covenant or eliminate liability for a tortious interference claim. In Research and Trading Corp. v. Pfuhl, 1992 WL 345465, *8-*11, three ex-employees made significant allegations that the old employer had breached certain express and implied covenants. These included failure to convey stock; failure to provide bonuses; and breach of the implied duty of good faith and fair dealing in allegedly terminating one of the three employees and forcing the other two to resign for refusing to make fraudulent statements to a lending bank. Nonetheless, the Court discounted these allegations of breach and held that the restrictive covenants were enforceable, and did not consider the employer's breaches in adjudicating the tortious interference claim. Research and Trading Corp. v. Pfuhl, supra, 1992 WL 345465, *13.

3. Unclean Hands, Estoppel or Other Equitable Defenses

Although Research and Trading Corp. v. Pfuhl, supra, did not specifically mention unclean hands, estoppel or other equitable defenses, the Court's decision in that case suggests that Delaware would allow only a very limited use of these defenses. See Research and Trading Corp. v. Pfuhl, supra.

In Research and Trading Corp. v. Pfuhl, supra, 1992 WL 345465, *12 (Del. Ch.), the Chancery Court rejected an equitable defense based on the comparative size of the new enterprise. The defendants asserted that granting an injunction would bring little benefit to the old employer, but could put the new corporation formed by the employees out of business. The Court refused to accept this assertion, holding that the requested injunctive relief would leave the defendants free to pursue customers who were not serviced by the employees while at the old employer, including two of the largest three distributors in the United States. The Court also found that the employer's interests in the case were significant, and that the relief being sought (an injunction against soliciting identified, important customers) was sufficiently narrow. The Court also found no fraud, overreaching, or other inequitable action on the part of the plaintiff. Research and Trading Corp. v. Pfuhl, supra.

4. What are the Parameters of the Affirmative Defense of Justification or the Competitor's Privilege?

No case has been found that addresses these elements in a tortious interference context.

No case was found that specifically analyzed damages in the context of a claim for intentional interference with the restrictive covenant itself.

2. What Type of Injunctive Relief is Available?

(a) State Court

Preliminary injunctive relief will be available in the Court of Chancery of Delaware if a plaintiff shows:

1. there is a reasonable probability of success on the merits;
2. irreparable harm; and
3. the harm resulting from failure to issue an injunction outweighs the harm to the opposing party if the court issues the injunction.

   COPI of Delaware, Inc. v. Kelly, 1996 WL 633302 (Del. Ch.).

(b) Federal Court

In Robert Half International, Inc. v. Stenz, 2000 WL 1716760 (E.D. Pa.) (applying Delaware law), the United States District Court for the Eastern District of Pennsylvania granted preliminary injunctive relief to a personnel placement firm enforcing its restrictive covenant. The restrictive covenant prohibited the following conduct:

1. employment with a competing executive recruiting firm, employment agency or temporary personnel service business within 50 miles of any of plaintiff's offices which the employee had exercised supervisory authority;
2. non-solicitation of any customers for a 12-month period;
3. non-solicitation of any employees for the 12-month period;
4. non-use of any confidential information of the employment agency.

The Court said that these four restrictions could be split into two categories:

1. restrictions on the use of information or contacts;
2. restrictions on the ability to work for a competing agency.

The Court granted preliminary injunctive relief to a limited extent. The Court refused to enjoin the defendant's ability to work for a competing personnel agency. The Court held that there was a reasonable likelihood that the remaining restrictions would be enforced, and granted an injunction prohibiting soliciting clients, inducing employees to leave the plaintiff, and disclosing confidential information. The Court held that the other tests for injunction (e.g., irreparable harm, the public interest, and absence of harm to the enjoined party) were met.

The Court rejected as duplicative the request to enjoin intentional interference. The Court stated that, to prevail on an intentional interference claim, the plaintiff would have to show an attempt to prevent a business relationship from occurring. The Court held that, since it was enjoining the defendant from soliciting former clients and using information obtained from the client, there was no risk that business relationships would be interfered with. The Court concluded, "essentially the same behavior need not be enjoined twice." Robert Half International, Inc. v. Stenz, 2000 WL 1716760, *7.

3. Are There Circumstances Where Attorneys Fees are Recoverable?

Yes. In Research and Trading Corp. v. Pfuhl, supra, the Court awarded attorneys fees on the strength of a fee shifting provision in the restrictive covenants. Research and Trading Corp. v. Pfuhl, 1992 WL 345465, *14 (Del. Ch.). The Court upheld the fee shifting provision although the provision allowed only the employer to recover counsel fees from the employee. The Court held that the agreement shifting attorneys fees was not oppressive, particularly since the defendants were "educated business managers." Id. The Court reached the decision with reluctance, on the basis of the strict enforcement of the contract, despite the Court's concern about the limited resources of the defendants and lack of any conclusion that the defendants had acted in bad faith. In a subsequent opinion, the Court considered the plaintiff's request for an attorneys fee award in the amount of $125,573.75. Research and Trading Corp. v. Pfuhl, 1993 WL 93369 (Del. Ch.). The Court awarded two-thirds of the amount sought, assessing the fees equally (one-third each) against two of three defendants. The Court awarded attorneys fees against the president and sales manager of the old employer, but not against the accounting officer, because the accounting officer did not deal with or call on customers or suppliers. The Court did not consider the plaintiff's case to be totally successful, because plaintiff did not prevail in its trade secret case or its tortious interference case.

E. What Similar Claims Does the State Recognize (e.g., Unfair Competition, Conspiracy, etc.)?

None of the reported Delaware cases dealing with tortious interference analyze any other claims such as unfair competition, conspiracy, etc. In Robert Half International, Inc. v. Stenz, 2000 WL 1716760 (E.D. Pa.) (applying Delaware law), the Eastern District of Pennsylvania held that there was no need to enjoin unfair competition by the defendant, on the ground that the same conduct (communication of trade secrets attempts to prevent business relationships from occurring) was already enjoined by the injunction enforcing the restrictive covenant.

III. MISCELLANEOUS ISSUES

No reported Delaware cases appear to deal with these issues in tortious interference cases. Nevertheless, a potential employer should ask whether a prospective employee has a restrictive covenant, because the employer may be charged with the knowledge of the restrictive covenant if the employer does not ask.

No reported Delaware cases appear to deal with these issues in tortious interference cases. Nevertheless, a potential employer should ask whether a prospective employee has a restrictive covenant, because the employer may be charged with the knowledge of the restrictive covenant if the employer does not ask.

No cases have been found on this subject in the context of tortious interference claims. Under Delaware's Corporation Law, Delaware corporations may indemnify corporate agents (including employees) in any action involving the corporate agent by reason of being a corporate agent, as broadly set forth under 8 Del. Code § 145. The power to indemnify generally exists if the corporate agent acted in good faith and in a manner reasonably believed to be in the best interests of the corporation. 8 Del. Code § 145(b). Indemnification is mandatory if the corporate agent has been successful on the merits. 8 Del. Code § 145(c). Indemnification is also possible through adoption of a by-law, by agreement, or by shareholder vote. 8 Del. Code § 145(f).

In Cochran v. Stifel Financial Corporation, 2000 WL 1847676 (Del. Ch.), the Court of Chancery of Delaware dismissed a former employee's indemnification claim for expenses in a non-compete case. The Court held that the litigation arose because of the employee's breach of a personal contractual obligation, not because of his service in an indemnification-eligible position. Cochran v. Stifel Financial Corporation, supra, at *7. Although Cochran dismissed an indemnification claim against an old employer, the treatment of defense of a tortious interference/restrictive covenant claim as "personal" could constitute an obstacle to indemnification from a new employer.

In Research and Trading Corp. v. Pfuhl, 1993 WL 93369 (Del. Ch.), the Chancery Court differentiated in awarding damages between employees who had had responsibility for customers and suppliers, and those who did not.

E. When May the Former Employer be Found Liable for Tortious Interference With the Former Employee's Relationship With His New Employer?

A former employer will not be liable for tortious interference with a former employee's relationship with a new employer if the former employer sues to enforce a restrictive covenant, and the restrictive covenant (or penalty clause under such covenant) is enforced. This was the result in Faw, Casson & Co., L.L.P. v. Halpen, 2001 WL 985104 (Del. Super.), in which an accounting firm sued to enforce a liquidated damages clause in a restrictive covenant and obtained liquidated damages in the amount of $5,275 from the ex-employee who had gone to another accounting firm. In the Court's concluding remarks, the Court held that the plaintiff did not tortiously interfere in defendant's employment with the new accounting firm.