An appellate court in Wisconsin recently held that noncompete agreements that were extended in duration if an employee violated them were invalid. H&R Block Eastern Enterprises, Inc. v. Swenson ( Wis.App.December 20, 2007).

Mary Swenson, Francine Sherbert, Tracy Hodson, Sally Stelloh, Lynette Guentz, and Gerald Niedfeldt were employed by H & R Block as tax preparers in La Crosse, Wisconsin. Their employment contracts each contained the following clauses:

11. Noncompetition Covenant. Associate covenants that for two (2) years following the voluntary or involuntary termination of Associate's employment (such period to be extended by any period(s) of violation), Associate shall not, directly or indirectly, provide any of the following services to any of the Company's Clients: (1) prepare tax returns, (2) file tax returns electronically, or (3) provide bookkeeping or any other alternative or additional service that the Company provides within the Associate's district of employment.

12. Nonsolicitation Covenant. Associate covenants that for two (2) years following the voluntary or involuntary termination of Associate's employment (such period to be extended by any period(s) of violation), Associate shall not directly or indirectly solicit or divert the Company's Clients or otherwise interfere with the Company's continuing relationships with its clients. Company Clients are those defined in Section 11.

In 2004, the former employees had each been working for H & R Block for periods ranging from 10 to more than 25 years. The employment of Hodson, Niedfeldt, and Stelloh with H & R Block ended in April 2004 and the employment of the other three ended in November 2004. Swenson and Sherbert began a new business in December 2004, known as “King Street Tax & Bookkeeping,” and hired the other four employees.

H & R Block filed an action against the former employees in late December 2004. The complaint alleged that all the former employees breached the restrictive clauses in their contracts and Swenson and Sherbert tortiously interfered with those clauses in the contracts of the other four employees. H & R Block sought injunctive relief and damages.

After the circuit court denied H & R Block's motion for a temporary restraining order, H & R Block moved for summary judgment on its claims. The former employees also moved for summary judgment on H & R Block's claims, contending that the restrictive clauses were overbroad on a number of grounds and therefore unenforceable under Wisconsin law. The invalidity of these clauses, they contended, required dismissal of both the breach of contract and the tortious interference claims.

The circuit court granted summary judgment in favor of the former employees. The court concluded that the restrictive clauses were invalid, primarily because of the duration of the restraint. The court stated that a two-year limitation was more than necessary to protect H & R Block's interests; with the extension permitted in addition to the two years, the duration restriction was “plainly invalid.”

On appeal, H & R Block contended it was entitled to summary judgment on its claims. The issue of the validity of the restrictive clauses in the employees' contracts involved the construction and application of Wis. Stat. §103.465 in light of existing case law. That law provides as follows:

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 subsection, 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.

According to the Wisconsin Court of Appeals, “[i]n order to be enforceable, a contract provision governed by this statute must: (1) be necessary to protect the employer; (2) provide a reasonable time limit; (3) provide a reasonable territorial limit; (4) not be harsh or oppressive to the employee; and (5) not be contrary to public policy.”

In examining restrictive covenants, the court applied the following canons of construction to noncompete provisions: “(1) they are prima facie suspect; (2) they must withstand close scrutiny to pass legal muster as being reasonable; (3) they will not be construed to extend beyond their proper import or further than the language of the contract absolutely requires; and (4) they are to be construed in favor of the employee.”

The appellate court acknowledged that “[w]hen an employer's customers or clients regularly deal with a particular employee, the employer's interest in protecting its stock of customers when that employee leaves may be a legitimate interest that justifies a reasonable restraint on the employee.” Indeed, “[t]he customer goodwill that comes from a positive relationship between a customer and the employee with whom the customer regularly deals is a valuable asset of the employer's business, and, for some businesses, may be the most important asset. The purpose of a time restriction in this context is to give the employer a reasonable chance to keep the customers.”

H & R Block presented submissions showing that its tax professionals had well-developed relationships with clients, many of whom had returned year after year to the same tax professional, and that H & R Block encouraged clients to return to the same tax professional each year. According to these submissions, virtually all of the contact a client has with H & R Block is through the tax professionals. The court therefore assumed that H & R Block had a legitimate interest in protecting its client base with reasonable restrictions on tax professionals who leave its employment.

The issue then became whether the restrictions it placed on the former employees to protect this interest were necessary and reasonable in duration and territory. Although the parties debated the necessity and reasonableness of the restrictive clauses on a number of grounds, the appeals court only addressed the issue of the reasonableness of the duration restriction in both clauses. It assumed without deciding that the two-year period was reasonable and focused on the extension of the two-year period “by any period(s) of violation.”

H & R Block argued that this extension provision was reasonable because the effect is to restrain the former employees for a total of only two years, and if two years is reasonable, then the extension for a violation to make up a total of two years is reasonable as well. In their view “a one-day violation leads to a one-day extension, a one-week violation to a one week extension.” The former employees responded that the extension provision was unreasonable because it could extend the duration restriction indefinitely. They construed the provision to mean that if, in the twenty-second month after leaving H & R Block, an employee prepared a tax return for a company client, the time period would be extended for another two years, making the total period of restraint forty-six months.

The Court of Appeals concluded the extension provision made the duration of the restraints unreasonable for two independent reasons. First, if it accepted H & R Block's proposed construction, the court wrote, it did not understand how this provision was to be applied in the context of the two restrictive clauses at issue, which deal with providing services to company clients and soliciting those clients. “What constitutes a “one-day” violation? Is it any day in which there is any contact with a company client for whom one of the listed services is being provided? Does the violation then extend until the service is completed for that client? If there are contacts with different company clients on one day for the purposes of providing the listed services does that count as a one day violation, the same as if there were contact with only one company client in a day?” According to the court, “[t]hese questions, unanswered by the contract terms, mean that a former employee cannot tell from the terms of his or her contract how long the extension will be for particular conduct in violation of the clauses.”

Second, the court observed that there may be legitimate disputes between a former employee and H & R Block over whether particular conduct violates the clauses. “An employee will not know until the dispute is resolved by a court whether the conduct is or is not a violation. Only then will the employee know if there is an extension and how long it is. The effect of the extension provision thus makes the duration of the restraint not a fixed and definite time period but a time period that is contingent upon outcomes the employee cannot predict.”

H & R Block referred to cases from other jurisdictions in which courts have extended the time periods in noncompete covenants as part of the equitable relief awarded after a breach has been determined. H & R Block argued that if extension of the time period is appropriate equitable relief then its inclusion in the contract to define the duration of the restrictions is necessarily valid.

The court did not agree with this reasoning. “Whether the length of a time period in a restrictive covenant is reasonable is a distinct issue from whether an extension of the time period is necessary to provide a remedy to the employer after a breach has been determined.” The former determination focuses on the business of the employer, the interest it seeks to protect, and the position of the employee. The latter determination, in those jurisdictions that allow this remedy, is a matter for the court's discretion; and the court takes into account factors such as the circumstances of the breach, the effect on the employer, and the inadequacy of monetary damages.

The Wisconsin Court of Appeals thus concluded the extension provision in both the noncompetition and the nonsolicitation clauses was unreasonable and rendered the two-year time period in each clause unreasonable. Because the restraint in each clause was unreasonable, each clause was void and unenforceable under Wisconsin law, even if each was otherwise reasonable. Therefore, the appellate court found that the lower court properly dismissed on summary judgment H & R Block's breach of contract claim.

Although this case was decided under Wisconsin law, it illustrates how important it is for employers to draft noncompete clauses carefully. These provisions must be narrowly tailored to protect the legitimate business interests of the company. If there is any overreaching or ambiguity in the duration, geographic scope, or restricted activity, the employer may end up with little or no protection against unfair competition from former employees.

Attorneys in Arent Fox’s Labor & Employment Law Group have substantial experience in drafting restrictive covenants for employers, and enforcing them in court if and when disputes develop. If you have any questions about this case or any other issue involving noncompetition or nonsolicitation provisions, please feel free to contact us.

Michael L. Stevens
stevens.michael@arentfox.com
202.857.6382