The Indiana Court of Appeals recently issued a restrictive covenant ruling addressing several significant issues. On November 30, 2016, in Hannum Wagle & Cline Engineering, Inc. v. American Consulting, Inc., the Indiana Court of Appeals elaborated on a number of important issues in restrictive covenant cases:
Business development activities that divert the pipeline of opportunities for a company can constitute irreparable harm regardless of lost business.
Business development activities, such as fishing trips and golf outings with former clients, violated a defendant’s noncompetition provision.
A better practice is to object to known violations of restrictive covenants, but investigating internally and consulting counsel before filing suit 10 months later does not constitute laches—especially when there is no identified prejudice to the defendants.
A party’s claim that it has finished recruiting employees from a prior employer is not a basis to avoid a preliminary injunction based on a non-solicitation contract.
Enforceability of Extension Clauses
Courts should not enforce extension clauses for the period of the violation at the preliminary injunction stage, instead saving that for a final determination on the merits.
American Consulting, Inc., d/b/a American Structurepoint, Inc. (ASI) sued several former employees along with their new employer, Hannum Wagle & Cline Engineering, Inc., d/b/a HWC Engineering, Inc. (HWC), a competitor in the construction industry, for breach of noncompetition and non-solicitation agreements.
ASI moved for a preliminary injunction four months later. Marion Superior Court Judge Heather A. Welch held a three-day evidentiary hearing and then issued findings of fact and conclusions of law. ASI obtained the preliminary injunction against HWC and three former employees: Marlin A. Knowles, Jr., Jonathan A. Day, and David Lancet. Knowles, who had held a senior position at and an ownership interest in ASI, persuaded the trial court several months later to dissolve the injunction against him on the grounds that the two-year period was expiring.
The Courts’ Decisions
The Indiana Court of Appeals considered the injunctions against the three employees on noncompetition and non-solicitation grounds and the dissolution of the injunction against Knowles. The court of appeals affirmed the trial court in all respects.
Irreparable Harm: Business development activities that divert the pipeline of opportunities for a company can constitute irreparable harm regardless of lost business.
The trial court believed the testimony of ASI’s president that Knowles’s business development activities with ASI clients were diverting ASI’s pipeline of business opportunities. The harm from Knowles’s activity was “necessarily intangible” but damaging nonetheless. And the fact that the damage could not be quantified is an argument in favor of equitable relief. The court of appeals affirmed the finding that Knowles was damaging ASI’s goodwill and was “a present and imminent threat” to its business.
Reasonable Restrictions: Business development activities, such as fishing trips and golf outings with former clients, violated a defendant’s noncompetition provision.
The trial court ruled that it was reasonable to limit both business development and formal business activity under Knowles’s noncompetition agreement. The trial court again agreed with an ASI executive about the need to build relationships, trust, and goodwill with clients in order to obtain future business. The trial court also noted that Knowles had built these relationships while with ASI, which had paid for his business development activities.
The appellate court found that the restriction on formal work activities was reasonable because Knowles could engage in internal operations and work with HWC clients as long as he had not worked with them while at ASI.
Laches: A better practice is to object to known violations of restrictive covenants, but investigating internally and consulting counsel before filing suit 10 months later does not constitute laches—especially when there is no identified prejudice to the defendants.
The trial court ruled that a 10-month delay in filing suit was reasonable and did not constitute laches under the circumstances even though ASI knew that Knowles was working for a competitor and had social contact with ASI clients.
The Indiana Court of Appeals said “the better practice may have been” for ASI to object to the known activities of its former employees, but its delay for internal investigation and consulting counsel was not unreasonable. The court of appeals also found no prejudice from the delay.
Non-Solicitation: A party’s claim that it has finished recruiting employees from a prior employer is not a basis to avoid a preliminary injunction based on a non-solicitation contract.
The defendants argued they were done recruiting from ASI, so there was no need for an injunction based on the non-solicitation agreement. The trial court expressly found that two defendant witnesses lied or were deceptive, so it could not trust that HWC was finished soliciting ASI employees. The court of appeals found that the trial court was within its discretion to enjoin solicitation based on further recruitment or even the threat of it.
Enforceability of Extension Clauses: Courts should not enforce extension clauses for the period of the violation at the preliminary injunction stage, instead saving that for a final determination on the merits.
Knowles asked the trial court to dissolve the injunction against him because the two-year period in which he was restricted from competing with his former employer was expiring. ASI argued that the injunction should be extended for the same period of time for which Knowles violated the noncompete, starting on the date of its violation and lasting until the injunction was entered, as was provided for in the agreement’s extension clause.
The trial court followed a 2013 Court of Appeals case, which held that a preliminary injunction was not an appropriate vehicle to extend a noncompetition ban. Since the point of a preliminary injunction is to preserve the status quo, any extension of the noncompetition provision should wait until a final determination on the merits, the Kuntz court held.
The court of appeals rejected ASI’s attempts to distinguish its contract. Instead, the court found that Kuntz controls and does not allow for enforcement of an extension clause at the preliminary injunction stage.
Indiana employers may want to reevaluate their noncompetition and non-solicitation agreements in light of this ruling to ensure they protect such legitimate interests as goodwill and relationships based on business development activities. Employers should also be aware that preliminary injunctive relief is harder to obtain the longer a company waits to take action after learning of a breach of a restrictive covenant.