July 31, 2009 – The Wisconsin Supreme Court adopted on July 14 new standards that tend to save contracts aimed at preventing ex-employees from competing with their former employers.

In Star Direct v. Dal Pra, 2009 WI 76, the court announced that portions of a restrictive covenant may be enforced even after another section is deemed unenforceable, so long as the surviving provisions remain understandable and capable of independent enforcement.

Dissenting justices criticized part of the majority’s analysis for assuming that a court signals approval of issues it could have addressed, but did not. The dissent warned that this new interpretative tool defies precedent and judicial restraint.

Competing distributors

Eugene Dal Pra was a route salesperson for Star Direct, a distributor of products to about 800 retail outlets, including convenience stores, service stations, truck stops, and travel centers in the Midwest. Dal Pra quit in 2006 to begin his own distribution company rivaling Star Direct.

Star Direct sued, asserting clauses in Dal Pra’s employment contract preventing him from engaging in business “substantially similar to or in competition with” its own and forbidding him from approaching its customers. In addition to this “business clause” and “customer clause,” the contract included a “confidentiality clause” that barred its former employee from revealing proprietary information.

On cross motions for summary judgment, the circuit court concluded that the three clauses were vague, overbroad, not reasonably necessary to protect Star Direct, and consequently unenforceable. The circuit court also held that each clause was indivisible from and “inextricably entwined” with the other two under Streiff v. Am. Family Mut. Ins. Co., 118 Wis. 2d 602 (1984).

The court of appeals found the business clause too broad because it barred Dal Pra from engaging in a “substantially similar” business whose products are not competitive with Star Direct. The court of appeals concluded that when one clause failed, none could be enforced because they were indivisible under Mutual Service Casualty Insurance Co. v. Brass, 2001 WI App 92.

Star Direct’s ‘protectable interest’

In a majority opinion authored by Justice Michael Gableman, the supreme court noted that restrictive covenants such as these are disfavored as restraints of trade. Under Wis. Stat. § 103.465, non-compete agreements are lawful only if the restriction is “reasonably necessary for the protection of the employer.” Among other things, this requires the employer to show a legitimate protectable interest.

In this case, the court found that Star Direct generally has a protectable interest in the special knowledge of its business practices and customers accessed by its salespeople in a competitive, relationship-based industry.

Meaning of silence

Star Direct’s interest in prohibiting competition with an ex-employee for its customers is legitimate, but Dal Pra attacked the customer clause for overbreadth. In particular, Dal Pra charged that the covenant unreasonably prohibits Dal Pra from soliciting customers no longer doing business with Star Direct or customers who hadn’t dealt with Dal Pra for years.

The court rebuffed Dal Pra’s arguments and upheld the customer clause, citing Star Direct’s need to protect itself from a rival with privileged information and its right to win back former customers. But in doing so, the court confronted the lack of any Wisconsin case that “has explicitly addressed or affirmed an employer’s interest in customers who have recently chosen to cease doing business with the employer.”

However, the justices noted, past cases have implicated this issue and reviewing courts “have been untroubled by this asserted interest.” For example, the court explained, a covenant prohibited contact with “anyone who had been a customer of the company” within a specified time in Rollins Burdick Hunter of Wis., Inc. v. Hamilton, 101 Wis. 2d 460 (1981).

“Though the court did not discuss it, such a customer pool certainly could have included customers who had chosen to take their business elsewhere,” the court reasoned. “Thus, this provision prevented the employees from contacting both current and past customers with whom they may or may not have had contact.”

With its implications for past customers, the Hamilton court “reversed the court of appeals and circuit court who had previously found the provision invalid,” the justices reported.

“While these cases do not settle the matter, the customer clause is distinguishable from these other cases only in that it expressly divided the customers into two identifiable groups – current and past customers,” the court wrote.

In dissent, Justice Ann Walsh Bradley rejected this interpretative approach. Opinions of the court do not “purport to address a proposition greater than the legal question before the court,” Bradley said, quoting Horst v. Deere & Co., 2009 WI 75. Consistent with judicial restraint, she added that a court only decides the issues the parties raise.

“To interpret the court’s silence on an issue that could have been implicated in a dispute as a tacit decision on its merits unsettles these principles,” Bradley wrote. “Such a framework would force the court to reach out and decide issues not presented by the parties and without full briefing and arguments on the merits.”

Responding to Bradley, the majority downplayed its reliance on cases suggesting, but not addressing, a pertinent issue.

“We explicitly state that these cases do not settle the matter,” the court wrote. Rather, the cases merely illustrate that “the implicit interest in past customers, and this sort of provision is not really all that unique,” the court said.

The other clauses

A clause forbidding an ex-employee from competing in a business “substantially similar” to – but not in direct competition with – the former employer is too broad, the justices held.

On the other hand, the justices declared that the confidentiality clause was not unreasonable, contrary to the circuit court’s determination. The circuit court objected to the prohibition on disclosure of “any” information as overly expansive. But the justices said that examples of protected material included in the clause narrowed its scope to just “confidential and sensitive” information about the business.

Divisibility of clauses

The court noted § 103.465 instructs that if a covenant imposes an unreasonable restraint, it is unenforceable “even as to any part of the covenant … that would be a reasonable restraint.”

In Streiff, the supreme court applied this statute to an employer’s promise of payments to a former employee on the condition of satisfying restrictive provisions. When one of the provisions proved to be unreasonable, the entirety could not be enforced because the promise was so intertwined with its conditions. That is, “to understand the ramifications of not complying with the third provision, an employee would need to refer back to the first provision which mandated compliance with the contract in its entirety,” the justices explained.

“We read Streiff as being premised primarily on the fact that the provisions were intertwined via their textual link,” the court said, overruling the court of appeals case Brass which interprets Streiff as setting a broader standard for intertwined and indivisible provisions.

Brass set out a test under which provisions are indivisible if they “govern several similar types of activities and establish several time and geographic restraints.” The justices criticized Brass for rendering “nearly all covenants not to compete unenforceable if one provision of one of the covenants is unreasonable.”

The justices declared the new test for whether a covenant is divisible to be “whether, if the unreasonable portion is stricken, the other provision or provisions may be understood and independently enforced.”

“This inquiry will be fact-intensive and depend on the totality of the circumstances,” the court continued. “In the context of multiple non-compete provisions in a contract, indivisibility will usually be seen by an intertwining, or inextricable link, between the various provisions via a textual reference such that one provision cannot be read or interpreted without reference to the other.

“Restrictive covenants are divisible when the contract contains different covenants supporting different interests that can be independently read and enforced,” the court stated. “Overlap, even substantial overlap, between clauses is not necessarily determinative. Employers may have several protectable interests that apply in similar, though not exactly the same, situations and it makes sense to set these out in separate post-termination restrictive covenants.”

New test applied

Under its newly announced test, the court found that the Star Direct clauses overlap, but they protect legitimate and separate interests so they are independently enforceable. “[O]ne need not refer to the business clause or confidentiality clause, for example, to determine one’s rights under the customer clause,” the court explained.

“Striking the overbroad business clause does not affect the independently sufficient and enunciated provisions of the customer and confidentiality clauses,” the court added.