Restrictive covenant law has changed dramatically within the last couple of years. A Wisconsin Court of Appeals’ decision in Diamond Assets, LLC v. Godina is the latest development in the state’s restrictive covenant laws.
In Diamond Assets, the court’s decision provides three takeaways:
- procedural guidance on motions to dismiss as they relate to restrictive covenants;
- insight into whether employees can be restricted from soliciting prospective clients; and
- guidance on the scope of information that may be lawfully restricted by a post-employment confidentiality covenant.
This article provides an overview of each of the major holdings in Diamond Assets, and discusses issues employees and employers should consider before entering into restrictive covenant agreements.
Background: Diamond Assets
Carlos Godina worked for Diamond Assets and entered into a restrictive covenant agreement that included a noncompetition restriction and confidential information provisions.
After Godina left Diamond Assets, he began working for a competitor. Diamond Assets sued, alleging that he violated his restrictive covenant agreement. Godina moved to dismiss the case, arguing that both the noncompete and confidentiality provisions were unenforceable as a matter of law.
The circuit court agreed with Godina and held the restrictive covenant obligations unenforceable as a matter of law. Diamond Assets appealed.
A Procedural Grounds Caution
The court of appeals first addressed whether restrictive covenants should be subject to motions to dismiss.
Diamond Assets argued that extrinsic evidence is necessary to analyze the enforceability of restrictive covenants, including assessments of the breadth and reasonableness of the restrictions. Because a court is limited to considering the pleadings in a motion to dismiss context, Diamond Assets argued dismissal is not appropriate.
The court disagreed, finding that restrictive covenants may be drafted so unreasonably and broadly that they are unenforceable as a matter of law. The court stated, “whether there is at least one evident or hypothetical application of the covenant’s plain text that is unreasonable because no facts could be proven that would render the protection created by the restrain reasonably necessary to Diamond,” the covenant may be held unenforceable on a motion to dismiss.
Defining Unreasonable Noncompetition Covenants
The court next evaluated whether the restrictions were so unreasonable as matters of law that dismissal based on the pleadings was appropriate.
- The noncompetition covenant restricted Godina from engaging in activities that were:
- substantially similar to those he performed for Diamond Assets;
- competitive to Diamond Assets; and
- taken on behalf of Diamond Assets’ clients or customers Godina had actually served, or potential customers to whom Godina had presented written proposals.
Godina argued that restrictions on potentialcustomers were per-se unenforceable.
The court disagreed. Instead, it held that Diamond Assets could develop the record to demonstrate it had protectable interests justifying such a restriction. In support, the court explained that Godina had access to Diamond Assets’ pricing information, and the ability to use that information to hurt Diamond Assets, demonstrating its protectable interest.
The court further concluded that the potentialcustomer restriction was sufficiently narrow because it was limited to those customers Godina had developed competitive knowledge about, customers to whom he had been introduced, and to whom he had presented written proposals within the one year preceding his termination.
The court explained that these limitations served to make it likely that the number of potential customers that Godina would be restricted from soliciting was well-defined and small.
The court reversed the circuit court’s holding that Diamond Asset’s noncompetition covenant was unenforceable at law, and remanded those claims.
Defining Confidential Information
Godina also argued that the agreement’s restriction on disclosure of “confidential information” was unenforceable pursuant to Wis. Stat. section 103.465. That provision defines confidential information to include “all data and information relating to the business and management,” and used terms such as “the manner and methods of conducting the Employer’s business,” and vendor “characteristics.”
The covenant also detailed which information was excluded from the definition of confidential information including, among other things, information that was:
- developed by the employee independent from the employer;
- widely known; and
- which the employee rightfully received from a third-party.
The court noted that, while language detailing information excluded from the definition of confidential information is helpful, the whole covenant must be stricken should the court find any of its provisions unreasonable.
The court agreed with Godina that the covenant was overly broad, focusing on the “manner and methods of conducting the Employer’s business” and vendor “characteristics” language. The court held that such language would make Godina liable for sharing any detail about Diamond Assets, including the most mundane details. The court explained that these terms are virtually limitless, and described a hypothetical where the covenant would prevent Godina from sharing what type of pens Diamond Assets used.
Because the definition of confidential information was excessively broad, the court held that it was unenforceable as a matter of law, and affirmed the circuit court’s dismissal of that claim.
A Cautionary Warning
This decision is a cautionary warning to employers drafting confidentiality clauses that “less may be more.” Because Wisconsin’s restrictive covenant law does not allow blue-penciling of clauses indivisible from one another, if one phrase or term is too broad, the whole covenant will be stricken.
Drafters who include too many terms in the confidential information definition run the risk that a term will be found overly broad or that a “catch-all” term is unreasonable, and subsequently risk the entire confidential information covenant deemed unenforceable.
Employers should carefully review their model restrictive covenant agreements to ensure they are narrowly drafted. Employers should pay particular attention to confidentiality provisions and analyze whether the terms included in the definition of “confidential information” are overly broad – even hypothetically.
Restrictive covenant law can change quickly. State and federal trends demonstrate an increasingly narrow acceptance of the use of restrictive covenants. Attorneys, employers, and employees should stay abreast of the latest changes in the law, and that any covenants entered into reflect these changes.
This article was originally published on the State Bar of Wisconsin’s Labor & Employment Law Section Blog. Visit the State Bar sections or the Labor & Employment Law Section webpages to learn more about the benefits of section membership.