Outcome Of Recent 11th Circuit Decision On Restrictive Covenants Likely Would Have Been Less Favorable To Employer Had New Restrictive Covenants Act Been In Effect

The United States Court of Appeals for the Eleventh Circuit (based in Atlanta) recently issued a decision interpreting Georgia’s caselaw governing restrictive covenants in employment agreements. The Court enforced the covenants and reversed a decision by the District Judge that the covenants were not enforceable. This decision has been cited by supporters of Georgia’s upcoming constitutional referendum on restrictive covenants as an example of the confusion among judges and practitioners over this area of the law. Supporters of the proposed constitutional amendment argue that this decision justifies the claim that the law needs to be “fixed” with a new body of statutes and a constitutional amendment authorizing the statutes. Yet, a review of the case demonstrates that it was merely one in which the District Judge either misapplied the current law or (more likely) heard evidence that gave him a reason to rule the way he did, with the Eleventh Circuit reaching a different conclusion in its own de novo (“fresh”) review of the pleadings in the case. That is one of the purposes of an appellate court.

Interestingly, an analysis of the facts of the case under Georgia’s new restrictive covenants act, O.C.G.A. §§13-8-50 et seq. (the “Act”), which awaits approval in a constitutional referendum to be held in November 2010 before it can become effective, indicates that the employer likely would have been unable to protect itself from the former employee’s competitive conduct had the Act been in effect when the employee signed the employment agreement.

Rulings About Which Referendum Supporters Have Complained

In the case of H&R Block Eastern Enterprises, Inc. v. Vicki D. Morris, No. 09-11184, decided on May 17, 2010, a three judge panel of the Eleventh Circuit reversed the District Judge’s denial of H&R Block’s request for preliminary injunctive relief to enforce restrictions against Ms. Morris (1) competing with H&R Block within a specified territory, and (2) soliciting business from H&R Block customers that she had serviced while employed by H&R Block. The restrictions enforced by the Eleventh Circuit had been set forth in an employment agreement that Ms. Morris signed when she was hired by H&R Block as a seasonal tax preparer.

Ms. Morris’ Position and the Restrictive Covenants at Issue

Ms. Morris worked as a seasonal tax preparer for H&R Block for six tax preparation seasons. Each time she was hired, she signed an employment agreement that contained both a geographic restriction on competition with H&R Block and a restriction on soliciting tax preparation work for customers of H&R Block that she had serviced as an employee of H&R Block. She last signed an employment agreement with H&R Block in late 2004, for the 2005 tax preparation season.

The noncompete in the 2004 employment agreement prohibited Ms. Morris from providing tax preparation services, electronic tax return filing, or related services that she had provided as an H&R Block employee. The restriction was to remain in effect for a two year period following the termination of her employment with H&R Block. This restriction applied only to those customers whom Ms. Morris had serviced on behalf of H&R Block while the employment agreement was in effect, where the customers were located within a 25 mile radius of the office at which she had worked for H&R Block. For clarity, she was given a map of the restricted area when she signed the agreement.

The covenant not to solicit customers prohibited Ms. Morris from soliciting the customers whom she had serviced on behalf of H&R Block while the employment agreement was in effect, with the prohibited solicitation limited to tax return preparation, electronic filing of tax returns, and the provision of related services during a two year period following the termination of Ms. Morris’ employment with H&R Block.

Ms. Morris’ Post-Employment Conduct that Resulted in the Lawsuit

Ms. Morris was not re-hired for the 2006 tax preparation season. In January 2006, she opened her own tax preparation business and located her offices within the 25-mile radius prohibited by the noncompete. She personally prepared income tax returns for 47 clients whom she had serviced on behalf of H&R Block during previous tax preparation seasons. Her employees prepared an additional 40 income tax returns for her former H&R Block clients.

The Courts’ Analysis of the Restrictive Covenants

After initially entering a temporary restraining order enforcing the restrictive covenants, the District Judge later concluded that the noncompete was overbroad and unenforceable. Because in Georgia a restrictive covenant in an employment agreement cannot be revised by a court in order to render it enforceable, and because an unenforceable noncompete renders a covenant not to solicit customers unenforceable as well (and vice versa), the result was that the noncompete and the covenant not to solicit customers were both deemed by the District Judge to be unenforceable. Under the District Judge’s ruling, Ms. Morris was free to continue to violate the restrictive covenants in her employment agreement with impunity.

On appeal, the Eleventh Circuit reviewed the enforceability of the restrictive covenants de novo (fresh) and correctly concluded that the restrictions were each enforceable. In reaching this conclusion, the Eleventh Circuit applied the standard three prong test used by Georgia’s courts, determining that the covenants were each reasonable as to (1) duration, (2) scope, and (3) geographic territory. Because the noncompete was reasonable as to duration (2 years), scope (services Ms. Morris had provided while employed by H&R Block), and geographic territory (25 mile radius shown to her on a map when she signed the agreement), the District Judge’s concern that the noncompete precluded Ms. Morris from accepting unsolicited business from former clients within that territory was misplaced and the noncompete was determined to be reasonable.

Because the noncompete was enforceable, the Eleventh Circuit then turned its attention to the covenant not to solicit customers. Because the two year restriction was limited to the solicitation by Ms. Morris of clients she had serviced on behalf of H&R Block for the purpose of providing the same set of services she had provided to those clients at H&R Block, this covenant was also enforceable. Therefore, the Eleventh Circuit reversed the District Judge and reinstated the injunction against Ms. Morris, allowing H&R Block to protect its client relationships.

Analysis of H&R Block Covenants Under Georgia’s New Restrictive Covenants Act Establishes that H&R Block Likely Would Have Lost Under the New Law.

As is noted above, supporters of the upcoming constitutional referendum to change the Georgia law governing restrictive covenants have pointed to the District Court’s erroneous decision as an example of the confusion that surrounds the current caselaw governing restrictive covenants. Critics of the current state of the law argue that if a District Judge cannot make a correct ruling, a typical attorney cannot properly advise his or her client. Of course, it is not unusual for an attorney to analyze a complex dispute differently than a judge does, and this reality of law practice does not by itself warrant changes in this or any other area of the law.

An interesting aspect of the use of this case to support passage of the proposed constitutional amendment is that the outcome of this case might have been far less favorable to H&R Block had the company been forced to rely on the new restrictive covenants act, O.C.G.A. §§13-8-50 et seq. (the “Act”) for protection. The Act (which will only become effective if it is approved in a constitutional referendum in November 2010) facially applies to only four categories of employees: executives, salespeople, professionals and key employees. See O.C.G.A. §13-8-53(a). These four categories are defined at O.C.G.A. §§13-8-51. One interpretation of O.C.G.A. §13-8-54(b) is that the Act precludes the use of Georgia’s common law to bind any other categories of employees to restrictive covenants, leaving just these four categories of employees as potential candidates to be bound by restrictive covenants. (A court will eventually have to determine whether this interpretation is correct.)

A quick review of the Act’s definitions of these four categories of employees suggests that as a run-of-the-mill tax preparer Ms. Morris may not have fallen within any of the categories. She was not an executive, because there is no evidence that she was a member of management. There was no evidence that she was involved in soliciting tax preparation business on behalf of H&R Block or signing up tax preparation clients for others at H&R Block to service, and thus she was not a salesperson. She was not a professional, as there was no evidence that she had engaged in any prolonged academic study – and the receipt of on the job training of the sort provided to Ms. Morris by H&R Block is specifically excluded from the Act’s definition of a professional. Finally, as a run of the mill tax preparer Ms. Morris was unlikely to satisfy the definition of a key employee because she was easily replaceable: others could and did perform the same set of services for H&R Block as she performed during each tax preparation season.

If Ms. Morris’ job description failed to satisfy any of the four definitions set forth in the Act, H&R Block might have been left with no recourse against Ms. Morris’ diversion of her client base had the Act been in effect when she engaged in the diversion. H&R Block is clearly better of with the current state of the law.

The analysis set forth in this article is provided for general understanding only and should not be considered legal advice.  Counsel should always be consulted for advice regarding a specific situation.

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