Quirky Question # 179 – Restrictive Covenants in an Expired Term Contract
Our company has a sales force composed of individuals located throughout the U.S. When we hire sales employees, we use a term employment agreement, typically of three years’ duration. Our employment contracts include post-employment restrictive covenants, the most important of which are non-competes and non-solicits with respect to our customers. Each restrictive covenant last two years.
We try to negotiate new agreements for the sales employees who are doing a good job. Our goal is to get the new agreements in place at least one month before the existing agreements expire. Sometimes, however, things fall through the cracks and we find ourselves negotiating a new agreement following the expiration of the former contract. In the interim, the employees usually just keep working for us under the terms of the prior agreement. Then, if there are compensation changes, we make them retroactive to the date the prior contract expired.
One of our best salespeople recently advised us she was resigning to join a competitor. Her contract apparently expired about three months ago but we failed to notice and did not negotiate with her regarding a new agreement. Nevertheless, she continued working under the terms of her old contract and did not raise any concerns.
When she told us she was leaving, we tried to sweeten the offer to persuade her to stay. We were not successful. We then told her we expected her to abide by the two-year non-compete and the two-year non-solicit. Her response was that those provisions expired with the contract’s expiration. That can’t be right, can it? The contract specifically provides that the restrictive covenants continue for two years after the contract’s termination.
There are a number of interesting aspects to your question. But, let’s start with the basics.
First, as you noted in the first sentence of your question, your employees are located throughout the U.S. As we’ve remarked in many prior Blog posts, it is critical to understand that post-employment restrictive covenants are governed by state law. Moreover, state laws vary widely with respect to the these covenants – some states repudiate the restrictive covenants except in very limited circumstances, some states enforce them but only where they are justified by a legitimate corporate interest, and some states largely enforce the contracts as written. Thus, your first task is to ensure you understand the law of the state where the issue you identified has arisen.
Second, perhaps we belabor the obvious to state that in any question involving contract interpretation, it is crucial to carefully parse through the language of the contract. What did the parties intend? Were the parties’ intentions accurately represented in the contract? More specifically here, did the contract differentiate between termination and expiration? Did the contract address the question of whether the post-employment restrictive covenants would survive the expiration of the contract?
Third, as you acknowledged, your employee’s contract “expired about three months ago but [you] failed to notice.” As you seemingly understand, this is not a helpful fact. Although your employee continued working without a contract for the last several months, her continued employment following the expiration of her contract likely has little impact on the legal issue you now confront.
Turning then to the specifics of your question, let’s start with the first issue referenced above – what state’s law applies to the contract interpretation issue. Where does this employee work? Where was the contract executed? Is there an enforceable choice of law provision in the contract (i.e., a provision specifying that the law of a certain state will govern the enforcement of the contract)? (It’s beyond the scope of this Blog analysis to provide you a state-by-state survey of this issue. For the purposes of your question, in a moment we’ll reference a couple of Minnesota cases that shed some light on this issue.)
As also referenced above, the contract language is critical. Since you have not referenced the specific language in question, we’ll make some assumptions. In our experience, term employment contracts (i.e., a contract that includes a term specifying the duration of the employment contract), often do not address what obligations the parties (employer and employee alike) may owe each other when the contract expires. This omission may reflect the fact that companies and employees utilizing term employment agreements expect the contract to be renewed prior to its expiration. Indeed, contracts often include provisions mandating automatic renewal unless one of the parties to the agreement notifies the other of its/her intention not to renew by a certain date (often several months before the contract’s scheduled expiration date). Here, however, it does not sound as though your contract had an automatic renewal provision.
Alternatively, companies simply may not have given sufficient thought to the issue of the end of a term contract due to “termination,” as opposed to the end of a term contract due to its “expiration.” We have seen many employment contracts that go on for pages defining the different circumstances under which the contract may be “terminated” – terminations for cause, terminations without cause, terminations as a result of a change in control, terminations due to a disability, etc. Rarely, however, do we see contracts that devote any verbiage to the issue of the expiration of the contract. This is a mistake. To the extent that your contract fails to address this issue, you may have a problem.
For example, in the Minnesota case of Burke v. Fine, 608 N.W.2d 909 (Minn. Ct. App. 2000), a dispute arose between two cardiologists regarding a non-compete clause. Fine hired Burke pursuant to a two-year term contract. The contract also contained a two-year non-compete that precluded Burke from working for a specific hospital (Abbott-Northwestern) following the termination of his employment. Burke worked for the two years set forth in his contract. He continued working following the end of the contract’s term, notwithstanding the fact that his agreement had expired.
Burke then sought a position with the hospital system specifically referenced in his employment contract. When the hospital sought information on his pre-existing restrictive covenants, Burke brought a declaratory judgment action, seeking a declaration that because his contract had expired, the restrictive covenant was unenforceable. The District Court ruled in Burke’s favor, holding that when the employment agreement ended, the restrictive covenant also ended, rendering it unenforceable. Fine appealed this determination but the appellate court affirmed.
Note that the contract in question in the Burke litigation did have an automatic renewal provision. But, the language of that provision stated, “any extension of this agreement must be in writing and executed by both parties.” Although Burke had continued to work with Fine following the end of their agreement, the parties had not extended the agreement in writing.
The intermediate appellate court found, “When the employment contract expired, its terms were no longer binding on the parties. Appellant has not cited any language in the employment contract that indicates the noncompete was to survive the termination of the underlying contract. Consequently, the proper construction of the noncompete agreement is irrelevant because there is no longer any contract to construe.”
The appellate court went on to differentiate between termination and the expiration of the contract. “There is no language in the noncompete provision that indicates that the provision survives the expiration of the underlying contract. The provision says no more than if employment terminates, the employee agrees not to practice medicine or cardiology at Abbott-Northwestern Hospital for a period of two years. The fact that, if there is a termination during the two-year contract period, the agreed-upon, two-year noncompete period will necessarily extend beyond the two-year contract period, does not mean that the noncompete provision remains applicable to a termination that occurs after the two-year contract period ends.”
As the court held, “When the parties’ two-year employment contract expired at the end of the two-year contract period, the noncompete provision in the contract also expired. Therefore, the noncompete agreement was not enforceable when the respondent employee later terminated his employment.”
The Burke court cited to a number of similar holdings, both from Minnesota and other jurisdictions. Given these holdings, we think your ex-employee may have the better arguments with respect to the ongoing validity of her non-compete provisions. We suspect you would have a difficult time persuading a court that the post-employment restrictive covenants of an expired contract nevertheless should be enforced. This will be a particularly tough argument in those states (like Minnesota) which view restrictive covenants with skepticism, recognizing that they are anti-competitive and restrict employee’s mobility.
In our view, the fact that your agreement provided that the restrictive covenants continue for two years after the contract’s “termination” will not salvage the situation, particularly if your agreement defined with some precision the different types of “termination,” none of which apply to your current situation. Your company’s failure to address in the agreement the consequences of the contract’s “expiration” on the validity of the restrictive covenants, particularly when coupled with your failure to focus on this issue with your employee before her contract ended, well may doom your attempts to enforce the restrictive covenants.