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Article Summary

The enforceability of non-compete agreements is a hot button legal issue. But even where a court finds a non-compete agreement enforceable, imposing unnecessarily strict non-competes on employees can have an unintended side-effect that very few people are discussing: increased damages in employment litigation.

This article by TELG managing principal R. Scott Oswald and TELG principal Adam Augustine Carter was published by The Employment Law Group, P.C. on March 28, 2016.

In a Bind: The Unintended Consequences of Non-Compete Agreements on Damages Mitigation

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The enforceability of non-compete agreements is a hot button legal issue.  In 2015 the Jimmy John’s restaurant chain came under scrutiny for requiring its sandwich makers to sign non-compete agreements and the Pennsylvania Supreme Court ruled on whether continued employment could constitute consideration for requiring an employee to sign a non-compete.  Though we are hesitant to paint with too broad of a brush, it appears that the tide is turning – both with judges and with public sentiment – toward a re-thinking of the way in which companies can restrict the ability of former employees to find work.

In light of this, companies are doing their best to conform to new rules in their jurisdiction.  Companies are cutting back on the scope of their non-compete agreements and, for example, reducing their duration from three years to two.  But even where a court finds a non-compete agreement enforceable, imposing unnecessarily strict non-competes on employees can have an unintended side-effect that very few people are discussing:  increased damages in employment litigation.

Economic Damages – Why They Are Important and How They Work

As employment attorneys, it is easy to get wrapped up in focusing on the substantive aspects of a case.  Was the employee a victim of discrimination or retaliation?  How was he or she treated as compared to his or her peers?  Did he or she receive favorable performance evaluations?  Certainly, all of this is critical to establishing an employee’s case, but it fails to focus on what is arguably the most important question:  How has the termination affected the client’s income?

Answering this question requires an examination of damages and dissecting how they work.  So often, a client will come to you and have a great claim with respect to establishing liability.  The employee discloses some kind of unlawful conduct and, immediately thereafter, the company terminates her.  After a few moments of explaining to the client how strong her case is, she then tells you, “I’m on my lunch break and have to get back to work.”  Alarms go off.  You learn that the client was out of work for only a matter of weeks and that she actually makes more money with her new employer.  You then inform the potential client about how economic damages work and are met with silence on the other end of the line as she fails to understand your about-face on the strength of her claim.

An employee’s damages are largely a function of the time that she spent out of work.  To make things simple, take the employee who earned $100,000 per year and, following her wrongful termination, was out of work for six months before finding a new job making the exact same $100,000 per year salary.  This means that the employee has six months’ worth of economic damages, totaling $50,000.  Now, assume that same employee was, after six months, only able to obtain a job making $80,000 per year; her economic damages would be the $50,000 for the six months she was unemployed (referred to as “back-pay”) plus the differential in what she would have earned had the wrongful termination never happened.  The court[1] will look at the difference in what the employee was making before the wrongful termination and the employee’s new salary.  This delta – here, $20,000 – is then extrapolated out over the remainder of the employee’s career to determine the impact of the wrongful termination on the employee’s future earnings (referred to as “front-pay”).  Assuming the employee intended to work five more years, this means that his economic damages would be $50,000 plus $20,000 per year for five years, all totaling $150,000.[2]

The Duty to Mitigate

The concept of “mitigation” is important to understanding legal damages in employment cases.  To put it in layman’s terms, the duty to mitigate means that the employee, following a termination, must conduct a good faith job search.  He should apply for positions, contact recruiters, attend job fairs, and otherwise do everything that a prudent job-seeker in his position would do.  Where the employee does not undertake these efforts, an employer may have a defense that the employee “failed to mitigate his damages.”

What does this mean, exactly?  Returning to the above hypothetical, assume that our wrongfully terminated employee failed to apply for any jobs following her exit from the company.  She files a lawsuit against her employer and is successful in establishing that her termination was, indeed, illegal.  In this case, the company will have a strong defense that the employee failed to mitigate her damages.  As stated by the Kansas Supreme Court in Krehbiel v. Goering, “[P]laintiffs must not only show the amount of damages suffered as a result of the breach, but must further show that such damages could not have been prevented or mitigated. Such is not the general rule of law.  Mitigation of damages is a matter of affirmative defense and the burden of proof is upon the party who seeks to establish it.”  In our case, the employee’s failure to apply for any job openings means that the company is likely going to be successful in establishing a failure to mitigate.  This means that even if the employee is successful in establishing liability, he or she may not be entitled to a single dollar from the company for the wrongful termination.

The Effect of Non-Compete Agreements on Mitigation

Now that we have established the mechanics behind economic damages and their interplay with the employee’s duty to mitigate, we must look at how non-compete agreements can complicate the calculus.  Let us assume that the employee is subject to a broad non-compete agreement that precludes her from working in any capacity for any company in a line of business similar to that of her former employer.  Putting aside issues of enforceability, it is clear how such a restraint would hinder that employee’s job search.

Badahman v. Catering St. Louis,[3] a case out of the Missouri Court of Appeals its facts help to illustrate this point.  There, an employee brought a wrongful termination claim against her company.  Following her termination, the employee tried to obtain employment elsewhere but was unsuccessful in doing so “because she failed to secure a written release from her non-compete agreement from her former employer.”  This case illustrates how the existence of a non-compete agreement can have the effect of scaring away potential employers.  In addition, an employee under a non-compete agreement may be too afraid even to apply to other positions or be considered unfit to work in any capacity that does not run afoul of her non-compete.  This, too, has the obvious effect of hindering an employee’s job search and could certainly increase the time that the employee remains unemployed.

The existence of a non-compete agreement can have some negative impacts on employers.  First, a former employee under a non-compete agreement is likely to be out of work for a longer period of time than an unrestrained employee.  This means that, should that employee bring a claim against his employer, his economic damages are likely to be more significant.  A second related issue has to do with the availability of the mitigation defense.  A court (or jury) is likely to be more forgiving to an employee who was unsuccessful in finding new employment where that employee faced severe restraints in his job search.  To this point, the existence of a broad non-compete agreement could be used by an employee to combat the employer’s mitigation defense.  In other words, how is an employee supposed to mitigate his damages where the company has completely eliminated all of the employee’s options?  We would argue that the existence of a broad non-compete could have the effect of vitiating an employer’s mitigation defense all together.

Concluding Thoughts for Employers

A non-compete agreement is appropriately used to (i) protect a company’s intellectual property, and (ii) ensure that its employees do not run to competitors with confidential information.  It is not appropriate, however, to overly restrict an employee’s ability to work beyond what is necessary to achieve these goals.  Even where an employee toes the line with respect to what is and is not enforceable, it behooves a company to think hard about what is necessary to protect itself.

  • Is a two year non-compete necessary or will six months achieve the same goal?
  • Should the company limit the employee from working in an entire industry or is it sufficient to identify a few of its primary competitors?
  • Is a nation-wide non-compete important to protecting the company’s interests or do we not care if an employee moves across the country to work for another company?
  • Do we need to prevent the employee from working for a competitor in any capacity or is it only appropriate that the employee – a salesman, for example – be prevented from selling products for a competitor?

Asking these questions helps to identify the issues that are most important to the company and will allow for more targeted, reasonable, and enforceable non-compete agreements.  This will have the effect of minimizing the departing employee’s time out of work and, hopefully, the economic damages that he or she accrues.

In the employer’s best case scenario, a wrongfully terminated employee will walk out of his company and find new employment elsewhere.  A narrowly tailored non-compete agreement can protect the company’s interests, promote employability of the departing employee, and minimize the risk of litigation and liability exposure.  If nothing else, it is our hope that this article highlights how overly broad non-compete agreements really do a disservice to employees as well as the companies that employ them.

 

[1]           This case was overruled on other grounds.  Its inclusion here is only to illustrate how non-competes can impact an employee’s job search.

[2]           We say “the court,” but, in actuality, this is a hotly contested issue at trial.  Plaintiffs put on vocational rehabilitation and economic experts to try to predict how a termination will affect an employee’s income over the entirety of his or her career.

[3]           To underscore the point made in Footnote 1, this is a highly simplified version of the economic damages analysis.  Typically, expected salary increases, the value of employee benefits, workplace stability, and a variety of other factors go into the calculus.  All we want to do here is to illustrate the basics.

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