JKYLE Final AWR

ELIMINATING INDIANA’S COVENANTS NOT TO COMPETE:

IMPROVING INDIANA’S COLLECTIVE ECONOMIC INTEREST AND SUPPORTING INNOVATION.

JORDAN J. KYLE*

“Competition is always a fantastic thing, and the computer industry is intensely competitive. Whether it's Google or Apple or free software, we've got some fantastic competitors and it

keeps us on our toes.”

Bill Gates 1

INTRODUCTION

Covenants Not to Compete (“CNC”) are legal tools that allow a former employer to

impose future restrictions on a former employee. These constraints ban a former employee from

working for her employer’s competitors in a predetermined geographic area for a specified

period of time. The primary justification of CNC is to protect an employer’s confidential

information, thereby allowing the employer to retain a competitive advantage in his business or

industry. While companies throughout the United States have used CNC for over two centuries,

economic growth in California suggests these post-employment contracts negatively impact job

growth and business creation, particularly within the high-tech sector. Like the majority of U.S.

jurisdictions, Indiana regularly enforces employers’ CNC shielding them from beneficial

competition and simultaneously depressing the economy. Removing these legal barriers could

directly improve Indiana’s economy.

While U.S. courts generally believe that CNC are in restraint of trade and are disfavored

by judges, they paradoxically continue to uphold them.2 This inconsistency hinders economic

growth in Indiana and the U.S. The country is divided among states that enforce CNC, states *J.D. Candidate, 2016, Indiana University Robert H. McKinney School of Law; B.S. 2010, University of Colorado – Boulder. 1 Bill Gates, Discussing Apple™ and Microsoft™ , (2008), available in, Strategic Market Management – Global Prospectives, David A. Acker and Damien McLoughlin, John Wiley and Sons Ltd. (2010). 2 See generally, Martin v. Credit Protection Ass'n, Inc., 793 S.W.2d 667 (Tex. 1990); Lucht's Concrete Pumping, Inc. v. Homer, 255 P.3d 1058 (Colo. 2011); Sisters of Charity Health System, Inc. v. Farrago, 21 A.3d 110, (Me. 2011).

ELIMINATING INDIANA’S COVENANTS NOT TO COMPETE

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that do not, and states that allow CNC with restrictions and exceptions. For instance, California

largely prohibits CNC. Conversely, Massachusetts allows CNC and is one state that recognizes

an employer’s alleged need to keep its employees from leaving and going to work for a

competitor. Indiana law is more aligned with Massachusetts’ law – allowing reasonable CNC

based on a legitimate business interests. It is my position that these restrictive covenants

ultimately hinder economic growth and restrict innovation. This paper describes how

restrictive, non-competitive agreements depress business industries, harm individual

employers, and discourage the necessary sharing of information in the American economy. For

the reasons described herein, the Indiana General Assembly should create a statewide

prohibition on CNC, with the only exception for the sale of a business.3

This paper first examines issues with CNC from an economic perspective and then

discusses the current legal tools to protect employer information. In section three, I compare

the CNC laws of California and Massachusetts. Section four addresses the current legislative

landscape in Indiana and provides a proposal to largely remove CNC from Indiana law. To

improve the state’s collective economic interest and support innovation, Indiana should prohibit

CNC and permit instead only Non-Disclosure Agreements (“NDA”). NDA are contracts between

employers and employees, which prohibit a former employee from divulging Confidential

Information about the former employer’s business. 4

These NDA would only apply to Confidential Information (“Confidential Information”)

that which is specifically defined and protected by the Uniform Trade Secrets Act (“UTSA”).

3 This paper does not evaluate in detail CNC imposed in connection with the sale of a business – a situation where a CNC might be justified. E.G., Beverage Systems of the Carolinas, LLC. v. Assc. Beverage Repair, LLC, 2016 WL 1084117, (N.C. 2016). Notably, one of the only situations where California allows CNC is during the sale of a business. Cal. Bus & Prof. Code (West 2015) 16600 Void Contracts, “Sale of Goodwill of Business or Ownership Interest in or Operating Assets of Business Entity or Division or Subsidiary thereof; Agreement not to Compete”, (WEST 2016). 4 Brooks Automation, Inc. v. Blueshift Techs., Inc., 20 Mass L. Rep. 541 (Mass. Supp. 2006) (affirmed in Brooks Automation, Inc. v. Blueshift Techs., Inc., 868 N.E.2d 953 (2007) (not published).


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This Confidential Information includes, but is not limited to, product formulas, chemical

makeups, and patentable products.5

This paper demonstrates how “[l]egal infrastructure[s] prominently influence the

dynamic of high technology industrial districts” 6, and how CNC restrict employee mobility,

decrease knowledge transfer, and diminish innovation. Indiana should follow California’s lead

by adopting policies that allow people to freely work wherever they wish and grow the Indiana

economy through competitive markets. The sum of economic detriments created by CNC

outweighs the individual employer protections provided by CNC.

I. ECONOMIC BACKGROUND

Competition between companies is a major reason why businesses improve over time.

“Competition has a positive impact, not only on the wellbeing of consumers, but also on a

country's economy as a whole. Competition bolsters the productivity and international

competitiveness of the business sector and promotes dynamic markets and economic growth.”7

Hypothetically, if two widget manufacturers, A and B, are forced to compete against each other,

then each company will attempt to make the best widget possible.8 If the manufacturers know

that consumers desire a stronger, smaller, and lighter widget, then A and B will each strive to

create such a product. By appealing to consumer’s demands, each company consequently

improves the market through production of a more innovative widget.

During this competition, employees of Manufacturer A and B obtain information

surrounding the production of widgets. Some of this information will be General Knowledge

(“General Knowledge”), non-specific information learned through the day-to-day completion of

a job which is not protected by the UTSA, while other information will be Confidential

5 A complete list of protectable trade secret information is found in Section II(B) of this paper. 6 Ronald J. Gilson, The Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U. L.REV. p. 575 (1999). 7 William J. Kolasky, Deputy Assistant Attorney General Antitrust Division U.S. Department of Justice, Address to the Tokyo-America Center: The Role of Competition in Promoting Dynamic Markets and Economic Growth (Nov. 12, 2002). 8 Id. For the general principle that when two companies compete against one another, they each strive to create the best product possible. As a consequence, consumers receive a superior product.


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Information. Confidential Information should remain protected and proprietary because it is

unfair for a company to invest money into a product or idea, only to have that information

become available to a competitor. Disclosing Confidential Information to a competitor could

cripple a business.

For example, the product formula of Coca-Cola’s most popular beverage, Coca-Cola

Classic™, is one of the most profitable and best-kept secrets in the world. Disregarding the legal

ramifications to a former employee, if a former Coca-Cola employee took the product formula to

Pepsi™ and immediately began producing the Coke formula under the Pepsi™ name, Coke™

could suffer an extraordinary loss of profit and market share.9 Alternatively, if a Coke™

employee left Coke™ to work for Pepsi™, the employee might use her General Knowledge

surrounding how to more effectively run production, keep a product from spoiling, and best

manage lower-level employees. The former Coke™ employee should be allowed to use her

General Knowledge of Coke™ and the beverage industry to excel in her role at Pepsi™.

Confidential Information should not be disclosed. Employees should not be allowed to

disseminate Confidential Information to other companies before or after they leave their

employer because Confidential Information is so distinct, so secret, and so critical to the

company’s economic viability. Conversely, General Knowledge about an industry or a process at

large should not be protected because that information helps improve the entire economy

without diminishing an individual company’s market viability.10 To improve innovation and

competition, employees should be able to harness General Knowledge and use it from one

employer to the next.

9 Matthew Bloom, Subpoenaed Sources and the Internet: A Test for When Bloggers Should Reveal Who Misappropriated a Trade Secret, 24 YALE LAW & POLICY REV. Article 8, P.481 (2006) (“Coca Cola’s formula is unique and the economic damage to the company would be severe if the secret were published.”) 10 Orly Lobel, TALENT WANTS TO BE FREE, p.8, (Yale Univ. Press 2013).


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II. EXISTING LEGAL TOOLS TO PROTECT CONFIDENTIAL INFORMATION

A Company’s information should be protected when it is so distinct, so secret, and so

critical to the organization that failing to do so would cause irreparable financial harm to the

company. To protect this kind of information, current law provides several legal tools to

preserve Confidential Information and ensure its secrecy. To do so, employers use patents, trade

secrets, non-disclosure agreements, and covenants not to compete.

A. Patents

To promote innovation and creativity in the American economy, Congress enacted the

US Patent Act and subsequently created the United States Patent and Trademark office.11

Companies and individual’s take advantage of the ability to protect their inventions without

competitors infringing upon them by applying for and obtaining a patent. A patent grants the

patent holder the sole right to exclude others from making, using, importing, or selling the

patented innovation for a limited period of time.12 While patents help protect companies’

research and creations, they only last for seventeen years, at which point competitors are

allowed to access the formula or “blue prints” to create the patented product.

B. Trade Secrets and the Uniform Trade Secrets Act

In 1979, the Uniform Law Commission (“ULC”, also known as the National Conference

of Commissioners on Uniform State Laws) drafted the Uniform Trade Secrets Act (UTSA).

13 The purpose of this act was to provide companies operating in multiple states a legal

framework for protecting trade secrets. Importantly, the UTSA does not become law until each

jurisdiction enacts the provision into their state code. That said, every state in the Union has

11 United States Patents and Trademark Office, 35 U.S.C § 1-42 (2015). 12 Id. 13 Uniform Law Commission, The Trade Secrets Act, The National Conference of Commissioners on Uniform State Laws (2016). The purpose of the Uniform Law Commission (ULC) is to create uniformity of state laws. The ULC is a private organization that “provides states with non-partisan, well-conceived and well drafted litigation that brings clarity and stability to critical areas of statutory law.”


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adopted the UTSA with the exception of New York, Massachusetts, and North Carolina.14

According to the Uniform Trade Secrets Act, trade secrets are:

“information, including a formula, pattern, compilation, program, device,

method, technique, or process, that: (i) derives independent economic value,

actual or potential, from not being generally known to, and not being readily

ascertainable by proper means, other person who can obtain economic value

from its disclosure or use, and (ii) is the subject of efforts that are reasonable

under the circumstances to maintain its secrecy.” 15

Additionally, the UTSA protects customer and supplier lists as trade secrets. 16

C. Employer Concerns

Even with the previously mentioned protections, federal and state laws do not grant

companies the same protections under trade secrets laws that they do under patents. For

instance, a competitor may obtain the details of a trade secret through “independent discovery,

reverse engineering, or inadvertent disclosure resulting from the trade secret holder's failure to

take reasonable protective measures.” 17 A significant challenge in this arena is determining

whether a competitor obtained the details of a trade secret through lawful means, as opposed to

learning the information from a former employee. One reason employers are motivated to use

CNC is because their former employees can use the General Information obtained from one

employer to excel in their position at another employer.

Employers also use CNC is due to the challenge of ensuring that a former employee does

not disclose Confidential Information to subsequent employers. This oversight would require the

former employer to monitor the former employee and verify that the employee has not

misappropriated Confidential Information. Therefore, the employer seeks to prevent the

14 Id. 15 Uniform Trade Secret Act (amended 1985), 14 U.L.A. 437 (1990 & Supp. 1998). 16 Ackerman v. Kimball Int’l, 652 N.E.2d 507 (Ind. 1995). Where an employee was required to sign post employment contract that included a non-disclosure agreement and a covenant not to compete. 17 Legal Information Institute, Trade Secrets, Cornell Uni. Law School (2016).


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employment in the first place by using a CNC to bypass a misappropriation issue altogether.

However, restrictive post employment contracts are overly broad and unnecessary in states which

have adopted the UTSA – all of them except for three! When the ULC drafted the UTSA, it created

a comprehensive trade secret law, incorporating major legal principles, filing the gaps left by

courts, and providing real remedies for disclosing trade secrets. 18

Another reason employers use CNC is because of the significant time and resources spent

training and mentoring employees. An employer does not want to invest in an employee only to

have another company reap the benefits of that investment. An example of these investments is

the mentor/mentee relationships within a law firm. Partners regularly train their associates, only

to become inconvenienced when that associate goes to work for a competitor. As I will explain

later in this paper, non-competition agreements among attorneys are unenforceable. In summary,

while employees may use the General Information they obtain from a former employer in a new

setting, they should not be allowed to use Confidential Information. 19

D. Non-Disclosure Agreements

NDAs typically require an employee to keep certain information about the employer’s

business secret, except for knowledge or data that is generally known to the public. 20, 21 The idea

behind NDAs is similar to this paper’s theory of protecting Confidential Information while

allowing General Knowledge to freely flow from employer to employee and from company to

company. There is nothing so secretive or so distinct about General Knowledge that would put

an organization at a severe economic detriment if it were disclosed. For example, the software

development industry routinely shares best practices among all the software development

companies, resulting in an improved industry where consumers are better off.

18 Supra, note 8, Uniform Law Commission. 19 Ronald J. Gilson, supra Note 1, at 23. 20 Legal Information Institute, 48 CFR 3452.227-72,Use and Non-Disclosure Agreement, Cornell Uni. Law School (2016), (Mar. 11, 2016, 4:15 P.M.), https://www.law.cornell.edu/cfr/text/48/3452.227-72. 21 Ackerman, supra note 10 at 510. Example of a post-employment agreement with a provision to protect Confidential Information.


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E. Covenants Not To Compete

Even with the above legal protections, employers continuously fear that their proprietary

information will fall into competitor’s hands, and that fear causes employers to force their

employees to sign CNC. If an employee violates the terms of the CNC then the employer can seek

an injunction against the employee; however, courts do not automatically grant injunctions

based on per se breaches of CNC. To be enforceable, many states require CNC to have three

characteristics: a legitimate business interest, a geographic restriction, and a time restriction.22

In addressing the lawfulness of a CNC, courts typically first categorize covenants by

those ancillary to the sale of a business and those ancillary to employment. While this paper

does not closely examine CNC in relation to the sale of business, it is helpful to understand that

many jurisdictions view CNC ancillary to employment with a higher level of scrutiny than CNC

in the sale of a business. For example, in Georgia courts apply a higher level of scrutiny to

employment because they often involve unequal and unfair levels of bargaining between the

employer and the employee.23 Such an uneven level of bargaining power exists because an

employee can be pressured by an executive to sign a CNC as a condition for a promotion.

Frequently, this type of imbalanced negotiation occurs when an employee is strong-armed into

signing a CNC after he begins his employment.24 Conversely, if the owners of two businesses

negotiate the sale of a company, the belief is that the parties will reach an equitable solution

22 Id., Advance Technologies Consultants, Inc., v. RoadTrac, LLC, 551 S.E.2d 735, 737 (Ga. Ct. App. 2001), “We employ the strict scrutiny standard, under which such covenants are enforceable only if strictly limited in time and territorial effect and are otherwise reasonable considering the business interest of the supplier sought to be protected and the effect on the distributor.”; Brown & Brown, Inc. v. Johnson, 34 N.E.3d 357, 360 (NY Ct. App. 2015), “ The law[s] of [Florida and New York] . . . [are] similar to the extent that they both require restrictive covenants to be reasonably limited in time, scope and geographical area, and to be grounded in a legitimate business purpose.” 23 Palmer & Cay, Inc. v. Marsh & McLennan Cos., 404 F.3d 1297 (11 Cir. 2005). Former employer brought action against former employee and the employee’s new employer for breach of CNC; however, the former employer lost the suit. 24 Guinn v. Applied Composites Eng’g Inc., 994 N.E.2d 1256, (Ind. Ct. App. 2013). The employer forced an employee to sign a CNC after the employer worked for the company for ten months.


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since an employer/employee relationship does not exist and because neither party is inferior to

the other, as is the case in an employer/employee relationship.25

III. MASSACHUSETTS AND CALIFORNIA

California and Massachusetts harbor entrepreneurial hubs in Silicon Valley and Route

128, respectively. However, Silicon Valley’s technology industry grew exponentially faster and

garnered more long lasting innovation than Route 128. 26 This paper posits that one reason for

this disparity is the differing approaches the two states take regarding CNC. The economic

variance between Silicon Valley and Route 128 is partially because “[l]egal infrastructure[s]

prominently influence the dynamic of high technology industrial districts.”27

A. Massachusetts and Route 128

Boston is home to Harvard University, the Massachusetts Institute of Technology,

Boston College, and several other top-ranked national institutions. The prestige of these

scholastic institutions is among the most elite in the United States. Nevertheless, Route 128

never experienced the high growth rate and entrepreneurial development as Silicon Valley. And

while “Silicon Valley developed a business structure that reflected nonlinear career patterns and

a special status for entrepreneurs” 28, Route 128 “developed in more traditional fashion,

imitating the vertically integrated structures of large mass-production companies.”29 “More

traditional fashion” refers to an employee working within a single vertical or for a single

employer for a majority of his or her career.

25 E.G Kuntz v. EVI, 999 N.E.2d 425 (Ind. Ct. App. 2013). To illustrate how two businesses buy and sell a company and the accompanying CNC: Part of the consideration in purchasing a business is that the seller cannot turn around the next day and compete with the buyer. It is unfair if, after the seller sells the company to the buyer, the seller turns around and starts competing against the buyer. The seller is the one who established all of the goodwill and business relationships, which is part of what the buyer purchased. 26 Ronald J. Gilson, supra Note 1, p. 603. 27 Id. 28 Id. at 577. 29 AnnaLee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, 70 (1994).


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One reason economic growth in Route 128 lagged behind Silicon Valley is because of

Massachusetts’ non-competition laws, which vary from those in California. Massachusetts law

recognizes CNC if they are “necessary to protect a legitimate business interest, reasonably

limited in time and space, and consistent with the public policy interest.”30 The most

challenging aspect of meeting this test is quantifying legitimate business interest. Routinely,

Massachusetts’ courts recognize a legitimate business interests in trade secrets, confidentiality,

and good will.31 “Protection of the employer from ordinary competition, however, is not a

legitimate business interest, and a covenant not to compete designed solely for the purpose will

not be enforced.”32

Despite Massachusetts’ decades long approval of CNC, former Democratic Governor

Deval Patrick recently attempted to alter the effect of CNC while in office (2007 – 2015). The

two-term governor proposed legislation abolishing CNC in early spring 2015 to “retain talented

entrepreneurs, support individual career growth, and encourage innovative new businesses . . .

.” 33 That Bill, House Bill No. 4401, entitled “An Act to Promote Competition and Economic

Development”, aimed to accomplish those goals by banning non-competition agreements and by

having Massachusetts adopt instead the Uniform Trade Secrets Act as drafted by The Uniform

Law Commission. 34 The former governor initially proposed a bill which completely banned

CNC, but the bill failed and the legislation was not enacted. Governor Patrick then proposed a

second bill that would have allowed CNC but only under specific, narrow circumstances. 35

Nevertheless, Governor Patrick acknowledged the importance of companies protecting their

intellectual property and trade secrets. Supporting Governor Patricks’ legislation, Greg

30 Boulanger v. Dunkin’ Donuts, Inc., 815 N.E.2d 572, 578 (Mass 2004); Citing Marine Contrs. Co. v. Hurley, 310 N.E.2d 915 (Mass. 1974). 31 See Generally Id., Alexander & Alexander, Inc. v. Danahy, 488 N.E.2d 22 (Mass. App. 1986). 32 Marine Contrs Co. 310 N.E. 915.; citing Richmond Bros, Inc. v. Westinghouse Bdcst. Co, In. 256 N.E.2d 304, (Mass. 1970). 33 H.B 4401, 2014 Leg., 189th Sess. (Mass. 2014). 34 Id. at 3. 35 Id. at 107. Here the bill redefines some employer protections as not falling under the guise of CNC. Such protections include but are not limited to: non-solicitation agreements, forfeiture agreements, nondisclosure agreements, and invention assignment agreements.)


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Bialecki, Massachusetts Secretary of Housing and Economic Development, stated that “[w]e feel

like non-competes are a barrier to innovation in Massachusetts.” 36

Interestingly, House Bill No. 4401 contains similar provisions to Cal. Code 16600,

California’s law against CNC. A portion of the HB No. 4401 states that

“[t]he agreement must be necessary to protect one or more of the following

legitimate business interests of the employer: (A) the employer’s trade secrets . . .

to which the employee had access while employed; (B) the employer’s

confidential information that otherwise would not qualify as a trade secret; or (c)

the employer’s goodwill.”37

Governor Patrick’s legislation would have protected employer’s Confidential Information, but it

would have also provided Massachusetts the legal environment necessary to facilitate startup

companies, increase jobs, and drive innovation particularly in the high-tech sector.

Unfortunately, the Massachusetts House of Representative’s did not vote the bill into law. 38

Sharing similar economic ideologies as former Governor Patrick, business professionals

in Massachusetts are also taking up arms against CNC in the Commonwealth. Recently, the

New England Venture Capital Association, a group working to improve the entrepreneurial

environment in Massachusetts, spoke out in favor of the initiative to ban CNC. Judy Rose,

executive director of the program, recently wrote “we believe that non competes are a drag on

the innovation ecosystem: hurting workers, impeding talent retention, hindering growth, and

holding back the greater Massachusetts economy.”39 Additionally, Boston business leaders are

suggesting that the reason Silicon Valley is light-years ahead of Route 128 in business

36 Calum Borchers and Michael B. Farrell, Patrick Looks to Eliminate Tech Noncompeting Agreements, BOSTON GLOBE, April 10, 2014, (Jan. 8, 2016, 11:30A.M.), https://www.bostonglobe.com/business/2014/04/09/gov-patrick-pushes-ban-noncompete-agreements-employment-contracts/kgOq3rkbtQkhYooVIicfOO/story.html. 37 Supra, note 27 , Section 24(L)(b)(iv). 38 The 189th Gen. Ct. of the Commonwealth of Mass., History of H.B. 4401, (Feb. 15, 2016, 1:00 P.M.), https://malegislature.gov/Bills/188/House/H4401. 39 Judy Rose, New England Venture Cap. Assc., An Important Update on Non-Compete Reform, (Mar. 1, 2016, 9:45 AM), http://www.newenglandvc.org/.


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development is, at least in part, due to the states antiquated CNC laws. Bijan Sabet, general

partner at Spark Capital, a venture capital company with offices in San Francisco, Boston, and

New York City, proclaimed that “[n]on competes stifle innovation because the companies can’t

hire the best talent. Silicon Valley companies hire the best people without limitation.”40

B. California and Silicon Valley

Since the American Tech Bubble, the late 1990s to early 2000s, California technology

developers have routinely migrated from one company to another, uprooting their technological

IQ and planting themselves at the base of a competitor. Yet, this knowledge transfer among

organizations surprisingly improved the innovation and growth of not only a few companies but

the entire software industry in Silicon Valley. Proof of this migration is that one in five

Facebook employees previously worked at Google.41 Like the prestigious universities in Route

128, Silicon Valley harbors the entrepreneurial prowess of Stanford University. According to a

recent Stanford study, Stanford graduates generate $2.7 trillion annually and since 1930 created

over 5.4 million jobs. With some of the biggest and most profitable companies in the world

located in Silicon Valley (Apple, Google, Facebook, Cicso, Intel, HP, Oracle, Yahoo, E-Bay,

Abode, Intuit, NetFlix, Electronic Arts, Twitter, LinkedIn 42), California is the 8th largest

economy in the world.43

C. California’s Public Policy

One reason that California’s economy continued to flourish after the tech bubble, while

other states’ economies dwindled, was because of California’s strong public policy against CNC.

In 1872, California enacted the Civil Code, which included restrictions on CNC and deviated

40 Bijan Sabet, Lets Get Rid of Employee Non Compete Agreements Once and For All, (Feb. 13, 2016, 11:15 am), http://bijansabet.com/post/82281605975/lets-get-rid-of-employee-non-compete-agreements. 41 Orly Lobel, Supra note 10 p. 3. 42 Silicon Valley.com, 20 Most Influential Companies, (Jan. 7, 2016, 8:30 PM), http://www.siliconvalley.com/sv2020. 43 Allen Young, Sacramento Business Journal, California Regains Ranking as World’s Eighth Largest Economy, (Feb. 22, 2016, 1:17 PM), http://www.bizjournals.com/sacramento/news/2014/07/07/tech-construction-drive-california-s-worldwide-gdp.html.


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from Massachusetts and states specializing in heavy manufacturing.44 With the enactment of

the Civil Code, the California legislature rejected the common law “rule of reasonableness” – a

doctrine allowing CNC if the covenant was reasonable in terms of geography, scope, and

duration.45 California’s law against CNC states that “[e]xcept as provided in this chapter, every

contract by which anyone is restrained from engaging in a lawful profession, trade, or business

of any kind is to that extent void.”46 In 1944, the California Supreme Court decided Continental

Car-Na-Var Corp v. Moseley, a case where the plaintiff and former employee solicited the

former employer’s customers in a new business and the former employer brought suit. 47 Due to

the public policy against CNC in California, that court allowed the employee to compete against

his former employer and thereby stated that, ‘[a] former employee has the right to . . . enter into

competition with his former employer, even for the business of those who had formerly been the

customers of his former employer, provided such competition is fairly and legally conducted.48,49

Why does California generally disallow CNC when states like Indiana and Massachusetts

believe in the use of CNC? California’s rationale is that businesses, the legislature, and general

public policy prefer open competition and employee mobility.50 When an employee works for an

employer for twenty years and then decides to start his own company, the employee is able to

take General Knowledge and experience when with him when he starts the new venture. The

lack of post-employment agreements allows the employee’s General Knowledge to spillover to

the new firm. 51 Many of the arguments both in favor of and disapproving of CNC stem from a

44 Ronald J. Gilson, supra note 1, at 43. 45 Edwards v. Arthur Andersen, 189 P.3d 285, 287(Cal. 2008). 46 Cal. Bus & Prof. Code (West 2015) 16600 Void Contracts. California allows CNC in the sale of a business and when the goodwill of the business is a factor of the transaction. 47 Continental Car-Na-Var Corp v. Moseley, 148 P.2d 9 (Cal. 1944). 48 Id. at 13. 49 Lawyers and politicians could argue the meaning of the phrase “fairly conducted” that the court used in Mosely. While not specifically defined in the UTSA, fairly could mean when a former employee or outside competitor reverse engineers a product or formula and then uses that information to his economic advantage. 50 See Generally, Edwards, supra, note 39 at 946. 51 Ronald J. Gilson, supra note 2 at 575.


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state’s culture. California, with its mountains, beaches, national forests, and startup companies

harbors a culture of openness, entrepreneurship, and understanding.

IV. INDIANA

A decade ago, Indianapolis was virtually unknown for its technology industry. The city

supported traditional manufacturing and biotechnology companies like Rolls Royce™, Eli

Lilly™, and Allison Transmission™. The city began to transform, when Angie’s List ™, Exact

Target ™, and Apparatus™ started attracting software engineering talent and venture capital.

Local entrepreneurs, tapping into the young talent from Butler University, Indiana University,

Notre Dame, Purdue University, and Rose Hulman, realized Indianapolis’ potential as a

Midwest tech-hub and startup environment. The entire state of Indiana has benefited from the

repercussions of Indianapolis’ startup mentality. While this shift from traditional

manufacturing to technology creation accelerated Indiana’s technology industry, state laws and

current public policy continue to restrain the state’s ability to further drive economic

development.

To date, there is not a specific statute that governs CNC in Indiana; therefore, the

determination of reasonableness of a CNC lies in the hands of the Indiana Supreme Court.52

Indiana’s highest court disfavors post-employment covenants, but it still allows them.53

Indiana, like similarly situated states, recognizes CNC reasonable in light of the employer and

employee relationship. The state’s test, set forth by the judiciary, includes two prongs: whether

the employer has a legitimate protectable interest and whether the covenant is reasonable in

scope.54 However, this reasonableness test did not always exist as it does today. In Donahue v.

Permael Tape Corporation., a salesman agreed to a CNC where he was bared from competing

52 Indiana has two statutes that discuss post-employment contracts and trade, but these statutes are not completely to the point. The first is Ind. Code. 24-1-1-1: Contracts against public policy; null and void contracts”. The second is Ind. Code. 24-1-2-1: Illegal combinations; exceptions; offense; defense”. In Raymundo v. Hammond, that court found that Ind. Code. 24-1-2-1 was intended only to affect general restraint, and that the statute did not apply to the restrictive covenant. It does not appear that either of these statutes protect employees regarding CNC. 449 N.E. 2d 276,279 (Ind.1983). 53 Licocci v. Cardinal Assc., Inc., 445 N.E. 2d 556, 561 (Ind. 1983). 54 Id. at 779.


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against his former employer in northern Indiana.55 That court adamantly acknowledged an

employees’ right and did not uphold the CNC. Ultimately, that court stated ,“[w]e are here

concerned with one of the most basic rights of man as recognized by our Judean-Anglican

civilization, ‘that man is endowed by his Creator with the right to life, liberty and the pursuit of

happiness.”56 Furthermore, if a CNC exists between an employer and an employee, Indiana

courts apply a higher level of scrutiny to the covenant because of unequal bargaining power.57

A. Legitimate Protectable Interest

For an employer to meet the requirements of legitimate protectable interest, the

employer must show that unfairness would exist if the former employee competed against the

employer or their company generated goodwill or client relationships.58 Indiana courts

recognize that “the advantageous familiarity and personal contract which employees derive from

dealing with an employer’s customers are elements of an employer’s ‘good will’ and are a

protectable interest which may justify a restraint . . . .” 59 Examples of goodwill might include a

dentist’s relationships with her patients or the long-term business rapport between a buyer and

seller. Recently, the Indiana Court of Appeals held that if an employees’ knowledge and skills

were too general, i.e. General Knowledge, then a CNC was not appropriate.60 Lastly, an

employee cannot entice away a former employer’s customers.61

B. Covenant Reasonable in Scope

Reasonableness in scope depends on the following factors: time, geography, and

activity.62 In Indiana, a reasonable time restraint for post employment covenants is between

55 127 N.E.2d 235 (Ind. 1955). 56 Id. at 409-10. 57 Id. at 15 -16. Quoting Restatement (Second) of Contracts SS 188 cmt. G (1981) - “Post-employment restraints are scrutinized with particular care because they are often the product of unequal bargaining power and because the employee is likely to give scant attention to the hardship he may later suffer through loss of this livelihood.” 58 Id. at 780, citing Pathfinder Commc’ns Corp., 795 N.E.2d 1103, 1110 (Ind. Ct. App. 2003). 59 Supra, note 52, Licocci at 561. 60 See generally, Buffkin v. Glacier Group, 997 N.E.2d 1 (Ind. Ct. App. 2013). 61 Clark’s Sales & Serv. Inc. v. Smith, 4 N.E.3d 772, 778 (Ind. Ct. App. 2014). 62 Id. at 781.


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two and three years. 63 The geographic reach of the CNC must also be limited. The geographic

region must be limited to an area where the employer would be most directly affected by the

former employee's presence. For instance, in Central Indiana Podiatry, where the court did not

uphold a physician CNC, the court stated “[t]o be geographically reasonable, the agreement may

restrict only that area in which the physician developed patient relationships using the practice

group’s resources.”64

The final element of reasonableness in scope is the type of activity that the employer is

restricting. Employees typically work in a few different areas of a company. Even if the

employee is a president or executive of the company, the likelihood that she has Confidential

Information on numerous facets of the organization is not a given and often unlikely.

Remember, Confidential Information includes only information specifically protected by the

UTSA. Furthermore, an employer cannot restrict an employee from working in an area which

he was never involved with the former company.65 Employers also create too broad of a CNC

when they restrict former employees from interacting with customers and clients. The employer

cannot restrict a former employee from interacting with all past, present, or future clients.66 The

restriction must be more limited to present clients. Allowing an employer to craft a CNC where

the former employee could not work for a similar company, even if the employee worked in a

completely unrelated function, would unfairly prevent the former employee from obtain a

wage.

C. Pencil Doctrines of Severability

The Pencil Doctrines of Severability are proof of the unfairness and ineffectiveness of

CNC. These doctrines reflect different tools courts use when evaluating the legality of a CNC.

63 Titus v. Rheitone, 758 N.E.2d 85 (Ind. Ct. App. 2001), (3 years); Washel v. Bryant, 770 N.E.2d 902 (Ind.Ct. App. 2002), (2 years). 64 Central Indiana Podiatry, P.C. v. Krueger, 882 N.E.2d 723, 725 (Ind. 2008). 65 Supra note 57, Clark. at 782. 66 See generally, Seach v. Richards, Dieterle & Co., 439 N.E.2d. 208 (Ind. Ct. App. 1982). Where that court did not enforce a CNC provision stating that the former employee would not directly or indirectly solicit past, present or future clients.


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Additionally, they exemplify the courts’ struggle in upholding CNC and therefore highlight good

reasons why the Indiana Legislature should disallow CNC.

Jurisdictions often encounter CNC that contain both reasonable and unreasonable

terms. To retain the lawful portions of a covenant, a court will utilize a judicial modification

technique know as the Pencil Doctrine. The goal of the Pencil Doctrine is to parse-out the

overbearing portions of the covenant, while retaining the enforceable restrictions. Courts in the

United States use a red, blue, or purple “pencil” to bring the overly restrictive covenants within

acceptable parameters of the law. The blue pencil doctrine allows a court to eliminate

inappropriate language from the contract, while the red pencil completely strikes the entire

agreement if any portion is overbroad. The purple pencil allows a judge, to rewrite or modify the

CNC based on the her perception of the parties’ intents. However, all of these doctrines allow a

judge the discretion to determine or re-create the bargain of the contract. This is a problem

because a judge could inadvertently create, through the Pencil Doctrines, a bargain that was not

part of the parties’ agreement.

Indiana courts follow the “Blue Pencil Doctrine”, where the court removes or strikes-out

the inappropriate language from the contract if the burdensome language is divisible and is

clearly separated into parts.67 In Seach, an employer’s CNC restricted contact with anyone who

was a “present, past or prospective client” of the organization .68 That court determined that

while the employer could restrict business interactions between the employee and current

clients to protect the good will of the company, restricting the CNC to “present past or

prospective clients” was “onerous as an undue restriction on Seach’s economic freedom.69 That

court used the “Blue Pencil Doctrine” to devise and separate portions of the covenant and

replaced “present, past or prospective clients” with “present clients.”

67 Id. 68 Id. at 213. 69 Id. at 214, citing Arthur Murray Dance Studios of Cleveland, Inc. v. Witter, 105 N.E.2d 685 (Ohio Law Abs. 1952).


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The major issue with the Pencil Doctrines is that they allow a judge the discretion to

create a contract that the parties did not intend. As every law student learned in their first year

contracts class, a contract requires offer, acceptance, consideration, legality, capacity, and

sometimes in a writing. A judge using a Pencil Doctrine on a CNC removes the consideration

that the parties (employer and employee) based their decision on. Removing the requirement of

consideration from the drafting of contracts should make the contracts null and void. This lack

of consideration should nullify the mutual obligation required to form a binding contract.70

D. Argument to Remove CNC in Indiana

Legal scholars and economists could argue about the merits of CNC, but the California

experience strongly suggests that restrictive covenants are detrimental to the economy and

“[l]egal infrastructure[s] prominently influence the dynamic of high technology industrial

districts.” 71 Legal infrastructures must create a foundation for economic growth, not a pitfall.

While both Silicon Valley and Route 128 grew from the presence of prestigious universities and

venture capital, Silicon Valley grew faster, created more companies, and retained more

employees because California law allowed it to. In essence, California got its law on CNC right,

while Massachusetts got its wrong, and consequently Massachusetts has suffered suboptimal

economic repercussions since. Moreover, the former Massachusetts Governor’s attempted to

completely abolish CNC, an action he believed would drive the creation of companies in the

Commonwealth. The Indiana Legislature has the opportunity to improve its economy by

removing CNC and it should.

Recently, Indianapolis Mayor Joseph H. Hogsett presented a lecture to Indianapolis

venture capital firm High Alpha™, titled “The Future of Tech in Indianapolis”. The speech

focused on creating an environment in Indianapolis that welcomes entrepreneurs, smart young

minds, and investors. During his speech Mayor Hogsett stated “[w]e need an atmosphere and

70 RESTATEMENT (SECOND) OF CONTRACTS: Requirement of Exchange; Types of Change § 71 (1981). 71 Ronald J. Gilson, supra note 2 at 4


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an environment where innovation is promoted, not discouraged.”72 To foster Mayor Hogsett’s

hopes of what Indianapolis could become, the city has planned a cutting edge development just

outside the city’s downtown core. The development, 16 Tech, has recruited significant investors

for the area, including The Indiana Biosciences Research Institute, a $360 million industry led

research institute. 73 Furthermore, the first phase of the development will generate 2,700 jobs

within the next ten years and total project jobs of 9,100. 74 Indianapolis businesswoman, Betsy

McCaw, speared-headed the development and recently stated, “16 Tech represents an

opportunity for the city of Indianapolis to accelerate its economic growth in ways it has not had

before by creating a place where talent and innovation and collaboration can all come

together.”75 This development could act as a catalyst to catapult Indiana into the high-tech,

innovation focused state that of which Mayor Hogsett speaks.

However, Indiana will not be able to experience high innovation and increased

entrepreneurship until the Indiana Legislature removes CNC from the Indiana Code.

Interestingly, lawyers follow a similar ideology in not enforcing post employment covenants

through the Model Rules of Professional Conduct (MRPC). The MPRC, rules that govern the

professional behavior of attorneys, disallow an attorney from adopting or making any agreement

restricting the ability of an attorney to practice law.76 The MRPC essentially does not allow CNC,

with a few exceptions.77

E. The Solution and Proposal to the Indiana Legislature

My recommendation is for the Indiana Legislature to draft a bill to remove CNC

completely from the Indiana Code with the exception of CNC in relation to the sale of a business.

72 Joseph Hogsett, Major of Indianapolis, High Alpha Speaker Series: The Future of Tech Talent in Indy (Feb. 26, 2016). 73 16 Tech, Developing Indianapolis, (Mar. 13, 2016, 5:45 P.M.),http://www.16techindy.com/. 74 Id. 75 J.K. Wall, 2015 Newsmaker: Betsy McCaw, INDIANAPOLIS BUSINESS JOURNAL, (Apr. 30, 2016). http://www.ibj.com/articles/56381-newsmaker-betsy-mccaw. 76 Model Rules of Professional Conduct, Rule 5.6. Restrictions on Right to Practice 77 Id. The Model Rules allow restrictive covenants for the sale of a law firm and for benefits upon retirement.


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This recommendation allows Indiana to increase innovation, create more companies, and align

Indiana with increased entrepreneurial investment. This proposal does not allow former

employees to steal Confidential Information nor does it provide them an outlet to

misappropriate trade secrets. The Indiana Code contains the protections for Confidential

Information and the remedies therein for the misappropriation of trade secrets through its

adoption of the Uniform Trade Secret Act. 78 Furthermore, in 2013, the Indiana Court of

Appeals acknowledged that, “although an employer has a protectable interest in the good will of

his business (including secret or confidential information), the same is not true regarding the

general information or skills gained by the employee in the course of his employment.”79

Indiana’s Uniform Trade Secrets Act coupled with injunctive relief, has enough teeth to

protect businesses’ Confidential Information. If a former employer discovers that a former

employee is misappropriating trade secrets, then the former employer may file suit for an

injunction to prevent current and future misappropriation. But injunctive remedies create a

burden for the employer, requiring them to regularly investigate the former employee to ensure

that Confidential Information is not misappropriated.

The Indiana Legislature could ameliorate this issue by allowing employers the discretion

to force their employees to sign a NDA coupled with a liquidated damages provision. Liquidated

damages allow a performing party of a contract to recover money damages from the breaching

party, “where the nature of the agreement is such that damages for breach would be uncertain,

difficult, or impossible to ascertain.”80 However, the damages would have to be reasonable, and

if the damages looked more like penalties as opposed to damages, they would not be

enforceable.81 To comply with this rule, the former employer could base the liquidated damages

calculation on the percentage of business that the company would lose if the Confidential

78 Ind. Code (West 2016) § 24-2-3, Chapter 3 Trade Secrets. 79 Guinn v. Applied Composites Eng’g, Inc., 994 N.E.2d 1256, 1267 (Ind. Ct. App. 2013). 80 Dean v. Kruse Foundation, Inc. v. Gates, 973 N.E.2d 583, 591 (Ind. Ct. App. 2012), - (citing Rogers v. Lockard, 767 N.E.2d 982, 990 (Ind.Ct.App.2002). 81 Uniform Commercial Code, 2-718 (WEST 2016).


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Information were disclosed. An employee who signs an NDA with a liquidated damages clause

fears he will lose money and this fear is a strong deterrent.

The Indiana Supreme Court has previously recognized this form of specific performance

as permissible in connection with CNC. In Raymondo v. Hammond, a medical clinic and a

physician agreed to a post employment contract with a liquidated damages provision of $25,000

if the physician violated the CNC.82 When the physician breached the covenant, that court

upheld the liquidated damages provision and the court forced the physician to pay the clinic

$25,000.83 Additionally, the Indiana Legislature could write into this bill that the new employer

and former employee would be jointly and severally liable if the former employee breached the

contract – a concept which is commonly referred to as tortious interference.84 Lastly, it is

critical to acknowledge that even if an employer has a valid liquidated damages provision

connected to a NDA, the employer could also be entitled to injunctive relief.85

V. CONCLUSION

Competition improves our society and allows engineers, lawyers, doctors, construction

workers, and window washers the opportunity to learn from their trade and enhance their

careers. People should have the right to work where the want, and when they want. Indiana has

an opportunity to catapult itself out of the “Rust Belt” stigma, and allow innovation to flourish

and a collective economy to grow. Indiana must remove covenants not to compete.

82 Raymundo v. Hammond Clinic Ass'n, 449 N.E. 2d 276,279 (Ind.1983). 83 Id. at 284. 84 Supra, note 76, Guinn at 1267; “A plaintiff alleging tortious interference with a contractual relationship must establish five elements: (1) the existence of a valid and enforceable contract; (2) the defendant’s knowledge of the existence of the contract; (3) the defendant’s intentional inducement of the breach of the contract; (4) the absence of justification; and (5) damages resulting from the defendant’s wrongful inducement of the breach.” Allison v. Union Hosp., Inc., 883 N.E. 2d 113, 118 (Ind. Ct. App. 2008); (citing Winkler v. V.G. Reed & Sons, Inc., 638 N.E.2d 1228,1235 (Ind. 1994). 85 Jeff Ferriell, Understanding Contracts, Second Edition, Professor of Law, Capital Univ. Law School (Lexis 2009); (citing Restatement (Second) of Contracts § cmt. c. (1981).

Documents

JKYLE Final AWR