Restraining the Departed’

When Agents Divorce Their Insurance Company

Insurance companies and insurance brokerage houses (employers) use a variety of devices to try to prevent departing agents from competing against them. Sometimes smaller agencies do this, too. The three principal theories in these suits are contractual agreements not to compete, misappropriation of trade secrets, and breach of fiduciary duty. This column will describe those three theories, and then describe several ways for dealing with them. The point of view here is that of the departing agent.

Covenants not to compete
Contractual promises not to compete are enforceable common law, so long as they are reasonable. In Texas, the common law has been codified as a statute. Mostly courts still rely on precedent. Both say that covenants not to compete are enforceable to the extent that they contain only reasonable restrictions as to time, area and scope of activity. A covenant is reasonable only if it does not impose a greater restraint upon the departing employee (or other operative) than is necessary to protect the goodwill or other business interest of the employer.

At common law, a no-compete covenant that was too broad was not enforceable by damages. It was enforceable by injunction, up to the point that the covenant stopped being reasonable. Sometimes, this is called the “Blue Pencil Rule.” Sometimes it is falsely described as a reformation of the contract.

The statute suggests that covenants not to compete must be formed at the same time as the contract of employment. In theory, covenants not to compete cannot be tacked onto existing contracts, after employment has begun. This move seems potentially shifty and abusive.

Trade secrets
A trade secret is virtually any piece of information relevant to the employer’s business that has value and is secret. One authority says that a trade secret may consist of “any formula, pattern, device or compilation of information” that is utilized in a business and worth something. For instance, a gadget, a customer list, a discount formula, or a price list could all qualify as trade secrets. However, courts are nervous about classifying customer lists, and the like, as trade secrets.

Misappropriating trade secrets is tortious, while the violation of a covenant not to compete is a breach of contract. Nevertheless, the two causes of action are similar. Both are enforceable by damages, injunction, or both. Because trade secret misappropriation can be an intentional tort, punitive damages can sometimes be awarded. Trade secret misappropriation can support an award of mental anguish, while breach of a contract-any contract-cannot. Although most contracts cannot be enforced by injunctions, non-compete agreements can be.

Fiduciary duties
Mostly, the law treats two people quarreling with each other as if they were something like strangers, dealing-as the say-with each other at “arm’s length.” The law conceives of some relationships as much closer; in these relationships, the respective parties owe each other special, higher duties. Such relations may be visualized as two people hugging.

Some examples of these relationships are lawyer-client, trustee-beneficiary, (sometimes) parent-child, psychiatrists/psychologists-patient/client (but not ordinary medical doctor-patient), and employer-employee. These high-level duties are called fiduciary duties. In general, when A is a fiduciary of B, A owes B a duty of highest loyalty and confidentiality, as well as a duty to take care of the interests of B. B has a right to confide and place confidence in A. In general, if parties form a contract, each has a duty to perform and not to damage the interests of other parties, insofar as they are affected by the contract. Fiduciary duties are much higher, stronger and broader.

The law remedies breaches of fiduciary duty injuries with damages, injunctions, or both. Fiduciary relations are created by situations and by convention, not by contract. Deliberate breaches of fiduciary duties can lead to punitive damages and awards for mental anguish. (Obviously, corporations cannot recover mental anguish damages.)

Siphoning off (i.e., embezzling) commissions is a fiduciary duty breach. Breaching a covenant not to compete by itself is not. Diverting customers away from one’s employer, while employed, is, however.

Practicalities
There are a number of ways to resist attempts to enforce covenants not to compete, trade secret rights and fiduciary duty rights.

(1) When signing a contract, don’t resist obviously over-broad temporal and geographical prohibitions. A court may find these provisions so unreasonable (and hence oppressive) it will refuse to enforce the covenant at all.

(2) When a business seeks to enforce a covenant not to compete against an individual, usually, the remedy that matters is temporary injunction. Often, agents don’t have the money to pay damages or findings of attorney’s fees. Usually, permanent injunctions come too late. Business moves at a goodly pace. If temporary injunction is entered, and then prolonged for a year or so, the departing agent is already out of business.

Therefore, litigate the temporary injunction phase of the case with determination. Money should be saved up and set aside to accomplish this goal.

(3) Hire experienced, capable counsel. Most general business litigators do not know very much about litigating covenants not to compete. They often know very little about the business context in which these covenants are litigated. Often, insurer and agency employers do not hire the right lawyers either. Often, they hire huge business law firms, and smallish covenant-not-to-compete cases trickle down to inexperienced associates.

(4) A covenant not to compete can be defeated or limited if it is unreasonable in any respect. There is an even better defense, however. Defeat the temporary injunction, and you’re usually home free.

This fact creates special problems for an entity trying to enforce the covenant. Bad actors frequently cannot obtain injunctions. This is called the “Dirty Hands Rule.” The general idea is that in order to get a court to invoke a remedy as draconian as an injunction, the plaintiff must have treated the defendant fairly in every relevant respect.

People usually don’t want to leave their jobs without a reason. Often, the reasons they leave involve having been mistreated by their employers. Sometimes they have been unjustly fired. Departing agents subject to covenants not to compete would be well advised to collect documentary evidence showing that they have been mistreated by the entity with which they have a contract.

Such documentary evidence often exists, and making copies of it is not like stealing. (5) The journal should also contain detailed accounts of any unlawful activities of the employer. This is particularly true of securities violations, anti-trust violations, commercial bribery and insurance code violations.

(6) It is ill-advised to take price lists, customer lists, procedure manuals, adjustment and underwriting manuals, and so forth. Many courts will classify this as stealing trade secrets.

Technically, if trade secrets have been memorized for the purpose of their misappropriation, the departing salesman can be enjoined from selling to the customers who appear on the list. That’s a hard way to make a point, however. Usually, if the departing employee turns in all of the data that might be a trade secret, that case against the departing operative cannot be made.

Trade secret cases against insurance agents are usually weak. Customer lists are really not a big deal, except in the most specialized lines of insurance. Pricing structures are usually widely, if approximately, known in the industry, and this fact can be proved with relative ease, perhaps through an expert witness.

(7) If the lawyer you select suggests (of even condones) your failing to turn over documents that you have swiped or copied and which are properly requested by your opponent, fire the lawyer immediately, don’t pay him any money, and try to get your money back. Any lawyer who makes such a suggestion (or who condones such conduct) is a crook, a faithless fiduciary, and he has therefore forfeited his fees.

Resist the temptation to cheat when you feel it in yourself. Most litigants face that temptation.

(8) When an individual agent is up against the large brokerage house or insurance company, keep in mind that you can be nimble while it cannot. It may use its larger budget to oppress and outlast you. You need to carefully budget your assets; don’t over reply to any of their pleadings or motions; don’t plead your own case any more than is necessary under the rules; don’t brief your case anymore than it really needs; don’t take unnecessary expensive discovery; and so forth. Participate in the case. Don’t just leave it to the lawyer!

(9) If you get a demand letter from an insurer or brokerage house, and it presents a credible threat, consider filing a declaratory judgment action yourself in a favorable venue. That will increase the probability that the lawsuit will have to be tried in your backyard. It will increase the probability that no temporary injunction will be issued by a court in Dallas when you live in San Saba.

(10) Consider filing counterclaims if they are appropriate. For example, if management has been bad mouthing you, sue them for slander. Nevertheless, don’t file frivolous claims. Intentional infliction of emotional distress is hardly ever a winner, for example.

(11) Consider trying to prove that the employer was enforcing covenants only erratically. Theoretically, this fact should be irrelevant in a contract action. In an injunction action, however, where equities matter more, litigants can often make it relevant. The plaintiff will usually resist answering discovery on this point. That obstinacy can be a useful way to delay a temporary injunction hearing. Delaying that hearing is almost always a good tactic of the defendant-agent.

(12) Keep in mind that the statute, as well as significant cases, says that a covenant not to compete must be reasonable as to area. That seems to prohibit customer-only covenants not to compete. It suggests that every covenant not to compete must cover a specific area, instead of a customer here and a customer there.

(13) Should a contract state that the law of some other state applies, consider contesting the choice of law clause. You will almost certainly win if Texas law is more favorable to you. On the other hand, if the law of the other jurisdiction favors you, don’t object to its use. Insist upon it.

(14) Try to drive a wedge between the contract-to-not-compete aspects of the case and the trade secrets misappropriation side of the case. Count on the fact that the opponent-whether a brokerage house or an insurer-will try to claim that it needs to enforce the covenant not to compete in order to protect its trade secrets. Your view should be that the company must prove that it has trade secrets first.

(15) Businesses seeking to enforce covenants generally try to argue that they have spent considerable sums training the departed operative. Usually, in smaller cases, they are sloppy about this kind of testimony, and fail to prove the case. A departing agent should think carefully in advance about the extent to which the employer actually provided meaningful training. The agent should be prepared to testify about the extent to which he trained himself or was trained elsewhere and about the money he spent obtaining such training.

(16) Often these cases settle, and here is how to do it. Figure out which five or ten customers produced the most revenue for the least work. Agree to keep those customers; let your opponent have the next five down the list. Therefore, you pick one; it picks one; you pick one; and so. Chances are you will come out fine.

Conclusion
Courts regard covenants not to compete with deep suspicion. As a result, their enforcement has been unpredictable for many years. The Texas Supreme Court has wobbled around considerably in the last decade, or so, about them. When the Supreme Court was more liberal than it is now, it tried to wipe them out. They are now here to stay.

Quinn is an Austin shareholder in the law firm of Sheinfeld, Maley & Kay. He litigates and testifies on insurance related problems and is currently the chair of the Insurance Section of the State Bar of Texas. He also is a Visiting Professor of Law at the University of Texas-Austin.

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